MHI Hospitality CORP (Form: S-11/A, Received: 10/20/2004 17:02:06)

As filed with the Securities and Exchange Commission on October 20, 2004

Registration No. 333-118873

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Pre-Effective Amendment No. 1

FORM S-11

FOR REGISTRATION UNDER THE SECURITIES ACT OF 1933

OF CERTAIN REAL ESTATE COMPANIES

MHI Hospitality Corporation

(Exact Name of Registrant As Specified in its Governing Instruments)

814 Capitol Landing Road

Williamsburg, Virginia 23185

(757) 229-5648

(Address, Including Zip Code, and Telephone Number, including

Area Code, of Registrant’s Principal Executive Offices)

Andrew M. Sims

President and CEO

MHI Hospitality Corporation

814 Capitol Landing Road

Williamsburg, Virginia 23185

(757) 229-5648

(757) 564-8801 (Telecopy)

(Name, Address, Including Zip Code, and Telephone

Number, Including Area Code, of Agent for Service)

Copies to:

Thomas J. Egan, Jr. Esq.

Baker & McKenzie LLP

815 Connecticut Avenue, NW

Washington, DC 20006

(202) 452-7000

(202) 452-7074 (Telecopy)

David C. Wright, Esq.

Hunton & Williams LLP

951 E. Byrd Street

Richmond, Virginia 23219-4074

(804) 788-8200

(804) 788-8218 (Telecopy)

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

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, 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, check the following box and list the Securities Act registration 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, 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 Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

The information in this prospectus is not complete and may be changed or supplemented without notice. We may not sell the securities described in this prospectus until the registration statement that we have filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities, and we are not soliciting offers to buy these securities, in any state where the offer or sale of these securities is not permitted.

Subject to Completion

Preliminary Prospectus dated October 20, 2004

PROSPECTUS

6,000,000 Shares of Common Stock

LOGO

MHI HOSPITALITY CORPORATION

MHI Hospitality Corporation is a recently-formed, self-advised Maryland corporation that intends to qualify as a real estate investment trust or “REIT” for federal income tax purposes. We were organized to succeed to certain of the lodging assets and operations of our predecessor group, which began operations in 1957, and other affiliated entities, and to take advantage of investment opportunities in the lodging industry with a focus on full-service hotels. Upon completion of this offering and our related formation transactions, we will own six hotels located in the Mid-Atlantic and Southeastern United States operated under well known national hotel brands such as Hilton ^® and Holiday Inn ^® and will acquire a leasehold interest in one resort property.

This is our initial public offering of our common stock. No public market currently exists for our common stock. All of the shares offered by this prospectus are being sold by us. Shares of our common stock are subject to ownership limitations relating to the maintenance of our status as a REIT.

We currently expect the public offering price to be between $9.00 and $11.00 per share. After pricing of this offering, we expect that our common stock will trade on the American Stock Exchange under the symbol “MDH.”

See “ Risk Factors ” beginning on page 17 of this prospectus for risk factors relevant to an investment in shares of our common stock.


	Per Share	Total
Public offering price	$	$
Underwriting discount and commissions	$	$
Proceeds to us before expenses	$	$

The underwriters may also purchase up to an additional 900,000 shares of our common stock from us at the public offering price, less the underwriting discount, within 30 days from the date of this prospectus solely to cover over-allotments, if any. The underwriters are offering our common stock as described in “Underwriting.”

We expect to deliver the shares of common stock on or about , 2004.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

BB&T CAPITAL MARKETS

The date of this prospectus is , 2004.

You should rely only on the information contained in this prospectus. Neither the underwriters nor we have authorized any other person to provide you with different or additional information. If anyone provides you with different, additional or inconsistent information, you should not rely on it. This prospectus does not constitute an offer to sell or a solicitation of an offer to buy any securities in any jurisdiction in which such an offer or solicitation is not authorized or in which the person making such offer or solicitation is not qualified to do so, or to any person to whom it is unlawful to make such offer or solicitation. Neither the delivery of this prospectus nor any sale made hereunder shall, under any circumstances, create any implication that there has been no change in our affairs or that information contained herein is correct as of any time subsequent to the date hereof.

TABLE OF CONTENTS


		Page
PROSPECTUS SUMMARY		1
RISK FACTORS		17
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS		35
MARKET DATA		35
USE OF PROCEEDS		36
CAPITALIZATION		37
DISTRIBUTION POLICY		38
DILUTION		39
SELECTED FINANCIAL DATA		40
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		43
FORMATION TRANSACTIONS		53
OUR BUSINESS AND PROPERTIES		56
OUR PRINCIPAL AGREEMENTS		77
MANAGEMENT		87
INVESTMENT POLICIES AND POLICIES WITH RESPECT TO CERTAIN ACTIVITIES		96
PRINCIPAL STOCKHOLDERS		100
SHARES AVAILABLE FOR FUTURE SALE		101
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS		103
DESCRIPTION OF COMMON STOCK		108
CERTAIN PROVISIONS OF MARYLAND LAW AND OF OUR CHARTER AND BYLAWS		111
PARTNERSHIP AGREEMENT		116
MATERIAL FEDERAL INCOME TAX CONSIDERATIONS		120
UNDERWRITING		142
EXPERTS		145
LEGAL MATTERS		145
WHERE YOU CAN FIND MORE INFORMATION		145
INDEX TO FINANCIAL STATEMENTS		F-1

All brand and trade names, logos or trademarks contained or referred to in this prospectus are the property of their respective owners, and their appearance in this prospectus may not in any way be construed as participation by, or endorsement of, this offering by any of our franchisors. For more information, see “Our Principal Agreements—Our Franchise Agreements.”

Until , 2004, 25 days after the date of this prospectus, all dealers that buy, sell or trade our common stock, whether or not participating in the offering, may be required to deliver a prospectus. This requirement is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

PROSPECTUS SUMMARY

The following summary highlights information contained elsewhere in this prospectus. This summary is not complete and does not contain all of the information that you should consider before investing in our common stock. You should read the entire prospectus, including “Risk Factors” before making a decision to invest in our common stock. In this prospectus, references to “our company,” “we,” “us” and “our” mean MHI Hospitality Corporation, including MHI Hospitality, L.P., our operating partnership, and our other subsidiaries, including our taxable REIT subsidiary holding company, MHI Hospitality TRS Holding, Inc. or “MHI TRS.” References to MHI TRS include references to its wholly-owned subsidiary, MHI Hospitality TRS, LLC, our TRS Lessee, which is the lessee of our initial properties. References to “MHI Hotels Services” means MHI Hotels Services, LLC, a company in which we have no ownership interest, that will manage our initial hotels. When we use the terms “full-service,” “Upper Upscale,” “Upscale” and “Midscale” in this prospectus, we mean hotels as classified in those categories by Smith Travel Research, which we refer to as “STR.” STR categorizes hotels into Luxury, Upper Upscale, Upscale, Midscale with Food and Beverage and Midscale without Food and Beverage, and Economy by reference to the national hotel franchise with which a hotel is affiliated. All of our initial hotels are currently classified as Upper Upscale and Midscale. Unless otherwise indicated, the information contained in this prospectus assumes that the underwriter’s over-allotment option to purchase up to 900,000 additional shares of common stock has not been exercised and that the shares of common stock to be sold in this offering are sold at a price of $10.00 per share, which is the mid-point of the range set forth on the cover page.

Overview

We are a self-advised hotel investment company organized in August 2004 that intends to qualify as a real estate investment trust, or REIT, for federal income tax purposes. Following completion of this offering, we will initially own six full-service, Upper Upscale and Midscale hotels that are located in primary and secondary markets in the mid-Atlantic and Southeastern United States and are operated under well-known national hotel brands such as Hilton and Holiday Inn. We intend to pursue a growth strategy of purchasing, renovating and upbranding additional underperforming, full-service hotels while seeking to improve the operating results of our initial portfolio.

We intend to focus our investment activities on the following opportunities that involve the acquisition, renovation and upbranding of underperforming or functionally obsolete hotels with a goal of achieving total investment that is substantially less than replacement cost of a hotel or the acquisition cost of a market performing hotel:

•

Deep Turn Opportunity: The acquisition of a hotel that is closed or functionally obsolete and requires a restructuring of both the business components of the operations as well as the physical plant of the hotel, including extensive renovation of the building, furniture, fixtures and equipment.

•

Shallow Turn Opportunity: The acquisition of an underperforming but structurally sound hotel that requires moderate renovation to re-establish the hotel in its market.

•

Upbranding Opportunity: The acquisition of properties that can be upgraded physically and enhanced operationally to qualify for what we view as higher quality franchise brands including Hilton, Doubletree ^® , Crowne Plaza ^® , Holiday Inn Select ^® , Holiday Inn, Westin ^® , Sheraton ^® and Intercontinental ^® . We refer to this as our upbranding strategy. Our upbranding strategy may also be a component of our deep and shallow turn opportunities.

By pursuing deep and shallow turn opportunities and implementing our upbranding strategy, we hope to improve revenue and cash flow and increase the long-term value of the hotels we acquire in the future.

We currently have plans to renovate three of our initial hotel properties, one of which is currently underperforming in its marketplace and represents a shallow turn opportunity. As these hotels are located in attractive markets, we believe that these properties are well positioned for future growth and will benefit from improving industry wide market conditions, our renovations and the efforts of our management team. See “Our Business and Properties – Our Initial Properties.”

MHI Hotels Services and its affiliates hold controlling interests in the entities that own four of our initial hotel properties. These entities comprise our predecessor group. MHI Hotels Services will contribute its interests in these entities to our operating partnership in exchange for units in our operating partnership. Because of federal income tax laws applicable to REITs, we cannot manage the hotels we own. MHI Hotels Services will manage each of our initial hotels pursuant to a management agreement and, together with its affiliates, will hold a significant equity interest in our operating partnership.

MHI Hotels Services and its predecessors have been in the hospitality industry since 1957 and provide full- service expertise in hotel management, construction, redevelopment, financing and consulting. Over the past 47 years, MHI Hotels Services has won numerous awards for its outstanding guest services, including Hilton Pride awards at two of our initial hotels. We expect to benefit from MHI Hotels Services extensive experience in managing hotel properties.

We will own our hotels and conduct our business through an operating partnership, MHI Hospitality, L.P. We will be the sole general partner of our operating partnership, and upon completion of the offering and the related formation transactions, will own an approximate 61.1% interest in our operating partnership. The remaining 38.9% interest will be owned by the contributors of five of our initial hotels, including an approximately 29.2% interest which will be owned by our officers, directors, affiliates and family members.

Investment Highlights

We expect to benefit from the following factors as we implement our business plan:

Turn Around Growth Strategy

We intend to pursue investments in underperforming or functionally obsolete hotels that are otherwise structurally sound, at a substantially lower cost than replacement cost or what we would pay for a performing hotel in the same market. We believe that such deep and shallow turn opportunities will yield favorable long-term returns and facilitate attractive dividend distributions. For example, the Maryland Inn, one of our initial hotels, is underperforming in its market. We will use approximately $3.9 million of the offering proceeds to fund renovations to this hotel. We anticipate these renovations, and an intended concurrent upbranding to a Holiday Inn franchise, will improve the hotel’s performance.

Growth-Oriented Balance Sheet

We will have $25.7 million of debt, representing an initial leverage ratio of approximately 24.6% of our pro forma total assets as of June 30, 2004, upon completion of the offering. We intend to maintain target debt levels of 45-55% of total assets and plan to enter into a $23.0 million secured revolving credit facility from an affiliate of BB&T Capital Markets following completion of the offering. Neither our charter nor our bylaws limits the amount of debt that we can incur. We believe our initial leverage ratio and access to an anticipated credit facility will permit future borrowings and will provide us with the flexibility to capitalize on attractive investment opportunities.

Improving Lodging Cycle

Over the three year period from 2001-2003, the U.S. lodging industry suffered what we believe was one of the most significant downturns in its performance in several decades. We believe that current economic trends and, in particular, trends in the lodging industry evidenced by an overall increase in average room rates, occupancy and RevPAR, demonstrate that a recovery is underway. We expect that our initial hotels and any additional hotels we acquire will benefit from improving supply and demand conditions. See “Our Business and Properties—Industry Overview.”

Experienced and Aligned Management Team

We expect to benefit from the extensive experience of our management team in identifying, developing, repositioning, financing and managing hotels. Collectively, our senior executive officers have acquired or sold over 22 hotel properties. Upon completion of the offering and the related formation transactions, our officers, directors, and their affiliates and family members will beneficially own approximately 29.2% of the equity interests in our company on a fully diluted basis, which we believe will align their economic interest with those of our stockholders.

Strategic Relationship with MHI Hotels Services

We will enter into a management agreement whereby MHI Hotels Services will manage our initial hotels. We will also enter into a 10-year strategic alliance agreement with MHI Hotels Services which provides that, unless a majority of our independent directors concludes, for valid business reasons, that another management company should manage a hotel owned by us, we will offer MHI Hotels Services the opportunity to manage hotels acquired in the future. In addition, MHI Hotels Services will refer to us, on an exclusive basis, any hotel investment opportunity that is presented to it, in each case subject to certain exceptions.

Risk Factors

You should carefully consider the matters discussed in the “Risk Factors” section prior to deciding whether to invest in our common stock. Some of the material risks include:

•

Failure of the lodging industry to exhibit improvement would adversely effect our business plan and cause a decline in the value of our common stock.

•

Conflicts of interest could result in our executive officers and certain of our directors acting other than in our stockholders’ best interest.

•

Our executive officers and certain of our directors may experience conflicts of interest in connection with their ownership interest in our operating partnership.

•

Our tax indemnification obligations, which were not the result of arm’s-length negotiations and apply in the event that we sell certain properties in taxable transactions, could subject us to liability for substantial payments. The tax indemnification agreements have a 10-year term and require us to indemnify each contributor for 100% of any tax liabilities such contributor may incur as a result of a sale of a property contributed by such person during the first five years, 50% for a sale during year six, 40% for the seventh year, 30% during the eighth year, 20% during the ninth year and 10% during the tenth year. These obligations could limit our operating flexibility and reduce our returns on our investments. Such indemnification obligations could aggregate approximately $46.0 million.

•

Because we will use approximately $25.1 million and $18.5 million from the proceeds of the offering to repay indebtedness and fund the cash portions of the purchase price for three of our initial properties, the cash available for general corporate and working capital purposes will be reduced.

•

We did not obtain independent appraisals of our initial hotel properties or the leasehold interests in the resort property, and thus the consideration paid for these properties may exceed fair market value as determined by third party appraisals.

•

Unanticipated expenses and insufficient demand for hotels we acquire in new geographic markets could adversely affect our profitability and our ability to make distributions to our stockholders.

•

We do 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 and as a result, our returns are dependent on the management of our hotels by MHI Hotels Services.

•

Our ability to make distributions to our stockholders is subject to fluctuations in our financial performance, operating results and capital improvements requirements.

•

We have agreed to provide certain of our contributors opportunities to guarantee liabilities of our operating partnership which may limit our ability to make similar opportunities available to owners of properties that we would like to purchase. This limitation may adversely affect our ability to acquire properties in the future.

•

Neither our charter nor our bylaws limits the amount of debt we can incur. While we intend to maintain target debt levels of 45-55% of total assets, our board of directors may change this debt policy at any time without stockholder approval. Upon completion of the offering, we will have outstanding debt in the amount of $25.7 million and we intend to enter into a $23.0 million revolving credit facility. Future debt service obligations could adversely affect our overall operating results, may require us to liquidate our properties, may jeopardize our tax status as a REIT and limit our ability make distributions to our stockholders.

•

Our company is newly formed and has no operating history and currently owns no properties but has entered into agreements to acquire six hotels.

•

Our officers, directors and affiliates and their family members initially will beneficially own up to approximately 29.2% of our units that may be converted into our common stock and may exercise significant control over our company. In addition, MHI Hotels Services, under the terms of our strategic alliance agreement, has the right to nominate one director to our board.

•

If we do not qualify as a REIT, we will be subject to tax as a regular corporation and face substantial tax liability, which would limit our ability to make distributions to our stockholders.

Our Initial Properties

Upon consummation of this offering and the related formation transactions, we will own six hotels. The following table sets forth certain information for each of our initial hotel properties:


Property	Location	Year Opened/ Renovated	Average Occupancy ⁽¹⁾		ADR (Average Daily Rate) ⁽¹⁾		RevPAR (revenue per available room) ⁽¹⁾		Number of Rooms ⁽²⁾	Meeting Space Sq. Ft. ⁽²⁾	Acquisition Cost ⁽³⁾
Hilton Philadelphia Airport	Philadelphia, PA	1972/ 1994/ 2001	76.5	%	$	87.20	$	66.73	331	10,000	$25,271,240

Holiday Inn Downtown Williamsburg	Williamsburg, VA	1968/ 1986/ 2000	52.0	%		76.26		39.62	137	6,000	5,025,000

Holiday Inn Brownstone	Raleigh, NC	1971/ 2002	63.2	%		74.67		47.18	188	15,000	9,396,120

Hilton Savannah DeSoto	Savannah, GA	1968/ 1996/ 2003-4	75.0	%		115.61		86.67	246	20,000	27,279,940

Hilton Wilmington Riverside	Wilmington, NC	1970/ 1988/ 1998/ 2000	69.6	%		96.00		66.78	274	20,000	25,646,760

Maryland Inn ⁽⁴⁾	Laurel, MD	1985/ 1989	65.1	%		68.00		44.27	205	8,000	12,200,205

TOTALS / WEIGHTED AVERAGES			68.9	%	$	88.37	$	61.61	1,381	79,000	$104,819,060

⁽¹⁾	For the 12-months ended June 30, 2004.

⁽²⁾	As of June 30, 2004.

⁽³⁾	Estimated transaction costs, debt assumed, and units issued in the acquisition valued at the assumed initial public offering price of $10.00 per share, the midpoint of the price range for this offering of our common stock.

⁽⁴⁾	We intend to upbrand the Maryland Inn as a Holiday Inn. For additional information see “Our Business and Properties—Our Initial Properties.”

In addition to these six hotels, we will acquire leasehold interests in the common area of a resort condominium property that we will sublease to MHI Hotels Two, Inc. and MHI Hotels LLC, affiliates of MHI Hotels Services. MHI Hotels LLC and MHI Hotels Two, Inc. will pay us a fixed annual rent of $640,000 in connection with the sublease of such property. The resort condominium, which opened in 1986, has 160 suites and includes a restaurant, kitchens, meeting rooms and a swimming pool.

Formation Transactions

We refer to the following series of transactions as our formation transactions:

•

We will sell 6,000,000 shares of common stock in the offering. We will contribute the net proceeds of the offering to MHI Hospitality, L.P., our operating partnership, in exchange for 6,000,000 operating

partnership units, which we refer to as units, which will represent an approximate 61.1% initial interest in our operating partnership. We will act as sole general partner of our operating partnership.

•

Four of the six initial hotel properties will be contributed to our operating partnership by MHI Hotels Services and its affiliates, in exchange for an aggregate of 3,084,783 units, $1.0 million in cash and the assumption of $35.5 million in debt.

•

We will acquire the Hilton Philadelphia Airport from third parties not affiliated with MHI Hotels Services, in exchange for 732,254 units, $1.8 million in cash and the assumption of $15.2 million in debt. The entity that owns the Hilton Philadelphia Airport may receive additional units in exchange for the contribution of the property. In the event that the initial offering price of our common stock is less than $9.50 per share, the number of additional units to be issued to this entity will be increased to reflect the difference between the offering price and $9.50 per share multiplied by 732,254. For example, if the offering price is $9.00, this entity would receive an additional 40,681 units worth $366,127.

•

We will acquire the Maryland Inn for a cash paymen t of approximately $12.2 million. An affiliate of MHI Hotels Services will receive $500,000 in cash for its 25% interest in Accord LLC and West Laurel Corp., the entities that own the Maryland Inn.

•

We will use $25.1 million of the proceeds of the offering to repay outstanding indebtedness on three of our initial hotel properties.

•

We will acquire two space leases for the common areas of the Shell Island Resort, a condominium resort property located in Wrightsville Beach, North Carolina, from MHI Hotels LLC and its affiliate, MHI Hotels Two, Inc. for a cash payment of $3.5 million, $3.0 million of which will be used to acquire the lease for the common areas and $500,000 for the lease of the restaurant area. We will enter into sublease agreements with MHI Hotels Two, Inc. and MHI Hotels LLC with respect to such property. MHI Hotels Two, Inc. and MHI Hotels LLC will pay us a fixed annual rent of $640,000 in connection with the sublease of such property and we will incur annual lease expense of approximately $120,000.

•

We will enter into tax indemnity and debt allocation agreements with the entities that contribute five of our initial properties. These agreements will require us to indemnify the contributors against tax liabilities in the event we sell those properties in a taxable transaction during a 10-year period. Such indemnification obligations could aggregate up to approximately $46.0 million. The terms of the tax indemnity agreements also require us to gross up the tax indemnity payment for the amount of income taxes due as a result of the tax indemnity payment. The contributing entities will guaranty a portion of our initial indebtedness following the closing and we will be obliged to give the contributors the opportunity to guaranty a similar amount of debt in the future.

•

We will lease each of our initial hotel properties to our TRS Lessee, a wholly-owned subsidiary of our taxable REIT subsidiary, MHI TRS.

•

Our operating partnership will use approximately $2.0 million of the net proceeds of the offering to compensate MHI Hotels Services for the amendment and restructuring of existing management agreements relating to five of our initial hotel properties. Our TRS Lessee will enter into a new management agreement with MHI Hotels Services upon completion of the offering that will cover all of our initial properties and any future hotels managed by MHI Hotels Services. See “Our Principal Agreements – Our Management Agreement.”

•

We will issue 1,000 shares of restricted common stock to each of our initial directors, which shares will vest on the first anniversary of the date of grant.

Our Team

Our executive officers have extensive experience in the lodging industry as set forth below:

Andrew M. Sims , our president, chief executive officer and chairman of the board, has served as President of MHI Hotels Services since 1995 after serving for seven years as vice president of finance and development.

Following the completion of the formation transactions, Andrew Sims will own a 6.5% equity interest in our company on a fully diluted basis.

William J. Zaiser , our executive vice president, chief financial officer and treasurer, has served as vice president of accounting of MHI Hotels Services since 1990 and is responsible for financial analysis, cash management, insurance, investment and reporting. Following the completion of the formation transactions, William Zaiser will own a 1.6% equity interest in our company on a fully diluted basis.

Our chairman and our senior executive officers may be considered promoters of the offering. None of our officers have experience operating a public company or a REIT. See “Management—Directors and Executive Officers.”

Conflicts of Interest

Our executive officers and certain of our directors have interests that may conflict with our interests and the interests of our stockholders. Andrew Sims, our president, chief executive officer and chairman, and William Zaiser, our chief financial officer, together with Christopher and Kim Sims who will become directors upon completion of the offering, hold substantial ownership interests in and are currently officers and employees of MHI Hotels Services. MHI Hotels Services currently owns, with certain affiliates, directly or indirectly, a substantial amount of the ownership interests in the entities that own four of our six initial hotel properties and the sublessees of the resort property. As such, they are beneficiaries of the payments to be made by us under the agreements pursuant to which we will acquire these initial hotels and payments we will make to acquire our leasehold interest in our resort property and terminate existing management agreements with MHI Hotels Services. The terms of these agreements and the valuation methods used to determine the value of the initial hotel properties and amounts to be paid in respect of the leasehold interest and restructuring of existing management agreements were determined by our management team who had conflicts of interest as described above. Because our agreements with MHI Hotels Services were not negotiated on an arm’s-length basis, they may be less favorable to us than we could have obtained from third parties. We did not obtain third-party appraisals of the initial hotel properties in connection with our acquisition of these properties and the consideration being paid by us in exchange for the initial properties may exceed the fair market value as determined by third-party appraisals. Upon completion of the offering and the formation transactions, our executive officers, directors and their affiliates and family members will beneficially own, in the aggregate, approximately 29.2% of the equity interests in our company on a fully diluted basis. See “Certain Relationships and Related Party Transactions – Other Benefits to Related Parties”.

Additionally, MHI Hotels Services, our hotel management company, will enter into a management agreement with us to manage our initial hotels and will receive management fees from us pursuant to the management agreement. Conflicts may arise as a result of Andrew Sims’, Kim Sims’, Christopher Sims’ and William Zaiser’s ownership interests in MHI Hotels Services to the extent that MHI Hotels Services’ interests diverge from our interests, particularly with regard to the management of our hotel properties. The initial term of the management agreement is 10 years, and is subject to extension options. If we terminate the management agreement with respect to a hotel, we may be required to pay MHI Hotels Services a substantial termination fee.

We will also enter into a Strategic Alliance Agreement with MHI Hotels Services pursuant to which, unless a majority of our independent directors in good faith concludes for valid business reasons that another management company should manage a hotel owned by us, we will offer MHI Hotels Services the right to manage hotels we acquire, subject to certain exceptions. In addition, for so long as Andrew, Kim and Christopher Sims and their families and affiliates hold, in the aggregate, not less than 1.5 million units or shares of our common stock, MHI Hotels Services will have the right to nominate one person for election to our board of

directors at our annual meeting of stockholders, subject to approval of such nominee by the Governance and Compensation Committee.

Conflicts may also arise as a result of Andrew Sims’, Kim Sims’, Christopher Sims’ and William Zaiser’s ownership interests in our operating partnership to the extent that their interests as limited partners diverge from our interests, particularly with regard to transactions such as sales of assets or repayment of indebtedness, that could be in our and our stockholders best interests, but may have adverse tax consequences to the limited partners in our operating partnership.

We may be required to indemnify the contributors of some of our initial hotels against a percentage of, or possibly all, of such contributor’s tax liabilities if we sell such hotels in a taxable transaction within 10 years or fail to make available to these contributors opportunities to guarantee specified amounts of the liabilities of our operating partnership to defer such guarantors’ tax liabilities. The tax indemnity agreements also require us to gross up the tax indemnity payment for the amount of income taxes due as a result of the tax indemnity payment. These tax indemnities may adversely affect the way we conduct our business, including when and under what circumstances we sell these properties or interests therein during the indemnification period. While we currently do not intend to sell any of these properties in transactions that would trigger these tax indemnification obligations, if we were to do so, the tax indemnification payment amounts would be substantial. See “Certain Relationships and Related Party Transactions.”

To comply with our charter and the rules and regulations of the American Stock Exchange, which we refer to as the AMEX, our initial board of directors will consist of a majority of independent directors. Under our bylaws, any transaction between us and MHI Hotels Services or its affiliates or any interested director must be approved by a committee consisting of only independent directors. However, there can be no assurance that these policies always will be successful in mitigating such conflicts, and decisions could be made that might not fully reflect the interests of all of our stockholders.

Benefits to Affiliates

The following table summarizes consideration to be received by our affiliates in connection with the formation transactions at an assumed offering price of $10.00 per share.


Transaction	Affiliated Party	Consideration
Contribution of initial hotels	MHI Hotels Services, an aggregate of 79.0% of which is owned in equal parts by each of Andrew, Kim and Christopher Sims and 9.0% by William Zaiser.	$18.1 million which represents the aggregate value of the units issuable to MHI Hotels Services in connection with the contribution of its 80% interest in Savannah Hotel Associates LLC (1,332,395 units having a value of approximately $13.3 million), its 25% interest in Capitol Hotel Associates LP, LLP (314,919 units having a value of approximately $3.1 million), and its 50% ownership in Brownestone Partners LLC (159,512 units having a value of $1.6 million issuable to KDCA Partnership, which is 100% owned by MHI Hotels Services and its affiliates), and $1.0 million in cash, which will be used to repay a $1.0 million construction loan.


Transaction	Affiliated Party	Consideration
	MHI Hotels LLC, an aggregate of 79.0% of which is owned in equal parts by each of Andrew, Kim and Christopher Sims and 9.0% owned by William Zaiser.	$3.0 million in cash in consideration for the assignment of the common area lease at the Shell Island resort property.

	MHI Hotels Two, Inc., an aggregate of 79.0% of which is owned in equal parts by each of Andrew, Kim and Christopher Sims and 9.0% owned by William Zaiser.	$500,000 in cash in consideration for the assignment of the restaurant lease at the Shell Island resort property.

	Edgar Sims, Jr. Irrevocable Trust Andrew, Christopher and Kim Sims, Trustees for the benefit of Edgar Sims’ grandchildren	$0.8 million, which represents the aggregate value of the 75,581 units issuable to the Edgar Sims, Jr. Irrevocable Trust in connection with the contribution of the 6% equity interests of Capitol Hotel Associates LP, LLP, held by such trust. Edgar Sims, Jr. is the father of Andrew, Kim and Christopher Sims.

	Laurel Holdings LLC (owned by Edgar Sims, Jr.)	Approximately $500,000 cash for its 25% interest in Accord LLC and West Laurel Corp., the entities that own the Maryland Inn.

	Andrew Sims, Kim Sims and Christopher Sims	$4.9 million, which represents the aggregate value of 491,274 units issuable in connection with the contribution of the 39.0% equity interests of Capitol Hotel Associates LP, LLP, (each of Andrew, Christopher and Kim Sims have a 13.0% interest in Capitol Hotel Associates LP, LLP).

	Krischman Trusts (Edward Stein, Trustee)	$3.3 million, which represents the aggregate value of 333,099 units issuable to the Krischman Trusts in connection with their contribution of their 20% ownership interest in Savannah Hotel Associates LLC. Edward Stein, who will serve as a member of our board of directors following completion of the offering, is the Trustee of the Trusts.

	Wilmington Hotel Associates Corp. (100% owned by Jeanette Sims)	$3.8 million, which represents the aggregate value of 377,903 units issuable to Wilmington Hotel Associates Corp, in connection with contribution of its 30% ownership interest in Capitol Hotel Associates


Transaction	Affiliated Party	Consideration
		LP, LLP. Jeanette Sims, the mother of Andrew, Kim and Christopher Sims, is the sole stockholder of Wilmington Hotel Associates Corp.

Restructuring of Management Agreements	MHI Hotels Services	$2.0 million in cash in consideration of the restructuring of the management agreements relating to five of our initial hotel properties.

Repayment of offering expenses	MHI Hotels Services	Approximately $1.5 million in cash.

Repayment of Indebtedness/Release of Guaranty	MHI Hotels Services, Andrew Sims, Christopher Sims, Kim Sims	MHI Hotels Services, Andrew, Christopher and Kim Sims will be released from their guaranties of $9.8 million of debt with respect to two initial properties being contributed by entities partially owned by MHI Hotels Services which debt will be repaid with offering proceeds.

Management Agreement	MHI Hotels Services	Monthly base management fee of 2.0% for the first year, 2.5% for the second year, and 3.0% thereafter of all gross revenues for the hotels managed by MHI Hotels Services plus an annual incentive management fee in an amount equal to 10% of the annual year over year increase in consolidated net operating income not to exceed 0.25% of gross hotel revenues.

Strategic Alliance Agreement	MHI Hotels Services	During the 10-year term of the strategic alliance agreement, unless a majority of our independent directors in good faith concludes for valid business reasons that another management company should manage a hotel owned by us, we have agreed to offer MHI Hotels Services the right to manage hotel properties we acquire, subject to certain exceptions. MHI Hotels Services has agreed to refer to us on an exclusive basis, any hotel investment opportunity presented to it, subject to certain exceptions. For so long as Andrew, Kim and Christopher Sims own 1.5 million units or shares, MHI Hotels Services will have the right to nominate a director.


Transaction	Affiliated Party	Consideration
Tax Indemnification	Andrew, Christopher and Kim Sims, Wilmington Hotel Associates (Jeanette Sims), Krischman Trusts (Edward Stein), Edgar Sims, Jr. irrevocable Trust, William J. Zaiser	If we sell, during the 10-year period following the closing of the acquisition of the initial hotels, the five initial hotels contributed to us in exchange for units in a taxable transaction, we would be required to indemnify the contributors for their tax liability plus a gross up tax amount. Such indemnification obligations could aggregate approximately $46.0 million.

Corporate Information

Our corporate offices are located at 814 Capitol Landing Road, Williamsburg, Virginia 23185. Our telephone number is (757) 229-5648.

We intend to elect to be taxed as a REIT under the Internal Revenue Code of 1986, as amended. As long as we maintain our status as a REIT, we generally will not be subject to federal income taxes on our net income to the extent we distribute our net income to our stockholders. However, we will be subject to tax at normal corporate rates on net income or capital gains not distributed to stockholders, and we may be subject to state income and franchise taxes. Our taxable REIT subsidiary, MHI TRS, will be fully subject to corporate income tax as a C corporation.

In order for our income to constitute “rents from real property” for purposes of the gross income test required for REIT qualification, we cannot directly operate any of our hotels. Instead, we must lease our hotels. Accordingly, we will lease each of our hotels to our TRS Lessee, a wholly-owned subsidiary of MHI TRS, our taxable REIT subsidiary, which will pay rent to us that can qualify as “rents from real property,” provided that the TRS Lessee engages an “eligible independent contractor,” which will be MHI Hotels Services, to manage our hotels.

Our Structure

The following chart shows the structure of our company following completion of the offering and the formation transactions described above:

LOGO

The Offering

Shares of common stock offered

6,000,000 shares ⁽¹⁾

Shares of common stock to be outstanding upon completion of the offering

6,004,000 shares ^(1)(2)(3)

Proposed AMEX symbol

“MDH”

⁽¹⁾	Does not include 900,000 shares issuable upon exercise of the underwriters’ over-allotment option in full.

⁽²⁾	Includes 4,000 shares of common stock that will be issued to our independent directors as restricted stock awards under our 2004 Omnibus Stock Incentive Plan.

⁽³⁾	Does not include 3,817,036 shares of common stock issuable upon redemption of units issuable in the formation transactions.

Use of Proceeds

We estimate that the net proceeds from the offering of 6,000,000 shares of our common stock pursuant to this prospectus, after deducting the underwriting discount and estimated offering costs and expenses, will be approximately $54.6 million. If the underwriter’s over-allotment is exercised in full, our net proceeds from the offering will be approximately $63.0 million. We will contribute the net proceeds to our operating partnership. Our operating partnership intends to subsequently use the net proceeds as follows:

•

approximately $25.1 million to repay the outstanding indebtedness on three of our initial properties as follows:

•

a loan secured by a first mortgage lien on the Hilton Philadelphia Airport with a principal amount outstanding of approximately $15.2 million, an interest rate of 8.25% and a maturity date of September 2006;

•

a loan from an affiliate of BB&T Capital Markets secured by a first mortgage lien on the Holiday Inn Brownstone with a principal amount outstanding of approximately $4.8 million, an interest rate of prime plus 0.25% and a maturity date of December 2008;

•

a loan secured by a first mortgage lien on the Holiday Inn Downtown Williamsburg with a principal amount outstanding of approximately $3.0 million, an interest rate of 5.82% and a maturity date of January 2023; and

•

two construction loans with respect to the Holiday Inn Brownstone hotel with a combined principal amount outstanding of approximately $2.0 million, an interest rate of prime plus 1% and a maturity date of August 2005;

•

approximately $12.2 million to fund the acquisition of the Maryland Inn in Laurel, Maryland and approximately $3.9 million for subsequent renovations of the hotel;

•

approximately $4.1 million to fund renovation and pay closing costs and $1.8 million to fund the cash portion of the purchase of the Hilton Philadelphia Airport;

•

approximately $0.5 million to fund renovations at the Holiday Inn Downtown Williamsburg;

•

approximately $1.0 million to fund the cash portion of the purchase of the Holiday Inn Brownstone;

•

approximately $3.5 million to fund the acquisition of the leasehold interests in the resort property;

•

$2.0 million to MHI Hotels Services in consideration of the amendment and restructuring of existing management agreements relating to five of our initial hotel properties; and;

•

approximately $0.4 million for general corporate and working capital purposes.

Each of the agreements to acquire the initial properties is subject to customary closing conditions. As a result, we cannot provide any assurances that we will complete the acquisitions. In the event that we do not complete the acquisition of one or more of the initial properties, the offering proceeds allocated to these acquisitions will be available to fund future Upper Upscale, Upscale and Midscale lodging-related investments and for general corporate and working capital purposes.

Pending these uses, we intend to invest the net proceeds in interest-bearing, short-term investment grade securities or money-market accounts that are consistent with our intention to qualify as a REIT. Such investments may include, for example, government and government agency certificates, certificates of deposit, interest-bearing bank deposits and mortgage loan participations.

Distribution Policy

To maintain our qualification as a REIT, we intend to make annual distributions to our stockholders of at least 90% of our REIT taxable income excluding net capital gains, which does not necessarily equal net income as calculated in accordance with accounting principles generally accepted in the United States of America. We intend to commence making distributions to stockholders after the first full calendar quarter following completion of this offering. However, the timing, frequency and amount of distributions will be authorized by our board of directors and declared by us based upon a variety of factors deemed relevant by our directors. Our ability to pay distributions to our stockholders will depend, in part, upon our receipt of distributions from our operating partnership, MHI Hospitality, L.P., which will depend upon receipt of rent payments with respect to our properties from our TRS Lessee. Our cash available for distribution may be less than 90% of our REIT taxable income which may require us to sell assets or borrow funds in order to make distributions. 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 hotel properties, which will result in depreciation and non-cash charges against our income, a portion of our distributions may constitute a return of capital. To the extent not inconsistent with maintaining our REIT status, our taxable REIT subsidiary, MHI TRS, and our TRS Lessee may retain any after-tax earnings.

Summary Historical and Pro Forma Financial Data

The following table sets forth summary historical combined operating and financial data for MHI Hotels Services Group, the entities that comprise the accounting predecessor to the business of MHI Hospitality Corporation, and summary pro forma combined operating and financial data for MHI Hospitality Corporation. For more information, see “Selected Financial Data.”


	MHI Hospitality Corporation						MHI Hotels Services Group (Predecessor Group)
	Pro Forma for						Historical for the Years Ended December 31
	Year Ended December 31, 2003			Six Months Ended June 30, 2004			1999			2000			2001			2002			2003
*Statement of Operations*
Operating Income
Total Revenues	$	44,566,587		$	24,236,289		$	25,484,152		$	28,053,344		$	28,078,110		$	28,521,527		$	29,186,188
Total Operating Expenses excluding Depreciation & Amortization		(36,324,518	)		(19,022,712	)		(20,829,544	)		(22,366,551	)		(22,886,147	)		(23,002,020	)		(23,803,340	)
Depreciation & Amortization		(4,530,798	)		(2,145,296	)		(2,200,680	)		(2,645,616	)		(2,711,124	)		(2,699,925	)		(2,578,297	)

Net Operating Income		3,711,271			3,068,281			2,453,928			3,041,177			2,480,839			2,819,582			2,804,551

Other Income (Expense)
Interest Income		13,152			430			—			—			105,575			33,584			13,152
Interest Expense		(2,168,318	)		(1,053,612	)		(2,832,360	)		(3,200,254	)		(3,046,309	)		(2,881,263	)		(2,697,793	)
Other Income—net		(16,456	)		—			(8,279	)		(25,295	)		(690,106	)		—			(2,313	)
Minority Interest		(598,923	)		(783,874	)		238,587			240,029			681,282			147,202			77,809

Net Income (Loss)	$	940,726		$	1,231,225		$	(148,124	)	$	55,657		$	(468,719	)	$	119,105		$	195,406

*Statement of Cash Flows*
Net Cash from Operating activities	$	(7,502,239	)	$	4,042,225		$	3,530,234		$	1,127,299		$	4,117,978		$	2,161,828		$	3,350,564
Net Cash provided (used) from Investing activities		(27,190,208	)		(850,757	)		(8,725,286	)		(1,698,185	)		(2,936,253	)		(1,809,355	)		(1,408,699	)
Net Cash provided (used) from Financing activities		36,653,549			(1,081,526	)		4,880,311			505,716			(7,058	)		(691,703	)		(2,028,881	)

Net Increase (Decrease) in Cash Flow	$	1,961,102		$	2,109,942		$	(314,741	)	$	(65,170	)	$	1,174,667		$	(339,230	)	$	(87,016	)

*Balance Sheet*
Total Assets ⁽¹⁾	$	100,933,111		$	104,324,453		$	41,895,152		$	40,970,038		$	42,490,481		$	39,970,331		$	38,231,181
Long-Term Debt ⁽¹⁾ including Current Portion ⁽¹⁾		26,587,594			25,879,773			38,740,366			37,922,132			39,588,102			38,402,567			34,989,381
Total Current and Long-Term Liabilities ⁽¹⁾		31,448,008			32,544,249			42,968,863			41,853,872			44,436,817			42,372,667			38,340,219
Minority Interest ⁽¹⁾		27,029,706			27,922,499			89,281			(128,247	)		(769,219	)		(754,231	)		327,263
Total Owners’ Equity (Deficit) ⁽¹⁾		42,455,399			43,857,705			(1,162,992	)		(755,587	)		(1,177,117	)		(1,648,105	)		(436,301	)

*Operating Data*
Number of Rooms ⁽¹⁾		1,381			1,381			845			845			845			845			845
Number of Room Nights for Period		504,795			251,706			289,126			309,270			308,425			308,425			308,425
Occupancy Percent ⁽²⁾		64.4	%		72.7	%		63.0	%		62.4	%		64.5	%		64.9	%		66.0	%
Average Daily Rate (ADR) ⁽²⁾	$	89.45		$	89.72		$	95.07		$	93.23		$	90.68		$	93.31		$	93.06
Revenue Per Available Room (RevPAR) ⁽²⁾	$	58.29		$	65.40		$	59.92		$	59.33		$	60.33		$	60.55		$	61.42

*Additional Financial Data*
FFO ⁽³⁾	$	6,086,903		$	4,160,395		$	1,822,248		$	2,486,539		$	2,251,229		$	2,671,828		$	2,698,207

(1)	As of the period end.

(2)

Occupancy Percent is calculated by dividing the total number of rooms sold by the total number of room nights available. Average Daily Rate, ADR, is calculated by dividing the total room revenue by the total number of rooms sold. Revenue Per Available Room, RevPAR, is calculated by dividing the total room revenue by the total number of room nights available.

(3)

itself. Thus, NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from GAAP net income. Management believes that the use of FFO, combined with the required GAAP presentations, improves the understanding of the operating results of REITs and makes comparisons of REIT operating results more meaningful. Management considers FFO to be a useful measure of adjusted net income (loss) for reviewing comparative operating and financial performance. Management also believes FFO is most directly comparable to net income (loss), which remains the primary measure of performance. By excluding gains or losses related to sales of previously depreciated operating real estate assets and excluding real estate asset depreciation and amortization, FFO assists in comparing the operating performance of a company's real estate between periods or as compared to different companies. Although FFO is intended to be a REIT industry standard, other companies may not calculate FFO in the same manner as we do, and investors should not assume that FFO as reported by us is comparable to FFO as reported by other REITs. Below is a reconciliation of FFO to net income (loss).


	MHI Hospitality Corporation
	Pro Forma for				MHI Hotels Services Group (Predecessor Group)
	Year Ended December 31, 2003		Six Months Ended June 30, 2004		Historical for the Years Ended December 31
	Year Ended December 31, 2003		Six Months Ended June 30, 2004		1999			2000			2001			2002			2003
Reconciliation of FFO
Net income (loss)	$	940,726	$	1,231,225	$	(148,124	)	$	55,657		$	(468,719	)	$	119,105		$	195,406
add back minority interest		598,923		783,874		(238,587	)		(240,029	)		(681,282	)		(147,202	)		(77,809	)
add back depreciation & amortization		4,530,798		2,145,296		2,200,680			2,645,616			2,711,124			2,699,925			2,578,297
add back loss (gain) on disposal of assets		16,456		—		8,279			25,295			690,106			—			2,313

FFO	$	6,086,903	$	4,160,395	$	1,822,248		$	2,486,539		$	2,251,229		$	2,671,828		$	2,698,207

RISK FACTORS

The following are the material risks that apply to an investment in our common stock. In addition to other information in this prospectus, you should carefully consider the following risk factors before deciding whether to purchase our common stock.

Risks Related to Our Business and Properties

Failure of the lodging industry to exhibit improvement would adversely effect our business plan and cause a decline in the value of our common stock.

A substantial part of our business plan is based on our belief that the lodging markets in which we intend to invest are experiencing improving economic fundamentals. There can be no assurance that lodging industry fundamentals will continue to improve. In the event conditions in the industry do not continue to improve as we expect, our cash available for distribution would be less than anticipated.

Conflicts of interest could result in our executive officers and certain of our directors acting other than in our stockholders’ best interest.

Conflicts of interest relating to MHI Hotel Services and the terms of its management agreement may lead to management decisions that are not in the stockholders’ best interest.

Conflicts of interest relating to MHI Hotels Services may lead to management decisions that are not in the stockholders’ best interest. MHI Hotels Services is owned and controlled by members of the Sims family, including Andrew Sims, our chairman and CEO, Kim Sims and Christopher Sims, who will serve on our board of directors, William Zaiser, our executive vice president and CFO, and Steven Smith who is the Executive Vice President of MHI Hotels Services. Andrew Sims, Kim Sims, Christopher Sims and William Zaiser are currently officers and employees of MHI Hotels Services. Four of our initial hotels will be contributed to our operating partnership by MHI Hotels Services and its affiliates. MHI Hotels Services will manage our initial hotel properties. In addition, MHI Hotel Services will have a right of first offer to manage hotels we acquire in the future, subject to certain exceptions, and will receive substantial management fees based on the revenues and operating profit of our hotels. Our management agreement with MHI Hotels Services, including the financial terms thereof, was not negotiated on an arm’s-length basis and may be less favorable to us than we could have obtained from third parties.

Our management agreement establishes the terms of MHI Hotels Services’ management of our hotels. Under certain circumstances, if we terminate our management agreement as to one of the hotels, we will be required to pay MHI Hotels Services a termination fee. If we were to terminate the management agreement with respect to all six of these initial hotels immediately after this offering in connection with a sale of those hotels, the aggregate termination fee would be approximately $8.8 million. As majority owners of MHI Hotels Services, which would receive any management and management termination fees payable by us under the management agreement, Andrew Sims, Christopher Sims, Kim Sims and William Zaiser may influence our decisions to sell a hotel or acquire or develop a hotel when it is not in the best interests of our stockholders to do so. In addition, Andrew Sims and William Zaiser will have conflicts of interest with respect to decisions to enforce provisions of the management agreement, including any termination thereof.

There can be no assurance that provisions in our bylaws will always be successful in mitigating conflicts of interest.

Under our bylaws, any transaction between us and MHI Hotels Services or its affiliates or any interested director must be approved by a committee consisting of only independent directors. However, there can be no assurance that these policies always will be successful in mitigating such conflicts, and decisions could be made that might not fully reflect the interests of all of our stockholders.

Certain of our officers and directors will hold units and may seek to avoid adverse tax consequences, which could result from transactions that would otherwise benefit our stockholders.

Holders of units, including members of our management team, may suffer adverse tax consequences upon our sale or refinancing of certain properties. Therefore, holders of units, including Andrew Sims, William Zaiser, Kim Sims, Christopher Sims, and Edward Stein may have different objectives than holders of our common stock regarding the appropriate pricing and timing of a property’s sale or timing and amount of a property’s refinancing. These officers and directors of ours may influence us not to sell or refinance certain properties, even if such sale or refinancing might be financially advantageous to our stockholders, or to enter into tax-deferred exchanges with the proceeds of such sales when such a reinvestment might not otherwise be in our best interest. For more information regarding the tax indemnity agreements that we have entered into with the contributors of the initial hotels, see “—Our tax indemnification obligations, which were not the result of arm’s-length negotiations and which apply in the event that we sell certain properties, could subject us to liability for substantial payments and limit our operating flexibility and reduce our returns on our investments” and “Certain Relationships and Related Party Transactions” in this prospectus.

Our executive officers and certain of our directors may experience conflicts of interest in connection with their ownership interests in our operating partnership.

Our executive officers and certain of our directors, which include Andrew Sims, Williams Zaiser, Kim Sims, Christopher Sims and Ed Stein, may experience conflicts of interest relating to their ownership interests in our operating partnership. With regard to ownership interests in our operating partnership, upon completion of this offering and our formation transactions, Andrew Sims, William Zaiser, Kim Sims, Christopher Sims and Ed Stein will beneficially own 6.5%, 1.6%, 6.5%, 6.5% and 3.4% interests in our operating partnership, respectively. These individuals, together with their affiliates, will own in the aggregate approximately 29.2% of the outstanding units in our operating partnership upon completion of this offering and our formation transactions. Conflicts may arise as a result of these persons’ ownership interests as limited partners diverge from the interests of MHI Hospitality Corporation, particularly with regard to transactions such as sales of assets or the repayment of indebtedness, that could be in the best interests of MHI Hospitality Corporation and its stockholders but may have adverse tax consequences to the limited partners in our operating partnership.

Our tax indemnification obligations, which were not the result of arm’s-length negotiations and which apply in the event that we sell certain properties, could subject us to liability which we currently estimate to be approximately $46.0 million, and limit our operating flexibility and reduce our returns on our investments.

If we dispose of any of the initial hotels, we would be obligated to indemnify the original contributors (including their permitted transferees and persons who are taxable on the income of a contributor or permitted transferee) against certain tax consequences of the sale pursuant to the tax indemnity agreements, the terms of which were not the result of arm’s-length negotiations. These original contributors include Andrew Sims, our chairman, president and chief executive officer, William Zaiser, our chief financial officer, Kim Sims, one of our director nominees, and Christopher Sims, one of our director nominees. We have agreed to pay a certain amount of the contributor’s tax liability with respect to gain allocated to the contributor under Section 704(c) of the Internal Revenue Code if we dispose of a property contributed by the contributor in a taxable transaction during a “protected period,” which continues until the earlier of:

•

10 years after the contribution of such property; or

•

the date on which the contributor no longer owns, in the aggregate, at least 25% of the units we issued to the contributor at the time of its contribution of property to our operating partnership.

This tax indemnity will be equal to a certain amount of the federal and state income tax liability the contributor incurs with respect to the gain allocated to the contributor upon such sale based on a sliding scale percentage. Specifically, we will indemnify the contributors for 100% of their tax liability during the first five

years after contribution, 50% during the sixth year, 40% during the seventh year, 30% during the eighth year, 20% during the ninth year and 10% during the tenth year. The terms of the tax indemnity agreements also require us to gross up the tax indemnity payment for the amount of income taxes due as a result of the tax indemnity payment. While the tax indemnities do not contractually limit our ability to conduct our business in the way we desire, we are less likely to sell any of the contributed properties in a taxable transaction during the protected period because of the significant tax liability we would have to the contributors. Instead, we would either hold the property for the entire protected period, or at least the first five years, or seek to transfer the property in a tax-deferred like-kind exchange.

If we were to sell during the next five years in a taxable transaction the five initial hotels contributed to us in exchange for units immediately after the closing of the offering, our estimated total tax indemnification obligation to our indemnified contributors, including the gross-up payment, would be approximately $46.0 million.

We did not obtain third-party appraisals of the initial hotel properties in connection with our acquisition of these properties and the consideration being paid by us in exchange for the initial properties may exceed the fair market value as determined by third-party appraisals. The terms of these agreements and the valuation methods used to determine the value of the initial hotel properties were determined by our management team who had conflicts of interest is described above. Our executive officers and certain of our directors, including Andrew Sims, our president and chief executive officer, will receive an aggregate of 2,870,863 units, having an aggregate value of approximately $28.7 million, in the formation transactions. It is possible that the consideration we give in exchange for our initial hotels may exceed their fair market value and that we could realize less value from the hotels than we would have realized if the agreements had been entered into with an unrelated third party or if we had obtained independent appraisals of the initial assets. For more information on the allocation of units to our directors and executive officers, see “Management” and “Certain Relationships and Related Party Transactions” in this prospectus.

Unanticipated expenses and insufficient demand for hotels we acquire in new geographic markets could adversely affect our profitability and our ability to make distributions to our stockholders.

As part of our business plan, we may develop or acquire hotels in geographic areas in which our management may have little or no operating experience and in which potential customers may not be familiar with our franchise brands. As a result, we may have to incur costs relating to the opening, operation and promotion of those new hotel properties that are substantially greater than those incurred in other areas. These hotels may attract fewer customers than our existing hotels, while at the same time, we may incur substantial additional costs with these new hotel properties. Unanticipated expenses and insufficient demand at a new hotel property, therefore, could adversely affect our profitability and our ability to make distributions to our stockholders.

Under the terms of the management agreement that we will enter into with MHI Hotels Services and the REIT qualification rules, our ability to participate in operating decisions regarding the hotels is limited. We will depend on MHI Hotels Services to operate our hotels as provided in the management agreement. We do 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 (for instance, setting room rates). Thus, even if we believe our hotels are being operated inefficiently or

in a manner that does not result in satisfactory occupancy rates, revenue per available room, which we refer to as RevPAR, and average daily rates, we may not be able to force MHI Hotels Services to change its method of operation of our hotels. Additionally, in the event that we need to replace MHI Hotels Services or any other management companies in the future, we may be required by the terms of the management agreement to pay substantial termination fees and may experience significant disruptions at the affected hotels.

Our ability to make distributions to our stockholders is subject to fluctuations in our financial performance, operating results and capital improvements requirements.

As a REIT, we are required to distribute at least 90% of our REIT taxable income, excluding net capital gains, each year to our stockholders. In the event of future downturns in our operating results and financial performance or unanticipated capital improvements to our hotels, including capital improvements which may be required by our franchisors, we may be unable to declare or pay distributions to our stockholders. The timing and amount of distributions are in the sole discretion of our board of directors which will consider, among other factors, our financial performance, debt service obligations and debt covenants, and capital expenditure requirements. We cannot assure you that we will continue to generate sufficient cash to fund distributions.

Among the factors which could adversely affect our results of operations and our distributions to stockholders are the failure of our TRS Lessee to make required rent payments because of reduced net operating profits or operating losses, increased debt service requirements and capital expenditures at our hotels, including capital expenditures required by the franchisors of our hotels. Among the factors which could reduce the net operating profits of our TRS Lessee are decreases in hotel revenues and increases in hotel operating expenses. Hotel revenue can decrease for a number of reasons, including increased competition from a new supply of hotel rooms and decreased demand for hotel rooms. These factors can reduce both occupancy and room rates at our hotels.

We will lease all of our hotels to our TRS Lessee. The TRS Lessee will be subject to hotel operating risks, including risks of sustaining operating losses after payment of hotel operating expenses, including management fees. These risks can affect adversely the net operating profits of our TRS Lessee, our operating expenses, and our ability to make distributions to our stockholders.

Under certain of the tax indemnification agreements, we have agreed to use commercially reasonable efforts during the protected period to make available to certain contributors opportunities to guarantee liabilities of our operating partnership. By guaranteeing liabilities of the operating partnership, the contributors will be entitled to defer recognition of gain in connection with the contribution of certain hotels. As a consequence of the allocation of debt to them for tax purposes by virtue of guaranteeing liabilities of the operating partnership, contributors will not be deemed to have received a distribution under the applicable provisions of the Code. In the case of our tax indemnification obligation, the protected period continues until the earlier of

•

10 years after the contribution of such property; or

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the date on which the contributor no longer owns, in the aggregate, at least 25% of the units we issued to the contributor at the time of its contribution of property to our operating partnership.

The obligation to make guarantee opportunities available to the contributors could adversely affect our ability to acquire additional properties in the future by reducing the amount of debt that could be guaranteed by other, future contributors.

We intend to use approximately $25.1 million from the proceeds of the offering to repay outstanding indebtedness relating to three of our initial hotel properties, including one loan in which the lender is affiliated with BB&T Capital Markets, our lead managing underwriter, and approximately $18.5 million to acquire certain of our initial hotel properties. This use of funds from the offering will reduce the amount of cash available for general corporate and working capital purposes.

Future debt service obligations could adversely affect our overall operating results, may require us to liquidate our properties, may jeopardize our tax status as a REIT and limit our ability to make distributions to our stockholders.

After the completion of the offering, we will have approximately $25.7 million in debt representing an initial leverage ratio of approximately 24.6% of our pro forma total assets as of June 30, 2004. While we intend to maintain target debt levels of 45-55% of total assets, our board of directors may change this debt policy at any time without stockholder approval. In addition, we intend to enter into a $23.0 million revolving credit facility following completion of the offering. Our lenders may impose restrictions that could affect our distribution and operating policies, as well as our ability to incur additional debt. We and our subsidiaries may be able to incur substantial additional debt, including secured debt, in the future. Incurring debt could subject us to many risks, including the risks that:

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our cash flow from operations will be insufficient to make required payments of principal and interest;

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our debt may increase our vulnerability to adverse economic and industry conditions;

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we may be required to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing cash available for distribution to our stockholders, funds available for operations and capital expenditures, future business opportunities or other purposes;

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our debt service obligations on floating rate debt will increase as interest rates rise;

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the terms of any refinancing will not be as favorable as the terms of the debt being refinanced; and

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the use of leverage could adversely affect our ability to make distributions to our stockholders and the market price of our common stock.

If we violate covenants in our future indebtedness agreements, we could be required to repay all or a portion of our indebtedness before maturity at a time when we might be unable to arrange financing for such repayment on attractive terms, if at all.

If we incur debt in the future and do not have sufficient funds to repay our debt at maturity, it may be necessary to refinance this debt through additional debt financing, private or public offerings of debt securities, or additional equity financings. If, at the time of any refinancing, prevailing interest rates or other factors result in higher interest rates on refinancings, increases in interest expense would lower our cash flow, and, consequently, cash available for distribution to our stockholders. If we are unable to refinance our debt on acceptable terms, we may be forced to dispose of hotel properties on disadvantageous terms, potentially resulting in losses that reduce cash flow from operating activities. We may place mortgages on our hotel properties to secure our line of credit or other debt. To the extent we cannot meet our debt service obligations, we risk losing some or all of those properties to foreclosure. Also, covenants applicable to our debt could impair our planned strategies and, if violated, result in a default of our debt obligations.

We are subject to risks of increased hotel operating expenses and decreased hotel revenues.

Our leases with our TRS Lessee will provide for the payment of rent based in part on gross revenues from our hotels. Our TRS Lessee is subject to hotel operating risks including decreased hotel revenues and increased hotel operating expenses, including but not limited to the following:

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wage and benefit costs;

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repair and maintenance expenses;

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energy costs;

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property taxes;

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insurance costs; and

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other operating expenses.

Any increases in these operating expenses can have a significant adverse impact on the TRS Lessee’s ability to pay rent and other operating expenses and, consequently, our earnings and cash flow.

Operating our hotels under franchise agreements could increase our operating costs and lower our net income.

Our hotels will operate under franchise agreements which will subject us to risks in the event of negative publicity related to one of our franchisors.

The maintenance of the franchise licenses for our hotels is subject to our franchisors’ operating standards and other terms and conditions. Our franchisors periodically inspect our hotels to ensure that we, our lessee and our management company follow their standards. Failure by us, our TRS Lessee or our management company to maintain these standards or other terms and conditions could result in a franchise license being canceled. If a franchise license terminates due to our failure to make required improvements or to otherwise comply with its terms, we may also be liable to the franchisor for a termination payment, which varies by franchisor and by hotel. As a condition of continuing a franchise license, a franchisor could also possibly require us to make capital expenditures, even if we do not believe the capital improvements are necessary or desirable or will result in an acceptable return on our investment. Nonetheless, we may risk losing a franchise license if we do not make franchisor-required capital expenditures.

If a franchisor terminates the franchise license, we may try either to obtain a suitable replacement franchise or to operate the hotel without a franchise license. The loss of a franchise license could significantly decrease the revenues at the hotel and reduce the underlying value of the hotel because of the loss of associated name recognition, marketing support and centralized reservation systems provided by the franchisor. A loss of a franchise license for one or more hotels could materially and adversely affect our revenues. This loss of revenues could, therefore, also adversely affect our financial condition and results of operations and reduce our cash available for distribution to stockholders.

Our executive officers have no experience operating a public company or a REIT, which could increase our general and administrative costs and reduce our cash available for distributions.

None of our senior executive officers has any experience operating a public company or a REIT. Qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions. As a result, we may initially incur higher general and administrative expenses than our competitors that are managed by persons with experience operating a public company or a REIT, which would reduce our net income and cash available for distribution.

We have recently been organized and have no operating history.

Our company was incorporated in August 2004 and has no prior operating history. We will be subject to the risks generally associated with the formation of any new business.

Future acquisitions may not yield the returns expected, may result in disruptions to our business, may strain management resources and may result in stockholder dilution.

Our business strategy may not ultimately be successful and may not provide positive returns on our investments. Acquisitions may cause disruptions in our operations and divert management’s attention away from day-to-day operations. The issuance of equity securities in connection with any acquisition could be substantially dilutive to our stockholders.

Our net income would be adversely affected if our leases for the resort property are terminated.

If the leases for the Shell Island resort property are terminated, our sublease agreements for the resort property will also be terminated. The leases for the Shell Island resort property may be terminated by the resort property’s home owners association if MHI Hotels, LLC breaches certain provisions under the leases. The leases may also be terminated if MHI Hotels, LLC serves as central rental agent for less than 80 of the 160 rental units at the resort. Upon termination of these subleases, we would no longer receive the fixed annual rent of approximately $640,000 less our lease payments to the resort property’s home owners association, which would adversely affect our net income.

We may realize reduced revenue because our management company may experience conflicts of interest in connection with the management of the resort property.

MHI Hotels Services may experience conflicts of interest in connection with the management of our resort property and one of our initial hotel properties, which are located less than one mile from each other, and the management company’s continued management of an additional resort property not owned by us located nearby in the same geographic market. Because the fees MHI Hotels Services earns for managing our properties are largely fixed under our management agreement with MHI Hotels Services and may be less than the fees it earns for the additional resort property and because MHI Hotels Services handles the reservations for these three properties, MHI Hotels Services may have a greater financial incentive to direct guests to the resort property that we do not own.

Geographic concentration of our initial hotels will make our business vulnerable to economic downturns in the Mid-Atlantic and Southeastern United States.

All of our six initial hotels are located in the Mid-Atlantic and Southeastern United States. Economic conditions in the Mid-Atlantic and Southeastern United States will significantly affect our revenues and the value of our hotels. Business layoffs or downsizing, industry slowdowns, changing demographics and other similar factors may adversely affect the economic climate in these areas. Any resulting oversupply or reduced demand for hotels in the Mid-Atlantic and Southeastern United States and our markets in particular would therefore have a disproportionate negative impact on our revenues and limit our ability to make distributions to stockholders.

Our borrowing costs are sensitive to fluctuations in interest rates.

Higher interest rates could increase debt service requirements on our floating rate debt including any borrowings, under our proposed credit facility. We currently do not intend to engage in interest rate protection—in the form of swap agreements, interest rate cap contracts or similar agreements—to “hedge” against the possible negative effects of interest rate fluctuations. Adverse economic conditions could also cause the terms on which we borrow to be unfavorable. We could be required to liquidate one or more of our hotel investments at times which may not permit us to receive an attractive return on our investments in order to meet our debt service obligations.

Risks Related to the Hotel Industry

Our ability to make distributions to our stockholders may be affected by factors in the lodging industry.

Operating Risks

Our hotel properties are subject to various operating risks common to the lodging industry, many of which are beyond our control, including the following:

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competition from other hotel properties in our markets;

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over-building of hotels in our markets, which adversely affects occupancy and revenues at our hotels;

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dependence on business and commercial travelers and tourism;

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increases in energy costs and other expenses affecting travel, which may affect travel patterns and reduce the number of business and commercial travelers and tourists;

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increases in operating costs due to inflation 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;

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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, national, regional and local economic and market conditions;

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adverse effects of a downturn in the lodging industry; and

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risks generally associated with the ownership of hotel properties and real estate, as we discuss in detail below.

These factors could reduce the net income of our TRS Lessee, which in turn could adversely affect our ability to make distributions to our stockholders.

Competition for Acquisitions

We compete for investment opportunities with entities that have substantially greater financial resources than we do. These entities generally may be able to accept more risk than we can prudently manage. This competition may generally limit the number of suitable investment opportunities offered to us. This competition may also increase the bargaining power of property owners seeking to sell to us, making it more difficult for us to acquire new properties on attractive terms.

Seasonality of Hotel Business

The hotel industry is seasonal in nature. This seasonality can be expected to cause quarterly fluctuations in our revenues. Our quarterly earnings may be adversely affected by factors outside our control, including weather conditions and poor economic factors. As a result, we may have to enter into short-term borrowings in certain quarters in order to offset these fluctuations in revenues and to make distributions to our stockholders.

Investment Concentration in Particular Segments of Single Industry

Our entire business is lodging-related. Therefore, a downturn in the lodging industry, in general, and the segments in which we operate, in particular, will have a material adverse effect on amounts available for distribution to our stockholders.

Capital Expenditures

Our hotel properties have an ongoing need for renovations and other capital improvements, including replacements, from time to time, of furniture, fixtures and equipment. The franchisors of our hotels also require

periodic capital improvements as a condition of keeping the franchise licenses. In addition, our lenders will likely require that we set aside annual amounts for capital improvements to our hotel properties. The existing loan obligations relating to the Hilton Savannah DeSoto and the Hilton Wilmington Riverside, which we will assume in the formation transactions, will require us to set aside 5% of gross sales for capital improvements. The existing loans on the Hilton Philadelphia Airport and the Holiday Inn Brownstone, which will be repaid with proceeds from the offering, mandate that 3% of room sales be set aside for capital improvement. We expect future credit arrangements to be consistent with such requirements and expect the average lenders’ capital improvements reserve requirement for all of our hotels will be approximately 4% of gross sales. We may spend in excess of lender reserve requirements. These capital improvements may give rise to the following risks:

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possible environmental problems;

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construction cost overruns and delays;

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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; and

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

The costs of all these capital improvements could adversely affect our financial condition and amounts available for distribution to our stockholders.

Hotel re-development is subject to timing, budgeting and other risks that would increase our operating costs and limit our ability to make distributions to stockholders.

We intend to acquire hotel properties from time to time as suitable opportunities arise, taking into consideration general economic conditions and seek to re-develop or reposition these hotels. Redevelopment of hotel properties involve a number of risks, including risks associated with:

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construction delays or cost overruns that may increase project costs;

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receipt of zoning, occupancy and other required governmental permits and authorizations;

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development costs incurred for projects that are not pursued to completion;

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acts of God such as earthquakes, hurricanes, floods or fires that could adversely impact a project;

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financing; and

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governmental restrictions on the nature or size of a project.

We cannot assure you that any re-development project will be completed on time or within budget. Our inability to complete a project on time or within budget would increase our operating costs and reduce our net income.

The hotel business is capital intensive, and our inability to obtain financing could limit our growth.

Our hotel properties will require periodic capital expenditures and renovation to remain competitive. Acquisitions or development of additional hotel properties will require significant capital expenditures. The lenders under some of the mortgage debt that we will assume will require us to set aside varying amounts each year for capital improvements at our hotels. We may not be able to fund capital improvements or acquisitions solely from cash provided from our operating activities because we must distribute at least 90% of our REIT taxable income, excluding net capital gains, each year to maintain our REIT tax status. Consequently, we rely upon the availability of debt or equity capital to fund hotel acquisitions and improvements. As a result, our ability to fund capital expenditures, acquisitions or hotel development through retained earnings is very limited. Our ability to grow through acquisitions or development of hotels will be limited if we cannot obtain satisfactory debt or equity financing which will depend on market conditions. Neither our charter nor our bylaws limits the amount of debt that we can incur. However, we cannot assure you that we will be able to obtain additional equity or debt financing or that we will be able to obtain such financing on favorable terms.

The events of September 11, 2001, recent economic trends, the military action in Afghanistan and Iraq and prospects for future terrorist acts and military action have adversely affected the hotel industry generally, and these adverse effects may continue.

Before September 11, 2001, hotel owners and operators had begun experiencing declining RevPAR, as a result of the slowing U.S. economy. The terrorist attacks of September 11, 2001 and the after-effects (including the prospects for more terror attacks in the United States and abroad), combined with economic trends and the U.S.-led military action in Afghanistan and Iraq, substantially reduced business and leisure travel and lodging industry RevPAR generally. We cannot predict the extent to which these factors will directly or indirectly impact your investment in our common stock, the lodging industry or our operating results in the future. Declining RevPAR at hotels that we acquire would reduce our net income and restrict our ability to fund capital improvements at our hotels and our ability to make distributions to stockholders necessary to maintain our status as a REIT. Additional terrorist attacks, acts of war or similar events could have further material adverse effects on the markets on which shares of our common stock will trade, the lodging industry at large and our operations in particular.

Uninsured and underinsured losses could adversely affect our operating results and our ability to make distributions to our stockholders.

We intend to maintain comprehensive insurance on each of our hotel properties, including liability, fire and extended coverage, of the type and amount we believe are customarily obtained for or by hotel owners. There are no assurances that current coverage will continue to be available at reasonable rates. Various types of catastrophic losses, like earthquakes and floods, losses from foreign terrorist activities such as those on September 11, 2001 or losses from domestic terrorist activities such as the Oklahoma City bombing on April 19, 1995, may not be insurable or may not be economically insurable. Initially, we do not expect to obtain terrorism insurance on our hotel properties because it is costly. Lenders may require such insurance and our failure to obtain such insurance could constitute a default under loan agreements. Depending on our access to capital, liquidity and the value of the properties securing the affected loan in relation to the balance of the loan, a default could reduce our net income and limit our ability to obtain future financing.

In the event of a substantial 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 mortgage debt or other financial obligations related to the property. 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 property.

Noncompliance with governmental regulations could adversely affect our operating results.

Environmental Matters

Our hotels may be subject to environmental liabilities. An owner of real property can face liability for environmental contamination created by the presence or discharge of hazardous substances on the property. We may face liability regardless of:

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our knowledge of the contamination;

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the timing of the contamination;

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the cause of the contamination; or

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the party responsible for the contamination of the property.

There may be unknown environmental problems associated with our properties. If environmental contamination exists on our properties, we could become subject to strict, joint and several liability for the contamination by virtue of our ownership interest.

The presence of hazardous substances on a property may adversely affect our ability to sell the property and we may incur substantial remediation costs. The discovery of environmental liabilities attached to our properties could have a material adverse effect on our results of operations and financial condition and our ability to pay dividends to stockholders.

Americans with Disabilities Act and Other Changes in Governmental Rules and Regulations

Under the Americans with Disabilities Act of 1990, or 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 ability to make distributions to our stockholders could be adversely affected.

General Risks Related to the Real Estate Industry

Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties and harm our financial condition.

Because real estate investments are relatively illiquid, our ability to promptly sell one or more hotel properties or mortgage loans in our portfolio in response to changing economic, financial and investment conditions is limited. The real estate market is affected by many factors that are beyond our control, including:

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adverse changes in international, national, regional and local economic and market conditions;

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changes in interest rates and in the availability, cost and terms of debt financing;

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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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the ongoing need for capital improvements, particularly in older structures;

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changes in operating expenses; and

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civil unrest, acts of God, including earthquakes, floods and other natural disasters, which may result in uninsured losses, and acts of war or terrorism, including the consequences of the terrorist acts such as those that occurred on September 11, 2001.

We may decide to sell our hotels in the future. We cannot predict whether we will be able to sell any hotel property or loan for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a hotel property or loan.

We may be required to expend funds to correct defects or to make improvements before a hotel property can be sold. We cannot assure you that we will have funds available to correct those defects or to make those improvements. In acquiring a hotel property, we may agree to lock-out provisions that materially restrict us from selling that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. These factors and any others that would impede our ability to respond to adverse changes in the performance of our properties could have a material adverse effect on our operating results and financial condition, as well as our ability to pay distributions to stockholders.

Our hotels may contain or develop harmful mold, which could lead to liability for adverse health effects and costs of remediating the problem.

When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Concern about indoor exposure to mold has been increasing, as exposure to mold may cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold at any of our properties could require us to undertake a costly remediation program to contain or remove the mold from the affected property, which would reduce our cash available for distribution. In addition, the presence of significant mold could expose us to liability from our guests, employees or our management company and others if property damage or health concerns arise.

Risks Related to Our Organization and Structure

Our failure to qualify as a REIT under the federal tax laws will result in substantial tax liability, which would reduce the amount of cash available for distribution to our stockholders.

The federal income tax laws governing REITs are complex.

We intend to operate in a manner that will qualify us as a REIT under the federal income tax laws. The REIT qualification requirements are extremely complex, however, and interpretations of the federal income tax laws governing qualification as a REIT are limited. We have not applied for or obtained a ruling from the Internal Revenue Service that we will qualify as a REIT. Accordingly, we cannot be certain that we will be successful in operating so we can qualify as a REIT. At any time, new laws, interpretations or court decisions may change the federal tax laws or the federal income tax consequences of our qualification as a REIT.

Failure to make distributions could subject us to tax.

In order to qualify as a REIT, each year we must pay out to our stockholders in distributions at least 90% of our REIT taxable income, excluding net capital gain. To the extent that we satisfy this distribution minimum, but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed taxable income. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we pay out to our stockholders in a calendar year is less than the minimum amount specified under federal tax laws. Our only source of funds to make these distributions comes from rent and dividends we receive from MHI TRS, which in turn receives revenues from hotel operations. Accordingly, we may be required to borrow money or sell assets to make distributions sufficient to enable us to pay out enough of our taxable income to satisfy the distribution requirement and to avoid corporate income tax and the 4% nondeductible excise tax in a particular year.

Failure to qualify as a REIT would subject us to federal income tax.

If we fail to qualify as a REIT in any taxable year (including, but not limited to, a failure resulting from not making the minimum distributions), we will be subject to federal income tax on our taxable income. We might need to borrow money or sell hotels in order to pay any such tax. If we cease to be a REIT, we no longer would be required to distribute most of our taxable income to our stockholders. Unless the federal income tax laws excused our failure to qualify as a REIT, we could not re-elect REIT status until the fifth calendar year after the year in which we failed to qualify as a REIT.

The formation of MHI TRS and our TRS Lessee increases our overall tax liability.

MHI TRS and our TRS Lessee are subject to federal and state income tax on their taxable income, which will consist of the revenues from the hotels leased by our TRS Lessee, net of the operating expenses for such hotels and rent payments to us. Accordingly, although our ownership of our TRS Lessee will allow us to participate in the operating income from our hotels in addition to receiving rent, that operating income will be fully subject to income tax. The after-tax net income of our TRS Lessee is available for distribution to us.

We will incur a 100% excise tax on transactions with MHI TRS and our TRS Lessee that are not conducted on an arm’s-length basis. For example, to the extent that the rent paid by our TRS Lessee to us exceeds an arm’s-length rental amount, such amount potentially will be subject to this excise tax. We intend that all transactions between us and MHI TRS and our TRS Lessee will be conducted on an arm’s-length basis and, therefore, that the rent paid by our TRS Lessee to us will not be subject to this excise tax.

Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.

Even if we remain qualified for taxation as a REIT, we may be subject to certain federal, state and local taxes on our income and assets. For example:

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We will be required to pay tax on undistributed REIT taxable income.

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We may be required to pay “alternative minimum tax” on our items of tax preference.

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If we have net income from the disposition of foreclosure property held primarily for sale to customers in the ordinary course of business or other non-qualifying income from foreclosure property, we must pay tax on that income at the highest corporate rate.

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If we sell a property in a “prohibited transaction,” our gain from the sale would be subject to a 100% penalty tax. A “prohibited transaction” would be a sale of property, other than a foreclosure property, held primarily for sale to customers in the ordinary course of business.

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MHI TRS is a fully taxable corporation and will be required to pay federal and state taxes on its income, which will consist of the revenues from the hotels leased from our operating partnership, net of the operating expenses for such hotels and rent payments to us.

Our ability to effect a merger or other business combination transaction may be restricted by our operating partnership agreement.

Conflicts of interest relating to a merger or other business combination transactions involving our change of control may occur between us and Andrew Sims, our chairman of our board of directors, president and chief executive officer, William Zaiser, our chief financial officer and Kim Sims, Christopher Sims, and Edward Stein, three of our director nominees. Our operating partnership’s agreement of limited partnership provides that the holders of 66.7% of the outstanding limited partnership interests in our operating partnership (including our limited partnership interest in our operating partnership) must approve such a merger or other business combination transaction, unless the holders of 50% or more of the outstanding limited partnership interests (other than our limited partnership interest) approves such a merger or other business combination transaction. Upon completion of this offering and our formation transactions, Andrew Sims, William Zaiser, Kim Sims, Christopher Sims and Ed Stein will beneficially own 24.6% of our outstanding limited partnership interests, and we will own 60.1%. Although our stockholders must approve a merger or other business combination transaction under applicable Maryland law, under our operating partnership agreement, limited partners, including certain of our officers and directors, must approve certain other business combination transactions involving us. These approval rights of limited partners may lead to conflicts of interest, which could result in decisions that do not fully reflect our best interests or the best interests of our stockholders.

In addition, in the event of a change of control of our company, the limited partners will have the right, for a period of one year following the change of control event, to cause the operating partnership to redeem all of the units held by the limited partners for a cash amount equal to the greater of (i) the cash redemption amount otherwise payable upon redemption pursuant to the partnership agreement, or (ii) the amount the limited partners would have received had the limited partners exercised their redemption rights and sold, tendered or exchanged the shares of our common stock issuable upon such redemption in the change of control transaction.

Complying with REIT requirements may cause us to forego attractive opportunities that could otherwise generate strong risk-adjusted returns and instead pursue less attractive opportunities, or none at all.

To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to

our stockholders and the ownership of our stock. Thus, compliance with the REIT requirements may hinder our ability to operate solely on the basis of generating strong risk-adjusted returns on invested capital for our stockholders.

Complying with REIT requirements may force us to liquidate otherwise attractive investments, which could result in an overall loss on our investments.

To qualify as a REIT, we must also ensure that at the end of each calendar quarter at least 75% of the value of our assets consists of cash, cash items, government securities and qualified REIT real estate assets. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer, and no more than 20% of the value of our total securities can be represented by securities of one or more taxable REIT subsidiaries. If we fail to comply with these requirements at the end of any calendar quarter, we must correct such failure within 30 days after the end of the calendar quarter to avoid losing our REIT status and suffering adverse tax consequences. As a result, we may be required to liquidate otherwise attractive investments.

Changes in the tax laws governing the tax rates of dividend income could make our common stock less attractive to investors and reduce the market price of our common stock.

At any time, the federal income tax laws governing REITs or the administrative interpretations of those laws may be amended. Any of those new laws or interpretations may take effect retroactively and could adversely affect us or you as a stockholder. On May 28, 2003, the President signed the Jobs and Growth Tax Relief Reconciliation Act of 2003, which we refer to as the Jobs and Growth Tax Act. Effective for taxable years beginning after December 31, 2002, and before January 1, 2009, the Jobs and Growth Tax Act generally reduced the maximum rate of tax applicable to individuals, trusts and estates on dividend income from regular C corporations to 15.0%. This reduced substantially the so called “double taxation” (that is, taxation at both the corporate and stockholder levels) that has generally applied to corporations that are not taxed as REITs. Generally, dividends from REITs do not qualify for the dividend tax reduction because, as a result of the dividends paid deduction to which REITs are entitled, REITs generally do not pay corporate level tax on income that they distribute to stockholders. As a result of the Jobs and Growth Tax Act, individual, trust, and estate investors could view stocks of non REIT corporations as more attractive relative to shares of REITs than was the case previously because the dividends paid by non REIT corporations are subject to lower tax rates for such investors.

Provisions of our charter may limit the ability of a third party to acquire control of our company.

Aggregate Share and Common Share Ownership Limits

Our charter provides that no person may directly or indirectly own more than 9.9% of the value of our outstanding shares of stock or more than 9.9% of the number of our outstanding shares of common stock. These ownership limitations may prevent an acquisition of control of our company by a third party without our board of directors’ approval, even if our stockholders believe the change of control is in their interest. Our board of directors has discretion to waive that ownership limit if the board receives evidence that ownership in excess of the limit will not jeopardize our REIT status.

Authority to Issue Stock

Our amended and restated Charter authorizes our board of directors to issue up to 49,000,000 shares of common stock and up to 1,000,000 shares of preferred stock, to classify or reclassify any unissued shares of 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 transactions at a premium over the market price of our stock, even if stockholders believe that a change of control is in their interest. We will be able to issue additional shares of stock or preferred stock without stockholder approval, unless stockholder approval is required by applicable law or the rules of any stock exchange or automated quotation system on which our securities may be listed or traded.

Provisions of Maryland law may limit the ability of a third party to acquire control of our company.

Certain provisions of the Maryland General Corporation Law, or the MGCL, may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change of control under circumstances that otherwise could provide the holders of shares of our common stock with the opportunity to realize a premium over the then-prevailing market price of such shares, including:

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“business combination” provisions that, subject to limitations, prohibit certain business combinations between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of the voting power of our shares or an affiliate thereof) for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter imposes special appraisal rights and special stockholder voting requirements on these combinations; and

•

“control share” provisions that provide that “control shares” of our company (defined as shares which, when aggregated with other shares controlled by the stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares.

We have opted out of these provisions of the MGCL, in the case of the business combination provisions of the MGCL by resolution of our board of directors, and in the case of the control share provisions of the MGCL pursuant to a provision in our bylaws. However, our board of directors may by resolution elect to opt in to the business combination provisions of the MGCL and we may, by amendment to our bylaws, opt in to the control share provisions of the MGCL in the future.

Additionally, Title 8, Subtitle 3 of the MGCL permits our board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to implement takeover defenses, some of which (for example, a classified board) we do not yet have. These provisions may have the effect of inhibiting a third party from making an acquisition proposal for our company or of delaying, deferring or preventing a change in control of our company under the circumstances that otherwise could provide the holders of our common stock with the opportunity to realize a premium over the then current market price.

Our ownership limitations may restrict or prevent you from engaging in certain transfers of our common stock.

In order to maintain our REIT qualification, no more than 50% in value of our outstanding stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the federal income tax laws to include various kinds of entities) during the last half of any taxable year (other than the first year for which a REIT election is made). To preserve our REIT qualification, our charter contains a 9.9% aggregate share ownership limit and a 9.9% common share ownership limit. Generally, any shares of our stock owned by affiliated owners will be added together for purposes of the aggregate share ownership limit, and any shares of common stock owned by affiliated owners will be added together for purposes of the common share ownership limit.

If anyone transfers shares in a way that would violate the aggregate share ownership limit or the common share ownership limit, or prevent us from continuing to qualify as a REIT under the federal income tax laws, those shares instead will be transferred to a trust for the benefit of a charitable beneficiary and will be either redeemed by us or

sold to a person whose ownership of the shares will not violate the aggregate share ownership limit or the common share ownership limit. If this transfer to a trust fails to prevent such a violation or our continued qualification as a REIT, then we will consider the initial intended transfer to be null and void from the outset. The intended transferee of those shares will be deemed never to have owned the shares. Anyone who acquires shares in violation of the aggregate share ownership limit, the common share ownership limit or the other restrictions on transfer in our charter bears the risk of suffering a financial loss when the shares are redeemed or sold if the market price of our stock falls between the date of purchase and the date of redemption or sale.

The board of directors’ revocation of our REIT status without stockholder approval may decrease our stockholders’ total return.

Our charter provides that our board of directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interest to continue to qualify as a REIT. If we cease to be a REIT, we would become subject to federal income tax on our taxable income and would no longer be required to distribute most of our taxable income to our stockholders, which may have adverse consequences on our total return to our stockholders.

The ability of our board of directors to change our major corporate policies may not be in your interest.

Our board of directors determines our major corporate policies, including our acquisition, financing, growth, operations and distribution policies. Our board may amend or revise these and other policies from time to time without the vote or consent of our stockholders.

Our success depends on key personnel whose continued service is not guaranteed.

We depend on the efforts and expertise of our president and chief executive officer, Andrew Sims, and our executive vice president, chief financial officer and treasurer, William Zaiser, to manage our day-to-day operations and strategic business direction. The loss of any of their services could have an adverse effect on our operations.

Risks Related to the Offering

We cannot assure you that a public market for our common stock will develop.

Prior to the offering, there has not been a public market for our common stock and, even though we have applied for listing on the AMEX under the proposed symbol “MDH,” we cannot assure you that a regular trading market for the shares of common stock offered hereby 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 has been determined by us and the underwriters. We cannot assure you that the price at which the shares of common stock will sell in the public market after the closing of the offering will not 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 have historically been affected by changes in market interest rates. One of the factors that may influence the price of our common stock or preferred stock in public trading markets is the annual yield from distributions on our common stock or preferred stock as compared to yields on other financial instruments. An increase in market interest rates, or a decrease in our distributions to stockholders, may lead prospective purchasers of our stock to demand a higher annual yield, which could reduce the market price of our equity securities.

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

•

actual or anticipated variations in our quarterly results of operations;

•

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

•

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

•

fluctuations in stock market prices and volumes;

•

issuances of common stock or other securities in the future;

•

the addition or departure of key personnel; and

•

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

The number of shares available for future sale could cause our share price to decline.

Upon the completion of this offering, we will have 6,004,000 shares of common stock outstanding and 3,817,036 shares of common stock reserved for issuance upon redemption of units. We cannot predict whether future issuances of shares of our common stock or the availability of shares for resale in the open market will decrease the market price of our common stock. Sales of substantial numbers of shares of our common stock in the public market, or the perception that such sales might occur, could adversely affect the market price of our common stock.

The exercise of the underwriter’s over-allotment option, the redemption of units for common stock, portfolio or business acquisitions and other issuances of our common stock could have an adverse effect on the market price of our common stock. In addition, future issuances of our common stock may be dilutive to existing stockholders.

Investors in this offering will experience immediate and significant dilution in the book value per share.

The initial public offering price of our common stock is substantially higher than what our net tangible book value per share will be immediately after this offering. Purchasers of our common stock in this offering will incur immediate dilution of approximately $3.21 in net tangible book value per share of our common stock, based on the mid-point of the price range for the shares to be sold in this offering.

There are no assurances of our ability to make distributions in the future.

We intend to make quarterly distributions to our stockholders in amounts such that all or substantially all of our taxable income in each year, subject to certain adjustments, is distributed. This, along with other factors, should enable us to qualify for the tax benefits accorded to a REIT under the Internal Revenue Code. However, our ability to pay distributions may be adversely affected by the risk factors described in this prospectus. All distributions will be made at the discretion of our board of directors and will depend upon our earnings, our financial condition, maintenance of our REIT status and such other factors as our board of directors may deem relevant from time to time. There are no assurances of our ability to pay distributions in the future. In addition, some of our distributions may include a return of capital.

An increase in market interest rates may have an adverse effect on the market price of our securities.

One of the factors that investors may consider in deciding whether to buy or sell our securities is our dividend rate as a percentage of our share or unit price, relative to market interest rates. If market interest rates increase, prospective investors may desire a higher dividend or interest rate on our securities or seek securities paying higher dividends or interest. The market price of our common stock likely will be strongly affected by the earnings and return that we derive from our investments and income with respect to our properties and our related distributions to stockholders, and not from the market value or underlying appraised value of the properties or investments themselves. As a result, interest rate fluctuations and capital market conditions can affect the market price of our common stock. For instance, if interest rates rise without an increase in our

dividend rate, the market price of our common stock could decrease because potential investors may require a higher dividend yield on our common stock as market rates on interest-bearing securities, such as bonds, rise. In addition, rising interest rates would result in increased interest expense on our variable rate debt, thereby adversely affecting cash flow and our ability to service our indebtedness and pay dividends.

Upon completion of the offering and related formation transactions, Andrew Sims, our chief executive officer, William Zaiser, our chief financial officer, and Christopher and Kim Sims, who will become directors upon completion of the offering and their affiliates and family members, will beneficially own units which represent an aggregate of approximately 29.2% of the equity interests in us. Accordingly, our officers, directors, their affiliates and family members may 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 the determination of our day-to-day corporate and management policies. In addition, Andrew Sims, Christopher Sims, Kim Sims and William Zaiser may be able to exercise significant control over the outcome of any proposed merger or consolidation of our company through their roles as our directors and executive officers and through the supermajority voting requirement for these types of transactions set forth in our limited partnership agreement, which would also require the affirmative vote of the holders of a majority of the outstanding shares of our common stock. Their ownership interest in our company may discourage third parties from seeking to acquire control of our company at a premium to the then current market price of our common stock.

Future offerings of debt securities or preferred stock, which would be senior to our common stock upon liquidation and for the purposes of distributions, may cause the market price of our common stock to decline.

In the future, we may attempt to increase our capital resources by making additional offerings of debt or equity securities, including commercial paper, medium-term notes, senior or subordinated notes and classes of preferred stock or common stock. We will be able to issue additional shares of stock or preferred stock without stockholder approval, unless stockholder approval is required by applicable law or the rules of any stock exchange or automated quotation system on which our securities may be listed or traded. Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. Holders of our common stock are not entitled to preemptive rights or other protections against dilution. Preferred stock and debt, if issued, could have a preference on liquidating distributions or a preference on dividend or interest payments that could limit our ability to make a distribution to the holders of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock and diluting their interest.

Because the number of units we will issue to our officers and directors and their affiliates in the formation transactions is fixed, any increase in the offering price will increase the value of their consideration.

The number of units we will issue in the formation transactions to our officers and directors and their affiliates is fixed. Therefore, if the offering price increases, the value of the consideration received by these officers, directors and affiliates will also increase.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

We make forward-looking statements in this prospectus that are subject to risks and uncertainties. These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. Statements regarding the following subjects are forward-looking by their nature:

•

our business and investment strategy;

•

our forecasted operating results;

•

completion of any pending or future transactions;

•

our ability to obtain future financing arrangements;

•

our understanding of our competition;

•

market and industry trends;

•

projected capital expenditures; and

•

use of the proceeds of the offering.

The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statement. You should carefully consider this risk when you make an investment decision concerning our common stock. Additionally, the following factors could cause actual results to vary from our forward-looking statements:

•

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

•

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

•

changes in our business or investment strategy;

•

availability, terms and deployment of capital;

•

availability of and our ability to retain qualified personnel;

•

changes in our industry and the markets in which we operate, interest rates or the general U.S. or international economy; and

•

the degree and nature of our competition.

When we use the words “will likely result,” “may,” “anticipate,” “estimate,” “should,” “expect,” “believe,” “intend” or similar expressions, we intend to identify forward-looking statements. You should not place undue reliance on these forward-looking statements. We are not obligated to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

MARKET DATA

Market data and forecasts used in this prospectus have been obtained from independent industry sources as well as from research reports prepared for other purposes, including market information compiled by Smith Travel Research. Smith Travel Research, a Tennessee-based lodging and travel research firm, among other things, provides research reports and forecasts on the performance of the lodging and travel industry. We have not independently verified the data obtained from these sources. Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and the additional uncertainties regarding the other forward-looking statements in this prospectus.

USE OF PROCEEDS

We will contribute the net proceeds to our operating partnership. Our operating partnership intends to subsequently use the net proceeds received from us as follows:

•

approximately $25.1 million to repay the outstanding indebtedness on three of our initial properties as follows:

•

approximately $12.2 million to fund the acquisition of the Maryland Inn in Laurel, Maryland and approximately $3.9 million for the subsequent renovation of the hotel;

•

approximately $4.1 million to fund renovation and to pay closing costs and $1.8 million to fund the cash portion of the purchase of the Hilton Philadelphia Airport;

•

approximately $0.5 million to fund renovations at the Holiday Inn Downtown Williamsburg;

•

$3.5 million to fund the acquisition of the leasehold interests in the resort property;

•

$1.0 million to fund the cash portion of the acquisition of the Holiday Inn Brownstone;

•

$2.0 million to MHI Hotels Services in consideration of the amendment and restructuring of existing management agreements relating to five of our initial hotel properties; and

•

approximately $0.4 million for general corporate and working capital purposes.

Our agreements to acquire the initial hotel properties are subject to customary closing conditions and contingencies, and no assurances can be given that these acquisitions will occur. The obligations of the contributing entities under the contribution agreements to transfer the initial hotel properties to us are conditioned upon completion of this offering, payment of the consideration described above and other customary conditions, including receipt of third party consents, approval of the franchisors, execution of indemnity agreements, the operating partnership agreement and assignment agreements. The contribution agreements relating to the Holiday Inn Brownstone and Hilton Philadelphia Airport also provide for the repayment of debt. The sale agreement relating to the Maryland Inn is conditioned upon the receipt of third party consents. In the event that we do not close the acquisition of one or more of the initial hotel properties, the offering proceeds allocated to these acquisitions will be available to fund future lodging-related investments and for general corporate and working capital purposes.

CAPITALIZATION

The following table sets forth the historical capitalization, as of June 30, 2004, of MHI Hotels Services Group, our accounting predecessor that owns four of the initial hotels. The pro forma column reflects our capitalization, as of June 30, 2004, after giving effect to the contribution of the four initial hotel properties (the Hilton Savannah DeSoto, the Hilton Wilmington Riverside, the Holiday Inn Downtown Williamsburg and the Holiday Inn Brownstone) and the historical results of the other two initial hotel properties (Hilton Philadelphia Airport and Maryland Inn). The pro forma as adjusted column reflects our capitalization, as of June 30, 2004, after giving effect to (i) the sale of 6,000,000 shares of our common stock at the offering price of $10.00 per share, which is the mid-point of the range set forth on the cover page of this prospectus, (ii) after deducting the underwriting discount and estimated expenses payable by us in connection with this offering and (iii) the application of the net proceeds of the offering as described in “Use of Proceeds.”

This table should be read in conjunction with the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Formation Transactions” and “Use of Proceeds” and our historical and unaudited pro forma financial information and related notes included elsewhere in this prospectus.


	As of June 30, 2004
	MHI Hotels Services Group (Predecessor Group)		Pro Forma ⁽¹⁾			Pro Forma As Adjusted ⁽¹⁾⁽²⁾

Long-term debt (including current portion)	$	33,938,027	$	56,197,120		$	25,879,773

Minority interest in operating partnership		—		—			27,922,499

Stockholders’ equity:
Preferred stock, $.01 par value, 1,000,000 shares authorized, no shares issued and outstanding		—		—			—
Common stock, $.01 par value, 9,000,000 shares authorized, 6,004,000 shares issued and outstanding, after offering ⁽¹⁾ ⁽³⁾		—		—			60,040
Minority Interest		500,392		500,392			—
Equity of Contributing Members/Owners		304,515		(5,054,279	)		—
Common stock		—		1,000			—
Additional paid-in capital		—		586,990			43,797,665

Total stockholders’ equity		804,907		(3,965,897	)		43,857,705

Total capitalization	$	34,742,934	$	52,231,223		$	97,659,977

⁽¹⁾	Does not include 3,817,036 shares of common stock issuable upon redemption of units issued as consideration for the acquisition of certain of our initial hotels.

⁽²⁾	We expect to use approximately $25.1 million of the net proceeds of the offering to repay outstanding debt on three of the initial properties.

⁽³⁾	As of the date of this prospectus, 100 shares of our common stock were issued and outstanding, all of which were owned by Andrew Sims, which shares will be cancelled upon completion of this offering.

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 Internal Revenue Code; less

•

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

See “Material Federal Income Tax Considerations.”

We intend to commence making distributions to our stockholders after the first full calendar quarter following consummation of this offering.

The timing, frequency and amount of distributions will be authorized by our board of directors and declared by us based upon a number of factors, including:

•

actual results of operations;

•

the timing of the investment of the proceeds of the offering;

•

debt service requirements;

•

capital expenditure requirements for our properties;

•

our taxable income;

•

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

•

our operating expenses; and

•

other factors that our board of directors may deem relevant.

Our ability to make distributions to our stockholders will depend, in part, upon our receipt of distributions from our operating partnership, MHI Hospitality, L.P., which may depend upon receipt of lease payments from our TRS Lessee, and, in turn, upon the management of our hotel properties by MHI Hotels Services, who will be engaged to operate our hotels. Distributions to our stockholders will generally be taxable to our stockholders as ordinary income; however, because a 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. To the extent not inconsistent with maintaining our REIT status, our TRS, MHI TRS, may retain any after-tax earnings. For more information, see “Material Federal Income Tax Considerations—Taxation of our Company.”

DILUTION

The initial price per share to the public of the common stock offered under this prospectus exceeds the net tangible book value per share of our common stock immediately after this offering, but assuming no exercise of the underwriters’ over-allotment option. As a result, the holders of units issued in connection with the formation transactions will receive an immediate increase in the net tangible book value of their units, while purchasers of common stock in the offering will realize an immediate dilution in the net tangible book value of their shares. Pro forma net tangible book value per share is determined by subtracting our total liabilities from our total tangible assets and dividing the remainder by the number of shares of common stock and units that will be outstanding after the offering. Dilution is determined by subtracting pro forma net tangible book value per share after giving effect to the formation transactions and this offering from $10.00, the assumed initial public offering price per share, at the mid-point of the price range for this offering, before deducting the underwriter’s discount and estimated expenses of the offering. Net tangible book value per unit before the offering is determined by dividing tangible book value of approximately $(4.5) million (total tangible assets less total liabilities), as adjusted to reflect completion of our formation transactions, by 3,817,036 units issuable in the formation transactions. The following table illustrates the dilution to purchasers of shares sold in the offering, based on an assumed initial public offering price of $10.00 per share, which is the assumed mid-point of the offering range of our common stock.


Initial price per share to the public	$	10.00
Pro forma net tangible book value per unit before the offering	$	(1.17	)
Increase in net tangible book value per share and unit attributable to the offering and the formation transactions	$	7.96
Pro forma net tangible book value per share and unit after the offering(1)	$	6.79
Dilution in pro forma net tangible book value per share to new investors	$	3.21

⁽¹⁾	Based on the pro forma combined balance sheet contained elsewhere in this prospectus and assumes that 6,004,000 shares of common stock and 3,817,036 operating partnership units will be outstanding immediately after consummation of this offering and the formation transactions.

SELECTED FINANCIAL DATA

MHI Hospitality Corporation was formed in August 2004 and has no operating history. The following table sets forth selected historical combined operating and financial data for the entities that comprise the accounting predecessor to the business of MHI Hospitality Corporation. This information represents the collective historical combined financial condition and results of operations of the entities that own four of the six initial hotel properties, and is derived from the combined financial statements of Capitol Hotel Associates, LP, LLP, Savannah Hotel Associates, LLC, and Brownestone Partners LLC, collectively referred to as our predecessor entities and presented elsewhere in this prospectus as the financial statements of MHI Hotels Services Group. The four initial hotel properties, which consist of the Holiday Inn Downtown Williamsburg, the Holiday Inn Brownstone, the Hilton Wilmington Riverside and the Hilton Savannah DeSoto, are owned by MHI Hotels Services Group. The following selected historical combined financial data as of December 31, 2003 and 2002 and for each of the years in the three-year period ended December 31, 2003 were derived from audited combined financial statements contained elsewhere in this prospectus. These financial statements have been audited by Witt Mares & Company, PLC our independent registered public accounting firm. The selected historical combined financial data presented below as of and for the six months ended June 30, 2004 are derived from the unaudited financial statement of MHI Hotels Services Group. The following selected historical combined financial data as of December 31, 2001, 2000 and 1999 and for each of the years ending December 31, 2000 and 1999 were derived from unaudited financial statements that are not contained in this prospectus. The audited and unaudited historical combined financial statements include all adjustments, consisting of normal recurring adjustments, which we consider necessary for a fair presentation of our financial condition and the results of operations as of those dates and for those periods under accounting principles generally accepted in the United States.

The following selected pro forma financial and operating data includes consolidated pro forma financial information to reflect adjustments relating to the formation transactions. The unaudited pro forma statement of operations data for the year ended December 31, 2003 are presented as if the formation transactions, this offering and the application of the net proceeds from this offering had occurred on January 1, 2003. The unaudited pro forma statement of operations data for the six months ended June 30, 2004 are presented as if the formation transactions, this offering and the application of the net proceeds from this offering had occurred on January 1, 2004. The unaudited pro forma balance sheet data as of June 30, 2004 are presented as if the formation transactions, this offering and the application of the net proceeds of this offering had occurred on June 30, 2004.

The historical financial information for our predecessor entities included herein and set forth elsewhere in this prospectus are not necessarily indicative of our future performance. In addition, because the information presented below is only a summary and does not provide all of the information contained in our financial statements and those of our predecessor entities, including notes, you should read the following selected historical combined and pro forma consolidated financial and operating data together with “Unaudited Pro Forma Financial Information,” “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. Proforma information has been compiled from historical financial and other information, but does not purport to represent what our financial position or results of operations actually would have been had the formation transactions of this offering and repayment of debt in connection with the application of the net proceeds this offering occurred on the dates indicated, or, purport to project our financial position or results of operations for any future date or period.

SELECTED HISTORICAL AND PRO FORMA FINANCIAL DATA


	MHI Hospitality Corporation						MHI Hotels Services Group (Predecessor Group)
	Pro Forma for						Historical for the Years Ended December 31
	Year Ended December 31, 2003			Six Months Ended June 30, 2004			1999			2000			2001			2002			2003
*Statement of Operations*
Operating Income
Total Revenues	$	44,566,587		$	24,236,289		$	25,484,152		$	28,053,344		$	28,078,110		$	28,521,527		$	29,186,188
Total Operating Expenses excluding depreciation & amortization		(36,324,518	)		(19,022,712	)		(20,829,544	)		(22,366,551	)		(22,886,147	)		(23,002,020	)		(23,803,340	)
Depreciation & amortization ⁽²⁾		(4,530,798	)		(2,145,296	)		(2,200,680	)		(2,645,616	)		(2,711,124	)		(2,699,925	)		(2,578,297	)

Net Operating Income		3,711,271			3,068,281			2,453,928			3,041,177			2,480,839			2,819,582			2,804,551

Adjustments to Operating Income
Interest Income		13,152			430			—			—			105,575			33,584			13,152
Interest Expense		(2,168,318	)		(1,053,612	)		(2,832,360	)		(3,200,254	)		(3,046,309	)		(2,881,263	)		(2,697,793	)
Other Income—net		(16,456	)		—			(8,279	)		(25,295	)		(690,106	)		—			(2,313	)
Minority Interest		(598,923	)		(783,874	)		238,587			240,029			681,282			147,202			77,809

Net Income (loss)	$	940,726		$	1,231,225		$	(148,124	)	$	55,657		$	(468,719	)	$	119,105		$	195,406

*Statement of Cash Flows*
Cash from Operations—net	$	(7,502,239	)	$	4,042,225		$	3,530,234		$	1,127,299		$	4,117,978		$	2,161,828		$	3,350,564
Cash from (used in) Investing—net		(27,190,208	)		(850,757	)		(8,725,286	)		(1,698,185	)		(2,936,253	)		(1,809,355	)		(1,408,699	)
Cash from (used in) Financing—net		36,653,549			(1,081,526	)		4,880,311			505,716			(7,058	)		(691,703	)		(2,028,881	)

Net Increase (Decrease) in Cash Flow	$	1,961,102		$	2,109,942		$	(314,741	)	$	(65,170	)	$	1,174,667		$	(339,230	)	$	(87,016	)

*Balance Sheet*
Total Assets ⁽¹⁾		100,933,111			104,324,453			41,895,152			40,970,038			42,490,481			39,970,331			38,231,181
Total Long-Term Debt Including Current Portion ⁽¹⁾		26,587,594			25,879,773			38,740,366			37,922,132			39,588,102			38,402,567			34,989,381
Total Current and Long-Term Liabilities ⁽¹⁾		31,448,008			32,544,249			42,968,863			41,853,872			44,436,817			42,372,667			38,340,219
Minority Interest ⁽¹⁾		27,029,706			27,922,499			89,281			(128,247	)		(769,219	)		(754,231	)		327,263
Total Owners' Equity (deficit) ⁽¹⁾		42,455,399			43,857,705			(1,162,992	)		(755,587	)		(1,177,117	)		(1,648,105	)		(436,301	)
*Operating Data*
Number of Rooms ⁽¹⁾		1,381			1,381			845			845			845			845			845
Number of Room Nights Annually		504,795			251,706			289,126			309,270			308,425			308,425			308,425
Occupancy Percent ⁽²⁾		64.4	%		72.7	%		63.0	%		62.4	%		64.5	%		64.9	%		66.0	%
Average Daily Rate (ADR) ⁽²⁾	$	89.45		$	89.72		$	95.07		$	93.23		$	90.68		$	93.31		$	93.06
RevPAR ⁽²⁾	$	58.29		$	65.40		$	59.92		$	59.33		$	60.33		$	60.55		$	61.42
*Additional Financial Data*
FFO ⁽³⁾	$	6,086,903		$	4,160,395		$	1,822,248		$	2,486,539		$	2,251,229		$	2,671,828		$	2,698,207

(1)	As of the period end.

(2)

Average Daily Rate, ADR, is calculated by dividing the total daily room revenue by the total daily number of rooms sold. Revenue Per Available Room, RevPAR, is calculated by dividing the total daily room revenue by the total daily number of rooms available. Occupancy Percent is calculated by dividing the total daily number of rooms sold by the total daily number of rooms available.

(3)

Funds from Operations, FFO, is used by industry analysts and investors as a supplemental operating performance measure of an equity REIT. FFO is calculated in accordance with the definition that was adopted by the Board of Governors of the National Association of Real Estate Investment Trusts, NAREIT. FFO, as defined by NAREIT, represents net income or loss determined in accordance with GAAP, excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated operating real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after adjustment for any minority interest from unconsolidated partnerships and joint ventures. Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by itself. Thus, NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from GAAP net income. Management believes that the use of FFO, combined with the required GAAP presentations, has improved the understanding of the operating results of REITs among the investing public and made comparisons of REIT operating results more meaningful. Management considers FFO to be a useful measure of adjusted net income (loss) for reviewing comparative operating and financial performance because we believe FFO is most directly comparable to net income (loss), which remains the primary measure of performance, because by excluding gains or losses related to sales of previously depreciated operating real estate assets and excluding real estate asset depreciation and amortization, FFO assists in comparing the operating performance of a company's real estate between periods or as compared to different companies. Although FFO is intended to be a REIT industry standard, other companies may not calculate FFO in the same manner as

we do, and investors should not assume that FFO as reported by us is comparable to FFO as reported by other REITs. Below is a reconciliation of FFO to net income (loss).


	Pro Forma for
	Twelve Months Ended		Six Months Ended		Historical for the Years Ended December 31
	December 31, 2003		June 30, 2004		1999			2000			2001			2002			2003
Reconciliation of FFO
Net income (loss)	$	940,726	$	1,231,225	$	(148,124	)	$	55,657		$	(468,719	)	$	119,105		$	195,406
add back minority interest		598,923		783,874		(238,587	)		(240,029	)		(681,282	)		(147,202	)		(77,809	)
add back depreciation & amortization		4,530,798		2,145,296		2,200,680			2,645,616			2,711,124			2,699,925			2,578,297
add back loss (gain) on disposal of assets		16,456		—		8,279			25,295			690,106			—			2,313

FFO	$	6,086,903	$	4,160,395	$	1,822,248		$	2,486,539		$	2,251,229		$	2,671,828		$	2,698,207

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of financial condition, results of operations, liquidity and capital resources in conjunction with our combined historical financial statements and the related notes. The notes to the combined financial statements provide additional information about us and the basis of presentation used in this prospectus.

Overview

We are a Maryland corporation that was formed in August 2004 to pursue current and future opportunities in the full-service, Upper Upscale, Upscale and Midscale segments of the hotel industry. We intend to be self-advised and to own our hotels and conduct our business through our operating partnership, MHI Hospitality, L.P. Upon consummation of the formation transactions and the closing of this offering, we will be the sole general partner of our operating partnership and we initially will own an approximate 61.1% interest in our operating partnership, with the remaining interest initially being held by the contributors of our initial properties as limited partners. We also intend to elect to be treated as a REIT for federal income tax purposes.

Upon consummation of the formation transactions, our portfolio will consist of six full-service, Upper Upscale and Midscale hotels. We will acquire a 100% interest in all of our initial hotels. Based on an assumed offering price of $10.00 per share, the aggregate consideration to be paid for 100% of the interests in five of the initial hotels (excluding the Maryland Inn) is valued at $94.4 million, including the assumption of $50.8 million of consolidated debt. In accordance with generally accepted accounting principles, we are using the carryover basis for the majority interest in the hotels acquired from third parties. We expect to use $25.1 million of proceeds of the offering to retire the debt on the Holiday Inn Brownstone, the Hilton Philadelphia Airport and the Holiday Inn Downtown Williamsburg. We will acquire the Maryland Inn for approximately $12.0 million in cash. In addition, we will acquire leasehold interests in common areas and restaurant areas the Shell Island Resort, Wrightsville Beach, North Carolina for $3.5 million in cash and will pay $2.0 million in cash to restructure existing management agreements relating to five of our initial properties. See “Our Business and Properties –Our Initial Properties.”

In the hotel industry, most categories of operating costs, with the exception of franchise, management, and credit card fees and the costs of the food and beverages served, do not vary directly with revenues. This aspect of our operating costs creates operating leverage, whereby changes in sales volume disproportionately impacts operating results. Room revenue is the most important category of revenue and drives other revenue categories such as food and beverage and telephone. There are three key performance indicators used in the hotel industry to measure room revenues:

•

Occupancy, or the number of rooms sold, usually expressed as a percentage of total rooms available;

•

Average daily rate or ADR, which is total room revenue divided by the number of rooms sold; and

•

Revenue per available room or RevPAR, which is the room revenue divided by the total number of available room nights.

To qualify as a REIT, we cannot operate hotels. Therefore, our operating partnership will lease our hotel properties to our TRS Lessee. Our TRS Lessee will engage MHI Hotel Services to manage our hotels. Our TRS Lessee, and its parent, MHI TRS, will be consolidated into our financial statements for accounting purposes. Since both our operating partnership and MHI TRS are controlled by us, our principal source of funds on a consolidated basis will be from the operations of our hotels. The earnings of MHI TRS will be subject to taxation similar to other regular C corporations.

The discussion below relates to the consolidated financial condition and results of operations of our accounting predecessor company, MHI Hotels Services Group, which consists of the Hilton Savannah DeSoto, the Hilton Wilmington Riverside, the Holiday Inn Brownstone and the Holiday Inn Downtown Williamsburg. These four initial hotels were owned and operated by us on a combined basis. For the purposes of the following discussion, references to “we”, “us”, and “our” refer to MHI Hotels Services Group, our accounting predecessor. All significant intercompany accounts and transactions have been eliminated. The combined historical financial statements presented herein were prepared in accordance with GAAP.

Critical Accounting Policies

The critical accounting policies are described below. We consider these policies critical because they involve difficult management judgments and assumptions, are subject to material change from external factors or are pervasive, and they are significant to fully understand and evaluate our reported financial results.

Investment in Hotel Properties . Hotel properties are stated at cost, net of any impairment charges, and are depreciated using the straight-line method over an estimated useful life of 7-39 years for buildings and 3-10 years for furniture and equipment.

We review our hotel properties for impairment whenever events or changes in circumstances indicate the carrying value of the hotel properties may not be recoverable. Events or circumstances that may cause us to perform our review include, but are not limited to adverse changes in the demand for lodging at our properties due to declining national or local economic conditions and/or new hotel construction in markets where our hotels are located. When such conditions exist, management performs an analysis to determine if the estimated undiscounted future cash flows from operating activities and the proceeds from the ultimate disposition of a hotel property exceed its carrying value. If the estimated undiscounted future cash flows are less than the carrying amount of the asset, an adjustment to reduce the carrying value to the related hotel property’s estimated fair market value is recorded and an impairment loss is recognized.

There have been no charges for impairment recorded in 2003, 2002 or 2001.

We estimate the fair market values of our properties through cash flow analysis taking into account each property’s expected cash flow generated from operations, holding period and expected proceeds from ultimate disposition. These cash flow analyses are based upon significant management judgments and assumptions including revenues and operating costs, growth rates and economic conditions at the time of ultimate disposition. In projecting the expected cash flows from operations of the asset, we base our estimates on future projected net operating income before depreciation and eliminating non-recurring operating expenses, which is a non-GAAP operational measure, and deduct expected capital expenditure requirements. We then apply growth assumptions based on estimated changes in room rates and expenses and the demand for lodging at our properties, as impacted by local and national economic conditions and estimated or known future new hotel supply. The estimated proceeds from disposition are determined as a matter of management’s business judgment based on a combination of anticipated cash flow in the year of disposition, terminal capitalization rate, ratio of selling price to gross hotel revenues and selling price per room.

If actual conditions differ from those in our assumptions, the actual results of each asset’s operations and fair market value could be significantly different from the estimated results and value used in our analysis.

Revenue Recognition . Hotel revenues, including room, food, beverage and other hotel revenues, are recognized as the related services are delivered. We generally consider accounts receivable to be fully collectible; accordingly, no allowance for doubtful accounts is required. If we determine that amounts are uncollectible, which would generally be the result of a customer’s bankruptcy or other economic downturn, such amounts will be charged against operations when that determination is made.

Recent Accounting Pronouncements

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.” SFAS No. 145 amends existing guidance on reporting gains and losses on the extinguishments of debt to prohibit the classification of the gain or loss as extraordinary, as the use of such extinguishments have become part of the risk management strategy of many companies. SFAS No. 145 also amends SFAS No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback transactions. The provisions of the Statement related to the rescission of Statement No. 4 is applied in fiscal years beginning after May 15, 2002. The provisions of the Statement related to the rescission of Statement No. 13 were effective for transactions occurring after May 15, 2002. Management adopted SFAS No. 145 as of May 15, 2022 and it has no material effects on the financial statements.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities (revised), an Interpretation of ARB No. 51, Consolidated Financial Statements.” FIN 46(R) revises the requirements for consolidation by business enterprises of variable business entities with specific characteristics. FIN 46(R) is effective immediately for variable interests created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. For nonpublic entities, such as the Group, with a variable interest in a variable interest entity created before February 1, 2003, the Interpretation is applied to the enterprise no later than the end of the first annual reporting period beginning after June 30, 2003. Management adopted FIN 46(R) as of January 1, 2003. The application of this Interpretation is not expected to have a material effect on the group’s financial statements. The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that the Group will consolidate or disclose information about variable interest entities when the Interpretation becomes effective. The Group does not believe that it is reasonably possible that the adoption of FIN 46(R) will result in the consolidation of any of its equity investees in the future.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which clarifies certain implementation issues raised by constituents and amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” to include the conclusions reached by the FASB on certain FASB Staff Implementation issues; amends SFAS No. 133’s discussion of financial guarantee contracts and the application of the shortcut method to an interest rate swap agreement that includes an embedded option and amends other pronouncements. The guidance in SFAS No. 149 is effective for new contracts entered into or modified after June 30, 2003 and for hedging relationships designated after that date. Management adopted SFAS No. 149 as of July 1, 2003 and it has had no material effect on the financial statements.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with the Characteristics of both Liabilities and Equity.” This statement requires the classification of certain financial instruments, previously classified within the equity section of the balance sheet, to be included in liabilities. This statement is effective for financial instruments entered into or modified after May 31, 2003 and June 15, 2003 for all other instruments. The FASB subsequently deferred indefinitely the provisions of SFAS No. 150 which apply to mandatorily redeemable non-controlling minority interests in consolidated entities. Management adopted FASB No. 150 as of July 1, 2003 and it has had no material effect on the financial statements.

Results of Operations of the MHI Hotels Services Group

Overview . In the first half of 2004, the hotel industry began to recover from a challenging year in 2003. In 2003, travel in general, and the hospitality industry, were affected by a number of factors, including the war in Iraq, intermittently raised terror alert levels as well as an overall weak economy.

Comparison of the Six Months Ended June 30, 2004 to the Six Months Ended June 30, 2003

For the Six Month Period

Ended

June 30, 2004

Ended

June 30, 2003

Variance

% Change

ADR

99.42

94.93

4.49

4.7

RevPAR

68.00

63.25

4.75

7.5

Occupancy %

68.4

66.6

1.8

2.7

Room Revenue

10,447,519

9,669,240

778,279

8.0

Food and Beverage Revenue

4,853,244

4,604,168

249,076

5.4

Total Operating Revenue

15,812,779

14,766,182

1,046,597

7.1

Depreciation and Amortization

1,269,145

1,263,380

5,765

0.5

Total Operating Expenses

13,655,678

12,972,161

683,517

5.3

Net Operating Income

2,157,101

1,794,021

363,080

20.2

Interest Expense

1,252,751

1,386,091

(133,340

)

(9.6

Net Income

736,229

351,730

384,499

109.3

Revenues . Total operating revenue increased $1.0 million from $14.8 million in the first half of 2003 to $15.8 million in the first half of 2004. Of this $1.0 million increase, approximately $0.8 million was attributable to room revenue and $0.2 million was attributable to food and beverage revenue. Room revenue increased 14.5% in the Hilton Savannah DeSoto, 7.9% in the Hilton Wilmington Riverside and 7.2% in the Holiday Inn Brownstone. Room revenue for the Holiday Inn Downtown Williamsburg decreased 15.0% due to a weak local market in 2004, a decline in demand from military reservists training at nearby military installations due to the Iraqi situation and a reorganization and change of emphasis in the sales department of the hotel. With many military reservists serving overseas, the Holiday Inn Downtown Williamsburg sales team has refocused on other group business such as bus tours and student groups. We expect that in the event of a reduction in the number of military reservists serving abroad, the Holiday Inn Downtown Williamsburg will benefit from demand generated by an increase in military reservists training at local military installations. The food and beverage revenue increase is attributable to a 16.5% increase in food and beverage sales in the Hilton Savannah DeSoto. Collectively, the remaining hotels have had flat food and beverage sales.

Over the past few years, our general operating strategy has been to maintain ADR and occupancy for the entire portfolio, rather than reducing ADR in order to maintain or increase occupancy. The rationale for our strategy was to position our properties for future growth in ADR upon an expected rebound in the economy and hospitality markets.

As a result, portfolio ADR for the first half of 2004 was up $4.49 at $99.42 as compared to $94.93 in the first half of 2003. Occupancy increased 1.8 percentage points from 66.6% to 68.4%. Portfolio RevPAR grew 7.5% during the first half of 2004 to $68.00 from $63.25 in the same period in 2003.

Operating Expenses . Total operating expenses increased by $0.7 million, or 5.3%, from $13.0 million in the first half of 2003 to $13.7 million in the same period of 2004. Although energy costs rose slightly, the majority of

the increase was due to expense items such as franchise management, credit card fees, sales bonuses, and food and beverage costs that vary directly with volume of revenues.

Depreciation and Amortization Expense. Depreciation and amortization expense remained at 2003 levels for the same period in 2004.

Operating Income . Net operating income, increased by 20.2% from $1.8 million in the first half of 2003 to $2.2 million in the first half of 2004.

Interest Expense . Interest expense decreased $133,000, or 9.6%, in the first half of 2004 from the first half of 2003 due to stable interest rates and a declining principal balance on outstanding debt.

Net Income . Net income after depreciation increased 109.3% in the first half of 2004 from $351,000 in the first half of 2003 to $736,000 in the same period in 2004.

Comparison of 2003 to 2002

For the Twelve-Month Period

Ended

December 31,
2003

Ended

December 31,
2002

Variance

% Change

ADR

93.06

93.31

(0.25

)

(0.3

RevPAR

61.42

60.55

0.87

1.5

Occupancy %

66.0

64.9

1.1

1.7

Room Revenue

18,942,658

18,676,756

265,902

1.4

Food and Beverage Revenue

9,265,350

8,800,274

465,076

5.3

Total Operating Revenue

29,186,188

28,521,527

664,661

2.3

Total Operating Expenses

26,381,636

25,701,945

679,691

2.6

Depreciation and Amortization

2,578,297

2,699,925

(121,628

)

(4.5

Net Operating Income

2,804,552

2,819,582

(150,030

)

(0.5

Interest Expense

2,697,793

2,884,263

(186,470

)

(6.5

Net Income

195,407

116,105

79,301

68.3

Overview . The hotel industry had a very challenging year in 2003. In addition, our hotel properties in Wilmington and Raleigh, North Carolina and Williamsburg, Virginia suffered significant revenue losses due to the impact of hurricane Isabel in the second half of 2003.

Revenues . Total operating revenue increased $0.7 million, or 2.3%, from $28.5 million in 2002 to $29.2 million in 2003. This increase was due primarily to $1.1 million in growth from the Hilton Wilmington Riverside, partially offset by a drop of $0.5 million at the Hilton Savannah DeSoto.

Room revenue on an aggregate basis for the year ended December 31, 2003 increased $0.3 million as compared to the year ended December 31, 2002. The Hilton Wilmington Riverside increased room revenue by $0.5 million despite losing $100,000 to Hurricane Isabel through group cancellations. Room revenue at the Hilton Savannah DeSoto declined $0.4 million due to a decision to pursue new business at a higher rate than groups and tour business.

ADR declined $0.25 or 0.2% while RevPAR increased approximately $0.90 or 1.5% for the same period. Occupancy increased 1.1 occupancy percentage points as compared to 2002.

Operating Expenses . Total operating expenses increased by $0.7 million, or 2.6%, from $25.7 million in 2002 to $26.4 million in 2003. This increase was primarily due to higher sales department costs of $0.6 million and higher food and beverage costs of $0.2 million. Food and beverage costs were driven by the increase of 5.3% in food and beverage business, while sales cost were driven by our attempts to find additional business in a challenging climate for the hotel market.

Depreciation and Amortization Expense . Depreciation and amortization expense decreased by approximately $121,000 or 4.5% for the year ended December 31, 2003 as compared to 2002 due to the absence of major capital expenditures.

Net Operating Income . Net operating income decreased 0.5% in 2003. Operating expenses incurred in connection with efforts to attract and maintain new business outstripped the increase in revenues. The sales effort failed to find significant new business to increase our room sales. The food and beverage effort was successful, but the margins on food and beverage sales are significantly lower than on hotel rooms. Hence overall net operating income was flat.

Interest Expense . Interest expense was essentially flat year over year ended December 31, 2003 declining approximately $186,000 from 2002 as favorable interest rates and declining principal balances decreased the interest expense. Both the Holiday Inn Downtown Williamsburg and the Holiday Inn Brownstone were refinanced in 2003, which are expected to have a positive effect on interest expense in 2004.

Net Income (Loss): In 2003, we posted a net gain of approximately $195,000 as compared to approximately $116,000 in 2002, a 68.3% increase.

Comparison of 2002 to 2001

For the Twelve-Month Period

Ended

December 31,
2002

Ended

December 31,
2001

Variance

% Change

ADR

93.31

93.38

(0.07

)

—

RevPAR

60.55

60.23

0.32

0.5

Occupancy %

64.9

64.5

0.4

0.6

Room Revenue

18,676,756

18,575,737

101,019

0.5

Food and Beverage Revenue

8,800,274

8,485,786

314,488

3.7

Total Operating Revenue

28,521,527

28,078,110

443,417

1.6

Total Operating Expenses

25,701,945

25,597,272

104,673

0.4

Depreciation and Amortization

2,669,925

2,711,124

(41,199

)

(1.5

Net Operating Income

2,819,582

2,480,838

338,744

13.7

Interest Expense

2,884,263

3,046,309

(162,046

)

(5.3

Net Income (Loss)

116,105

(468,720

)

584,825

n/a

Overview . The hotel business began slowing in the late Spring of 2001. This soft market collapsed in the Fall due to terrorist attacks in New York and Washington, D.C. Travel for the months of September through

December particularly in the New York and Washington, D.C. areas, including Williamsburg, Virginia, was severely impacted. The year 2002 showed a mild rebound from these trends, but hotel business overall remained a soft market. Generally, a soft market is illustrated by a stagnate growth market overall. Opportunities for growth are limited and can be sector specific. Markets become soft when the economy, and travel, in particular, declines.

Revenues . Hotel operating revenue increased by $443,000, or 1.6%. Increased revenues at the Holiday Inn Brownstone and Hilton Savannah DeSoto were offset by declines at Hilton Wilmington Riverside and Holiday Inn Downtown Williamsburg.

Operating Expenses . Net hotel operating expenses were virtually unchanged for the two periods. Strict expense controls and wage and hiring freezes were put in effect after September 11, 2001. The net effect for the two periods was to hold expenses increase to approximately $104,000 increase, or 0.4%.

Depreciation and Amortization Expense . Depreciation and amortization expense remained virtually unchanged in 2002, declining by approximately $41,200.

Operating Income . Net operating income increased by approximately $339,000 from $2.5 million in 2001 to $2.8 million in 2002.

Interest Expense . Interest expense decreased from $3.0 million for the year ended December 31, 2001 to $2.9 million in 2002. This decrease was due to stable or declining interest rates combined with declining principal balances.

Net Income (Loss ). In 2001, we posted a net loss of approximately $468,000, including approximately $690,000 of loss on disposal of assets. This compares to a net profit of approximately $116,000 in 2002.

Liquidity and Capital Resources

Sources and Uses of Cash . Recurring capital expenditures and debt service are the most significant short-term liquidity requirements. During the next 12 months, we expect capital expenditures will be funded by our replacement reserve accounts, other than costs that we may incur to make capital improvements required by the franchisors as a condition of their consent to the transfer of the hotels in conjunction with the formation transactions. The capital reserve accounts are escrowed funds deposited monthly, (5% of gross sales), and reserved for capital projects. The Hilton Savannah DeSoto and Hilton Wilmington Riverside have these reserve accounts as a condition of the mortgages held by Mutual of New York. Our intent for the capital reserve accounts at other hotels is an overall blended rate of 4% of gross revenue. We intend to use approximately $7.9 million of the proceeds of the offering to fund renovations and capital improvements at three of the initial hotels.

We expect to fund our short-term liquidity requirements, including working capital, through a combination of cash flows from operating activities and borrowings under a $23.0 million secured revolving line of credit that we expect to enter into following the closing of this offering. However, there can be no assurance that we will be able to obtain such a credit facility on favorable terms or at all. Debt service requirements on our borrowings will reduce our cash flows. The offering and related restructuring of existing management agreements and execution of a new management agreement with lower management fees will reduce historical debt service payments, management fees and lease payments and, consequently, improve cash flow and liquidity. On a pro forma basis, the new management fees would have positively impacted cash flow by $425,000 for the year ended December 31, 2003, and $225,000 for the six months ended June 30, 2004. On a pro forma basis, there is no significant impact on cash flow from franchise related fees.

Our long-term liquidity needs will generally include the funding of future acquisitions and development activity, the retirement of mortgage debt and amounts outstanding under our secured line of credit, and

obligations under our tax indemnity agreements, if any. We remain committed to maintaining a flexible capital structure. Accordingly, in addition to the sources described above with respect to our short-term liquidity, we expect to meet our long-term liquidity needs through a combination of some or all of the following:

•

The issuance by the operating partnership of secured and unsecured debt securities;

•

The issuance of additional shares of our common stock or preferred stock;

•

The issuance of additional units;

•

The selective disposition of non-core assets; or

•

The sale or contribution of some of our wholly owned properties, development projects and development land to strategic joint ventures to be formed with unrelated investors, which would have the net effect of generating additional capital through such sale or contributions.

Our obligations under the tax indemnity agreements may effectively preclude us from selling or disposing of certain of the initial hotels in taxable transactions or reducing our consolidated indebtedness below approximately $11.0 million.

We anticipate that our available cash and cash equivalents and cash flows from operating activities, with cash available from borrowings and other sources, will be adequate to meet our capital and liquidity needs in both the short and long term. However, if these sources of funds are insufficient or unavailable, our ability to satisfy cash payment obligations and make stockholder distributions may be adversely affected.

Outstanding Debt . After application of a portion of the net proceeds from this offering to repay approximately $25.1 million of consolidated mortgage debt, we expect to have approximately $25.7 million of outstanding debt. The following table sets forth the debt to be assumed by our operating partnership upon completion of the formation transactions.

Property

Estimated
Amount
of
Debt to be

Assumed

Estimated

Principal

Balance as of

June 30, 2004

(In thousands)

Prepayment
Penalties ⁽¹⁾

Interest
Rate

Maturity
Date

Amortization
Provisions

Hilton Savannah DeSoto

10,650

10,812

yes

7.49

Nov. 2008

20 years

Hilton Wilmington Riverside

15,100

15,267

yes

8.22

June 2008

20 years

⁽¹⁾	As of November 1, 2004, the prepayment penalty for the Hilton Savannah DeSoto is $1.5 million and the prepayment penalty for the Hilton Wilmington Riverside is $2.3 million.

Contractual Obligations . The following table outlines the timing of payment requirements related to the consolidated mortgage debt and other commitments of MHI Hotels Services Group as of December 31, 2003.

Contractual Obligations

Total

Payments due by period

less than

1 year

1-3 years

3-5 years

more than 5 years

Long-Term Debt Obligations

42,709,805

3,672,441

7,370,336

28,206,081

3,460,947

Capital Lease Obligations

108,975

74,107

34,868

—

Operating Lease Obligations

116,389

46,722

59,565

10,102

—

Totals

42,935,169

3,793,270

7,464,769

28,216,183

3,460,947

Holiday Inn Brownstone Ground Lease ⁽¹⁾

Total ⁽²⁾

less than

1 year

1-3 years

3-5 years

more than 5 years

Lease Payment

39,144

5,592

11,184

16,776

5,592

Purchase Option

5,250

750

1,500

2,250

750

Total

44,394

6,342

12,684

19,026

6,342

⁽¹⁾	Additional parking space adjacent to the hotel.

⁽²⁾	Assume lease expires in seven years at the end of the initial term and is not renewed.

We do not expect our capital expenditures to exceed our reserves for such amounts, other than costs that we may incur to make capital improvements required by the franchisers as a condition of their consent to the transfer of the hotels in conjunction with the formation transactions.

In addition to the amounts disclosed above, we are subject to various franchise and management agreements that have ongoing fees that are contingent upon future results of operations of the hotels in our portfolio as well as a potential for termination fees dependent upon the timing and method of termination of such agreements.

Off-Balance Sheet Arrangements . We currently have no off-balance sheet arrangements and expect to have no such arrangements upon consummation of the formation transactions.

Distributions to Stockholders . We intend to elect to be taxed as a REIT commencing with our taxable year ending December 31, 2004. To qualify as a REIT, we will be required to make annual distributions to our stockholders of at least 90% of our REIT taxable income, excluding net capital gain, which does not necessarily equal net income as calculated in accordance with generally accepted accounting principles). The amount, 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 directors, and no assurance can be given that our distribution policy will not change in the future. Our ability to pay distributions to our stockholders will depend, in part, upon our receipt of distributions from our operating partnership which may depend upon receipt of lease payments with respect to our properties from our TRS Lessee, and in turn, upon the management of our properties by our hotel manager. Distributions to our stockholders will generally be taxable to our stockholders as ordinary income; however, because a 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. To the extent not inconsistent with maintaining our REIT status, our TRS may retain any after-tax earnings. For more information, see “Material Federal Income Tax Considerations-Taxation of our Company.”

Quantitative and Qualitative Disclosures About Market Risk

The effects of potential changes in interest rate prices are discussed below. Our market risk discussion includes “forward-looking statements” and represents an estimate of possible changes in fair value or future earnings that would occur assuming hypothetical future movements in interest rates. These disclosures are not precise indicators of expected future losses, but only indicators of reasonably possible losses. As a result, actual future results may differ materially from those presented. See the notes to the consolidated financial statements for a description of our accounting policies and other information related to these financial instruments to selected changes in market interest rates.

To meet in part our long-term liquidity requirements, we borrow funds at a combination of fixed and variable rates. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. We do not hold or issue derivative contracts for trading or speculative purposes.

Upon consummation of the formation transactions and repayment of approximately $25.1 million of outstanding debt, we expect to assume approximately $25.7 million of fixed-rate debt and no variable rate debt. As of June 30, 2004, the weighted average interest rate on the fixed-rate debt was 7.8%.

Inflation

We expect to generate revenues primarily from lease payments from our TRS Lessee and net income due to the operations of our TRS Lessee. Therefore, we initially will be relying primarily on the performance of the initial properties and the ability of our hotel manager to increase revenues and to keep pace with inflation. Operators of hotels, in general, possess the ability to adjust room rates daily to reflect the effects of inflation.

However, competitive pressures at some or all of our hotels may limit the ability of our management companies to raise room rates.

Seasonality

The operations of the initial properties historically have been seasonal. The periods from mid-November through mid-February are traditionally slow. The months of March and April are traditionally strong, as is October. The remaining months are generally good, but are subject to the weather and can vary significantly.

Geographic Concentration

Our initial hotels are located in North Carolina, Georgia, Virginia, Maryland and Pennsylvania.

Tax and Depreciation

The following table reflects certain real estate tax information for our initial properties:

Property

Federal Tax

Basis

Property Tax

Rate

2004

estimate ⁽¹⁾

Real Estate

Tax

2004 Estimate

Depreciation

Method ⁽²⁾

Depreciation
Life (Years) ⁽³⁾

Depreciation

Percent

(%)

Holiday Inn

Downtown

Williamsburg

3,555,000

5.4

22,100

⁽⁴⁾

2.6

Holiday Inn

Brownstone

6,693,000

9.9

56,607

2.6

Hilton Savannah

DeSoto

6,190,000

21.3

327,300

2.6

Hilton Wilmington

Riverside

14,057,000

11.6

151,100

2.6

Hilton Philadelphia

Airport

4,704,000

8.5

460,000

⁽⁵⁾

2.6

Maryland Inn

2,072,000

13.3

136,000

⁽⁶⁾

2.6

⁽¹⁾	Per $1,000 of assessed value.

⁽²⁾	Straight line method of depreciation.

⁽³⁾	Depreciation life in years.

⁽⁴⁾	We currently intend to spend approximately $500,000 on property renovations. These expenditures may increase real estate taxes by approximately $2,700.

⁽⁵⁾	We currently intend to spend approximately $3,400,000 on property renovations. These expenditures may increase real estate taxes by approximately $29,000.

⁽⁶⁾	We currently intend to spend approximately $4,200,000 on property renovations. These expenditures may increase real estate taxes by approximately $56,000.

FORMATION TRANSACTIONS

We refer to the following series of transactions as our formation transactions:

•

We will sell 6,000,000 shares of common stock in the offering. We will contribute the net proceeds of the offering to MHI Hospitality, L.P., our operating partnership. In return for our contribution, we will receive 6,000,000 units of and initially will own an approximate 61.1% interest in our operating partnership. We will act as sole general partner of our operating partnership.

•

Our operating partnership will issue an aggregate of 3,084,783 units having a value of approximately $31.0 million based on an assumed value of $10.00 per share, $1.0 million in cash and we will assume $35.5 million in debt in exchange for the contribution of all of the outstanding equity interests in the entities that own four of our initial hotel properties. These entities include the Holiday Inn Downtown Williamsburg, the Holiday Inn Brownstone, the Hilton Wilmington Riverside, and the Hilton Savannah DeSoto.

•

We will acquire the assets of the Hilton Philadelphia Airport in exchange for $1.8 million in cash, the assumption of $15.2 million in debt and 732,254 units having a value of approximately $7.3 million based on a value of $10.00 per share. The entity that owns the Hilton Philadelphia Airport may receive additional units in exchange for the contribution of the property. In the event that the initial offering price of our common stock is less than $9.50 per share, the number of units to be issued to this entity will be increased to reflect the difference between the offering price and $9.50 per share multiplied by 732,254. For example, if the offering price is $9.00, this entity would receive an additional 40,681 units worth $366,127.

•

We will acquire the Maryland Inn for a cash payment of approximately $12.2 million. An affiliate of MHI Hotels Services will receive $500,000 in cash for its 25% interest in Accord LLC and West Laurel Corp., the entities that own the Maryland Inn.

•

The consideration we will pay to MHI Hotels Services and its affiliates for the contribution of the initial properties was determined by our senior executive officers taking into account an analysis of market pricing multiples of expected earnings, sales of similar assets, an internal rate of return analysis and their assessment of the fair market value of the hotels. No single factor was given greater weight than any other in valuing any of these assets.

•

We will use approximately $25.1 million of the net proceeds of the offering to repay the outstanding indebtedness on three of our initial hotel properties. This indebtedness includes (i) $4.8 million of mortgage debt and $2.0 million in construction loans relating to the Holiday Inn Brownstone, as discussed above, and (ii) approximately $3.0 million mortgage debt on the Holiday Inn Downtown Williamsburg. The mortgage debt on the Holiday Inn Brownstone is personally guaranteed by MHI Hotels, LLC, Andrew Sims, Christopher Sims, Kim Sims and Mark Smith. The mortgage debt on the Holiday Inn Downtown Williamsburg is guaranteed by MHI Hotels Services, Andrew Sims, Kim Sims and Christopher Sims. Our operating partnership will also use approximately $15.2 million of the net proceeds of the offering to repay indebtedness on the Hilton Philadelphia Airport.

•

We will use approximately $2.0 million in cash of the net proceeds of the offering to compensate MHI Hotels Services for the restructuring of existing management agreements relating to five of our initial hotel properties. Upon closing of the offering, we will enter into a new management agreement with MHI Hotels Services for all of our initial properties and any future hotels managed by MHI Hotels Services. See “Our Principal Agreements – Our Management Agreement.”

•

We will acquire two leases for the common areas of the Shell Island Resort, a condominium resort property located in Wrightsville Beach, North Carolina, from MHI Hotels LLC and MHI Hotels Two, Inc. for a cash payment of $3.5 million, $3.0 million of which will be paid to acquire the lease for the common areas and $500,000 for the lease of the restaurant area. We will enter into sublease agreements

with MHI Hotels Two, Inc. and MHI Hotels LLC with respect to such property. MHI Hotels Two, Inc. and MHI Hotels LLC will pay us a fixed annual rent of $640,000 in connection with the sublease of such property, and we will incur annual lease expense of approximately $120,000.

•

We will lease each of our initial hotel properties to our TRS Lessee.

•

We will enter into tax indemnity and debt allocation agreements with the entities that contribute five of our initial properties. These agreements will require us to indemnify the contributors against tax liabilities in the event we sell those properties in a taxable transaction during a 10-year period. Specifically, we will indemnify the contributors for 100% of their tax liability during the first five years after contribution, 50% during the sixth year, 40% during the seventh year, 30% during the eighth year, 20% during the ninth year and 10% during the tenth year. Such indemnification obligations could aggregate up to approximately $46.0 million. The terms of the tax indemnity agreements also require us to gross up the tax indemnity payment for the amount of income taxes due as a result of the tax indemnity payment. The contributing entities will guaranty a portion of our initial indebtedness following the closing and we will be obliged to give the contributors the opportunity to guaranty a similar amount of debt in the future.

•

We will issue 1,000 shares of restricted common stock to each of our initial directors, which shares will vest on the first anniversary of the date of grant.

•

We will enter into a strategic alliance agreement with MHI Hotels Services which provides, among other matters, that, unless a majority of our independent directors concludes, for valid business reasons, that another management company should manage a hotel owned by us, we will offer MHI Hotels Services the opportunity to manage hotels and that MHI Hotels Services and its directors and executive officers acting in their individual capacity, will refer to us, on an exclusive basis, any hotel investment opportunity that is presented to it, in each case subject to certain exceptions. In addition, MHI Hotels Services will have the right to nominate one person for election to our board of directors for so long as Andrew, Kim and Christopher Sims and their families and affiliates hold, in the aggregate, not less than 1.5 million shares or units of our common stock.

The six initial hotel properties will be contributed to and/or acquired by our operating partnerships as follows:

Capitol Hotel Associates LP, LLP

Capitol Hotel Associates LP, LLP owns the Holiday Inn Downtown Williamsburg and the Hilton Wilmington Riverside in Wilmington, North Carolina. MHI Hotels Services and certain affiliates, including Andrew Sims, Kim Sims, Christopher Sims, and the Edgar Sims, Jr. Irrevocable Trust, collectively own 70% of the equity interests in Capitol Hotel Associates LP, LLP. Edgar Sims, Jr. is the father of Andrew Sims, Kim Sims and Christopher Sims. Andrew Sims, Kim Sims and Christopher Sims each own a 13.0% equity interest in MHI Hotels Services. Wilmington Hotel Associates Corp. owns the remaining 30% equity interest in Capitol Hotel Associates LP, LLP. Jeanette Sims, the mother of Andrew Sims, Kim Sims and Christopher Sims, is the sole stockholder of Wilmington Hotel Associates Corp. We will issue 314,919 units having a value of approximately $3.1 million based upon an assumed offering price of $10.00 per share in exchange for the contribution of MHI Hotels Services’ equity interest in Capitol Hotel Associates LP, LLP, and will issue to Andrew Sims, Christopher Sims, Kim Sims and the Edgar Sims, Jr. Irrevocable Trust an aggregate 566,855 units having a value of approximately $5.7 million in exchange for their contributions of their equity interest in Capitol Hotel Associates LP, LLP. We will issue to Wilmington Hotel Associates Corp., 377,903 units having a value of approximately $3.8 million in connection with the contribution of its equity interest in Capitol Hotel Associates LP, LLP. We will assume $15.1 million in existing mortgage debt in connection with the transaction.

Savannah Hotel Associates LLC

Savannah Hotel Associates LLC owns the Hilton DeSoto in Savannah, Georgia. MHI Hotel Services owns an 80% equity interest in Savannah Hotel Associates LLC. We will issue to MHI Hotels Services

1,332,395 units having a value of approximately $13.3 million in connection with the contribution of its ownership interest in Savannah Hotel Associates LLC to our company. We will assume approximately $10.6 million of existing mortgage debt in connection with the transaction.

The remaining 20% equity interest in Savannah Hotel Associates LLC is held by the Krischman Revocable Trust and the Krischman Charitable Trust, which we refer to as the Trusts. We will issue to these Trusts 333,099 units having a value of approximately $3.3 million in connection with the contribution of its 20% interest in Savannah Hotel Associates, LLC to our company. Edward S. Stein, who will become a director upon completion of the offering, is the trustee for the Trusts.

Brownestone Partners LLC

Brownestone Partners LLC owns the Holiday Inn Brownstone in Raleigh, North Carolina. MHI Hotels Services holds a 100% partnership interest in KDCA Partnership, an entity that owns 50% of the equity interests of Brownestone Partners LLC. We will issue to KDCA Partnership 159,512 units having a value of approximately $1.6 million, and approximately $1.0 million in cash in connection with its contribution of its 50% interest in Brownestone Partners LLC. The $1.0 million cash payment will be used to pay off a $1.0 million construction loan.

The remaining 50% interest in Brownestone Partners LLC is owned by MAVAS LLC. MAVAS LLC will receive 100 units having a value of approximately $1,000 and $2.0 million in cash for its 50% interest in Brownestone Partners LLC. MAVAS LLC will use the $2.0 million cash payment, in part, to pay off a $1.0 million construction loan on the Holiday Inn Brownstone.

Hilton Philadelphia Airport

The Hilton Philadelphia Airport is owned by third parties not related to MHI Hotels Services or the Sims family or their affiliates. We will issue an aggregate of 732,254 units, having a value of approximately $7.3 million, and $1.8 million in cash to acquire from these third parties the Hilton Philadelphia Airport in Philadelphia, Pennsylvania and related real property.

The entity that owns the Hilton Philadelphia Airport may receive additional units in exchange for the contribution of its interest in the property. In the event that the offering price of our common stock is less than $9.50 per share, the number of units to be issued to this entity will be increased to reflect the difference between the offering price and $9.50 per share multiplied by 732,254. For example, if the offering price is $9.00, this entity would receive an additional 40,681 units worth $366,127.

MHI Hotels Services has managed the Hilton Philadelphia Airport for the past 10 years.

Best Western Maryland Inn

We will acquire substantially all of the assets of Accord LLC and West Laurel Corp., the two entities that own the Best Western Maryland Inn, in Laurel, Maryland, for a purchase price of approximately $12.0 million in cash. Edgar Sims Jr., the father of Andrew Sims, Kim Sims and Christopher Sims, holds 100% interest in a holding company, Laurel Holdings, LLC, that is a 25% member in Accord LLC and a 25% stockholder in West Laurel Corp.

The obligations of the contributing entities under the contribution agreements to transfer the initial hotel properties to us are conditioned upon completion of this offering, payment of the consideration described above and other customary conditions, including receipt of third party consents, approval of the franchisors, execution of indemnity agreements, the operating partnership agreement and assignment agreements. The contribution agreements relating to the Holiday Inn Brownstone and Hilton Philadelphia Airport also provide for the repayment of debt. The sale agreement relating to the Maryland Inn is conditioned upon the receipt of third party consents.

OUR BUSINESS AND PROPERTIES

Overview

We are a self-advised hotel investment company organized as a Maryland corporation in August 2004 that intends to qualify as a real estate investment trust, or REIT, for federal income tax purposes. Following completion of this offering, we will initially own six full-service, Upper Upscale and Midscale hotels that are located in primary and secondary markets in the mid-Atlantic and Southeastern United States and are operated under well-known national hotel brands such as Hilton and Holiday Inn. We intend to pursue a growth strategy of purchasing, renovating and upbranding underperforming, full-service hotels while seeking to improve the operating results of our initial portfolio.

We intend to focus our investment activities on the following opportunities that involve the acquisition, renovation and upbranding of underperforming or functionally obsolete hotels with the goal of achieving a total investment that is substantially less than replacement cost of a hotel or the acquisition cost of a market performing hotel:

•

Shallow Turn Opportunity: The acquisition of an underperforming but structurally sound hotel that requires moderate renovation to re-establish the hotel in its market.

•

Upbranding Opportunity: The acquisition of properties that can be upgraded physically and enhanced operationally to qualify for what we view as higher quality franchise brands including Hilton, Doubletree, Crowne Plaza, Holiday Inn Select, Holiday Inn, Westin, Sheraton and Intercontinental. We refer to this as our upbranding strategy. Our upbranding strategy may also be a component of our deep and shallow turn opportunities.

An example of our management team’s shallow turn strategy is illustrated by the 1996 acquisition of the Hilton DeSoto hotel in Savannah, Georgia, one of our initial hotel properties. Prior to its acquisition, the hotel was in bankruptcy and the Hilton brand was in the process of being removed from the project. In 1995, the hotel, achieved a 56.0% occupancy for the prior period, an average daily rate of $70.00 and net operating income of approximately $650,000. MHI Hotels Services acquired the hotel for $6.9 million and, in 1997, effected a $5.7 million renovation for a total investment of $12.6 million or approximately $50,000 per room. MHI Hotels Services extended the license with Hilton for an additional 12 years. After a three-year stabilization period the hotel achieved 75.0% occupancy, an average daily rate of $113.00 and net operating income of $2.8 million for calendar 2001.

MHI Hotels Services and its predecessors have been in the hospitality industry since 1957 and provide a full-service expertise in hotel management, construction, redevelopment, financing and consulting. Over the past 47 years, MHI Hotels Services has won numerous awards for its outstanding guest services, including Hilton Pride awards at two of our initial hotels. We expect to benefit from MHI Hotels Services extensive experience in managing hotel properties.

We will be self-advised and own our hotels and conduct our business through our operating partnership, MHI Hospitality, L.P. We will be the sole general partner of our operating partnership and upon completion of the offering and related formation transactions, will own an approximate 61.1% interest in our operating partnership upon completion of the offering and formation transactions. The remaining 38.9% interest will be owned by the contributors of five of our initial hotels, including an approximately 29.2% interest which will be owned by our officers, directors, affiliates and family members.

Upon completion of the offering and the formation transactions, our executive officers, directors and their affiliates and families will beneficially own, in the aggregate, approximately 29.2% of the equity interest in our company on a fully diluted basis with an aggregate value of approximately $28.7 million.

Our Strategy

Our primary objectives are to enhance stockholder value over time by generating attractive risk-adjusted returns on invested capital, consistently paying distributions to our stockholders and achieving long-term appreciation in the value of our lodging investments. We will seek to grow internally by improving the operating results of our initial hotel properties. We will also seek to invest in additional well-located hotel properties which are underperforming in their respective markets and would benefit from renovation, upbranding or a change in management.

Acquisition Strategy

We believe the acquisition of hotel properties that are well located and possess sound operating fundamentals, but are underperforming in their respective markets and would benefit from upbranding, renovation or new management currently present the best opportunities to create value in the lodging industry. We may also pursue acquisition opportunities to convert non-hotel properties to use as a hotel.

•

Upbranding . We will investigate opportunities to acquire and re-brand existing hotels by analyzing brands available in the market, seeking to quantify the potential improvement in revenue and profitability resulting from a rebranding and undertaking a cost/benefit analysis relating to the capital expenditures required to bring the property into compliance with the standards of the selected brand.

•

Renovation . We will consider investing in hotel properties in prime locations that are structurally sound, but have been neglected and can be purchased at attractive prices and renovated and reintroduced into the market at a cost significantly lower than what would have been spent to acquire a stabilized property or to develop a new hotel of similar quality.

•

New management . We intend to identify hotel properties that are underperforming due to poor management where we can acquire the properties at attractive prices and replace management with MHI Hotels Services.

•

Best use . We will analyze opportunities to convert well-located real estate not currently being used as a hotel to a hotel property. Examples could include an office building which could be converted into a full-service hotel and benefit from a downtown setting where new hotel development is scarce, or the conversion of an apartment building into an extended stay hotel where conversion costs are relatively low due to the design structure.

Internal Growth Strategy - Our Initial Hotels

MHI Hotels Services designed and implemented an upbranding and renovation strategy which has yielded improved operating results for four of our six initial hotels, the Holiday Inn Williamsburg, the Holiday Inn

Brownstone, the Hilton Savannah DeSoto and the Hilton Wilmington Riverside. We currently plan to renovate the Holiday Inn Williamsburg in 2005. In addition, we plan to extensively renovate the Hilton Philadelphia Airport in 2005 to comply with Hilton relicensing requirements. As these hotels are located in attractive markets, we believe that these properties are well positioned for future growth and will benefit from improving industry wide market conditions, our renovations, and the efforts of our management team.

The Maryland Inn is currently underperforming in its market and represents a shallow turn opportunity. We intend to use approximately $3.9 million of the net proceeds of the offering to fund renovations to the Maryland Inn and anticipate improved operating results following renovation and upbranding to a Holiday Inn franchise. We have a franchise application currently pending with Holiday Inn. See “Our Business and Properties – Our Initial Properties.”

Financing Strategy

We will seek to maintain target debt levels of 45-55% of total assets. Upon completion of the offering and the related formation transactions, we will have $25.7 million of debt (representing an initial leverage ratio of approximately 24.6% of pro forma total assets as of June 30, 2004) on two of our initial hotels. We intend to enter into a $23.0 million secured revolving credit facility from an affiliate of BB&T Capital Markets secured by first mortgages on two of our initial hotel properties following completion of the offering. We expect the credit facility to be available for general corporate purposes, including the following:

•

funding of investments;

•

funding of hotel renovations and improvements;

•

payment of distributions to stockholders;

•

working capital needs; or

•

any other payments deemed necessary or desirable by management and approved by the lender.

Going forward, we will consider a number of factors when evaluating our level of indebtedness and making financial decisions, including, among others, the following:

•

the interest rate of the proposed financing;

•

prepayment penalties and restrictions on refinancing;

•

the purchase price of properties we acquire with debt financing;

•

our long-term objectives with respect to the financing;

•

our target investment returns;

•

the ability of particular properties, and our company as a whole, to generate cash flow sufficient to cover expected debt service payments;

•

overall level of consolidated indebtedness;

•

timing of debt and lease maturities;

•

provisions that require recourse and cross-collateralization;

•

corporate credit ratios, including debt service coverage, debt to total market capitalization and debt to undepreciated assets; and

•

the overall ratio of fixed and variable-rate debt.

Beyond our anticipated credit facility, we intend to use other financing methods as necessary, including obtaining from banks, institutional investors or other lenders, financings through property mortgages, bridge

loans, letters of credit, and other arrangements, any of which may be unsecured or may be secured by mortgages or other interests in our investments. In addition, we may issue publicly or privately placed debt instruments. When possible and desirable, we will seek to replace short-term sources of capital with long-term financing.

Our indebtedness may be recourse, non-recourse or cross-collateralized and may be fixed rate or variable rate. If the indebtedness is non-recourse, the collateral will be limited to the particular properties 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 to refinance existing indebtedness, to refinance investments, including the redevelopment of existing properties, for general working capital or to purchase additional interests in partnerships or joint ventures or for other purposes when we deem it advisable.

Our Team

We believe that our senior executive officers, who have extensive lodging industry experience, will help drive our growth. Our senior executive officers’ strategy over the years has been driven by a keen knowledge of lodging industry fundamentals, and their ability to:

•

identify lodging industry supply and demand trends and respond accordingly by selectively investing in and disposing of hotel properties;

•

drive property level performance through active asset management and capital improvement programs;

•

prudently finance investments to achieve attractive risk-adjusted returns; and

•

build relationships with leading franchisors in the lodging industry.

Upon completion of the offering, Andrew Sims, our president, chief executive officer and chairman and William Zaiser, our chief financial officer and treasurer, will resign from their positions as executive officers of MHI Hotels Services, and will continue as our senior executive officers and become our full-time employees. Our senior executive officers may be considered promoters of the offering. See “Management—Directors and Executive Officers.”

Kim Sims and Christopher Sims, who will remain officers and directors of MHI Hotels Services, will be members of our board of directors. Andrew Sims and William Zaiser will remain members of the board of directors of MHI Hotels Services. Each has been a senior executive officer of MHI Hotels Services and its predecessors for more than twenty years.

Our executive officers and directors include Andrew, Kim and Christopher Sims, three second generation hoteliers who have grown their family hospitality operations from a single 12 room motel in College Park, Maryland to a full-service hotel development and management group with over approximately 1,600 employees and more than 2,200 rooms. Consequently, in managing a lodging enterprise through the economic cycles that characterize the hotel industry, they have successfully adapted their business strategies to take advantage of opportunities presented during various stages of the cycle. During that time, they have established long-standing relationships with hotel owners, lodging industry brokers, management companies, franchisors and lenders and have pursued investment strategies that include opportunistically and successfully acquiring, developing, financing, repositioning, managing and selling hotel properties depending on their view of overall lodging industry fundamentals. Collectively, they have acquired or sold over 22 hotel properties and have managed over 33 hotel properties.

Strategic Relationship with MHI Hotels Services

MHI Hotels Services has extensive experience in the lodging industry and has developed the following:

•

a staff of highly competent professionals that have successfully worked together for many years on numerous projects, including the acquisition and the redevelopment of four of our initial hotels;

•

extensive contacts in the hospitality industry including those that may generate potential investments in lodging properties;

•

extensive relationships with premier hotel franchise companies that provide franchise opportunities to enhance the value of repositioned assets; and

•

the ability to initiate and complete development projects, oversee renovations, perform construction and identify suitable investments.

MHI Hotels Services is currently managing, or has managed in the past, each of our initial hotels.

We intend to enter into a strategic alliance agreement with MHI Hotels Services, which provides, among other matters, that, unless a majority of our independent directors concludes, for valid business reasons, that another management company should manage a hotel owned by us, we will offer MHI Hotels Services the opportunity to manage our hotels and MHI Hotels Services, will refer to us, on an exclusive basis, any hotel investment opportunity that is presented to any of them, in each case subject to certain exceptions. Upon completion of the offering and formation transactions, officers and directors of MHI Hotels Services, their affiliates and family members will beneficially own 2,870,863 units representing 29.2% of the fully diluted shares of our common stock. We believe that MHI Hotels Services will be motivated in assisting us in the successful growth of our company and that the interests of MHI Hotels Services will be aligned with the interests of our stockholders.

Industry Overview

We intend to invest in hotels that are underperforming, and which may benefit from renovation, upbranding, and new management. We intend to focus on investments in the “Upper Upscale,” “Upscale” and “Midscale” segments of the lodging industry, as defined by Smith Travel Research, which we refer to as STR. STR is a leader in lodging industry benchmarking and performance tracking.

STR maintains an extensive database on the U.S. lodging industry. According to STR, the database consists of detailed information on over 47,000 lodging establishments representing approximately 4.4 million rooms. The database is a collection of properties with 20 rooms or more. Each month, STR collects performance data on over 22,000 hotels including measures of rooms available for occupancy, rooms sold and room revenue. STR collects this data from hotel chain headquarters, management companies, owners and directly from independent hotels. STR frequently issues reports on the U.S. lodging industry. The information presented in this section is derived from one or more such STR reports.

STR segments the lodging industry into six segments. Below are STR’s segments and examples of representative hotel brands:

•

Luxury – Four Seasons ^® , Ritz Carlton ^® , Fairmont ^®

•

Upper Upscale – Embassy Suites ^® , Hilton, Marriott, Sheraton

•

Upscale – Hilton Garden Inn ^® , Courtyard by Marriott ^® , Crowne Plaza

•

Midscale with Food & Beverage (F&B) – Holiday Inn, Ramada ^®

•

Midscale without F&B – Hampton Inn ^® , Holiday Inn Express, Comfort Inn ^®

•

Economy – Motel 6 ^® , Red Roof ^® , Days Inn ^®

We evaluate our performance and that of the industry by focusing on the following key performance statistics: (1) occupancy, which is defined as total rooms sold divided by total rooms available for the period; (2) revenue per available room, or RevPAR, which is defined as total room revenue divided by total number of room nights; and (3) average daily rate, or ADR, which is defined as total room revenue divided by the total number of rooms occupied on a paid-for basis for the period. RevPAR does not include food and beverage or other ancillary revenues such as telephone, parking or other guest services generated by the hotel.

U.S. Lodging Industry

The U.S. hotel industry stabilized in 2003, after two consecutive years of declining performance in 2001 and 2002, which followed a period of sustained growth during the economic expansion of the 1990s as the following information from STR demonstrates. We believe this decline was caused by the severe contraction of the financial markets following market highs of 2000, a deterioration of general economic activity and consumer sentiment, reduced travel following the events of September 11, 2001, and, to a lesser degree, by new supply.

The following chart depicts changes in occupancy rate and the corresponding annual percentage change in occupancy rate for the U.S. lodging industry from 1994 through 2003, including projections for 2004 and 2005. The chart illustrates relatively flat occupancy levels in 2002 and 2003, and the projected improvements in 2004 and 2005 (Source: STR) :

LOGO

We believe continued improvement in the U.S. economy will drive increases in occupancy. We also believe occupancy will benefit from overall demand increases in the lodging industry, as new supply slows. The chart below illustrates historic and projected national levels of supply and demand in the lodging industry and further demonstrates, that along with an improving economic outlook, that a slowing of new supply may enhance industry performance (Source: STR) :

LOGO

We believe construction spending and rooms supply growth have reached a low point in the lodging cycle and should continue to remain at or near this level during the next two to three years. We expect that if new supply remains constrained over this period, even moderate increases in demand should translate into increases in hotel revenues and profitability. Based on the forecasted trend of demand exceeding supply, we expect overall industry occupancy rates to continue to climb in the near term.

We believe that, in addition to occupancy rates and supply/demand trends, RevPAR and ADR are also significant statistical measures of the lodging industry’s financial health. The charts below provide recent national trends in RevPAR and ADR in the U.S. lodging industry, as well as the corresponding annual percentage changes in these measures (Source: STR):

LOGO

Current Market Developments

Recent statistical comparisons of occupancy, ADR and RevPAR demonstrate that for the first eight months of 2004 these measures of performance exceeded 2003 levels. We believe these results are indicative of a recovery in the lodging industry ( Source: STR):

LOGO

Through the eight months ended in August, 2004, ADR improved 3.7% and RevPAR improved 7.1% over the same period in 2003 (Source: STR).

Our Initial Properties

Our Initial Hotels and Leased Property

Upon consummation of the formation transactions, we will own our six initial hotels in fee simple. Other than renovations for the Hilton Philadelphia Airport, the Holiday Inn Downtown Williamsburg, and the Maryland Inn, we have no present plans for major improvements on these properties. Other than the Maryland Inn, all of these hotels are currently managed by MHI Hotels Services. The Maryland Inn is currently managed by the current owners of the hotel and will be managed by MHI Hotels Services following our acquisition. We believe that each of these properties is adequately covered by insurance.

The following table sets forth information regarding the mortgage debt on our six initial hotel properties (dollars in thousands):

Property

Name of

Property-

Owning Entity

Principal

Balance as of

June 30,

2004

Prepayment

Penalties

Interest Rate

Maturity

Date

Amortization

Provisions

Hilton Philadelphia

Airport

Elpizo
Limited
Partnership
and Phileo
Land
Corporation

15,346

⁽¹⁾

—

8.25

Sept. 2006

25 years

Holiday Inn

Downtown

Williamsburg

Capitol Hotel
Associates
LP, LLP

2,973

⁽¹⁾

—

5.82

Jan. 2023

25 years

Holiday Inn

Brownstone

Brownestone
Partners
LLC

4,838

⁽¹⁾

—

Prime
+ 1/4

Dec. 2008

20 years

Hilton Savannah

DeSoto

Savannah
Hotel
Associates,
LLC

10,812

yes

⁽²⁾

7.49

Nov. 2008

20 years

Hilton Wilmington

Riverside

Capitol Hotel
Associates
LP, LLP

15,267

yes

⁽²⁾

8.22

June 2008

20 years

Maryland Inn

Accord LLC
and West
Laurel Corp.

6,914

yes

⁽³⁾

9.07

June 2007

25 years

⁽¹⁾	Debt to be repaid at closing with the proceeds of the offering.

⁽²⁾

Both loans being assumed by us are held by Mutual of New York. The prepayment of either loan requires a yield maintenance payment to the lender in an amount that would compensate the lender in full assuming the loan was paid off. The remaining term of the loan is determined by comparison of a market rate of interest on a U.S. Treasury note with the same maturity date. The rate difference is multiplied by the number of months remaining outstanding on the loan. The net present value of the loan is determined by a calculation of the gross monthly income loss. As of November 1, 2004, the prepayment penalty for the Hilton Wilmington Riverside is $2.3 million, and for the Hilton Savannah DeSoto, the prepayment penalty is $1.5 million.

⁽³⁾	Prepayment penalty equal to 3% of loan balance. Debt will be paid off by the sellers of the property with the proceeds of the sale.

The following table sets forth certain information for each of our six initial hotel properties:


Property	Location	Year Opened/ Renovated	Average Occupancy ⁽¹⁾		ADR ⁽¹⁾		RevPAR ⁽¹⁾		Number of Rooms ⁽²⁾	Meeting Space Sq. Ft. ⁽²⁾	Acquisition Cost ⁽³⁾
Hilton Philadelphia Airport	Philadelphia, PA	1972/ 1994/ 2001	76.5	%	$	87.20	$	66.73	331	10,000		$25,271,240

Holiday Inn Downtown Williamsburg	Williamsburg, VA	1968/ 1986/ 2000	52.0	%		76.26		39.62	137	6,000		5,025,000

Holiday Inn Brownstone	Raleigh, NC	1971/ 2002	63.2	%		74.67		47.18	188	15,000		9,396,120

Hilton Savannah DeSoto	Savannah, GA	1968/ 1996/ 2003-4	75.0	%		115.61		86.67	246	20,000		27,279,940

Hilton Wilmington Riverside	Wilmington, NC	1970/ 1988/ 1998/ 2000	69.6	%		96.00		66.78	274	20,000		25,646,760

Maryland Inn ⁽⁴⁾	Laurel, MD	1985/ 1989	65.1	%		68.00		44.27	205	8,000		12,200,200

TOTALS / WEIGHTED AVERAGES			68.9	%	$	88.37	$	61.61	1,381	79,000	$	104,819,060

⁽¹⁾	For the twelve months ended June 30, 2004.

⁽²⁾	As of June 30, 2004.

⁽³⁾	Estimated transaction cost, debt assumed and units issued in the acquisition valued at the assumed initial public offering price of $10.00 per share, the midpoint of the price range for this offering of our common stock.

⁽⁴⁾	We intend to upbrand the Maryland Inn as a Holiday Inn.

The Hilton Philadelphia Airport.

The Property

The Hilton Philadelphia Airport is contiguous to the Philadelphia Airport and located approximately eight miles south of Philadelphia’s central business district at 4509 Island Avenue in Philadelphia, Pennsylvania. The property is located within three miles of the new Lincoln Financial Field, Wachovia Spectrum Center and the new Citizens Bank Park which are homes to Philadelphia’s professional football, basketball, ice hockey, and baseball franchises. MHI Hotels Services and its affiliates have managed the Hilton Philadelphia Airport since 1994.

Key Highlights and Demand Generators

The Hilton Philadelphia Airport generates its corporate demand from transient travelers and corporate meetings. The top five accounts by revenue for 2003 were: US Airways and subsidiaries, Concordia, United Parcel

Service, Corporation for National Service, and Flight Options. The hotel also benefits from large conventions at the Philadelphia Convention Center. The hotel’s locations near the Philadelphia professional sports complexes generates leisure demand for hotel rooms. We believe the Hilton Philadelphia Airport is a market leader in the Upscale, full-service hotel sector in the Philadelphia airport market. We have plans to renovate the Hilton Philadelphia Airport and plan to spend approximately $3.2 million to fund renovations.

Guest Rooms

•

The Hilton Philadelphia Airport was opened in 1972 as a Sheraton Hotel and is comprised of 331 guest rooms, including three suites, in a nine-story L-shaped tower. All rooms provide modern conveniences including high-speed internet access.

Food and Beverage

•

Landing Restaurant and Grill – The restaurant, with 130 seats, features continental and regional cuisine and an upscale buffet for breakfast and lunch.

•

Players Sports Bar – The hotel also features a full-service bar with a sports theme and 120 seats.

Other Amenities

•

Indoor swimming pool, whirlpool spa, and recreational facilities.

•

10,000 square feet of meeting space.

•

The hotel is adjacent to the north side of the Philadelphia International Airport with direct access to the General Aviation facilities.

Competition

Competitor hotels include the Marriott, Renaissance, Embassy Suites, Sheraton Suites, Four Points, and Courtyard by Marriott.

Operating and Occupancy Information

The following table shows certain historical data regarding the Hilton Philadelphia Airport:


Year End	1999			2000			2001			2002			2003
Room Revenue	$	8,080,199		$	8,291,333		$	7,298,977		$	7,949,689		$	7,458,474
ADR	$	97.23		$	99.89		$	96.77		$	93.87		$	89.60
Occupancy %		68.8	%		68.5	%		62.4	%		70.1	%		68.9	%
RevPAR	$	66.88		$	68.44		$	60.41		$	65.80		$	61.74

Proposed Renovations

We intend to undertake a major renovation of the Hilton Philadelphia Airport hotel’s public spaces and guest rooms in 2005 to comply with Hilton relicensing. The total cost of the renovation is estimated to be $3.2 million. The guest room improvements will include new bedding, soft goods, seating, lighting, and HVAC units. The guest room, bathroom improvements will include tile replacement, vanities, mirrors, lighting, plumbing fixtures and accessories. The guest room corridors, lobby, dining room and meeting facilities will all be improved with new furniture fixtures and equipment. Additionally, the exterior of the building will be painted and new roof line added.

The Hilton Product Improvement Plan, which we refer to as PIP, will be funded from the proceeds of the offering. Prior to completion of the offering, approximately $1.0 million in funding will be required. In an effort to comply with Hilton requirements and protect its interests in its franchise, the owner of the hotel has obtained

from an unaffiliated third party a $1.0 million line of credit that may be drawn for the sole and express purpose to fund the PIP. The line of credit is with Republic Bank. The Republic Bank line of credit will be paid off with proceeds of the offering. Any funds utilized to repay the Republic Bank line of credit will be deducted from the $3.2 million budgeted PIP.

Holiday Inn Downtown Williamsburg

The Property

The Holiday Inn Downtown Williamsburg, is located one-half mile from Colonial Williamsburg and three and one-half miles from the Busch Gardens amusement and recreation park, at 814 Capitol Landing Road in Williamsburg, Virginia. The Holiday Inn Downtown Williamsburg was built in 1969, and in 1986, the hotel went through major reconstruction adding an indoor pool and tiered dining, among other amenities. The hotel also is convenient to the historic sites of Yorktown and Jamestown, shopping, dining and local golf courses. MHI Hotels Services and its affiliates have managed and maintained an ownership interest in the Holiday Inn Downtown Williamsburg since 1986.

Key Highlights and Demand Generators

The Holiday Inn Downtown Williamsburg is an established full-service hotel. The top five accounts by revenue for 2003 were: Navy Reserve Units Training, Colonial Connections, EPN Travel Services, VITSTA – Virginia Institute of Travel Services Training Activities, and Metro Tours. Group business is generated through tour and travel (both senior citizen tours and youth groups), government, and through the reunion and religious related segments.

Guest Rooms

•

The Holiday Inn Downtown Williamsburg is comprised of 137 guest rooms and one suite. All rooms are equipped with high speed internet access.

Food and Beverage

•

Ledo ^® Pizza and Pasta – Ledo, equipped with 120 seats, is a regional franchise concept that provides quality Italian fare at moderate prices. The facility serves both lunch and dinner.

•

EJ’s Landing – This facility, with 110 seats, provides full breakfast buffet and off menu selections in an open air indoor setting in the domed area that includes the hotel’s swimming pool and recreation area.

Other Amenities

•

Indoor swimming pool and recreational facilities.

Competition

Competitor hotels include Four Points, Quality Inn, Hampton Inn, Ramada Inn, Courtyard by Marriott, another Holiday Inn and Best Western.

Operating and Occupancy Information

The following table shows certain historical information regarding Holiday Inn Downtown Williamsburg since 1999.


Year End	1999			2000			2001			2002			2003
Room Revenue	$	2,229,736		$	2,153,180		$	2,111,450		$	2,124,084		$	2,138,977
ADR	$	74.82		$	73.21		$	73.92		$	76.77		$	73.83
Occupancy %		62.0	%		58.9	%		57.3	%		55.5	%		58.0	%
RevPAR	$	46.46		$	43.14		$	42.34		$	42.59		$	42.85

Proposed Renovations

The Holiday Inn Downtown Williamsburg will receive a renovation to its guest rooms and public spaces in calendar 2005 to comply with a Holiday Inn relicensing. The total cost of the renovation is estimated to be $500,000. The guest room improvements will include new seating, lighting, vanities and tile tub surrounds. The guest room corridors will be totally renovated including carpet, wall paper, painting and new ceilings. The proposed renovations will be funded with proceeds from the offering.

Holiday Inn Brownstone

The Property

The Holiday Inn Brownstone is located near the central Raleigh business district and adjacent to North Carolina State University, at 1707 Hillsborough Street in Raleigh, North Carolina. The Holiday Inn Brownstone was built in 1971 as an independent property and operated as a Hilton for 20 years. MHI Hotels Services and its affiliates have managed and maintained an ownership interest in the Holiday Inn Brownstone since 1999. We have no current plans for significant renovations of this hotel.

The hotel leases land adjacent to the hotel for use as a parking lot. The lease provides for annual rent of $76,104 and expires in August 2016 with options to renew for up to three additional 10-year periods with an option to purchase the leased property at fair market value at the end of the original lease term in August 2016, subject to payment of an annual fee of $9,000 and other conditions.

Key Highlights and Demand Generators

The Holiday Inn Brownstone generates its transient business demand from corporate and government related entities. The top five accounts by revenue for 2003 were: North Carolina Association of Educators, Youth Advocacy Involvement Office, North Carolina Waterworks Association, Worldtek Travel, and North Carolina Department of Public Instruction. Group demand is generated through these companies and additionally through conventions, North Carolina State University special events (sports and educational), youth sporting events, state association meetings and government training. Weddings, special events, and religious celebrations create the leisure market for this property. We believe the hotel’s strong ties to North Carolina State University and the projected expansion of the downtown convention center will provide for opportunities in RevPAR growth.

Guest Rooms

•

The hotel is comprised of 188 guest rooms in an eight-story building. The property site is also improved with 18 additional and separate apartment suites. All rooms are equipped with high-speed internet access.

Food and Beverage

•

Ledo Pizza and Pasta Restaurant – The regional franchise, equipped with 120 seats, offers quality Italian fare at moderate prices.

•

Ledo Sports Bar – The Sports Bar, with 20 seats, adjoins the main dining area.

Other Amenities

•

Outdoor swimming pool

•

Complimentary on-site fitness facility

•

Access to the YMCA

•

15,000 square feet of meeting space

Competition

Competition includes Sheraton, Hilton, Clarion, Ramada Inn, Holiday Inn and the Velvet Cloak Inn.

Operating and Occupancy Information

The following table shows certain historical information regarding the Holiday Inn Brownstone since 1999.


Year End	1999			2000			2001			2002			2003
Room Revenue	$	3,020,826		$	2,699,479		$	2,555,851		$	2,921,866		$	3,044,731
ADR	$	71.91		$	72.32		$	68.30		$	71.14		$	72.53
Occupancy %		55.1	%		54.5	%		54.1	%		59.9	%		61.4	%
RevPAR	$	39.60		$	39.39		$	36.94		$	42.58		$	44.52

Hilton Savannah DeSoto

The Property

The Hilton Savannah DeSoto hotel is located at 15 East Liberty Street in historic downtown Savannah, Georgia. The Hilton Savannah DeSoto overlooks Madison Square in the center of Savannah’s historic district. The site has been a hotel since 1890 and the current building was constructed in 1968. The hotel offers views of the Savannah skyline and the Savannah River. The Hilton Savannah DeSoto is connected via an enclosed atrium to a luxury condominium building. MHI Hotels Services and its affiliates have managed and maintained an ownership interest in the Hilton Savannah DeSoto since 1994. We have no current plans for significant renovations of this hotel.

Key Highlights and Demand Generators

The Hilton Savannah DeSoto has historically generated its corporate demand from upscale business travelers and corporate meetings generated by regional companies. The top five accounts by revenue for 2003 were: US Airways, Tauck World Discovery Tours, Net Jets, Savannah College of Art and Design, and International Paper. The historic sites of Savannah create demand from the leisure segment. Group business encompasses more than 50% of the Hilton Savannah DeSoto’s business primarily in the association and corporate meetings segments.

Guest Rooms

•

The Hilton Savannah DeSoto is a 14-story structure with 246 traditionally-styled guest rooms including five suites and an executive level. High-speed internet access is available to all guest rooms.

Food and Beverage

•

Magnolia Restaurant – The restaurant, with 125 seats, serves authentic Savannah cuisine and a buffet at both breakfast and lunch.

•

Expresso – The hotel’s coffee bar located in the lobby area serves coffees, juices, cookies and breakfast breads.

•

The Lion’s Den – The hotel’s lounge has a 75 person capacity.

Other Amenities

•

Executive Level accommodations with upgraded amenities, turndown service and a private, staffed concierge lounge for complimentary continental breakfast and evening beverage service.

•

Second-floor rooftop, outdoor pool and exercise facilities.

•

Complimentary access to the Downtown Athletic Club.

•

Gift shop.

•

20,000 square feet of meeting space.

Competition

Competitor hotels include Marriott, Westin, Hyatt, Radisson and the Mulberry.

Operating and Occupancy Information

The following table shows certain historical information regarding the Hilton Savannah DeSoto since 1999.


Year End	1999			2000			2001			2002			2003
Room Revenue	$	7,040,831		$	7,462,184		$	7,613,617		$	7,605,616		$	7,245,641
ADR	$	114.73		$	115.65		$	113.01		$	114.32		$	113.12
Occupancy %		68.3	%		71.7	%		75.0	%		74.1	%		71.3	%
RevPAR	$	78.41		$	82.88		$	84.79		$	84.70		$	80.70

Hilton Wilmington Riverside

The Property

The Hilton Wilmington Riverside is located five miles from the Wilmington International Airport at 301 N. Water Street in Wilmington, North Carolina. The Hilton Wilmington Riverside was originally constructed in 1971 and improved by expansion in 1999. The property is the only hotel located directly on the downtown Riverwalk and is situated directly across from the USS North Carolina Battleship Memorial. MHI Hotels Services and its affiliates have managed and maintained an ownership interest in the Hilton Wilmington Riverside since 1989. We have no current plans for significant renovations of this hotel.

Key Highlights and Demand Generators

The top five accounts by revenue for 2003 were: PPD Pharmaceutical, General Electric, International Paper, University of North Carolina Wilmington, and Wachovia Bank. Because of the hotel’s meeting space, group business accounts for over 50% of room revenues. State associations and educational related conferences contribute to the hotel’s utilization.

Guest Rooms

•

The Hilton Wilmington Riverside originally was constructed with 174 rooms and improved by expansion in 1999 to include 100 additional guest rooms for a current total of 274 rooms in a nine-story structure. All rooms are equipped with high-speed internet service.

Food and Beverage

•

Spencer’s – The restaurant, equipped with 130 seats, features American cuisine and daily chef’s specials.

•

The River Club Lounge – The Hotel Lounge, with 75 seats, offering cocktails and lite fare, provides panoramic views of the Cape Fear River.

Other Amenities

•

Outdoor pool overlooking the Cape Fear River

•

Cabaña bar poolside

•

Fitness center

•

Business center

•

Gift shop

•

20,000 square feet of meeting space

Competition

Competitor hotels include the Holiday Inn Sunspree, Blockade Runner, Holiday Inn, Courtyard by Marriott and Residence Inn.

Operating and Occupancy Information

The following table shows certain historical data regarding the Hilton Wilmington Riverside since 1999.


Year End	1999			2000			2001			2002			2003
Room Revenue	$	4,965,249		$	5,949,359		$	6,203,524		$	5,930,365		$	6,444,045
ADR	$	103.01		$	97.47		$	94.38		$	91.48		$	94.31
Occupancy %		65.5	%		61.1	%		65.9	%		64.8	%		68.3	%
RevPAR	$	67.51		$	59.52		$	62.15		$	59.30		$	64.41

Best Western Maryland Inn

The Property

The Best Western Maryland Inn is located near I-95 between Washington, D.C. and Baltimore at Route 197 in Laurel, Maryland. Upon acquiring this hotel with proceeds from this offering, we have made application to rebrand it as a Holiday Inn. The food and beverage facility, which is connected to the guest rooms via the banquet rooms and corridor, has its own free standing access and parking which we intend to lease to a nationally recognized franchise food and beverage operation. We currently have a non-binding site location approval for an Outback Steakhouse location.

Key Highlights and Demand Generators

The hotel is conveniently located at the entrance to a corporate office park with major employers such as United Parcel Service, SunTrust, and the Washington Suburban Sanitary Commission. The top five accounts by revenue for 2003 were: US Department of Agriculture, Garden’s Ice House, National Security Administration, Verizon, and SunTrust. Much of the leisure demand is generated from its easy access off I-95 and proximity to the Washington, DC, Baltimore and Annapolis areas. Laurel Race Track, the Fairland Aquatic Center and Gardens Ice House (the premier skating facility in the Mid-Atlantic region) are located near the hotel. We believe that the hotel is currently underperforming versus its competitors. We believe that our strategic plan to renovate and upbrand the hotel will improve its position in the marketplace.

Guest Rooms

•

The Best Western Maryland Inn Laurel opened in 1985 with 125 guest rooms and in 1989 completed an addition of 80 rooms for a current total of 205 guest rooms. All rooms are equipped with high-speed internet access.

Food and Beverage

•

Today’s Café – The café serves continental breakfast in the atrium of the hotel.

•

Brass Duck Lounge – The lounge occupies a portion of the former full-service restaurant. In connection with our re-branding plans following the acquisition, we expect that this facility will be re-positioned with a well-known franchise food and beverage operation, which we expect to be an Outback Steakhouse location.

Other Amenities

•

7,500 square foot atrium area with indoor pool, sauna, whirlpool, exercise room, game room, putting green, billiards, shuffleboard and gift shop.

•

Over 8,000 square feet of meeting and banquet space.

•

Business center.

•

Executive level accommodation with keyed access and upgraded amenities.

Competition

Competitor hotels include Sheraton, Fairfield Inn, Comfort Inn, Hampton Inn and Courtyard by Marriott.

Operating and Occupancy Information

The following table shows certain historical information regarding Best Western Maryland Inn.


Year End	1999			2000			2001			2002			2003
Room Revenue	$	3,727,269		$	4,067,725		$	3,557,293		$	3,086,362		$	2,967,718
ADR	$	75.13		$	78.32		$	80.41		$	84.50		$	80.32
Occupancy %		66.5	%		66.1	%		66.2	%		53.4	%		50.8	%
RevPAR	$	49.61		$	50.10		$	53.22		$	45.16		$	40.77

Proposed Renovations

Following our acquisition of the Maryland Inn, we intend to undertake a total renovation to comply with a Holiday Inn licensing at a total cost of $4.0 million. A new exterior building renovation will be completed, including window and roof line improvements. The guest rooms will be completely renovated including replacement of all furniture, fixtures, equipment, décor and accessories. Similarly, the public spaces will receive extensive upgrades including all décor and fixtures. Major operating systems will be upgraded or replaced, including the heating ventilation and air conditioning systems, roof systems, and elevators.

Shell Island Resort

The Shell Island Resort is located on the beach, seven miles from the Wilmington International Airport on the northernmost end of Wrightsville Beach, North Carolina, at 2700 N. Lumina. Shell Island Resort was built in 1986. Its 160 suites all have Atlantic Ocean views as well as unimpeded views of the marsh and Intracoastal Waterway. Immediately north of the resort is a half mile of wildlife sanctuary and beach. Shell Island Oceanfront Suites is located near shopping, dining and historic downtown Wilmington.

Shell Island Resort is primarily a leisure destination with the majority of its business generated from guests from the Raleigh, Greensboro and Charlotte markets. Group demand is generated through state associations, University of North Carolina at Wilmington and local social activities. Wrightsville Beach is an upscale and primarily residential leisure destination, and we believe there is minimal opportunity for new development. The property competes strongly in the mid-scale full-service hotel sector.

Shell Island Resort is a condominium hotel and its 160 condominium suites are owned by individual owners. The common areas are owned by the condominium homeowners’ association. MHI Hotels LLC leases

the common area of the resort from the condominium homeowner’s association and manages the hotel’s condominium suite rental program under agreements with individual condominium suite owners. MHI Hotels Two, Inc. leases the restaurant, kitchen and other service areas from the condominium owners’ association. We will acquire the two leases from MHI Hotels LLC and MHI Hotels Two, Inc. for cash payments aggregating $3.5 million.

One lease relates to the restaurant, kitchens, meeting rooms, ball room, laundry, maintenance shop, offices and certain maid closets. This lease commenced on May 12, 2003 and has a term of five years. There is one five-year renewal period. The rent in the second year is $121,500 per annum. The rent increases to $145,000 per annum for years three through five. The second lease relates to the resort’s common areas and includes the lobby, swimming pools, outdoor café, front desk, back office, gift shop, certain storage areas, and ingress and egress throughout the building including parking areas. The public space lease commenced December 31, 1993 and the first term expired on December 31, 2003. The first of two five-year renewal options was exercised. The original base rent is $18,540 per annum. The rent increases pursuant to an annual CPI adjustment. We will enter into sublease agreements with each of MHI Hotels LLC and MHI Hotels Two, Inc., with respect to such leases which provide for fixed annual rent in the amount of $540,000 for the common areas and $100,000 for the restaurant and other areas, plus an annual consumer price index, or CPI, adjustment. MHI Hotels LLC will continue to operate the condominium suite rental program, but we will not receive any revenues from the rental of the condominium suites.

The leases with the condominium owners association can be terminated if MHI Hotels LLC ceases to serve as rental agent for at least 80 of the condominium suites (currently MHI Hotels Two, Inc. manages the rental programs for 160 of the condominium suites). In the event the lease is terminated, MHI Hotels LLC has agreed to continue to pay us the amount of rent otherwise payable under the terms of the subleases for the remainder of the initial lease terms and any renewal terms.

Competition

The hotel industry is highly competitive with various participants competing on the basis of price, level of service and geographic location. Each of our initial hotels is located in a developed area that includes other hotel properties. The number of competitive hotel properties in a particular area could have a material adverse effect on occupancy, ADR and RevPAR of our initial hotels or at hotel properties acquired in the future. We believe that brand recognition, location, the quality of the hotel, consistency of services provided, and price are the principal competitive factors affecting our hotels.

MHI Hotels Services currently competes in the full service Upper Upscale and Midscale segments of the market. Positive competitive factors affecting our position include geographic location, markets with growth potential and strong franchise partners, while certain disadvantages to our position include limited geographic diversity and smaller size in relation to larger competitors.

Environmental Matters

Our hotel properties are subject to various federal, state and local environmental laws. Under these laws, courts and government agencies have the authority to require us, as owner or operator of a contaminated property, to clean up the property, even if we did not know of or did not cause the contamination. These laws also apply to persons who owned or operated a property at the time it became contaminated. In addition to the costs of clean-up, 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 the 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, pay for the clean-up of that facility if it becomes contaminated and threatens human health or the environment. A person that arranges for the disposal of a

hazardous substance or transports for disposal or treatment such a substance to another’s property may be liable for the costs of removal or remediation of the hazardous substances released into the environment at that property.

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 a hotel may seek to recover damages if he or she suffers injury from the asbestos. Lastly, some of these environmental laws restrict the use of a property or place conditions on various activities. An example would be laws that require a business using chemicals (such as swimming pool chemicals or detergent at a hotel property) to manage them carefully and to notify local officials that the chemicals are being used.

The costs to clean up a contaminated property, to defend against a claim, or to comply with environmental laws could be material and could adversely affect the funds available for distribution to our stockholders. We can make no assurances that (1) future laws or regulations will not impose material environmental liabilities or (2) the current environmental condition of our hotel properties will not be affected by the condition of the properties in the vicinity of our hotel properties (such as the presence of leaking underground storage tanks) or by third parties unrelated to us.

Further, when excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Concern about indoor exposure to mold has been increasing, as exposure to mold may cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold at any of our properties could require us to undertake a costly remediation program to contain or remove the mold from the affected property.

We have reviewed reports of Phase I Environmental Site Assessments, or ESA, that were previously prepared for the majority of our initial hotels. All of the reviewed Phase I ESA reports were conducted within the last 10 years. Even though the Phase I ESAs reports we have reviewed did not reveal any material environmental contamination that might have a material adverse effect on our business, assets, results of operations or liquidity, we may have material environmental liabilities of which we are unaware. These Phase I ESA reports were obtained in the past, and do not protect us as the purchaser of the initial hotels under the six-month statutory safe harbor from CERCLA liabilities.

Our review of the Phase I ESA reports and an asbestos survey on the Hilton Savannah Desoto identified the presence of a diesel underground storage tank and the presence of asbestos-containing material on the property. The diesel underground storage tank was installed in 1967, was modified in 2000 to meet requirements for upgrading of existing underground storage tank systems and, in 2003, underwent and passed an annual tank tightness test certified by the State of Georgia. The tank’s registration is certified every year by the State of Georgia.

The asbestos survey conducted on the property identified asbestos-containing materials, or ACMs, all of which are enclosed behind walls or ceilings, or otherwise not exposed. The presence of these ACMs does not, in our opinion, pose an unacceptable risk and does not violate any law applicable to the property. Nevertheless, in response to the finding, the hotel voluntarily implemented an Asbestos Operations and Maintenance Program in 1997 giving hotel maintenance staff information on where the asbestos-containing materials are located and how to handle these materials in the event that they come into contact with them. To our knowledge, there have been no subsequent incidents or exposures to ACMs at the hotel.

Legal Proceedings

We are not involved in any material litigation nor, to our knowledge, is any material litigation threatened against us.

Insurance

The initial hotel properties are covered by insurance of the type and amount we believe are customary for these types of properties. We have limited terrorism insurance on our initial hotel properties, with the exception of the Hilton Philadelphia Hotel, which has a separate, comprehensive terrorism policy.

Capital Expenditures

We intend to maintain each hotel in good repair and condition and in conformity with applicable laws and regulations and in accordance with the franchisor’s standards and the agreed upon requirements in our management agreement. The cost of all such routine maintenance, repairs and alterations will be paid out of a furniture, fixtures and equipment reserve, which will be funded by a portion of hotel gross revenues. Routine repairs and maintenance will be administered by the management company. However, we will have approval rights over capital expenditures.

OUR PRINCIPAL AGREEMENTS

The following summary of the terms of our principal agreements does not purport to be complete and is subject to and qualified in its entirety by reference to the actual agreements, copies of which are exhibits, except for our franchise agreements, to the registration statement of which this prospectus is a part. See “Where You Can Find More Information.”

Our Strategic Alliance Agreement

At the conclusion of this offering, we will enter into a strategic alliance agreement with MHI Hotels Services pursuant to which MHI Hotels Services will refer to us, on an exclusive basis, any hotel investment opportunity that is presented to it subject to certain exceptions, and we will, subject to certain exceptions, offer MHI Hotels Services the opportunity to manage hotels we acquire in the future, unless a majority of our independent directors concludes for valid business reasons that another management company should manage the hotel.

Pursuant to the strategic alliance agreement, we will agree to cause our TRS Lessee to offer to MHI Hotels Services the opportunity to manage any hotel property we acquire and lease to our TRS Lessee during the term of the strategic alliance agreement which meets any of the following criteria:

•

the hotel property is not encumbered by a management contract that would continue beyond the date of our acquisition of the hotel property; or

•

no termination fee is payable by us in connection with termination of any then-existing management contract for the hotel property; or

•

if the then-existing management agreement for the hotel property can be terminated at the time of our purchase of the hotel property upon payment of a termination fee, MHI Hotels Services pays such termination fee.

Notwithstanding the foregoing, if a majority of our independent directors in good faith conclude for valid business reasons that a management company other than MHI Hotels Services should manage one or more hotel properties acquired by us in the future, we shall so notify MHI Hotels Services and MHI Hotels Services shall not have the right to manage such hotel properties.

Not less than 30 days prior to our acquisition of a hotel property that meets the criteria described above, we will be required to notify MHI Hotels Services of our proposed acquisition of the hotel property and will make available to MHI Hotels Services all information reasonably available to us with respect to the hotel property. MHI Hotels Services will have 10 business days from receipt of such notice to notify us in writing that it elects to manage, or cause one of its subsidiaries to manage, the hotel property. If MHI Hotels Services (a) notifies us that it or a subsidiary does not intend to manage the hotel property or (b) fails by the end of the 10 business day period to notify us of its election to manage a hotel property, then, in either event, we may offer management of the hotel property to other hotel management companies on such terms as we shall determine and MHI Hotels Services shall have no further rights with respect thereto.

We have agreed that the terms of the management agreement between us and MHI Hotels Services with respect to future hotel properties will be in substantially the same form as the management agreement for our initial hotel properties. Any material adverse change in the provisions of a management agreement, as they relate to our rights and obligations, from those in the management agreement for our initial hotels, shall be subject to approval by a majority of our independent directors.

The strategic alliance agreement will have a term of 10 years. During the term of the strategic alliance agreement, MHI Hotels Services has agreed to promptly notify us, on an exclusive basis, of any opportunity to invest in, acquire or develop a hotel property which is presented to MHI Hotels Services or its subsidiaries and that meets our acquisition criteria as we may communicate such criteria to MHI Hotels Services from time to

time, subject to certain exceptions described below. In addition to such notification, MHI Hotels Services shall promptly provide us all information, materials and documents reasonably available to MHI Hotels Services or its subsidiaries with respect to such hotel property or opportunity, subject to the requirements of any confidentiality agreements with third parties.

We will have ten business days following our receipt from MHI Hotels Services of information with respect to an investment, acquisition or development opportunity to notify MHI Hotels Services as to whether we intend to pursue such opportunity. If we notify MHI Hotels Services that we intend to pursue such opportunity, MHI Hotels Services shall not provide any information regarding such opportunity to any third party until otherwise notified by us, provided that we are making commercially reasonable efforts to conduct due diligence or otherwise actively pursue the investment, acquisition or development opportunity. If we (i) notify MHI Hotels Services that we do not intend to pursue the opportunity, or (ii) fail to notify MHI Hotels Services by the end of the ten business day period that we intend to pursue the opportunity, then, in either event, MHI Hotels Services may (a) pursue the opportunity on its own behalf or (b) notify other capital sources of the opportunity. If MHI Hotels Services subsequently becomes aware that the price or other terms with respect to the opportunity have changed materially and MHI Hotels Services continues to pursue the opportunity on its own behalf rather than in conjunction with another capital source, MHI Hotels Services must promptly notify us of any such changes in terms and provide us the opportunity to succeed to MHI Hotels Services’ rights as discussed in the paragraph above.

In addition, during the term of the agreement, MHI Hotels Services has the right to nominate one person for election to our board of directors at our annual meeting of stockholders, subject to approval of such nominee by the Governance and Compensation Committee for so long as Andrew Sims, Kim Sims, Christopher Sims and their families and affiliates hold, in the aggregate, not less than 1.5 million units or shares of our common stock. Kim Sims will be the initial nominee of MHI Hotels Services.

No amendment, modification or supplement to the strategic alliance agreement will be binding on any of the parties to the agreement unless it is in writing and signed by the parties in interest at the time of the modification and such modification is approved by a majority of our independent directors.

Our Management Agreement

Pursuant to the terms of a management agreement, we intend to engage MHI Hotels Services as the property manager for our six initial hotels, and to offer MHI Hotels Services the opportunity to manage any future hotels that we lease to MHI TRS or its subsidiaries. We and MHI Hotels Services will execute the management agreement at the closing of our initial public offering, but for the purposes of this section, we have assumed that the management agreement has already been executed. Our executive officers and certain of our directors are also directors of MHI Hotels Services. See “Management.”

Term

The management agreement will have an initial term of 10 years for each of the initial hotels and a term of 10 years for each hotel we acquire in the future. The term of the management agreement with respect to each hotel may be renewed by MHI Hotels Services, upon the mutual agreement of MHI Hotels Services and MHI TRS, subject to certain performance tests, for two successive periods of five years each, provided that at the time the option to renew is exercised, MHI Hotels Services is not then in default under the management agreement. If at the time of the exercise of any renewal period, MHI Hotels Services is in default, then the exercise of the renewal option will be conditional on timely cure of such default, and if such default is not timely cured, then our TRS Lessee may terminate the management agreement. If MHI Hotels Services desires to exercise any option to renew, it must give our TRS Lessee written notice of its election to renew the management agreement no less than 90 days before the expiration of the then current term of the management agreement.

Any amendment, supplement or modification of the management agreement must be in writing signed by all parties and approved by a majority of our independent directors.

Amounts Payable under the Management Agreement

MHI Hotels Services will receive a base management fee, and if the hotels exceed certain financial thresholds, an additional incentive management fee.

The base management fee for each of our initial hotels and for any subsequently acquired hotels, based on total gross revenues of the hotel, will be due monthly and payable as follows:

Existing Six Hotel Properties


	2004		2005		2006		2007
Holiday Inn Downtown Williamsburg	2.0	%	2.0	%	2.5	%	3.0	%
Hilton Savannah DeSoto	2.0	%	2.0	%	2.5	%	3.0	%
Hilton Wilmington Riverside	2.0	%	2.0	%	2.5	%	3.0	%
Hilton Philadelphia Airport	2.0	%	2.0	%	2.5	%	3.0	%
Holiday Inn Brownstone	2.0	%	2.0	%	2.5	%	3.0	%
Best Western Maryland Inn	2.0	%	2.0	%	2.5	%	3.0	%

Subsequently Acquired Hotel Properties


First year managed (for a partial and the first full year)	2.0	%
Second calendar year	2.5	%
Third calendar year and thereafter	3.0	%

On a pro forma basis, for the year 2003, base management fees under the new management agreement would have been $882,529.

The incentive management fee, if any, will be due annually in arrears within 90 days of the end of the fiscal year and will be equal to 10% of the amount by which the gross operating profit of the hotels on an aggregate basis for a given year exceeds the gross operating profit for the same hotels, on an aggregate basis, for a prior year. The incentive fee may not exceed 0.25% of the aggregate gross revenue of all of the hotels included in the incentive fee calculation for the year in which the incentive fee is earned. The calculation of the incentive fee will not include results of hotels for the year in which they are acquired or sold and newly acquired hotels will be included in the calculation beginning in the second full year such hotel is managed. All of our initial properties are eligible for the incentive fee in 2005, with the exception of the Maryland Inn, which will become eligible in 2006.

Early Termination

The management agreement may be terminated as to one or more of the hotels earlier than the stated term, if certain events occur, including:

•

a sale of a hotel or a substitution newly acquired hotels for an existing hotel;

•

the failure of MHI Hotels Services to satisfy certain performance standards with respect to any of the future hotels or with respect to the six initial hotels after the expiration of the initial 10 year term;

•

in the event of a casualty to, condemnation of, or force majeure involving a hotel; or

•

upon a default by MHI Hotels Services or us that is not cured prior to the expiration of any applicable cure periods.

Termination Fees

In certain cases of early termination of the management agreement with respect to one or more of the hotels, we must pay MHI Hotels Services a termination fee, plus any amounts otherwise due to MHI Hotels Services pursuant to the terms of the management agreement. We will be obligated to pay termination fees in the circumstances described below, provided that MHI Hotels Services is not then in default, subject to certain cure and grace periods.

Sale of a Hotel

•

Sale of an Initial Hotel — If any of the initial hotels is sold prior to the expiration of the initial 10-year term, the management agreement will terminate with respect to the sold hotels and we must pay a termination fee equal to the product obtained by multiplying (i) the aggregate management fees (both base fees and incentive fees) estimated to be paid to MHI Hotels Services with respect to the sold hotels pursuant to the then-current annual operating budget (but in no event less than the management fees for the preceding full fiscal year) by (ii) the years then remaining under the initial 10-year term. Our TRS Lessee does not have to pay any termination fee in connection with a sale of an initial hotel that occurs after the initial 10-year term. In addition, we have the right to substitute a hotel for any of the initial hotels we sell. The substitute hotel must be reasonably equivalent in terms of size, number of rooms, quality of the franchise, market type and gross revenues.

•

Sale of a Future Hotel — If a future hotel is sold during the first 12 months of the date such hotel becomes subject to the management agreement, our TRS Lessee may terminate the management agreement with respect to such sold hotel, provided that we pay to MHI Hotels Services, an amount equal to the management fee (both base fees and incentive fees) estimated to be paid to MHI Hotels Services with respect to the applicable hotels pursuant to the then-current annual operating budget for the balance of the first year of the 10-year base term. If any future hotel is sold at any time after the first year of the 10-year base term of the management agreement for that hotel and our TRS Lessee terminates the management agreement with respect to that hotel, our TRS Lessee will have no obligation to pay any termination fee.

Condemnation, Force Majeure or Casualty

•

In the event of a condemnation of, force majeure or casualty to any of the hotels, our TRS Lessee has no obligation to pay any termination fees.

Failure to Satisfy Performance Test

•

Future Hotels — If any of the future hotels fails to satisfy the applicable performance test, our TRS Lessee may terminate the management agreement with respect to such future hotel. MHI Hotels Services will have failed the performance test with respect to a particular hotel if during any fiscal year during the term (i) such hotel’s gross operating profit margin for such fiscal year is less than 75% of the average gross operating profit margins of comparable hotels in similar markets and geographical locations, as reasonably determined by MHI Hotels Services and our TRS Lessee, and (ii) such hotel’s RevPAR yield penetration is less than the targeted yield penetration for such fiscal year (the targeted yield penetration is the average of the RevPAR of hotels in a pre-identified competitive set). Upon a performance test failure, our TRS Lessee must give MHI Hotels Services two years to cure. If MHI Hotels Services fails the performance test during the second year of the cure period, then our TRS Lessee has the right to terminate the management agreement with respect to such hotel. Further, if any of the future hotels are within a cure period due to a failure of the performance test, an exercise of a renewal option shall be conditioned upon timely cure of the performance test failure, and if the performance failure is not timely cured, our TRS Lessee may elect to terminate the management agreement.

•

Initial Hotels — The initial hotels are not subject to the performance test until after the initial 10-year term of the management agreement.

New Manager; Strategic Alliance Agreement

Pursuant to the strategic alliance agreement between us, and MHI Hotels Services, we have agreed to engage MHI Hotels Services for the management of any future hotels unless a majority of our independent directors in good faith concludes, for valid business reasons, that another management company should manage

these hotels. If the management agreement terminates as to all of the hotels covered in connection with a default under the management agreement, the strategic alliance agreement will also terminate. See the section entitled “Our Principal Agreements - Our Strategic Alliance Agreement” in this prospectus.

Maintenance and Modifications

MHI Hotels Services must maintain each hotel in good repair and condition and make such routine maintenance, repairs and minor alterations as it deems reasonably necessary. The cost of all such maintenance, repairs and alterations will be paid by MHI TRS.

Insurance

MHI Hotels Services is responsible for maintaining and paying for all workers’ compensation, employer’s liability, property and casualty insurance, and other appropriate and customary insurance related to its operations as a property manager, the cost of which is the responsibility of MHI TRS. MHI Hotels will also be responsible for obtaining insurance covering operation of hotels at the expense of MHI TRS.

Assignment and Subleasing

Neither MHI Hotels Services nor our TRS Lessee may assign its rights and obligations under the management agreement without the other party’s prior written consent. However, MHI Hotels Services may assign its rights and obligations to an affiliate of MHI Hotels Services that satisfies the eligible independent contractor requirements and is “controlled” by Andrew Sims, Kim Sims and Christopher Sims, their respective family partnership or trusts, the sole members of which are at all times are their lineal descendants and spouses. “Control” means (i) the possession of a majority of the capital stock and voting power of such affiliate, directly or indirectly, or (ii) the power to direct or cause the direction of the management and policies of such affiliate in the capacity of chief executive officer, president, chairman, or other similar capacity where they are actively engaged or involved in providing such direction or control and spend a substantial amount of time managing such affiliate. No assignment will release MHI Hotels Services from any of its obligations under the management agreement.

Damage to Hotels

If any of our hotel properties is destroyed or damaged, our TRS Lessee is obligated, subject to the requirements of the underlying lease, to repair or replace the damaged or destroyed portion of the hotel to the same condition as existed prior to such damage or destruction. If the lease relating to such damaged hotel is terminated pursuant to the terms of the lease, our TRS Lessee has the right to terminate. In the event of a termination, neither our TRS Lessee nor MHI Hotels Services will have any further liabilities or obligations under the management agreement with respect to such damaged hotel. If the management agreement remains in effect with respect to such damaged hotel, and the damage does not result in a reduction of gross revenues at the hotel, our obligation to pay management fees will be unabated. If, however, the management agreement remains in effect with respect to such damaged hotel, but the damage does result in a reduction of gross revenues at the hotel, we will be entitled to partial abatement of the management fees while the hotel is being repaired.

Condemnation of a Property or Force Majeure

If any of our hotels is subject to a total condemnation or a partial taking that prevents use of the property as a hotel, the management agreement with respect to such condemned hotel, will terminate, subject to the requirements of the applicable lease. In the event of termination, neither our TRS Lessee nor MHI Hotels Services will have any further liabilities or obligations under the management agreement with respect to such hotel. If there is an event of force majeure or any other cause beyond the control of MHI Hotels Services that directly involves a hotel and has a significant adverse effect upon the continued operations of that hotel, then the

management agreement may be terminated by our TRS Lessee. In the event of a termination, neither our TRS Lessee nor MHI Hotels Services will have any further liabilities or obligations under the management agreement with respect to such hotel.

Annual Operating Budget

The management agreement provides that not less than 45 days prior to the beginning of each fiscal year during the term of the management agreement, MHI Hotels Services will submit to our TRS Lessee for each of the hotels, an annual operating budget setting forth in detail an estimated profit and loss statement for the next 12 months (or for the balance of the fiscal year in the event of a partial first fiscal year), including a schedule of hotel room rentals and other rentals and a marketing and business plan for each of the hotels and a budget of gross operating profit for purposes of the incentive fee. Such budget will be subject to our TRS Lessee’s approval, which may not be unreasonably withheld. The budget may be revised from time to time, taking into account such circumstances as our TRS Lessee deems appropriate or as business and operating conditions shall demand, subject to the reasonable approval of MHI Hotels Services.

Capital Improvement Budget

MHI Hotels Services must prepare a capital improvement budget of the expenditures necessary for replacement of furniture, fixtures and equipment and building repairs for the hotels during the following fiscal year and provide such budget to our TRS Lessee for approval, which approval may not be unreasonably withheld, at the same time MHI Hotels Services submits the proposed annual operating budget for approval. MHI Hotels Services will, in accordance with the capital improvement budget, make such substitutions and replacements of or renewals to furniture, fixtures and equipment and non-routine repairs and maintenance as it deems necessary to maintain our hotels. MHI Hotels Services may not make any other expenditures without our TRS Lessee’s approval, except expenditures which are required by reason of any (i) emergency, (ii) applicable legal requirements, (iii) the terms of any franchise agreement or (iv) are otherwise required for the continued safe and orderly operation of our hotels. The cost of all such changes, repairs, alterations, improvements, renewals, or replacements will be paid from the capital improvement reserve or other monies advanced by us or our TRS Lessee.

Service and Project Management Fees

Our TRS Lessee has agreed to pay MHI Hotels Services a project management fee equal to 5% of the total project costs associated with the implementation of the approved product improvement plan or major renovation project in the event our TRS Lessee requests that such services be provided by MHI Hotels Services. We currently expect to request that MHI Hotel Services provide such services for each of our hotels. This fee does not relate to the annual implementation of the annual capital expenditure budget which will be performed by MHI Hotels Services in consideration of the management fee. Project management services include (i) interior design assistance involved in implementing the product improvement plan, (ii) purchasing services, (iii) managing freight selection and shipping processes, (iv) the warehousing of goods delivered at the job site, inspection of materials delivered, and the filing of claims associated with the delivery of defective or damaged goods and (v) supervision and oversight of the installation of furniture, fixtures and equipment.

Indemnity Provisions

MHI Hotels Services has agreed to indemnify MHI TRS against all damages not covered by insurance that arise from (i) the fraud, willful misconduct or gross negligence of MHI Hotels Services; (ii) employee claims based on a substantial violation by MHI Hotels Services of employment laws or that are a direct result of the corporate policies of MHI Hotels Services; (iii) the knowing or reckless placing, discharge, leakage, use or storage of hazardous materials in violation of applicable environmental laws on or in any of our hotels by MHI Hotels Services; or (iv) the breach by MHI Hotels Services of the management agreement, including action taken by MHI Hotels Services beyond the scope of its authority under the management agreement, which is not cured.

Except to the extent indemnified by MHI Hotels Services as described in the preceding paragraph, MHI TRS has agreed to indemnify MHI Hotels Services against all damages not covered by insurance and that arise from (i) the performance of MHI Hotels Services’ under the management agreement; (ii) the condition or use of our hotels; (iii) certain liabilities to which MHI Hotels Services is subjected pursuant to the Worker Adjustment and Retraining Notification Act in connection with the termination of the management agreement; or (iv) any claims made by an employee of MHI Hotels Services against MHI Hotels Services or MHI TRS that are based on a violation or alleged violation of the employment laws.

Events of Default

Events of default under the management agreement include:

•

Our TRS Lessee or MHI Hotels Services experiences a bankruptcy-related event that is not discharged within 90 days.

•

Our TRS Lessee or MHI Hotels Services fails to make any payment due under the management agreement, subject to a 10-day grace period.

•

Our TRS Lessee or MHI Hotels Services fails to observe or perform any other term of the management agreement, subject to a 30-day grace period. There are certain instances in which the 30-day grace period extends to 120 days.

•

MHI Hotels Services does not qualify as an “eligible independent contractor” as such term is defined in Section 856(d)(9) of the Internal Revenue Code of 1986, as amended.

If an event of default occurs and continues beyond any grace period, the non-defaulting party will have the option of terminating the management agreement, on 30 days’ notice to the other party. If the event of default relates solely to one or more, but not all, of the hotels, then the management agreement may only be terminated with respect to the hotels to which the event of default relates.

Our Franchise Agreements

Our six initial hotels operate under franchise licenses from national hotel companies.

We anticipate that most of the additional hotels we acquire will be operated under franchise licenses. We believe that the public’s perception of quality associated with a franchisor is an important feature in the operation of a hotel. Franchisors provide a variety of benefits for franchisees, which include national advertising, publicity and other marketing programs designed to increase brand awareness, training of personnel, continuous review of quality standards and centralized reservation systems.

The franchise licenses will be held by our TRS Lessee. MHI Hotels Services must operate each of our hotels it manages in accordance with and pursuant to the terms of the franchise agreement for the hotel.

The franchise licenses generally specify certain management, operational, record keeping, accounting, reporting and marketing standards and procedures with which the franchisee must comply. Under the franchise licenses, the franchisee must 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;

•

display of signage; and

•

the type, quality and age of furniture, fixtures and equipment included in guest rooms, lobbies and other common areas.

Additionally, as the franchisee, our TRS Lessee will be required to pay the franchise fees described below.

The following table sets forth certain information for the franchise licenses for five of our initial six hotel properties:


Property	Franchise Fee ⁽¹⁾		Marketing/Reservation Fee ⁽¹⁾		Expiration Date
Hilton Philadelphia Airport	5.0	%	3.5	%	12/3/04 ⁽²⁾
Holiday Inn Brownstone	5.0	%	2.5	%	3/10/11
Holiday Inn Downtown Williamsburg	5.0	%	2.5	%	9/14/14
Hilton Wilmington Riverside	5.0	%	3.5	%	3/23/08
Hilton Savannah DeSoto	5.0	%	3.5	%	6/30/08
Best Western Maryland Inn	3.6	% ⁽³⁾	4.0	%	9/30/09

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

⁽²⁾	We are currently in negotiations to extend the franchise license on the Hilton Philadelphia Airport.

⁽³⁾	Annual fees charged by Best Western are based on number of rooms and number of room reservations at the property. Percentage presented is estimated franchise fee as a percentage of revenue based on historic averages.

The aggregate franchise fees for 2003 were $1,427,149.

Holiday Inn is a registered trademark of Intercontinental Hotel Group. Intercontinental Hotel Group has not endorsed or approved the offering. A grant of a franchise license for the initial properties is not intended and should not be interpreted as an express or implied approval or endorsement by Intercontinental Hotel or any of its affiliates, subsidiaries or divisions of us, our operating partnership or our common stock.

Hilton is a registered trademark of Hilton Hospitality, Inc. Hilton Hospitality, Inc. has not endorsed or approved the offering. A grant of a Hilton license is not intended and should not be interpreted as an express or implied approval or endorsement by Hilton Hospitality, Inc. or any of its affiliates, subsidiaries or divisions of us, our operating partnership or our common stock.

Best Western is a registered trademark of Best Western International. Best Western International has not endorsed or approved the offering. A grant of a Best Western membership for our initial hotel is not intended and should not be interpreted as an express or implied approval or endorsement by Best Western or any of its affiliates, subsidiaries or divisions of us, our operating partnership or our common stock.

Our TRS Leases

In order for us to qualify as a REIT, neither our company, the operating partnership or any subsidiary can operate our hotels. Our operating partnership, or subsidiaries of our operating partnership, as lessors, will lease our hotels to our TRS Lessee and our TRS Lessee will enter into management agreements with MHI Hotels Services or its subsidiaries, or other operators, to manage the hotels. The leases for our initial hotels will contain the provisions described below.

Lease Terms

Each lease will have a non-cancelable initial term of five years, subject to earlier termination upon the occurrence of certain contingencies described in the lease (including, particularly, the provisions described below under “Damage to Hotels,” “Condemnation of Hotels” and “Termination of Percentage Leases on Disposition of the Hotels”).

Amounts Payable Under the Percentage Leases

During the term of each lease, our TRS Lessee will be obligated to pay a fixed annual base rent plus a percentage rent and certain other additional charges. Base rent will accrue and be paid monthly. Percentage rent

is calculated by multiplying fixed percentages by gross room revenues in excess of certain threshold amounts and other revenues for each of the initial hotels. Percentage rent will be paid quarterly.

Other than real estate, certain insurance obligations and remaining capital improvements, which are obligations of the lessor, the leases require our TRS Lessee to pay rent, all costs and expenses and all utility and other charges incurred in the operation of the hotels it leases. The leases also provide for rent reductions and abatements in the event of damage to, or destruction or a partial taking of, any hotel as described under “Damage to Hotels” and “Condemnation of Hotels.”

Maintenance and Modifications

Under each lease, the lessor is required to maintain the structural elements of the improvements and the roof of the hotel. Except for capital improvements and maintenance of structural elements, our TRS Lessee will be required, at its expense, to maintain the hotels in good order and repair, except for ordinary wear and tear, and to make non-structural, foreseen and unforeseen, and ordinary and extraordinary, repairs which may be necessary and appropriate to keep the hotels in good order and repair.

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 thereon comprising their respective hotels, except to the extent that ownership of such personal property would cause the rent under the leases not to qualify as “rents from real property” for REIT income test purposes, in which case some or all of the personal property associated with a hotel will be owned by the TRS Lessee. See the sections entitled “Material Federal Income Tax Considerations—Requirements for Qualification - Income Tests” of this prospectus.

Insurance and Property Taxes

We will pay real estate and personal property taxes with respect to our hotels. The TRS Lessee is required to pay or reimburse us for all liability insurance on the hotels, with extended coverage, comprehensive general public liability, workers’ compensation and other insurance appropriate and customary for properties similar to their respective hotels and naming us, as the case may be, as an additional named insured.

Assignment, Subleasing and Change of Control

Our TRS Lessee is not permitted to sublet all or any part of the hotel or to assign its interest under the lease, other than to an affiliate of our TRS Lessee, without our prior written consent. No assignment or subletting will release our TRS Lessee from any of its obligations under the lease.

Damage to Hotels

In the event of damage to or destruction of any hotel covered by insurance, we may, at our option to be exercised within 30 days after our TRS Lessee elects to terminate the lease, repair, rebuild, or restore the hotel. If we decide not to rebuild, the lease will terminate and we will retain the insurance proceeds.

Condemnation of Hotels

In the event of a total condemnation of a hotel, the relevant lease will terminate with respect to such hotel as of the date of taking, and the lessor and our TRS Lessee will be entitled to its share of any condemnation award in accordance with the provisions of the lease. In the event of a partial taking which does not render the hotel unsuitable for our TRS Lessee’s use, we will restore the untaken portion of the hotel to a complete architectural unit of the same general character and condition as existed immediately prior to the condemnation subject to the receipt of sufficient condemnation awards.

Events of Default

Events of default under the leases include, among others, the following:

•

the failure by our TRS Lessee to pay base rent, percentage rent or additional charges within 10 days after receipt by lessee of such notice;

•

the failure by our TRS Lessee to observe or perform any other term, covenant or condition of a lease and the continuation of such failure for a period of 30 days after receipt by our TRS Lessee of notice from us thereof, unless such failure cannot with due diligence be cured within such period and our TRS Lessee commences appropriate action to cure such failure and diligently completes the curing thereof, but in no event shall the cure period extend beyond 120 days after notice;

•

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

•

if our TRS Lessee voluntarily discontinues operations of a hotel for more than 30 days, except as a result of damage, destruction, renovation or a partial or complete condemnation; or

•

if the franchisor under a franchise agreement has declared an event of default as a result of any action or failure to act by our TRS Lessee or any management company and such default continues beyond the applicable grace period.

If an event of default occurs and continues beyond any curative period, we will have the option of reclaiming the leased property. We intend that leases with respect to our hotels acquired in the future will contain substantially similar provisions, although we may, in our discretion, alter any of these provisions with respect to any particular lease.

Termination of Leases on Disposition of the Hotels

We will have the right to terminate the lease by either (i) paying our TRS Lessee a termination fee or (ii) offering to lease to our TRS Lessee a substitute hotel reasonably comparable in size, number of rooms, quality of franchise operation, market and geographical location, and gross revenues, to be governed by the terms and conditions of the lease.

Subleases of Shell Island Resort

We will also sublease the common areas of the Shell Island Resort to MHI Hotels LLC and MHI Hotels Two, Inc. See “Our Business and Properties—Our Initial Properties”

MANAGEMENT

Directors and Executive Officers

Our business and affairs are managed under the direction of our board of directors. Upon completion of this offering, our board of directors will consist of seven members, including our current director, the seven persons named below, each of whom has consented to serve as a director upon completion of the offering and an additional director. We believe Messrs. Stein, Beatty, Carey, and General Zinni meet, and we intend that our additional director will meet, the independence requirements of the American Stock Exchange, or AMEX. Our board will be responsible for determining independence. Our directors will serve one year terms and hold office until their successors are elected and qualified. The terms of our present directors and those persons who will become directors upon or shortly after completion of this offering, will expire at our next annual meeting of stockholders. Certain information regarding our executive officers and directors, and those persons who have agreed to become directors upon completion of the offering, is set forth below.


Name	Age	Position
Andrew M. Sims	47	President, Chief Executive Officer and Chairman of the Board
William J. Zaiser	58	Executive Vice President, Chief Financial Officer and Treasurer
General Anthony C. Zinni (USMC Ret.)	61	Director ⁽¹⁾
Kim Sims	49	Director ⁽¹⁾
Christopher Sims	45	Director ⁽¹⁾
Edward Stein	58	Director ⁽¹⁾
David Beatty	60	Director ⁽¹⁾
J. Paul Carey	46	Director ⁽¹⁾

⁽¹⁾	Each of such persons has agreed to become a director immediately after the closing of the offering.

The following is a summary of certain biographical information regarding our directors, director nominees and executive officers:

Andrew Sims is our president, chief executive officer and chairman of the board. He has served as President of MHI Hotels Services since 1995 after serving for seven years as vice president of finance and development. During his tenure as vice president of finance and development, he was instrumental in the purchase and renovation of several properties that drove the growth of MHI Hotels Services in the 1990’s. Among the acquisitions he helped negotiate are the Hilton Wilmington Riverside and the Shell Island Resort in Wrightsville Beach, North Carolina. Andrew Sims’ association with MHI Hotels Services continues a tradition of family management which began with his father, Edgar Sims, Jr., who founded MHI Hotels Services as Maryland Hospitality Inc. in 1957. Mr. Sims began his career as a sales associate for Merrill Lynch Commercial Realty. He is a graduate of Washington & Lee University, with a bachelor’s degree in commerce. Andrew Sims is the brother of directors Kim and Christopher Sims. Mr. Sims currently serves on the franchise advisory board for Hilton Hotels. Mr. Sims will resign as an officer of MHI Hotel Services upon completion of the offering but will continue to serve as a director of MHI Hotels Services following the offering.

William Zaiser is our executive vice president, chief financial officer and treasurer. A certified public accountant, he is responsible for financial analysis, cash management, insurance, investment and financial reporting. Mr. Zaiser began his career with MHI Hotels Services as a computer consultant, and became the first corporate controller for MHI Hotels Services. In 1990, he was elected to the board of directors and was promoted to vice president of accounting. Before joining the hospitality industry, Mr. Zaiser was an instructor of mathematics at both the University of Maryland and Montgomery College. A licensed CPA in the State of Maryland, he holds a masters degree in applied mathematics from the University of Maryland and a bachelor’s degree in mathematics and physics from Ohio Wesleyan University. Mr. Zaiser is a member of the American

Institute of Certified Public Accountants and the Hospitality Financial and Technology Professionals. Mr. Zaiser will resign as an officer of MHI Hotel Services upon completion of the offering but will continue to serve as a director of MHI Hotels Services following the offering.

General Anthony C. Zinni (USMC Ret.) will become a director after completion of the offering. General Zinni retired from the U.S. Marine Corps after 39 years of service in October 2000. During his military career, General Zinni served as the Commanding General, First Marine Expeditionary Force from 1994 to 1996, and as Commander-in-Chief, U.S. Central Command from 1997 to 2000. General Zinni has participated in numerous humanitarian operations and Presidential diplomatic missions. In November 2001, General Zinni was appointed senior adviser and U.S. envoy to the Middle East by Secretary of State Colin Powell. Since November 2000, General Zinni has consulted in the areas of defense, military, national security, foreign policy and regional issues. General Zinni serves as a professor at William & Mary College and at Virginia Military Institute, positions he has held since November 2000. General Zinni currently serves as a director and member of the compensation committee of BAE Systems. General Zinni received his bachelor’s degree in economics from Villanova University. He also earned a Masters degree in international relations from Salvae Regina College, a Masters degree in management and supervision from Central Michigan University, and an honorary doctorate degree from William and Mary College and the Maine Maritime Academy.

Kim Sims , an officer and director of MHI Hotels Services, will become a director after completion of the offering. He will become the President of MHI Hotels Services upon completion of the offering and has served as executive vice president of Operations since 1995, providing 27 years of service to the company. Mr. Sims was instrumental in MHI Hotels Services expansion as a multi-property management company beginning with his management and oversight of the Best Western Maryland Inn in Laurel, Maryland in 1986. His efforts proved crucial to MHI Hotels Services’ expansion into the Commonwealth of Virginia by purchasing two Holiday Inns in Williamsburg, Virginia. Mr. Sims’ knowledge of construction and design further led to the expansion of MHI Hotels Services into the operation and renovation of distressed properties. He is a graduate of Washington & Lee University with a degree in commerce. Kim Sims is the brother of Andrew and Christopher Sims.

Christopher Sims , an officer and director of MHI Hotels Services, will become a director after completion of the offering. He joined MHI Hotels Services in 1981 first as sales and general manager for the Best Western Maryland Inn in College Park until his promotion in 1988 to vice president of sales and marketing. Christopher Sims was instrumental in the opening of a number of MHI properties, including the Hilton Savannah Desoto in Savannah, Georgia. Mr. Sims is a graduate of Hampden-Sydney College, with a bachelor’s degree in economics. He is First Vice President of the Prince George Conference and Visitors Bureau and a member of Hospitality Sales and Marketing Association International. Christopher Sims is the brother of Andrew and Kim Sims.

Edward Stein will become a director after completion of the offering and will serve as chairman of the governance and compensation committee. He is a founding partner of the Norfolk, Virginia law firm of Weinberg and Stein. Mr. Stein has practiced law in the areas of real estate, estate planning, probate, corporate law, business law and licensing since 1974. He is admitted to the Virginia Bar and is a member of the Norfolk and Portsmouth, Virginia Bar Associations. Mr. Stein was educated at the Lawrenceville School (1964), Harvard College (A.B. 1968) and the University of Virginia School of Law (J.D. 1974).

David Beatty will become a director after completion of the offering. He began his 32-year career in finance and real estate development as head of marketing operations for George Kaufman real estate development group in 1972. He was a founder of Essex Commercial Mortgage in 1987 and founder and President of CENIT Commercial Mortgage Corp. in 1990. In 2001, Mr. Beatty founded Towne Commercial Mortgage, LLC, where he currently serves as president. Towne Commercial Mortgage specializes in placing debt and equity for the lodging industry. He has been President of Guest Quarters, Inc., Treasurer and CFO of Guest Quarters Development Group and President of mortgage financing for Lawson-Essex, Inc. Mr. Beatty holds a B.A. in Economics from Georgetown University and an M.B.A. in Finance and Marketing from the Colgate Darden School of Business at the University of Virginia.

J. Paul Carey will become a director after completion of the offering and will serve as the chairman of the audit committee. He is currently the Managing Partner for JPT Partners, a privately held investment partnership created to acquire and manage transaction processing companies in the education and financial services industry. J. Paul Carey also serves as the Chairman for Campus Partners, LLC, the leading Perkins and Campus based loan service in the country. Prior to his position with JPT Partners, J. Paul Carey served as the Chief Executive Officer of Enumerate Solutions, Inc., a venture backed software company, from November 2001 until October 2003. Mr. Carey also served as the Executive Vice President for Sallie Mae and was responsible for financial reporting from August 1997 to April 2001, and as a partner with LCL Ltd., a financial advisory management and investment firm from March 1993 to August 1997. He serves on the Board of Trustees for the University of Maryland College Park Foundation and for Trinity College. Mr. Carey received his M.B.A. from the University of Maryland and his B.S. from the Catholic University in Washington D.C.

Promoters

Andrew Sims and William Zaiser are our promoters, which means that they have taken initiative in funding and organizing our business.

Director Compensation

We intend to pay independent, non-employee directors fees for their services as directors. Independent, non-employee directors will receive annual compensation of $15,000, plus a fee of $750 (plus out-of-pocket expenses) for attendance in person at each meeting of the board of directors, and $750 for each committee meeting attended in person. Directors who attend meetings telephonically will receive a fee of $375. Directors who are also officers or employees of our company will not be paid any director fees. Directors Edward Stein and J. Paul Carey will receive an additional $5,000 per year for their services as chair of the corporate governance and audit committees, respectively. Additionally, we will issue 1,000 shares of restricted stock to each of the independent director upon consummation of this offering. Although distributions will be paid on all restricted stock, whether or not vested, at the same rate and on the same date as on shares of our common stock, these holders will be prohibited from selling such shares until they vest. All of the shares of restricted stock will vest on the first anniversary of the date of grant.

Our board of directors may change the compensation of our independent directors in its discretion.

Strategic Alliance Agreement

Under the terms of our strategic alliance agreement with MHI Hotels Services, they have the right to nominate one person for election to our board of directors at each annual meeting of stockholders for so long as Andrew Sims, Kim Sims, Christopher Sims and their affiliates and families own not less than 1.5 million units or shares of our common stock. The initial nominee of MHI Hotels Services will be Kim Sims. Such nominee may not be independent under the corporate governance standards of the American Stock Exchange.

Independent Directors

Under the enhanced corporate governance standards of the American Stock Exchange, a majority of our directors, and all of the members of our audit committee and governance and compensation committee, must meet “independence” standards as defined by the AMEX.

The AMEX’s enhanced corporate governance standards provide certain transition periods for issuers that will be listed on AMEX in conjunction with their initial public offering.

We believe that four of our board members, Edward Stein, David Beatty, J. Paul Carey and General Zinni meet the enhanced test of independence required by AMEX. Independence will be determined by our board of directors.

We expect that our independent directors will meet in executive sessions at least four times each year without the presence of any corporate officers. We do not intend to appoint a lead director to preside over such executive sessions. Rather, we expect that the independent directors themselves will designate a presiding independent director from time to time.

We intend to implement procedures for interested parties, including stockholders, who wish to communicate directly with our independent directors. We believe that providing a method for interested parties to communicate directly with our independent directors, rather than the full Board, will provide a more confidential, candid and efficient method of relaying any interested party’s concerns or comments.

The board will establish two committees whose principal functions are briefly described below.

Audit Committee

Our board of directors will establish an audit committee following completion of this offering, which will be comprised of David Beatty, J. Paul Carey and General Zinni. J. Paul Carey will serve as the chairperson of the audit committee. Each of the members of the audit committee will meet the financial literacy requirements promulgated by the Securities and Exchange Commission, and we believe the board will affirmatively determine that Mr. Carey is an “audit committee financial expert.” The audit committee will oversee, review and evaluate:

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our financial statements;

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our accounting and financial reporting processes;

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the integrity and audits of our financial statements;

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our disclosure controls and procedures;

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our compliance with legal and regulatory requirements;

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our internal control functions;

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the qualifications and independence of our independent auditors; and

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the performance of our internal and independent auditors.

The audit committee also will:

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have sole responsibility to appoint or replace our independent auditors;

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have sole responsibility to approve, in advance, all audit and permissible non-audit engagement services, if any, by our independent auditors and the fees to be paid in connection therewith;

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establish and maintain whistleblower procedures;

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conduct an annual self-evaluation;

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prepare an audit committee report for publication in our annual proxy statement;

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monitor compliance of our employees with our standards of business conduct and conflict of interest policies; and

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meet at least quarterly with our senior executive officers, internal audit staff and our independent auditors in separate executive sessions.

Our board will adopt a charter for the audit committee that sets forth its specific functions and responsibilities. We expect to make our audit committee charter available on our website. In addition, we expect to include on our website information regarding procedures established by the audit committee for the submission of complaints or concerns about our accounting, internal accounting controls or auditing matters.

Governance and Compensation Committee

Our board of directors will establish a governance and compensation committee following completion of this offering, which will consist of the independent directors, Edward Stein, David Beatty and J. Paul Carey. Director Edward Stein will act as the chairman of the governance and compensation committee. The purpose of the governance and compensation committee is to make recommendations to the board of directors regarding corporate governance policies and practices, recommend criteria for membership on the board of directors, nominate members to the board of directors, make recommendations to the board of directors concerning the members, size and responsibilities of each of the committees, develop general policy relating to compensation and benefits, determine compensation for, and evaluate the performance of, our executive officers and administer our 2004 Stock Incentive Plan with the consent of the full board.

In determining appropriate candidates to nominate to the board of directors, the governance and compensation committee will generally consider a number of factors, including the age, expertise, business experience, character and other board memberships of the candidate. The governance and compensation committee may employ a search firm to be used to identify director candidates or a compensation consultant to assist in the evaluation of the compensation of the chief executive officer or any other executive officer. In nominating members to the board of directors, the governance and compensation committee will consider nominees recommended by stockholders so long as the recommendation is submitted to our secretary within the timeframe required to request a proposal that will be included in the proxy materials for our next annual meeting of stockholders. However, the governance and compensation committee may, in its sole discretion, reject any such recommendation for any reason.

Our board will adopt a charter for the governance and compensation committee that sets forth its specific functions and responsibilities. We expect to make our governance and compensation committee charter available on our website.

Corporate Governance Guidelines and Code of Business Conduct and Ethics

Our board of directors will adopt a code of business conduct and ethics, including a conflicts of interest policy, relating to the conduct of our business by our employees, officers and directors. We intend to maintain the highest standards of ethical business practices and compliance with all laws and regulations applicable to our business.

Compensation Committee Interlocks and Insider Participation

We believe that the members of the governance and compensation committee of our board of directors will be independent directors. Upon completion of this offering, none of these directors, or any of our executive officers, will serve as a member of a board of directors or any compensation committee of any entity that has one or more executive officers serving as a member of our board.

Executive Compensation

We were organized in August 2004, did not conduct any prior operations and, accordingly, did not pay any compensation to our executive officers for the year ended December 31, 2003 or the six months ended June 2004. MHI Hotel Services compensated these persons for services performed during 2003.

The following table sets forth the annual base salary levels and other compensation expected to be paid by us in 2004 to our executive officers upon the consummation of this offering. We will assign certain of the rights and obligations under the employment agreements with the executive officers to our operating partnership, which will also employ the executive officers and will pay their compensation. See the section entitled “Management - Director Compensation” in this prospectus.


Name and Principal Position	Salary ⁽¹⁾		Bonus ⁽²⁾	Other Annual Compensation
Andrew Sims President and Chief Executive Officer	$	200,000	—
William Zaiser Chief Financial Officer	$	150,000	—

⁽¹⁾	We do not expect to pay salaries to our executive officers until consummation of this offering. The amounts set forth in these columns are annualized amounts payable to the named executive officer in 2004 pursuant to an employment agreement with us.

⁽²⁾

Our executive officers will be entitled to such bonuses as may be determined by our governance and compensation committee and the board of directors from time to time. There is no guaranteed minimum bonus. We do not expect to pay any bonus for Mr. Sims or Mr. Zaiser in 2004. Bonuses for Mr. Sims to be paid in 2005 based on 2004 results could range up to % of his base salary, and bonuses for Mr. Zaiser could range up to % of this base salary.

Employment Agreements

We will enter into employment agreements, effective upon completion of the offering, with Andrew Sims and William Zaiser that provide for an annual salary of $200,000 for Andrew Sims and $150,000 for William Zaiser. The employment agreements recognize the discounted nature of the salaries for Andrew Sims and William Zaiser and provide for an adjustment commencing January 1, 2006 to the greater of his then current annual salary or 80% of market and commencing January 1, 2007 to the greater of his then current annual salary or 90% of market. The “market rate” for chief executive officer and chief financial officer salaries will be determined by the independent compensation committee of the board of directors. In addition, the employment agreements provide these officers with severance benefits if their employment ends under certain circumstances. We believe that the agreements will benefit us by helping to retain the executives and by allowing them to focus on their duties without the distraction of the concern for their personal situations in the event of a possible change in control of our company.

The agreements have an initial term beginning on the effective date of the initial public offering and ending on December 31, 2009. Thereafter, the term of the agreements will be extended for an additional year, on each anniversary of the effective date of the offering, unless either party gives 180 days prior written notice that the term will not be extended.

Each of these executives will be entitled to receive benefits under his respective employment agreement if we terminate the executive’s employment without cause or the executive resigns with good reason or if there is a change in control of our company during the term of the agreement. Under these scenarios, each of the executives is entitled to receive the following:

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any accrued but unpaid salary and bonuses;

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vesting as of the executive’s last day of employment of any unvested stock options or restricted stock previously issued to the executive;

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payment of the executive’s life, health and disability insurance coverage for a period of 10 years; and

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a severance payment equal to five times the greater of such executive’s combined maximum salary base and actual bonus compensation for the preceding fiscal year.

Each of the executives will be eligible to receive payments to compensate the executive for the additional taxes, if any, imposed on the executive under Section 4999 of the Internal Revenue Code by reason of receipt of excess parachute payments.

The employment agreements contain customary non-competition covenants that apply during the term and for one year after the term of each executive’s employment with our company.

2004 Stock Incentive Plan

We will establish a stock plan for the purpose of attracting and retaining our executive officers, employees, directors and other persons that provide services to us. The stock plan authorizes (i) the issuance of options to purchase common stock and (ii) the grant of:

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stock awards;

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performance shares (the right to receive a future payment based on the value of the common stock if certain conditions are met);

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stock appreciation rights (the right to receive a payment of up to the amount by which the fair market value of a share of common stock on the date of exercise exceeds the fair market value of a share of common stock on the date the stock appreciation right was granted); and

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incentive awards (a cash bonus that is payable if certain objectives are achieved).

Administration of the stock plan is carried out by the governance and compensation committee of the board of directors. The governance and compensation committee may delegate its authority under the stock plan to one or more officers but it may not delegate its authority with respect to awards to individuals subject to Section 16 of the Exchange Act. As used in this summary of our stock plan, the term “administrator” means the compensation committee or its delegate.

As of the date of this prospectus, there were approximately officers, directors and employees of ours eligible to participate in the stock plan.

Up to shares of common stock are available for issuance under the stock plan. No more than shares may be issued as stock awards or in settlement of performance share grants. If an outstanding award expires or terminates before the end of the period during which awards may be granted, the unissued, underlying shares will be available for other awards under the plan.

Under Section 162(m) of the Code, a public company may not deduct compensation in excess of $1 million paid to any of its chief executive officer and the four next most highly paid executive officers. The stock plan is designed to comply with Section 162(m) of the Code so that the grant of options and stock appreciation rights under the stock plan, and the other awards, such as stock awards, performance shares and incentive awards, that are conditioned on the performance goals described in the stock plan, will be excluded from the calculation of annual compensation for purposes of Section 162(m) of the Code and will be fully deductible. To qualify for this exclusion, the incentive plan will be subject to the following restrictions:

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no more than shares may be granted during any one calendar year to any one participant under the stock plan in the form of options or stock appreciation rights or both, plus an additional shares if the grant is made in connection with his or her initial employment,

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no more than shares may be granted during any one calendar year to any one participant under the stock plan in the form of stock awards, and

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no more than $ in fair market value of any other awards (less any consideration paid by the participant for such award) may be granted to any one participant during any one calendar year under the stock plan.

In order to comply with Section 162(m) of the Code, the compensation committee also may determine that any award will be determined solely on the basis of one or more of the following goals:

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funds from operations;

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funds from operations per share;

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return on equity;

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total earnings;

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total return to stockholders;

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earnings per share;

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earnings growth;

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return on capital;

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fair market value of the common stock;

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peer stockholder returns; or

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other financial measures that the compensation committee may designate.

The administrator may, in its discretion, reduce (but not increase) any award, even if a specified goal is achieved. If an award is made on such basis, the administrator must establish goals before the beginning of the period for which such performance goal relates (or such later date as may be permitted under Section 162(m) of the Code). Any payment of an award granted with performance goals will be conditioned on the written certification of the administrator in each case that the performance goals and any other material conditions were satisfied.

In the event of a corporate transaction involving us (including a stock dividend, stock split, merger, spin-off or related transaction), the share authorization limits and restrictions described above will be adjusted proportionately, and the compensation committee may adjust awards to preserve their benefits or potential benefits.

The stock plan provides for the grant of (i) options intended to qualify as incentive stock options under Section 422 of the Code and (ii) options that are not intended to so qualify. The principal difference between incentive stock options and other options is that a participant generally will not recognize ordinary income at the time an incentive stock option is granted or exercised, but rather at the time the participant disposes of the shares acquired under the incentive stock option. In contrast, the exercise of an option that is not an incentive stock option generally is a taxable event that requires the participant to recognize ordinary income equal to the difference between the shares’ fair market value and the option price. The employer will not be entitled to a federal income tax deduction with respect to incentive stock options except in the case of certain dispositions of shares acquired under the options. The employer may claim a federal income tax deduction on account of the exercise of an option that is not an incentive stock option equal to the amount of ordinary income recognized by the participant. No participant may be granted incentive stock options that are first exercisable in a calendar year for shares of common stock having a total fair market value (determined as of the option grant), exceeding $ .

The governance and compensation committee will select the participants who are granted options and, consistent with the terms of the stock plan, will prescribe the terms of each option. The option price cannot be less than the shares’ fair market value on the date the option is granted. The option price may be paid in cash or, with the administrator’s consent, by surrendering common stock, a combination of cash and common stock or in installments. Options may be exercised in accordance with requirements set by the administrator. The maximum period in which an option may be exercised will be fixed by the administrator but cannot exceed 10 years. Options generally will be nontransferable except in the event of the participant’s death, but the administrator may allow the transfer of options to members of the participant’s immediate family, a family trust or a family partnership.

The administrator also will select the participants who are granted stock awards, performance shares, stock appreciation rights and incentive awards. Consistent with the terms of the stock plan, the administrator will establish the terms of each such award, which may be subject to vesting requirements or transfer restrictions or both as determined by the administrator. Those conditions may include, for example, a requirement that the participant complete a specified period of service or that certain objectives be achieved. The objectives may be based on performance goals that are stated with reference to our performance or the performance of our affiliates or business units.

A stock appreciation right will be exercisable at such times and subject to such conditions as may be established by the administrator. The amount payable upon the exercise of a stock appreciation right may be settled in cash, by the issuance of common stock or a combination of cash and common stock.

The period in which performance related to incentive awards is measured will be at least one year. No participant may be granted incentive awards in any calendar year that exceed the lesser of (i) % of the participant’s base salary (prior to any salary reduction or deferral election) as of the date of grant or (ii) $ .

The stock plan includes several provisions that apply if there is a change in control of our company (as defined in the stock plan). If there is a change in control, outstanding options and stock appreciation rights will become exercisable, stock awards will become vested and transferable, and performance share awards and incentive awards will be earned in full.

The board of directors may amend or terminate the stock plan at any time, but an amendment will not become effective without the approval of our stockholders if it increases the number of shares of common stock that may be issued under the stock plan (other than changes to reflect certain corporate transactions and changes in capitalization). No amendment or termination of the stock plan will affect a participant’s rights under outstanding awards without the participant’s consent.

Restricted Stock Grants

On the effective date of this offering, 4,000 shares of restricted stock will be granted to our non-employee directors (1,000 shares to each of Messrs. Beatty, Stein, Carey and General Zinni) as described under “Management — Director Compensation.”

Stock Incentive Grants

We may employ compensation and benefit consulting firm to help us develop a long-term incentive stock program that will reward our executive officers for consistently generating above-industry average stockholder returns.

INVESTMENT POLICIES AND POLICIES WITH RESPECT TO CERTAIN ACTIVITIES

The following is a discussion of our investment policies and our policies with respect to certain 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. Any change to any of these policies by our board of directors, however, would be made only after a thorough review and analysis of that change, in light of then-existing business and other circumstances, and then only if, in the exercise of its business judgment, our board of directors believes that it is advisable to do so in our and our stockholders’ best interests. We cannot assure you that our investment objectives will be attained.

Investments in Real Estate or Interests in Real Estate

We plan to invest principally in hotel properties. Our senior executive officers will identify and negotiate acquisition opportunities, subject to approval by our board of directors. For information concerning the investing experience of our senior executive officers, please see the sections entitled “Our Business and Properties - Our Team” and “Management” in this prospectus.

We intend to conduct substantially all of our investment activities through our operating partnership and its subsidiaries. Our primary investment objectives are to enhance stockholder value over time by improving the operating results of our initial properties and by identifying, acquiring and repositioning additional hotel properties that we expect to generate enhanced revenue, improved cash flow performance and long-term appreciation.

There are no limitations on the amount or percentage of our total assets that may be invested in any one property. Additionally, no limits have been set on the concentration of investments in any one location or facility type. Our policy is to acquire assets primarily for income.

Additional criteria with respect to our hotel investments are described in the section entitled “Our Business and Properties-Our Strategy” in this prospectus.

Investments in Mortgages, Structured Financings and Other Lending Policies

We have no current intention of investing in loans secured by properties or making loans to persons. However, we do not have a policy limiting our ability to invest in loans secured by properties or 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. We may make loans to joint ventures in which we may participate in the future. However, we do not intend to engage in significant lending activities.

Investments in Securities of or Interests in Persons Primarily Engaged in Real Estate Activities and Other Issuers

Generally, we do not expect to engage in any significant investment activities with other entities, although we may consider joint venture investments with other investors. We may also invest in securities of other issuers in connection with acquisitions of indirect interests in properties, which we expect will typically be general or limited partnership interests in special purpose partnerships owning 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 our investment policies and the REIT qualification requirements. There are no limitations on the amount or percentage of our total assets that may be invested in any one issuer, other than those imposed by the gross income and asset tests that we must satisfy to qualify as a REIT. 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 of 1940, as amended, and we intend to divest securities before any registration would be required.

We do not intend to engage in trading, underwriting, agency distribution or sales of securities of other issuers.

Disposition Policy

Although we have no current plans to dispose of properties within our portfolio, we will consider doing so, subject to REIT qualification and prohibited transaction rules, if our management determines that a 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 tax consequences of the sale and other factors and circumstances surrounding the proposed sale. For a discussion of the implications of disposing of certain of our initial properties, see the section entitled “Risk Factors-Risks Related to Our Business and Properties” in this prospectus.

Financing Policies

We will seek to maintain aggregate target debt levels of 45-55% of total assets. Upon completion of the offering and the related formation transactions, we will have $25.7 million in debt (representing approximately 24.6% of pro forma total assets as of June 30, 2004) on two of our initial hotels. We intend to obtain a $23.0 million revolving credit facility secured by first mortgages on two of our initial hotel properties following completion of the offering. We expect the credit facility to be available for general corporate purposes, including the following:

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funding of investments;

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funding of hotel renovations and improvements;

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payment of distributions to stockholders;

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working capital needs; or

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any other payments deemed necessary or desirable by senior management and approved by the lender.

Going forward, we will consider a number of factors when evaluating our level of indebtedness and making financial decisions, including, among others, the following:

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the interest rate of the proposed financing;

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prepayment penalties and restrictions on refinancing;

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the purchase price of properties we acquire with debt financing;

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our long-term objectives with respect to the financing;

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our target investment returns;

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the ability of particular properties, and our company as a whole, to generate cash flow sufficient to cover expected debt service payments;

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overall level of consolidated indebtedness;

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timing of debt and lease maturities;

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provisions that require recourse and cross-collateralization;

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corporate credit ratios including debt service coverage, debt to total market capitalization and debt to undepreciated assets; and

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the overall ratio of fixed- and variable-rate debt.

Equity Capital Policies

Subject to applicable law and the requirements for listed companies on the AMEX, our board of directors has the authority, without further stockholder approval, to issue additional authorized common stock and preferred stock or otherwise raise capital, including through the issuance of senior securities, in any manner and on the terms and for the consideration it deems appropriate, including in exchange for property. Existing stockholders will have no preemptive right to additional stock issued in any offering, and any offering might cause a dilution of investment. We may in the future issue common stock in connection with acquisitions. We also may issue units in connection with acquisitions of property.

Our board of directors may authorize the issuance of preferred stock with terms and conditions that could have the effect of delaying, deterring or preventing a transaction or a change in control in us that might involve a premium price for holders of our common stock or otherwise might be in their best interests. Additionally, preferred stock could have distribution, voting, liquidation and other rights and preferences that are senior to those of our common stock.

We may, under certain circumstances, purchase common stock in the open market or in private transactions with our stockholders, if those purchases are approved by our board of directors. Our board of directors has no present intention of causing us to repurchase any stock, 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 common stock by automatically reinvesting their cash dividends. Stock would be acquired pursuant to the plan based on 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 Policy

Our current board of directors consists of Andrew Sims. Accordingly, the transactions and agreements in connection with the formation of our company prior to the offering have not been approved by any independent directors.

MHI Hotels Services is owned and controlled by members of the Sims family, Andrew, Kim and Christopher Sims, along with William Zaiser and Steve Smith. Andrew Sims is our chairman, president and chief executive officer, and William Zaiser is our executive vice president and chief financial officer. Kim and Christopher Sims will serve on our board of directors. Steve Smith is the executive vice president of MHI Hotels Services. As a result, our strategic alliance and hotel management agreements with MHI Hotels Services as well as certain agreements entered into in connection with the formation transactions, including tax indemnity provisions in connection with the contributions of our initial properties, have not been approved by any independent directors and may not represent the results of arm’s-length negotiation between disinterested or independent parties. Several of these agreements will continue to affect our business and results of operations following consummation of this offering and the formation transactions and for the foreseeable future. See “Risk Factors – Risks Related to Our Business and Properties” and “Certain Relationships and Related Party Transactions.”

Our bylaws require that certain transactions between us and any of our directors, officers or employees must be approved by a majority of our disinterested directors. Effective upon completion of this offering, we intend to adopt policies to reduce potential conflicts of interest in accordance with our bylaws. However, we cannot assure you that these policies will be successful in eliminating the influence of these conflicts. See “Risk Factors – Risk Related to Our Business and Properties.” Neither our charter or bylaws, nor any of our policies, restrict any of our directors, officers, stockholders or affiliates from conducting, for their own account, or on behalf of others, business activities of the type we conduct. Pursuant to employment agreements entered into with our Chief Executive Officer and Chief Financial Officer, such individuals have agreed not to solicit certain of our employees or engage in certain competitive activities with us.

The Maryland General Corporation Law, or MGCL, provides that a contract or other transaction between a corporation and any of that corporation’s directors or any other entity in which that director is also a director or has a material financial interest is not void or voidable solely on the grounds of the common directorship or interest, the fact that the director was present at the meeting at which the contract or transaction is approved or the fact that the director’s vote was counted in favor of the contract or transaction, if:

•

the fact of the common directorship or interest is disclosed to the board or a committee of the board, and the board or that committee authorizes the contract or transaction by the affirmative vote of a majority of the disinterested directors, even if the disinterested directors constitute less than a quorum;

•

the fact of the common directorship or interest is disclosed to stockholders entitled to vote on the contract or transaction, and the contract or transaction is approved by a majority of the votes cast by the stockholders entitled to vote on the matter, other than votes of stock owned of record or beneficially by the interested director, corporation, firm or other entity; or

•

the contract or transaction is fair and reasonable to the corporation.

Reporting Policies

Generally, we intend to make available to our stockholders audited annual financial statements and annual reports. After the offering, we will become subject to the information reporting requirements of the Securities Exchange Act of 1934, as amended. Pursuant to these requirements, we will file periodic reports, proxy statements and other information, including audited financial statements, with the SEC.

PRINCIPAL STOCKHOLDERS

Unless otherwise noted below, the following table sets forth the total number of units which may be redeemed for shares of our common stock and will be beneficially owned immediately following the completion of this offering and the formation transactions by each person or group known to us to be holding more than 5% of our common stock, for each person who will become a director upon completion of the offering, each executive officer and for our directors and executive officers as a group assuming the issuance of common stock upon exercise of redemption rights with respect to the units. To our knowledge, each person that beneficially owns our shares has sole voting and dispositive power with regard to such shares, unless otherwise noted in the footnotes in the following table. The number of shares shown represents the number of shares of common stock the person “beneficially owns,” as determined by the rules of the SEC, including the number of shares that may be issued upon redemption of units. As of the date of this prospectus, 100 shares of our common stock were issued and outstanding. All of these shares of common stock were held by Andrew Sims. These shares will be cancelled upon completion of the offering. We are the sole general partner of the operating partnership. After one year, the operating partnership is generally obligated to redeem each unit at the request of the holder thereof for the cash value of one share of common stock or, at our option, one share of common stock. Holders of units may not exercise such redemption rights prior to the one year anniversary of the issuance of the units without the prior approval of our board of directors.


Name of Beneficial Owner	Number of Shares Beneficially Owned ⁽¹⁾⁽²⁾		Percent of Class ⁽¹⁾⁽³⁾
Andrew Sims	639,556		9.6	%
William Zaiser	162,614		2.6	%
Kim Sims	639,555		9.6	%
Christopher Sims	639,555		9.6	%
J. Paul Carey	1,000	⁽⁴⁾	*
David J. Beatty	1,000	⁽⁴⁾	*
General Anthony C. Zinni (USMC Ret.)	1,000	⁽⁴⁾	*
Edward Stein	334,099	⁽⁵⁾	5.3	%
Elpizo Limited Partnership	732,254		10.9	%
Wilmington Hotel Associates Corp ⁽⁶⁾	377,903		5.9	%
All executive officers and directors as a group (7 persons)	2,417,380		28.7	%

*	Represents less than 1% of the number of shares of common stock and units upon completion of the offering and formation transactions.

⁽¹⁾	Assumes that the units are redeemed for common stock.

⁽²⁾	Except as otherwise noted, represents the number of units prior to completion of the offering held by each person.

⁽³⁾	Assumes that all units held by such person or group of persons are redeemed for common stock. The total number of shares outstanding used in calculating the percentage assumes that none of the units held by other persons are redeemed for common stock.

⁽⁴⁾	Represents shares of restricted stock.

⁽⁵⁾	Represents 1,000 shares of restricted common stock and 333,099 units held by the Krischman Trusts of which Edward Stein is a Trustee.

⁽⁶⁾	Jeanette Sims, the mother of Andrew, Christopher and Kim Sims, is the sole stockholder of Wilmington Hotel Associates Corp.

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SHARES AVAILABLE FOR FUTURE SALE

General

Upon the completion of this offering, we will have 6,004,000 shares of common stock outstanding and 3,817,036 shares of common stock reserved for issuance upon redemption of units, or “redemption shares.” Our common stock issued in this offering will be freely tradable by persons other than our affiliates, subject to certain limitations on ownership set forth in our governing documents. See the section entitled “Description of Common Stock-Restrictions on Ownership and Transfer” in this prospectus.

Redemption Rights

Pursuant to the partnership agreement of our operating partnership, the individuals that own the units will have the right to cause the partnership to redeem their units. When a limited partner exercises this right, the partnership must redeem the units in exchange for cash or, at our option, shares of common stock, on a one-for-one basis. These redemption rights generally may be exercised by the limited partners at any time after one year following the issuance of the units. See “Partnership Agreement - Redemption Rights.” Any amendment to the partnership agreement that would affect these redemption rights would require our consent as general partner and the consent of limited partners holding more than 50% of the units held by limited partners (excluding us).

Rule 144

Unless registered by us prior to issuance, all of the redemption shares, if and when issued, will be “restricted” securities under the meaning of Rule 144 of the Securities Act of 1933. These shares may not be sold in the absence of registration under the Securities Act unless an exemption from registration is available, including exemptions contained in Rule 144.

In general, under Rule 144 as currently in effect, if one year has elapsed since the date of acquisition of restricted shares from us or any of our affiliates, the holder of such restricted shares can sell such shares; provided that the number of shares sold by such person within any three-month period cannot exceed the greater of:

•

1% of the total number of shares of our common stock then outstanding; or

•

the average weekly trading volume of our common stock during the four calendar weeks preceding the date on which notice of the sale is filed with the SEC.

Sales under Rule 144 also are subject to certain manner of sale provisions, notice requirements and the availability of current public information about us. If two years have elapsed since the date of acquisition of restricted shares from us or any of our affiliates and the holder is not one of our affiliates at any time during the three months preceding the proposed sale, such person can sell such shares in the public market under Rule 144(k) without regard to the volume limitations, manner of sale provisions, public information requirements or notice requirements.

Registration Rights

Provided that we are then eligible to use Form S-3, we have agreed to file a shelf registration statement with the SEC on or about the first anniversary of the closing of this offering, and thereafter to use our best efforts to have the registration statement declared effective, covering the continuous resale of the 3,817,036 shares of common stock issuable to our limited partners upon redemption of units issued in the formation transactions. Upon effectiveness of any such registration statement, those persons may sell such shares covered by the registration statement in the secondary market. We will bear expenses incident to the registration requirements other than any selling commissions, SEC or state securities registration fees, and transfer taxes or certain other fees or taxes relating to such shares.

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Registration rights may be granted to future sellers of properties to our operating partnership who may receive, in lieu of cash, common stock, units or other securities convertible into common stock.

Prior to this offering, there has been no public market for our common stock. Listing of our common stock on the AMEX is expected to be effective upon the completion of this offering. No prediction can be made as to the effect, if any, that future sales of shares, or the availability of shares for future sale, will have on the market price prevailing from time to time. Sales of substantial amounts of common stock, or the perception that such sales could occur, may affect adversely prevailing market prices of the common stock.

Lock-up Agreements

For a description of certain restrictions on transfers of our common stock held by certain of our stockholders, see the section entitled “Underwriting” in this prospectus.

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CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

MHI Hotels Services is owned and controlled by Andrew Sims (26.3%) our chairman and chief executive officer, Kim Sims (26.3%) and Christopher Sims (26.3%), two of our directors, William Zaiser (9.0%), our executive vice president and chief financial officer and Steve Smith (12.0%) the Executive Vice President of MHI Hotels Services. Our current directors, including Andrew, Christopher and Kim Sims, and our chief financial officer, William Zaiser, are currently officers and employees of MHI Hotels Services. Andrew, Kim and Christopher Sims and William Zaiser are also directors of MHI Hotels Services. MHI Hotels Services currently owns, with certain affiliates, directly or indirectly, a 70.1% interest in the entity that owns the Holiday Inn Downtown Williamsburg and the Hilton Wilmington Riverside, a 50% interest in the entity that owns the Holiday Inn Brownstone, and an 80% interest in the entity that owns the Hilton Savannah DeSoto. These officers and directors will receive, directly and indirectly, units in connection with the acquisition of four of our initial properties. Edgar Sims, the father of Andrew, Christopher and Kim Sims, has a 100% interest in a holding company that owns a 25% interest in the Maryland Inn. Jeanette Sims, the mother of Andrew, Christopher and Kim Sims, beneficially owns a 30% interest in the entity that owns the Holiday Inn Downtown Williamsburg and Hilton Wilmington Riverside hotels. In addition, we will acquire two space leases for the common areas of the Shell Island Resort, a condominium resort property located in Wrightsville Beach, North Carolina from MHI Hotels Two, Inc., and MHI Hotels LLC, affiliates of MHI Hotels Services. We will enter into a sublease agreement with MHI Hotels Two, Inc. and MHI Hotels LLC with respect to such property. The units and other consideration in the formation transactions issuable to these persons are set forth in the table below. See also “Certain Relationships and Related Party Transactions – Other Benefits to Related Parties.”

The terms of the agreements and the valuation methods used to determine the value of the initial hotel properties and amounts to be paid in respect of the leasehold interest and restructuring of management agreements were determined by our management team who had conflicts of interest as described above. Because our agreements with MHI Hotels Services were not negotiated on an arm’s-length basis, they may be less favorable to us than we could have obtained from third parties. We did not obtain third-party appraisals of the initial hotel properties in connection with our acquisition of these properties and the consideration being paid by us in exchange for the initial properties may exceed the fair market value as determined by third-party appraisals.

The number of units we will issue in the formation transactions to our officers and directors and their affiliates is fixed. The contributing entities have no right under the contribution agreements to change their investment decision or to require us to deliver a greater number of units. The obligations of the contributing entities under the contribution agreements to transfer the initial hotel properties are conditioned upon completion of this offering, payment of the consideration described above and other customary conditions, including receipt of third party consents, approval of the franchisors, execution of indemnity agreements, the operating partnership agreement and assignment agreements. The contribution agreements relating to the Holiday Inn Brownstone and Hilton Philadelphia Airport also provide for the repayment of debt. The sale agreement relating to the Maryland Inn is conditioned upon the receipt of third party consents.

The consideration to be received by each of our directors and officers and their affiliates and family members in the formation transactions is summarized in the following table.


Contributor	Operating Partnership Units ⁽¹⁾		Shares of Common Stock	Cash Payments		Value of Consideration
Andrew Sims	639,556	⁽²⁾	—	$	1,398,333	$	7,793,893
Kim Sims	639,555	⁽²⁾	—		1,398,333		7,793,883
Christopher Sims	639,555	⁽²⁾	—		1,398,333		7,793,883
William Zaiser	162,614		—		495,000		2,121,140
Edward Stein ⁽³⁾	333,099		1,000		—		3,340,990
Jeannette Sims ⁽⁴⁾	377,903		—		—		3,779,030
Edgar Sims, Jr. Irrevocable Trust ⁽⁵⁾	75,581		—		150,001		905,811
Edgar Sims, Jr. ⁽⁶⁾	—		—		500,000		500,000

Total	2,867,863		1,000	$	5,340,000	$	34,528,630

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⁽¹⁾	MHI Hotels Services will receive 1,806,826 units for contribution of its equity interests in Capitol Hotel Associates LP, LLP, Savannah Hotel Associates LLC and Brownestone Partners LLC.

⁽²⁾

The units reflect 1,427,392 units issued to MHI Hotels Services for its equity contributions in our initial properties which will be equally allocated to Andrew, Christopher and Kim Sims. In addition, each of Andrew, Christopher and Kim Sims will receive approximately 163,908 units, or 491,274 units in the aggregate, for their 39% interest in Capitol Hotel Associates, the entity that owns the Hilton Wilmington Riverside and the Holiday Inn Downtown Williamsburg.

⁽³⁾	Director Edward Stein is the trustee of the Krischman Trusts which own a 20% interest in Savannah Hotel Associates, LLC, the entity that owns the Hilton Savannah DeSoto.

⁽⁴⁾

Jeannette Sims is the mother of Andrew, Kim and Christopher Sims. Jeannette Sims owns all of the outstanding stock of Wilmington Hotel Associates Corp., the entity that owns a 30% interest in Capitol Hotel Associates, LP, LLP the owner of the Holiday Inn Downtown Williamsburg and the Hilton Wilmington Riverside.

⁽⁵⁾	Edgar Sims, Jr. Irrevocable Trust owns a 6% interest in Capital Hotel Associates LP, LLP.

⁽⁶⁾	Edgar Sims is the father of Andrew, Kim and Christopher Sims. Edgar Sims has a beneficial ownership interest in the entities that own the Maryland Inn.

With respect to all of our initial hotels, we have agreed to indemnify the contributors for a certain amount of the tax liability they incur if, during the 10-year period following the completion of this offering, we (i) directly or indirectly sell, exchange or otherwise dispose of the properties contributed under such agreement in a taxable transaction before the tenth anniversary of the completion of this offering or, in certain cases, (ii) fail to use commercially reasonable efforts to make available to these contributors and their permitted transferees and persons taxable on the income of a contributor or permitted transferee opportunities to guarantee specified amounts of liabilities of our operating partnership to defer such guarantors’ tax liabilities. The amount that we will indemnify the contributors is based on a sliding scale percentage during the 10-year period. Specifically, we will indemnify the contributors for 100% of their tax liability during the first five years after contribution, 50% during the sixth year, 40% during the seventh year, 30% during the eighth year, 20% during the ninth year and 10% during the tenth year. Such indemnification obligations could aggregate up to approximately $46.0 million. For example, in the case of a taxable disposition of one of the initial hotels within five years of its contribution, we would have to indemnify the contributors for 100% of the tax on the gain allocable to them under Section 704(c) of the Internal Revenue Code and for the tax on indemnification payments. While the tax indemnities do not contractually limit our ability to conduct our business in the way we desire, we are less likely to sell any of the contributed properties in a taxable transaction during the protected period because of the significant tax liability we would have to the contributors. Instead, we would either hold the property for the entire protected period, or at least the first five years, or seek to transfer the property in a tax-deferred like-kind exchange. The indemnification obligations terminate on the tenth anniversary of the contribution.

We expect to use the net proceeds from the offering, in part, to repay $9.8 million of outstanding mortgage debt which was guaranteed by MHI Hotels LLC, Andrew Sims, Kim Sims and Christopher Sims.

Additionally, MHI Hotels Services will be the hotel manager for our six initial hotels, and will benefit from the payment of management fees by us pursuant to our management agreement. MHI Hotels Services will receive a base management fee equal to a percentage of the hotel’s revenues (2.0% for the first year, 2.5% for the second year and 3.0% thereafter) and an incentive fee equal to 10% of the amount by which gross operating profit of the hotels on an aggregate basis for a given year exceeds gross operating profits for the same hotels, on an aggregate basis, for a prior year, subject to a maximum amount of 0.25% of the aggregate gross revenue of the hotels. Assuming this management agreement had been in place during the twelve-months ended December 31, 2003, MHI Hotels Services would have received $0.9 million in base management fees for the six initial hotels. See the section entitled “Our Principal Agreements - Our Management Agreement” in this prospectus.

Upon completion of the offering, Andrew Sims and William Zaiser will resign as officers of MHI Hotels Services and become full-time employees of our company. Andrew Sims will continue as our president, chief

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executive officer and chairman of the board and William Zaiser will continue as our executive vice president, chief financial officer and treasurer. We will issue 1,000 shares of restricted stock to each of our independent directors. Although distributions will be paid on all restricted stock, whether or not vested, at the same rate and on the same date as on shares of our common stock, these holders will be prohibited from selling such shares until they vest. All of the shares of restricted stock will vest on the first anniversary of the date of grant.

In addition to the foregoing relationships and related party transactions, one of our director nominees, Edward Stein, is the founding partner of Weinberg and Stein, a law firm in Norfolk, Virginia that has provided legal services to MHI Hotels Services during the last fiscal year and will continue to provide legal services during the current fiscal year. Edward Stein also serves as trustee of the Krischman Revocable and Charitable Trusts, which have a 20% ownership interest in Savannah Hotel Associates LLC.

We have also entered into a strategic alliance agreement with MHI Hotels Services regarding lodging investment opportunities identified in the future during the term of the agreement. See “Our Principal Agreements – Our Strategic Alliance Agreement” in this prospectus.

Other Benefits to Related Parties

The following table summarizes consideration to be received by our affiliates in connection with the formation transactions at an assumed offering price of $10.00 per share.


Transaction	Affiliated Party	Consideration
Contribution of initial hotels	MHI Hotels Services, an aggregate of 79.0% of which is owned in equal parts by each of Andrew, Kim and Christopher Sims and 9.0% owned by William Zaiser.	$18.1 million which represents the aggregate value of the units issuable to MHI Hotels Services in connection with the contribution of its 80% interest in Savannah Hotel Associates LLC (1,332,395 units having a value of approximately $13.3 million), its 25% interest in Capitol Hotel Associates LP, LLP (314,919 units having a value of approximately $3.1 million) and its 50% ownership interest in Brownestone Partners LLC (159,512 units having a value of $1.6 million issuable to KDCA Partnership which is 100% owned by MHI Hotels Services and its affiliates), and $1.0 million in cash, which will be used to repay a $1.0 million construction loan.

	MHI Hotels LLC, an aggregate of 79.0% of which is owned in equal parts by each of Andrew, Kim and Christopher Sims and 9.0% owned by William Zaiser.	$3.0 million in cash in consideration for the assignment of the common area lease at the Shell Island resort property.

	MHI Hotels Two, Inc., an aggregate of 79.0% of which is owned in equal parts by each of Andrew, Kim and Christopher Sims and 9.0% owned by William Zaiser.	$500,000 in cash in consideration for the assignment of the restaurant lease at the Shell Island resort property.

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Transaction	Affiliated Party	Consideration
	Edgar Sims, Jr. Irrevocable Trust Andrew, Christopher and Kim Sims, Trustees for the benefit of Edgar Sims’ grandchildren	$0.8 million, which represents the aggregate value of the 75,581 units issuable to the Edgar Sims, Jr. Irrevocable Trust in connection with the contribution of the 6% equity interests of Capitol Hotel Associates LP, LLP, held by such trust. Edgar Sims, Jr. is the father of Andrew, Kim and Christopher Sims.

	Laurel Holdings LLC (owned by Edgar Sims, Jr.)	Approximately $500,000 cash for its 25% interest in Accord LLC and West Laurel Corp., the entities that own the Maryland Inn.

	Andrew Sims, Kim Sims and Christopher Sims	$4.9 million, which represents the aggregate value of 491,274 units issuable in connection with the contribution of the 39.0% equity interests of Capitol Hotel Associates LP, LLP (each of Andrew, Christopher and Kim Sims have a 13.0% interest in Capitol Hotel Associates, LP, LLP).

	Krischman Trusts (Edward Stein, Trustee)	$3.3 million, which represents the aggregate value of 333,099 units issuable to the Krishman Trusts in connection with their contribution of their 20% ownership interest in Savannah Hotel Associates LLC. Edward Stein, who will serve as a member of our board of directors following completion of the offering, is the Trustee of the Trusts.

	Wilmington Hotel Associates Corp. and Jeanette Sims (100% owned by Jeanette Sims)	$3.8 million, which represents the aggregate value of 377,903 units issuable to Wilmington Hotel Associates Corp. in connection with contribution of its 30% ownership interest in Capitol Hotel Associates LP, LLP. Jeanette Sims, the mother of Andrew, Kim and Christopher Sims, is the sole stockholder of Wilmington Hotel Associates Corp.

Restructuring of Management Agreements	MHI Hotels Services	$2.0 million in cash in consideration of the restructuring of the management agreements relating to five of our initial hotel properties.

Repayment of offering expenses	MHI Hotels Services	Approximately $1.5 million in cash.

Repayment of Indebtedness/ Release of Guaranty	MHI Hotels Services, Andrew Sims, Christopher Sims, Kim Sims	MHI Hotels Services, Andrew, Christopher and Kim Sims will be released from their guaranties of $9.8 million of debt with respect to two initial

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Transaction	Affiliated Party	Consideration
		properties being contributed by entities partially owned by MHI Hotels Services which debt will be repaid with offering proceeds. Mortgage loans on the Holiday Inn Downtown Williamsburg and the Holiday Inn Brownstone, in the aggregate amount of $7.8 million, are guaranteed by MHI Hotels, LLC, Andrew Sims, Christopher Sims and Kim Sims. The construction lines of credit related to Brownestone Partners LLC in the aggregate amount of $2.0 million are guaranteed by MHI Hotels Services, LLC, Andrew Sims, Kim Sims and Christopher Sims.

Management Agreement	MHI Hotels Services	Monthly base management fee of 2.0% for the first year, 2.5% for the second year, and 3.0% thereafter of all gross revenues for the hotels managed by MHI Hotels Services plus an annual incentive management fee in an amount equal to 10% of the annual year over year increase in consolidated net operating income not to exceed 0.25% of gross hotel revenues.

Strategic Alliance Agreement	MHI Hotels Services	During the 10-year term of the strategic alliance agreement, unless a majority of our independent directors in good faith concludes for valid business reasons that another management company should manage a hotel owned by us, we have agreed to offer MHI Hotels Services the right to manage hotel properties we acquire, subject to certain exceptions. MHI Hotels Services has agreed to refer to us on an exclusive basis, any hotel investment opportunity presented to it, subject to certain exceptions. For so long as Andrew, Kim and Christopher Sims own 1.5 million units or shares, MHI Hotels Services will have the right to nominate a director.

Tax Indemnification	Andrew, Christopher and Kim Sims, Wilmington Hotel Associates Corp. (Jeanette Sims), Krischman Trusts (Edward Stein), Edgar Sims, Jr. irrevocable Trust, William J. Zaiser	If we sell, during the 10-year period following the closing of the acquisition of the initial hotels, the five initial hotels contributed to us in exchange for units in a taxable transaction, we would be required to indemnify the contributors for their tax liability plus a gross up amount. Such indemnification obligations could aggregate approximately $46.0 million.

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DESCRIPTION OF COMMON STOCK

The following summary of the terms of our common stock does not purport to be complete and is subject to and qualified in its entirety by reference to our charter and bylaws, copies of which are exhibits to the registration statement of which this prospectus is a part. See “Where You Can Find More Information.”

General

Our amended and restated charter provides that we may issue up to 49,000,000 shares of common stock, $0.01 par value per share, and 1,000,000 shares of preferred stock, $0.01 par value per share. Upon completion of the offering and the related formation transactions, 6,000,000 shares of common stock will be issued and outstanding and no preferred stock will be issued and outstanding. Additionally, 4,000 shares of restricted common stock have been reserved for issuance upon completion of the offering under our 2004 Stock Incentive Plan. As permitted by the Maryland General Corporation Law, our charter contains a provision permitting our board of directors, without any action by our stockholders, to amend the 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.

Voting Rights of Common Stock

Subject to the provisions of our charter regarding the restrictions on the transfer and ownership of shares of common stock, each outstanding share of common stock entitles the holder to one vote on all matters submitted to a vote of stockholders, including the election of directors, and, except as may be provided with respect to any other subsequently issued class or series of common stock, the holders of such common stock possess the exclusive voting power. There is no cumulative voting in the election of directors, which means that the holders of a majority of the outstanding common stock, voting as a single class, can elect all of the directors and the holders of the remaining stock are not able to elect any directors.

Distributions, Liquidation and Other Rights

All common stock offered by this prospectus will be duly authorized, fully paid and nonassessable. Holders of our common stock are entitled to receive distributions when authorized by our board of directors out of assets legally available for the payment of distributions. They also are entitled to share ratably in our assets legally available for distribution to our stockholders in the event of our liquidation, dissolution or winding up, after payment of or adequate provision for all of our known debts and liabilities. These rights are subject to the preferential rights of any other class or series of our stock and to the provisions of our charter regarding restrictions on transfer of our stock.

Holders of our common stock have no preference, conversion, exchange, sinking fund, redemption or appraisal rights and have no preemptive rights to subscribe for any of our securities. Subject to the restrictions on transfer of stock contained in our charter, all common stock will have equal distribution, liquidation and other rights.

Power to Reclassify Stock

Our charter authorizes our board of directors to classify any unissued preferred stock and to reclassify any previously classified but unissued common stock and preferred stock of any series from time to time in one or more classes or series, as authorized by the board of directors. Prior to issuance of stock of each class or series, the board of directors is required by the MGCL and our charter to set for each such class or series, subject to the provisions of our charter regarding the restriction on transfer of common stock, 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 class or series. Thus, our board of directors

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could authorize the issuance of preferred stock with priority over the common stock with respect to distributions and rights upon liquidation and with other terms and conditions which could have the effect of delaying, deferring or preventing a transaction or a change in control of our company that might involve a premium price for holders of common stock or otherwise might be in their best interest. As of the date hereof, no shares of preferred stock are outstanding and we have no current plans to issue any preferred stock.

Power to Issue Additional Common Stock and Preferred Stock

We believe that the power to issue additional common stock or preferred stock and to classify or reclassify unissued common stock or preferred stock and thereafter to issue the classified or reclassified stock provides us with increased flexibility in structuring possible future financings and acquisitions and in meeting other needs which might arise. These actions can be taken without stockholder approval, unless stockholder approval is required by applicable law or the rules of any stock exchange or automated quotation system on which our securities may be listed or traded. Although we have no current intention of doing so, we could issue a class or series of stock that could delay, defer or prevent a transaction or a change in control that might involve a premium price for holders of common stock or otherwise be in their best interest.

Restrictions on Ownership and Transfer

For us to qualify as a REIT under the Code, our shares of stock must be beneficially owned by 100 or more persons during at least 335 days of a taxable year of 12 months (other than the first year for which an election to be a REIT has been made) or during a proportionate part of a shorter taxable year. Also, not more than 50% of the value of the outstanding shares of stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities) during the last half of a taxable year (other than the first year for which an election to be a REIT has been made).

Because our board of directors believes it is essential at present for us to qualify as a REIT, the charter, subject to certain exceptions, contains restrictions on the number of our shares of stock that a person may own. Our charter provides that no person may own, or be deemed to own by virtue of the attribution provisions of the Code, more than 9.9% (the “Aggregate Stock Ownership Limit”) in value of our outstanding shares of stock. In addition, the charter prohibits any person from acquiring or holding, directly or indirectly, shares of common stock in excess of 9.9% of the number of our outstanding shares of common stock (the “Common Stock Ownership Limit”).

Our charter prohibits (a) any person from beneficially or constructively owning our shares of stock that would result in us being “closely held” under Section 856(h) of the Code, (b) any person from transferring our shares of stock if such transfer would result in our shares of stock being owned by fewer than 100 persons, (c) any transfer that would cause us to own, directly or indirectly, 10% or more of the ownership interests in a tenant of our company (or a tenant of any entity owned or controlled by us) other than a taxable REIT subsidiary if the requirements of Section 856(d)(8)(B) of the Code are satisfied and (d) any transfer that would cause any of our hotel management companies to fail to qualify as an “eligible independent contractor” within the meaning of Section 856(d)(9) of the Code. Any person who acquires or attempts or intends to acquire beneficial or constructive ownership of our shares of stock that will or may violate any of the foregoing restrictions on transferability and ownership, or any person who would have owned our shares of stock that resulted in a transfer of shares to the Charitable Trust (as defined below), is required to give written notice immediately to us, or in the case of a proposed or attempted transaction, to give at least 15 days’ prior written notice, and provide us with such other information as we may request in order to determine the effect of such transfer on our status as a REIT. The foregoing restrictions on transferability and ownership will not apply if our board of directors determines that it is no longer in our best interests to attempt to qualify, or to continue to qualify, as a REIT.

Furthermore, our board of directors, in its sole discretion, may exempt a proposed transferee from the Aggregate Stock Ownership Limit, the Common Stock Ownership Limit and/or any of the restrictions described in the first sentence of the paragraph directly above (an “Excepted Holder”). However, the board of directors may

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not grant such an exemption to any person if such exemption would result in our failing to qualify as a REIT. Our board of directors may require a ruling from the Internal Revenue Service or an opinion of counsel, in either case in form and substance satisfactory to the board of directors, in its sole discretion, in order to determine or ensure our status as a REIT.

If any transfer of our shares of stock occurs which, if effective, would result in any person beneficially or constructively owning shares of stock in excess or in violation of the above transfer or ownership limitations (a “Prohibited Owner”), then that number of shares of stock the beneficial or constructive ownership of which otherwise would cause such person to violate such limitations (rounded to the nearest whole share) shall be automatically transferred to a trust (the “Charitable Trust”) for the exclusive benefit of one or more charitable beneficiaries (the “Charitable Beneficiary”), and the Prohibited Owner shall not acquire any rights in such shares. Such automatic transfer shall be deemed to be effective as of the close of business on the Business Day (as defined in the charter) prior to the date of such violative transfer. If any automatic transfer to the Charitable Trust is not effective, then the initial transfer of stock will be void ab initio to the extent necessary to prevent a violation of the above transfer or ownership limitations. Shares of stock held in the Charitable Trust shall be issued and outstanding shares of stock. The Prohibited Owner shall not benefit economically from ownership of any shares of stock held in the Charitable Trust, shall have no rights to dividends or other distributions and shall not possess any rights to vote or other rights attributable to the shares of stock held in the Charitable Trust. The trustee of the Charitable Trust (the “Trustee”) shall have all voting rights and rights to dividends or other distributions with respect to shares of stock held in the Charitable Trust, which rights shall be exercised for the exclusive benefit of the Charitable Beneficiary. Any dividend or other distribution paid prior to our discovery that shares of stock have been transferred to the Trustee shall be paid by the recipient of such dividend or distribution to the Trustee upon demand, and any dividend or other distribution authorized but unpaid shall be paid when due to the Trustee. Any dividend or distribution so paid to the Trustee shall be held in trust for the Charitable Beneficiary. The Prohibited Owner shall have no voting rights with respect to shares of stock held in the Charitable Trust and, subject to Maryland law, effective as of the date that such shares of stock have been transferred to the Trustee, the Trustee shall have the authority (at the Trustee’s sole discretion) (i) to rescind as void any vote cast by a Prohibited Owner prior to our discovery that such shares have been transferred to the Trustee and (ii) to recast such vote in accordance with the desires of the Trustee acting for the benefit of the Charitable Beneficiary. However, if we have already taken irreversible corporate action, then the Trustee shall not have the authority to rescind and recast such vote.

Within 20 days of receiving notice from us that shares of stock have been transferred to the Charitable Trust, the Trustee shall sell the shares of stock held in the Charitable Trust to a person, designated by the Trustee, whose ownership of the shares will not violate the ownership limitations set forth in the charter. Upon such sale, the interest of the Charitable Beneficiary in the shares sold shall terminate and the Trustee shall distribute the net proceeds of the sale to the Prohibited Owner and to the Charitable Beneficiary as follows: The Prohibited Owner shall receive the lesser of (i) the price paid by the Prohibited Owner for the shares or, if the Prohibited Owner did not give value for the shares in connection with the event causing the shares to be held in the Charitable Trust ( e.g. , in the case of a gift, devise or other such transaction), the Market Price (as defined in the charter) of such shares on the day of the event causing the shares to be held in the Charitable Trust and (ii) the price per share received by the Trustee from the sale or other disposition of the shares held in the Charitable Trust. Any net sale proceeds in excess of the amount payable to the Prohibited Owner shall be paid immediately to the Charitable Beneficiary. If, prior to our discovery that shares of stock have been transferred to the Charitable Trust, such shares are sold by a Prohibited Owner, then (i) such shares shall be deemed to have been sold on behalf of the Charitable Trust and (ii) to the extent that the Prohibited Owner received an amount for such shares that exceeds the amount that such Prohibited Owner was entitled to receive pursuant to the aforementioned requirement, such excess shall be paid to the Trustee upon demand.

In addition, shares of stock held in the Charitable Trust shall be deemed to have been offered for sale to us, or our designee, at a price per share equal to the lesser of (i) the price per share in the transaction that resulted in such transfer to the Charitable Trust (or, in the case of a devise or gift, the Market Price at the time of such devise

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or gift) and (ii) the market price on the date we, or our designee, accepts such offer. We shall have the right to accept such offer until the Trustee has sold the shares of stock held in the Charitable Trust. Upon such a sale to us, the interest of the Charitable Beneficiary in the shares sold shall terminate and the Trustee shall distribute the net proceeds of the sale to the Prohibited Owner and any dividends or other distributions held by the Trustee shall be paid to the Charitable Beneficiary.

All certificates representing our shares of stock will bear a legend referring to the restrictions described above.

Every owner of more than 5% (or such lower percentages as required by the Code or the Treasury Regulations promulgated thereunder) of all classes or series of our shares of stock, including common stock, within 30 days after the end of each taxable year, is required to give written notice to us stating the name and address of such owner, the number of shares of each class and series of shares of stock which the owner beneficially owns and a description of the manner in which such shares are held. Each such owner shall provide to us such additional information as we may request in order to determine the effect, if any, of such beneficial ownership on our status as a REIT and to ensure compliance with the Aggregate Stock Ownership Limit and the Common Stock Ownership Limit. In addition, each stockholder shall upon demand be required to provide to us such information as we may request, in good faith, in order to determine our status as a REIT and to comply with the requirements of any taxing authority or governmental authority or to determine such compliance and to ensure compliance with the Aggregate Stock Ownership Limit and the Common Stock Ownership Limit.

These ownership limitations could delay, defer or prevent a transaction or a change in control that might involve a premium price for the common stock or otherwise be in the best interest of our stockholders.

Other Matters

The transfer agent and registrar for our common stock is American Stock Transfer & Trust Company.

CERTAIN PROVISIONS OF MARYLAND LAW AND OF OUR CHARTER AND BYLAWS

The following description of certain provisions of Maryland law and of our charter and bylaws is only a summary. For a complete description, we refer you to Maryland law, 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. See “Where You Can Find More Information.”

Our Board of Directors

Our bylaws provide that the number of our directors may be established by our board of directors. Upon completion of the offering, we will have seven directors. The board of directors may increase or decrease the number of directors by a vote of a majority of the members of our board of directors, provided that the number of directors shall never be less than the number required by Maryland law and that the tenure of office of a director shall not be affected by any decrease in the number of directors. Except as may be provided by the board of directors in setting the terms of any class or series of preferred stock, any vacancy may be filled by a majority of the remaining directors, even if the remaining directors do not constitute a quorum, or, if no directors remain, by our stockholders. Any director elected to fill a vacancy shall serve for the remainder of the full term in which the vacancy occurred and until a successor is elected and qualifies.

At each annual meeting of stockholders, the holders of the common stock may vote to elect all of the directors on the board of directors. Holders of common stock have no right to cumulative voting in the election of directors. Consequently, at each annual meeting of stockholders, the holders of a majority of the outstanding shares of common stock are able to elect all of the directors.

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Removal of Directors

Our charter provides that a director may be removed, with or without cause, upon the affirmative vote of at least two-thirds 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 a substantial affirmative vote, and filling the vacancies created by such removal with their own nominees.

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 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:

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any person who beneficially owns 10% or more of the voting power of our stock; or

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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:

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80% of the votes entitled to be cast by holders of our then outstanding shares of voting stock; and

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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. However, our board of directors may, by resolution and without stockholders approval, opt into the business combination statute in the future.

Should our board opt in to the business combination statute, it may discourage others from trying to acquire control of us and increase the difficulty of consummating any transaction.

Control Share Acquisitions

Maryland law provides that “control shares” of a Maryland corporation acquired in a “control share acquisition” have no voting rights unless approved by a vote of two-thirds of the votes entitled to be cast on the matter. Shares owned by the acquiror, or by officers or by directors who are our employees are excluded from shares entitled to vote on the matter. “Control shares” are voting shares which, if aggregated with all other shares previously acquired by the acquiring person, or in respect of which the acquiring person is able to exercise or

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direct the exercise of voting power (except solely by virtue of a revocable proxy), would entitle the acquiring person to exercise voting power in electing directors within one of the following ranges of voting power:

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one-tenth or more but less than one-third;

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one-third or more but less than a majority; or

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a majority or more of all voting power.

Control shares do not include shares the acquiring person is then entitled to vote as a result of having previously obtained stockholder approval. A “control share acquisition” means the acquisition of control shares, subject to certain exceptions.

A person who has made or proposes to make a control share acquisition 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 shares. The right to compel the calling of a special meeting is subject to the satisfaction of certain conditions, including an undertaking to pay the expenses of the meeting. If no request for a meeting is made, we may present the question 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 and as of the date of the last 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 from the control share acquisition statute any and all acquisitions by any person of our shares of stock. Our board of directors may amend our bylaws, without stockholder approval, so as to implement the control share acquisition statute in the future.

Maryland Unsolicited Takeovers Act

Subtitle 8 of Title 3 of the Maryland General Corporation Law permits a Maryland corporation with a class of equity securities registered under the Securities Exchange Act of 1934, as amended, 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 five provisions:

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a classified board;

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a two-thirds vote requirement for removing a director;

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a requirement that the number of directors be fixed only by vote of the directors;

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a requirement that a vacancy on the board 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; and

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a majority requirement for the calling of a special meeting of stockholders.

Pursuant to Subtitle 8, we have elected to provide that vacancies on the board be filled only by the remaining directors and for the remainder of the full term of the directorship in which the vacancy occurred. Through provisions in our charter and bylaws unrelated to Subtitle 8, we already (a) require a two-thirds vote for

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the removal of any director from the board, (b) vest in the board the exclusive power to fix the number of directorships and (c) require, unless called by our Chairman of our board of directors, our President and Chief Executive Officer or our board of directors, the request of the holders of a majority of outstanding shares to call for a special meeting.

Merger; Amendment of Charter

Under the Maryland General Corporation Law, a Maryland corporation generally cannot dissolve, amend its charter or merge with another entity unless approved by the affirmative vote of stockholders holding at least two-thirds of the shares entitled to vote on the matter unless a lesser percentage (but not less than a majority of all the votes entitled to be cast on the matter) is set forth in the corporation’s charter. Our charter provides for approval by the holders of a majority of all the votes entitled to be cast on the matter for the matters described in this paragraph, except for amendments to various provisions of the charter, including the provisions relating to removal of directors, that require the affirmative vote of the holders of two-thirds of the votes entitled to be cast on the matter. As permitted by the Maryland General Corporation Law, our charter contains a provision permitting our directors, without any action by our stockholders, to amend the 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.

Limitation of Liability and Indemnification

Our charter limits the liability of our directors and officers for money damages to the maximum extent permitted by Maryland law.

Our charter authorizes us to obligate ourselves and our bylaws require us, to the maximum extent permitted by Maryland law, to indemnify, and to pay or reimburse reasonable expenses to, any of our present or former directors or officers or any individual who, while a director and at our request, serves or has served another entity, employee benefit plan or any other enterprise as a trustee, director, officer, partner or otherwise. The indemnification covers any claim or liability against the person by reason of his or her status as a present or former director or officer.

Maryland law permits us to indemnify our present and former directors and officers against liabilities and reasonable expenses actually incurred by them in any proceeding 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

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was committed in bad faith; or

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was the result of active and deliberate dishonesty; or

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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 a criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful.

However, Maryland law prohibits us from indemnifying our present and former directors and officers for an adverse judgment in a derivative action. Maryland law requires us, as a condition to advancing expenses in certain circumstances, to obtain:

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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

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a written undertaking to repay the amount reimbursed if the standard of conduct is not met.

The partnership agreement of our operating partnership provides for indemnification of officers, directors and employees of our operating partnership, as well as our indemnification, along with our employees, officers and directors.

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Insofar as the foregoing provisions permit indemnification of directors, officers or persons controlling us for liability arising under the Securities Act, we have been informed that, in the opinion of the SEC, this indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.

REIT Status

Dissolution

Pursuant to our charter, and subject to the provisions of any of our classes or series of shares of stock then outstanding and the approval by a majority of the entire board of directors, our stockholders, at any meeting thereof, by the affirmative vote of a majority of all of the votes entitled to be cast on the matter, may approve a plan of liquidation and dissolution.

Advance Notice of Director Nominations and New Business

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 at the annual meeting may be made only:

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pursuant to our notice of the meeting;

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by or at the direction of our board of directors; or

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by a stockholder who was a stockholder of record both at the time of the provision of notice and at the time of the meeting who is entitled to vote at the meeting and has complied with the advance notice procedures set forth in our bylaws.

With respect to special meetings of stockholders, only the business specified in our notice of meeting may be brought before the meeting of stockholders and nominations of individuals for election to our board of directors may be made only:

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pursuant to our notice of the meeting;

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by or at the direction of our board of directors; or

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provided that our board of directors has determined that directors shall be elected at such meeting, by a stockholder who was a stockholder of record both at the time of the provision of notice and at the time of the meeting who is entitled to vote at the meeting and has complied with the advance notice provisions set forth in our bylaws.

Possible Anti-Takeover Effect of Certain Provisions of Maryland Law and of our Charter and Bylaws

Our board may rescind the resolution opting out of the business combination statute or repeal the bylaw opting-out of the control share acquisition statute without stockholder approval. If the business combination provisions or control share provisions become applicable to our company, those provisions, in addition to the provisions in our charter regarding removal of directors and the restrictions on the transfer of shares of stock and the advance notice provisions of our bylaws could have the effect of delaying, deferring or preventing a transaction or a change in the control that might involve a premium price for holders of the common stock or otherwise be in their best interest.

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P ARTNERSHIP AGREEMENT

The following summary of the terms of the agreement of limited partnership of our operating partnership does not purport to be complete and is subject to and qualified in its entirety by reference to the Agreement of Limited Partnership of MHI Hospitality, L.P., a copy of which is an exhibit to the registration statement of which this prospectus is a part. See “Where You Can Find More Information.”

Management

MHI Hospitality, L.P., our operating partnership, has been organized as a Delaware limited partnership. Pursuant to the partnership agreement, MHI Hospitality Corporation, as general partner of our operating partnership, has, subject to certain protective rights of limited partners described below, full, exclusive and complete responsibility and discretion in the management and control of the operating partnership, including the ability to cause the operating partnership to enter into certain major transactions including acquisitions, dispositions, refinancings and selection of lessees and to cause changes in the operating partnership’s line of business and distribution policies.

Transferability of Interests

We may not voluntarily withdraw from the operating partnership or transfer or assign our interest in the operating partnership or engage in any transaction which would result in a change of control of our company unless:

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We receive the consent of limited partners holding more than 50% of the partnership interests of the limited partners (other than those held by the general partner or any subsidiary);

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The consent of limited partners (including the general partner or any subsidiary) holding more than 66.7% of the percentage interests of the limited partnership interests (including those held by the general partner or any subsidiary) is obtained and as a result of such transaction all limited partners will receive for each partnership unit an amount of cash, securities or other property equal in value to the product of the conversion factor and the greatest amount of cash, securities or other property paid in the transaction to a holder of one share of our common stock, 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% of the outstanding shares of our common stock, each holder of units shall be given the option to exchange its units for the greatest amount of cash, securities or other property that a limited partner would have received had it (A) exercised its redemption right (described below) and (B) sold, tendered or exchanged pursuant to the offer shares of our common stock received upon exercise of the redemption right immediately prior to the expiration of the offer; or

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In addition, in the event of a change of control of our company, the limited partners will have the right, for a period of one year following the change of control event, to cause the operating partnership to redeem all of the units held by the limited partners for a cash amount equal to the greater of (i) the cash redemption amount otherwise payable upon redemption pursuant to the partnership agreement, or (ii) the amount the limited partner would have received had the limited partner exercised its redemption right and sold, tendered or exchanged the shares of our common stock issuable upon such redemption in the change of control transaction.

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We also may merge with or into or consolidate with another entity if immediately after such merger or consolidation (i) substantially all of the assets of the successor or surviving entity, other than units held by us, are contributed, directly or indirectly, to the partnership as a capital contribution in exchange for units with a fair market value equal to the value of the assets so contributed as determined by the survivor in good faith and (ii) the survivor expressly agrees to assume all of our obligations under the partnership agreement, provided that the consent of limited partners (including the general partner or any subsidiary) holding more than 66.7% of the percentage interests of the limited partnership interests (including those held by the general partner or any subsidiary) is obtained. The partnership agreement shall be amended after any such merger or consolidation so as to arrive at a new method of calculating the amounts payable upon exercise of the redemption right that approximates the existing method for such calculation as closely as reasonably possible.

We also may (i) transfer all or any portion of our general partnership interest to an affiliate of the general partner, and following such transfer, may withdraw as the general partner and (ii) engage in a transaction required by law or by the rules of any national securities exchange on which our common stock is listed.

Limited partners may not transfer their units without our written consent as general partner.

Capital Contribution

We will contribute to our operating partnership substantially all the net proceeds of the offering as our initial capital contribution in exchange for approximately a 61.1% initial partnership interest. We initially will own a 1.0% interest as general partner and an approximately 60.1% interest as limited partner. Other parties, including MHI Hotels Services, will contribute their interests in the entities that own our initial properties to the operating partnership and become limited partners and, together with other limited partners, initially will own the remaining 38.9% interest in the partnership. The partnership agreement provides that if the operating partnership requires additional funds at any time in excess of funds available to the operating partnership from borrowing or capital contributions, we may borrow such funds from a financial institution or other lender and lend such funds to the operating partnership. Under the partnership agreement, we are obligated to contribute the proceeds of any offering of shares of stock as additional capital to the operating partnership. We are authorized to cause the operating partnership to issue partnership interests for less than fair market value if we have concluded in good faith that such issuance is in both the operating partnership’s and our best interests. If we contribute additional capital to the operating partnership, we will receive additional units and our percentage interest will be increased on a proportionate basis based upon the amount of such additional capital contributions and the value of the operating partnership at the time of such contributions. Conversely, the percentage interests of the limited partners will be decreased on a proportionate basis in the event of additional capital contributions by us. In addition, if we contribute additional capital to the operating partnership, we will revalue the property of the operating partnership to its fair market value (as determined by us) and the capital accounts of the partners will be adjusted to reflect the manner in which the unrealized gain or loss inherent in such property (that has not been reflected in the capital accounts previously) would be allocated among the partners under the terms of the partnership agreement if there were a taxable disposition of such property for its fair market value (as determined by us) on the date of the revaluation. The operating partnership may issue preferred partnership interests, in connection with acquisitions of property or otherwise, which could have priority over common partnership interests with respect to distributions from the operating partnership, including the partnership interests we own as the general partner.

Redemption Rights

Pursuant to the partnership agreement, the limited partners will receive redemption rights which will enable them to cause the operating partnership to redeem their units in exchange for cash or, at our option, shares of common stock. The cash redemption amount per unit is based on the market price of our common stock at the time of redemption. The number of shares of common stock issuable upon redemption of units held by limited partners may be adjusted upon the occurrence of certain events such as stock dividends, stock subdivisions or

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combinations. We expect to fund any cash redemptions out of available cash or borrowings. Notwithstanding the foregoing, a limited partner will not be entitled to exercise its redemption rights if the delivery of common stock to the redeeming limited partner would:

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result in any person owning, directly or indirectly, shares of common stock in excess of the stock ownership limit in our charter;

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result in shares of our common stock being owned by fewer than 100 persons (determined without reference to any rules of attribution);

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result in our being “closely held” within the meaning of Section 856(h) of the Code;

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cause us to own, actually or constructively, 10% or more of the ownership interests in a tenant of ours, the operating partnership or a subsidiary partnership’s real property, within the meaning of Section 856(d)(2)(B) of the Code other than a taxable REIT subsidiary if the requirements of Section 856(d)(8)(B) of the Code are satisfied;

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cause any of our hotel management companies to fail to qualify as an “eligible independent contractor” within the meaning of Section 856(d)(9) of the Code; or

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cause the acquisition of common stock by such redeeming limited partner to be “integrated” with any other distribution of common stock for purposes of complying with the registration provisions of the Securities Act of 1933, as amended.

We may, in our sole and absolute discretion, waive any of these restrictions.

With respect to the units issuable in connection with the acquisition of our initial properties, the redemption rights may be exercised by the limited partners at any time after the first anniversary of our acquisition of these properties; provided, however, unless we otherwise agree:

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a limited partner may not exercise the redemption right for fewer than 1,000 units or, if such limited partner holds fewer than 1,000 units, the limited partner must redeem all of the units held by such limited partner;

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a limited partner may not exercise the redemption right for more than the number of units that would, upon redemption, result in such limited partner or any other person owning, directly or indirectly, common stock in excess of the ownership limitation in our charter; and

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a limited partner may not exercise the redemption right more than two times annually.

Upon completion of the offering and the formation transactions, the aggregate number of shares of common stock issuable upon exercise of the redemption rights will be approximately 3,817,036. The number of shares of common stock issuable upon exercise of the redemption rights will be adjusted to account for stock splits, mergers, consolidations or similar pro rata stock transactions.

The partnership agreement requires that the operating partnership be operated in a manner that enables us to satisfy the requirements for being classified as a REIT, to avoid any federal income or excise tax liability imposed by the Code (other than any federal income tax liability associated with our retained capital gains) and to ensure that the partnership will not be classified as a “publicly traded partnership” taxable as a corporation under Section 7704 of the Code.

In addition to the administrative and operating costs and expenses incurred by the operating partnership, the operating partnership generally will pay all of our administrative costs and expenses, including:

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all expenses relating to our continuity of existence and our subsidiaries’ operations;

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all expenses relating to offerings and registration of securities;

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all expenses associated with the preparation and filing of any of our periodic or other reports and communications under federal, state or local laws or regulations;

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all expenses associated with our compliance with laws, rules and regulations promulgated by any regulatory body; and

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all of our other operating or administrative costs incurred in the ordinary course of business on behalf of the operating partnership.

These expenses, however, do not include any of our administrative and operating costs and expenses incurred that are attributable to hotel properties that are owned by us directly rather than by the operating partnership or its subsidiaries.

Distributions

The partnership agreement provides that the operating partnership will distribute cash at such time and in such amounts as determined by us in our sole discretion, to us and the limited partners in accordance with their respective percentage interests in the operating partnership.

Upon liquidation of the operating partnership, after payment of, or adequate provision for, debts and obligations of the partnership, including any partner loans, any remaining assets of the partnership will be distributed to us and the limited partners with positive capital accounts in accordance with their respective positive capital account balances.

Allocations

Profits and losses of the partnership (including depreciation and amortization deductions) for each fiscal year generally are allocated to us and the limited partners in accordance with the respective percentage interests in the partnership. All of the foregoing allocations are subject to compliance with the provisions of Sections 704(b), 704(c) and 706 of the Code and Treasury regulations promulgated thereunder. The operating partnership expects to use the “traditional method” under Section 704(c) of the Code for allocating items with respect to contributed property acquired in connection with the offering for which the fair market value differs from the adjusted tax basis at the time of contribution.

Term

The operating partnership will continue until , or until sooner dissolved upon:

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our bankruptcy, dissolution, removal or withdrawal (unless the limited partners elect to continue the partnership);

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the passage of 90 days after the sale or other disposition of all or substantially all the assets of the partnership;

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the redemption of all units (other than those held by us, if any); or

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an election by us in our capacity as the general partner.

Tax Matters

Pursuant to the partnership agreement, we are the tax matters partner of the operating partnership and, as such, have authority to handle tax audits and to make tax elections under the Code on behalf of the operating partnership.

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MATERIAL FEDERAL INCOME TAX CONSIDERATIONS

This section summarizes the federal material income tax considerations relating to our qualification and taxation as a REIT and the ownership and disposition of our common stock that you, as a stockholder, may consider relevant. Because this section is a summary, it does not address all of the tax issues that may be important to you and does not provide a detailed discussion of any state, local, foreign or other tax laws or considerations. Baker & McKenzie has acted as our counsel, has reviewed this summary, and is of the opinion that the discussion contained herein fairly summarizes the federal income tax considerations that are likely to be material to a holder of our common stock. The discussion does not address all aspects of taxation that may be relevant to particular stockholders in light of their personal investment or tax circumstances, or to certain types of stockholders that are subject to special treatment under the federal income tax laws, such as insurance companies, tax-exempt organizations (except to the extent discussed in “Taxation of Tax-Exempt Stockholders” below), financial institutions or broker-dealers, and non-U.S. individuals and foreign corporations (except to the extent discussed in “Taxation of Non-U.S. Stockholders” below).

The statements in this section and the opinions of Baker & McKenzie discussed herein are based on the current federal income tax laws. We cannot assure you that new laws, interpretations of law, or court decisions, any of which may take effect retroactively, will not cause any statement in this section to be inaccurate.

We urge you to consult your own tax advisor regarding the specific tax consequences to you of ownership of our common stock and of our election to be taxed as a REIT. Specifically, you should consult your own tax advisor regarding the federal, state, local, foreign, and other tax consequences of such ownership and election, and regarding potential changes in applicable tax laws.

Taxation of our Company

We currently have in effect an election to be taxed as a pass-through entity under subchapter S of the Code, but intend to revoke our S election on the business day prior to the closing of the offering. We plan to make an election to be taxed as a REIT under the federal income tax laws effective for our short taxable year beginning on the date of revocation of our S election and ending on December 31, 2004. We believe that, commencing with such short taxable year, we will be organized and will operate in such a manner as to qualify for taxation as a REIT under the federal income tax laws, and we intend to continue to operate in such a manner, but no assurance can be given that we will operate in a manner so as to qualify or remain qualified as a REIT. This section discusses the laws governing the federal income tax treatment of a REIT and its stockholders. These laws are highly technical and complex.

In connection with the offering of our common stock, Baker & McKenzie rendered an opinion, which is an exhibit to the registration statement of which this prospectus is a part, to the effect that, commencing with our short taxable year beginning on the business day prior to the closing of the offering and ending December 31, 2004, assuming that we complete the elections and other procedural steps described in this discussion of “Material Federal Income Tax Considerations” in a timely fashion, we will be organized in conformity with the requirements for qualification and taxation as a REIT under the federal income tax laws, and our proposed method of operation will enable us to meet the requirements for qualification and taxation as a REIT under the federal income tax laws.

Investors should be aware that Baker & McKenzie’s opinion is based upon customary assumptions, is conditioned upon certain representations made by us as to factual matters, including representations regarding the nature of our properties and the conduct of our business, and is not binding upon the Internal Revenue Service or any court. In addition, Baker & McKenzie’s opinion is based on existing federal income tax law governing qualification as a REIT, which is subject to change either prospectively or retroactively. Moreover, our qualification and taxation as a REIT depends upon our ability to meet on a continuing basis, through actual annual operating results, certain qualification tests set forth in the federal tax laws. Those qualification tests

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involve the percentage of income that we earn from specified sources, the percentage of our assets that falls within specified categories, the diversity of our stock ownership, and the percentage of our earnings that we distribute. Baker & McKenzie will not review our compliance with those tests on a continuing basis. Accordingly, no assurance can be given that the actual results of our operation for any particular taxable year will satisfy such requirements. For a discussion of the tax consequences of our failure to qualify as a REIT, see the section entitled “Material Federal Income Tax Considerations – Failure to Qualify” in this prospectus.

If we qualify as a REIT, we generally will not be subject to federal income tax on our taxable income that we distribute to our stockholders. The benefit of this tax treatment is that it avoids the “double taxation,” or taxation at both the corporate and stockholder levels, that generally results from owning stock in a corporation. However, we will be subject to federal tax in the following circumstances:

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We will pay federal income tax on our taxable income, including net capital gain, that we do not distribute to stockholders during, or within a specified time period after, the calendar year in which the income is earned.

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We may be subject to the “alternative minimum tax” on any items of tax preference that we do not distribute or allocate to stockholders.

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We will pay income tax at the highest corporate rate on:

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net income from the sale or other disposition of property acquired through foreclosure (“foreclosure property”) that we hold primarily for sale to customers in the ordinary course of business, and

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other non-qualifying income from foreclosure property.

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We will pay a 100% tax on net income from sales or other dispositions of property, other than foreclosure property, that we hold primarily for sale to customers in the ordinary course of business.

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If we fail to satisfy the 75% gross income test or the 95% gross income test, as described below under “Requirements for Qualification—Income Tests,” and nonetheless continue to qualify as a REIT because we meet other requirements, we will pay a 100% tax on:

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the gross income attributable to the greater of the amount by which we fail the 75% gross income test and the amount by which 90% of our gross income exceeds the amount of income qualifying under the 95% gross income test, multiplied, in either case, by

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a fraction intended to reflect our profitability.

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If we fail to distribute during a calendar year at least the sum of:

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85% of our REIT ordinary income for the year,

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95% of our REIT capital gain net income for the year, and

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any undistributed taxable income from earlier periods,

we will pay a nondeductible 4% excise tax on the excess of the required distribution over the amount we actually distributed.

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We may elect to retain and pay income tax on our net long-term capital gain. In that case, a U.S. stockholder would be taxed on its proportionate share of our undistributed long-term capital gain (to the extent that we make a timely designation of such gain to the stockholder) and would receive a credit or refund for its proportionate share of the tax we paid.

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We will be subject to a 100% excise tax on certain transactions with a taxable REIT subsidiary that are not conducted on an arm’s-length basis.

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If we acquire any asset from a C corporation, or a corporation that generally is subject to full corporate-level tax, in a merger or other transaction in which we acquire a basis in the asset that is determined by

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reference either to the C corporation’s basis in the asset or to another asset, we will pay tax at the highest regular corporate rate applicable if we recognize gain on the sale or disposition of the asset during the 10-year period after we acquire the asset. The amount of gain on which we will pay tax is the lesser of:

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the amount of gain that we recognize at the time of the sale or disposition, and

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the amount of gain that we would have recognized if we had sold the asset at the time we acquired it.

Requirements for Qualification

A REIT is a corporation, trust, or association that meets each of the following requirements:

1. It is managed by one or more trustees or directors.

2. Its beneficial ownership is evidenced by transferable shares, or by transferable certificates of beneficial interest.

3. It would be taxable as a domestic corporation, but for the REIT provisions of the federal income tax laws.

4. It is neither a financial institution nor an insurance company subject to special provisions of the federal income tax laws.

5. At least 100 persons are beneficial owners of its shares or ownership certificates.

6. Not more than 50% in value of its outstanding shares or ownership certificates is owned, directly or indirectly, by five or fewer individuals, which the federal income tax laws define to include certain entities, during the last half of any taxable year.

7. It elects to be a REIT, or has made such election for a previous taxable year, and satisfies all relevant filing and other administrative requirements established by the Internal Revenue Service that must be met to elect and maintain REIT status.

8. It meets certain other qualification tests, described below, regarding the nature of its income and assets.

We must meet requirements 1 through 4 during our entire taxable year and must meet requirement 5 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. If we comply with all the requirements for ascertaining the ownership of our outstanding stock in a taxable year and have no reason to know that we violated requirement 6, we will be deemed to have satisfied requirement 6 for that taxable year. For purposes of determining share ownership under requirement 6, an “individual” generally includes a supplemental unemployment compensation benefits plan, a private foundation, or a portion of a trust permanently set aside or used exclusively for charitable purposes. An “individual,” however, generally does not include a trust that is a qualified employee pension or profit sharing trust under the federal income tax laws, and beneficiaries of such a trust will be treated as holding our stock in proportion to their actuarial interests in the trust for purposes of requirement 6. Requirements 5 and 6 do not apply during our first taxable year as a REIT, which is our short taxable year ending December 31, 2004.

We believe that we are issuing sufficient common stock with sufficient diversity of ownership to satisfy requirements 5 and 6. In addition, our charter restricts the ownership and transfer of our stock so that we should continue to satisfy these requirements. The provisions of our charter restricting the ownership and transfer of the common stock are described in the section entitled “Description of Common Stock - Restrictions on Ownership and Transfer” in this prospectus.

A corporation that is a “qualified REIT subsidiary” is not treated as a corporation separate from its parent REIT. All assets, liabilities, and items of income, deduction, and credit of a “qualified REIT subsidiary” are

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treated as assets, liabilities, and items of income, deduction, and credit of the REIT. A “qualified REIT subsidiary” is a corporation, all of the stock of which is owned by the REIT. Thus, in applying the requirements described herein, any “qualified REIT subsidiary” that we own will be ignored, and all assets, liabilities, and items of income, deduction, and credit of such subsidiary will be treated as our assets, liabilities, and items of income, deduction, and credit. We do not anticipate owning any qualified REIT subsidiaries.

We will be the general partner of MHI Hospitality, L.P., our operating partnership. An unincorporated domestic entity, such as a partnership or limited liability company, that has a single owner generally is not treated as an entity separate from its parent for federal income tax purposes. An unincorporated domestic entity with two or more owners is generally treated as a partnership for federal income tax purposes. In the case of a REIT that is a partner in a partnership that has other partners, the REIT is treated as owning its proportionate share of the assets of the partnership and as earning its allocable share of the gross income of the partnership for purposes of the applicable REIT qualification tests. Thus, our proportionate share of the assets, liabilities, and items of income of our operating partnership, MHI Hospitality, L.P., and any other partnership, joint venture, or limited liability company that is treated as a partnership for federal income tax purposes in which we acquire an interest, directly or indirectly, will be treated as our assets and gross income for purposes of applying the various REIT qualification requirements.

A REIT is permitted to own (directly or indirectly) up to 100% of the stock of one or more “taxable REIT subsidiaries,” or TRSs. A TRS is a fully taxable corporation that may earn income that would not be qualifying income if earned directly by the parent REIT. 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. The subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A TRS will pay income tax at regular corporate rates on any income that it earns. In addition, the TRS rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation. Further, the rules impose a 100% excise tax on transactions between a TRS and its parent REIT or the REIT’s tenants that are not conducted on an arm’s-length basis. We have formed a TRS, MHI TRS Holding Corporation, which will be the holding company for our TRS Lessee and any TRS we form in the future. See “Material Federal Income Tax Consequences - Taxable REIT Subsidiaries.” Our TRS Lessee is a single member limited liability company owned by our TRS and is disregarded as an entity separate from our TRS for federal income tax purposes.

Income Tests

We must satisfy two gross income tests annually to maintain our qualification as a REIT. First, at least 75% of our gross income for each taxable year must consist of defined types of income that we derive, directly or indirectly, from investments relating to real property or mortgages on real property or qualified temporary investment income. Qualifying income for purposes of that 75% gross income test generally includes:

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rents from real property;

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interest on debt secured by mortgages on real property, or on interests in real property;

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dividends or other distributions on, and gain from the sale of, shares in other REITs;

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gain from the sale of real estate assets (See “Prohibited Transactions” and “Foreclosure Property” of this section); and

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income derived from the qualified temporary investment of new capital that is attributable to the issuance of our stock or a public offering of our debt with a maturity date of at least five years and that we receive during the one-year period beginning on the date on which we received such new capital.

Second, in general, at least 95% of our gross income for each taxable year must consist of income that is qualifying income for purposes of the 75% gross income test, other types of interest and dividends, gain from the sale or disposition of stock or securities, income from certain hedging instruments or any combination of these.

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Gross income from our sale of property that we hold primarily for sale to customers in the ordinary course of business is excluded from both the numerator and the denominator in both income tests. The following paragraphs discuss the specific application of the gross income tests to us.

Rents from Real Property

Rent that we receive from our hotels will qualify as “rents from real property,” which is qualifying income for purposes of the 75% and 95% gross income tests, only if the following conditions are met:

1. The rent must not be based, in whole or in part, on the income or profits of any person, but may be based on a fixed percentage or percentages of receipts or sales.

2. Neither we nor a direct or indirect owner of 10% or more of our stock may own, actually or constructively, 10% or more (by vote or value) of a tenant from whom we receive rent, other than a TRS. If the tenant is a TRS, such TRS may not directly or indirectly operate or manage the related property. Instead, the property must be 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 lodging facilities for any person unrelated to us and the TRS. See the section entitled “Material Federal Income Tax Considerations – Taxable REIT Subsidiaries” in this prospectus.

3. If the rent attributable to personal property leased in connection with a lease of real property is 15% or less of the total rent received under the lease, then the rent attributable to personal property will qualify as rents from real property. However, if the 15% threshold is exceeded, the rent attributable to personal property will not qualify as rents from real property.

4. We generally must not operate or manage our real property or furnish or render services to our tenants, other than through an “independent contractor” who is adequately compensated and from whom we do not derive revenue or through a TRS. However, we may provide services directly to our tenants if the services are “usually or customarily rendered” in connection with the rental of space for occupancy only, and those services are not considered to be provided for the tenants’ convenience. In addition, we may provide a minimal amount of “noncustomary” services to the tenants of a property, other than through an independent contractor or a TRS, as long as our income from the services does not exceed 1% of our income from that property. If this threshold is exceeded, all amounts from that property will be disqualified.

A more detailed explanation of each of these conditions is provided below.

Pursuant to percentage leases, our TRS Lessee will lease from MHI Hospitality, L.P., our operating partnership, and its subsidiaries the land, buildings, improvements, furnishings, and equipment comprising the hotels, for a term of five years. The percentage leases provide that the TRS Lessee is obligated to pay to our operating partnership or its subsidiaries (1) a fixed annual base rent, (2) percentage rent and (3) certain other “additional charges,” as defined in the leases. Percentage rent is calculated by multiplying fixed percentages by gross room revenues in excess of certain thresholds for each of the hotels. Base rent will be adjusted for inflation. Base rent accrues and is required to be paid monthly and percentage rent accrues and is required to be paid quarterly.

In order for the base rent, percentage rent, and additional charges to constitute “rents from real property,” the percentage 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. The determination of whether the percentage leases are true leases depends on an analysis of all the surrounding facts and circumstances. In making such a determination, courts have considered a variety of factors, including the following:

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the intent of the parties;

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the form of the agreement;

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the degree of control over the property that is retained by the property owner, or whether the lessee has substantial control over the operation of the property or is required simply to use its best efforts to perform its obligations under the agreement; and

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the extent to which the property owner retains the risk of loss with respect to the property, or whether the lessee bears the risk of increases in operating expenses or the risk of damage to the property or the potential for economic gain or appreciation with respect to the property.

In addition, federal income tax law provides that a contract that purports to be a service contract or a partnership agreement will be treated instead as a lease of property if the contract is properly treated as such, taking into account all relevant factors, including whether or not:

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the service recipient is in physical possession of the property;

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the service recipient controls the property;

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the service recipient has a significant economic or possessory interest in the property, as evidenced by such key factors as whether (i) the property’s use is likely to be dedicated to the service recipient for a substantial portion of the useful life of the property, (ii) the recipient shares the risk that the property will decline in value, (iii) the recipient shares in any appreciation in the value of the property, (iv) the recipient shares in savings in the property’s operating costs or (v) the recipient bears the risk of damage to or loss of the property;

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the service provider bears the risk of substantially diminished receipts or substantially increased expenditures if there is nonperformance under the contract;

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the service provider uses the property concurrently to provide significant services to entities unrelated to the service recipient; and

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the total contract price substantially exceeds the rental value of the property for the contract period.

Since the determination whether a service contract should be treated as a lease is inherently factual, the presence or absence of any single factor will not be dispositive in every case.

Baker & McKenzie is of the opinion that the percentage leases will be treated as true leases for federal income tax purposes. Such opinion is based, in part, on the following facts:

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MHI Hospitality, L.P., our operating partnership and its subsidiaries, on the one hand, and our TRS Lessee, on the other hand, intend for their relationship to be that of a lessor and lessee and such relationship is documented by lease agreements;

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the TRS Lessee has the right to the exclusive possession, use, and quiet enjoyment of the hotels during the term of the percentage leases;

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the TRS Lessee bears the cost of, and is responsible for, day-to-day maintenance and repair of the hotels, other than the cost of maintaining structural elements, and generally dictates how the hotels are operated and maintained;

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the TRS Lessee bears all of the costs and expenses of operating the hotels, including the cost of any inventory used in their operation, during the term of the percentage leases, other than real estate;

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the TRS Lessee benefits from any savings in the costs of operating the hotels during the term of the percentage leases;

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the TRS Lessee generally will indemnify MHI Hospitality, L.P., our operating partnership, and its subsidiaries against all liabilities imposed on our operating partnership and its subsidiaries during the term of the percentage leases by reason of (1) injury to persons or damage to property occurring at the hotels, (2) the TRS Lessee’ use, management, maintenance, or repair of the hotels, (3) any taxes and

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assessments that are the obligation of the TRS Lessee, (4) any failure on the part of the TRS Lessee to perform or comply with any of the terms of the lease and (5) the non-performance of any of the terms and provisions of any sublease;

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the TRS Lessee is obligated to pay substantial fixed rent for the period of use of the hotels;

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the TRS Lessee stands to incur substantial losses or reap substantial gains depending on how successfully it operates the hotels;

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MHI Hospitality, L.P., our operating partnership, and its subsidiaries cannot use the hotels concurrently to provide significant services to entities unrelated to the TRS Lessee;

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the total contract price under the percentage leases does not substantially exceed the rental value of the hotels for the term of the percentage leases; and

A leasehold interest in the common area at the Shell Island Resort currently held by MHI Hotels LLC will be assigned to MHI Hospitality L.P. pursuant to an assignment agreement. MHI Hotels LLC will enter into a separate sublease agreement with MHI Hospitality L.P. pursuant to which MHI Hotels LLC will lease such property back from MHI Hospitality L.P.

In addition, a leasehold interest in the restaurant space at the Shell Island Resort Hotel condominium facility known as Commercial Unit C-1 currently held by MHI Hotels Two, Inc. will be assigned to MHI Hospitality L.P. pursuant to an assignment agreement. MHI Hotels Two, Inc. will enter into a separate sublease agreement with MHI Hospitality L.P. pursuant to which MHI Hotels Two, Inc. will lease such property back from MHI Hospitality L.P.

Investors should be aware that there are no controlling Treasury regulations, published rulings, or judicial decisions involving leases with terms substantially the same as the percentage leases that discuss whether such leases constitute true leases for federal income tax purposes. If the percentage leases were characterized as service contracts or partnership agreements, rather than as true leases, part or all of the payments that our operating partnership and its subsidiaries receive from the TRS Lessee may not be considered rent or may not otherwise satisfy the various requirements for qualification as “rents from real property.” In that case, we likely would not be able to satisfy either the 75% or 95% gross income test and, as a result, would lose our REIT status.

As described above, in order for the rent that we receive to constitute “rents from real property,” several other requirements must be satisfied.

1. The first requirement is that the percentage rent must not be based in whole or in part on the income or profits of any person. The percentage rent, however, will qualify as “rents from real property” if it is based on percentages of receipts or sales and the percentages:

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are fixed at the time the percentage leases are entered into;

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are not renegotiated during the term of the percentage leases in a manner that has the effect of basing percentage rent on income or profits; and

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conform with normal business practice.

More generally, the rent will not qualify as “rents from real property” if, considering the leases and all the surrounding circumstances, the arrangement does not conform with normal business practice, but is in reality used as a means of basing the rent on income or profits. Since the rent that we will receive will be based on fixed percentages of the lessees’ gross revenues from the related hotel, our rent should not be considered based in whole or in part on the income or profits of any person. Furthermore, we have

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represented that, with respect to other hotels that we acquire in the future, we will not charge rent for any hotel that is based in whole or in part on the income or profits of any person, except by reason of being based on fixed percentages of gross revenues, as described above.

2. We must not own, actually or constructively, 10% or more of the stock or the assets or net profits of any lessee (a “related party tenant”) other than a TRS or TRS Lessee. The constructive ownership rules generally provide that, if 10% or more in value of our stock is owned, directly or indirectly, by or for any person, we are considered as owning the stock owned, directly or indirectly, by or for such person. We anticipate that each of our hotels will be leased to the TRS Lessee. In addition, we will own a leasehold interest in the common areas of the resort property which will be subleased to MHI Hotels Two, Inc. and MHI Hotels LLC. Furthermore, our charter prohibits transfers of our stock that would cause us to own, actually or constructively, 10% or more of the ownership interests in a lessee (other than a TRS or TRS Lessee). Based on the foregoing, we should never own, actually or constructively, 10% or more of any lessee other than a TRS or TRS Lessee. Furthermore, we have represented that, with respect to other hotels that we acquire in the future, we will not rent any property to a related party tenant. However, because the constructive ownership rules are broad and it is not possible to monitor continually direct and indirect transfers of our stock, no absolute assurance can be given that such transfers or other events of which we have no knowledge will not cause us to own constructively 10% or more of a lessee other than a TRS or TRS Lessee at some future date.

As described above, we may own up to 100% of the stock of one or more TRSs. A TRS is a fully taxable corporation that is permitted to lease hotels from the related REIT as long as it does 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. However, rent that we receive from a TRS or TRS Lessee will qualify as “rents from real property” as long as the property is operated on behalf of the TRS or TRS Lessee by an “independent contractor” who is adequately compensated, who does not, directly or through its stockholders, own more than 35% of our shares, taking into account certain ownership attribution rules, 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. See the sections entitled “Material Federal Income Tax Considerations – Taxable REIT Subsidiaries” in this prospectus.

We have formed one TRS to be the holding company for our TRS Lessee and any TRS we form in the future. Our TRS Lessee is a single member limited liability company owned by our TRS and is disregarded as an entity separate from our TRS for federal income tax purposes. Our TRS Lessee will engage independent hotel managers to operate the related hotels on their behalf. Furthermore, we have represented that, with respect to properties that we lease to the TRS or TRS Lessee in the future, such TRS or TRS Lessee will engage an “eligible independent contractor” to manage and operate the hotels leased by such TRS or TRS Lessee. MHI Hotels Services LLC will qualify as an “eligible independent contractor.”

3. The rent attributable to the personal property leased in connection with the lease of a property must not be greater than 15% of the total rent received under the lease. The rent attributable to the personal property contained in a property is the amount that bears the same ratio to total rent for the taxable year as the average of the fair market values of the personal property at the beginning and at the end of the taxable year bears to the average of the aggregate fair market values of both the real and personal property contained in the property at the beginning and at the end of such taxable year (the “personal property ratio”). With respect to each property, we believe either that the personal property ratio is less than 15% or that any rent attributable to personal property will not jeopardize our ability to qualify as a REIT. There can be no

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assurance, however, that the Internal Revenue Service would not challenge our calculation of a personal property ratio, or that a court would not uphold such assertion. If such a challenge were successfully asserted, we could fail to satisfy the 75% or 95% gross income test and thus lose our REIT status.

4. We cannot furnish or render noncustomary services to the tenants of our hotels, or manage or operate our hotels, other than through an independent contractor who is adequately compensated and from whom we do not derive or receive any income or through a TRS. However, we need not provide services through an “independent contractor” or a TRS, but instead may provide services directly to our tenants, if the services are “usually or customarily rendered” in connection with the rental of space for occupancy only and are not considered to be provided for the tenants’ convenience. In addition, we may provide a minimal amount of “noncustomary” services to the tenants of a property, other than through an independent contractor, or a TRS, as long as our income from the services does not exceed 1% of our income from the related property. We will not perform any services other than customary ones for our lessees, unless such services are provided through independent contractors or TRSs. Furthermore, we have represented that, with respect to other hotels that we acquire in the future, we will not perform noncustomary services for the lessees of the property to the extent that the provision of such services would jeopardize our REIT status.

If a portion of the rent that we receive from a property does not qualify as “rents from real property” because the rent attributable to personal property exceeds 15% of the total rent for a taxable year, the portion of the rent that is attributable to personal property will not be qualifying income for purposes of either the 75% or 95% gross income test. Thus, if such rent attributable to personal property, plus any other income that is nonqualifying income for purposes of the 95% gross income test, during a taxable year exceeds 5% of our gross income during the year, we would lose our REIT status. If, however, the rent from a particular property does not qualify as “rents from real property” because either (1) the rent is considered based on the income or profits of the related lessee, (2) the lessee either is a related party tenant or fails to qualify for the exception to the related party tenant rule for qualifying TRSs or (3) we furnish noncustomary services to the tenants of the property, or manage or operate the property, other than through a qualifying independent contractor or a TRS, none of the rent from that property would qualify as “rents from real property.” In that case, we might lose our REIT status because we would be unable to satisfy either the 75% or 95% gross income test.

In addition to the rent, the TRS Lessee is required to pay certain additional charges. To the extent that such additional charges represent either (1) reimbursements of amounts that we are obligated to pay to third parties, such as a lessee’s proportionate share of a property’s operational or capital expenses or (2) penalties for nonpayment or late payment of such amounts, such charges should qualify as “rents from real property.” However, to the extent that such charges do not qualify as “rents from real property,” they instead will be treated as interest that qualifies for the 95% gross income test.

Prohibited Transactions

A REIT will incur a 100% tax on the net income derived from any sale or other disposition of property, other than foreclosure property, that the REIT holds primarily for sale to customers in the ordinary course of a trade or business. We believe that none of our assets will be held primarily for sale to customers and that a sale of any of our assets will not be in the ordinary course of our business. Whether a REIT holds an asset “primarily for sale to customers in the ordinary course of a trade or business” depends, however, on the facts and circumstances in effect from time to time, including those related to a particular asset. Nevertheless, we will attempt to comply with the terms of safe-harbor provisions in the federal income tax laws prescribing when an asset sale will not be characterized as a prohibited transaction. We cannot assure you, however, that we can comply with the safe-harbor provisions or that we will avoid owning property that may be characterized as property that we hold “primarily for sale to customers in the ordinary course of a trade or business.”

Foreclosure Property

We will be subject to tax at the maximum corporate rate on any income from foreclosure property, other than income that otherwise would be qualifying income for purposes of the 75% gross income test, less expenses

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directly connected with the production of that income. However, gross income from foreclosure property will qualify under the 75% and 95% gross income tests. Foreclosure property is any real property, including interests in real property, and any personal property incident to such real property:

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that is acquired by a REIT as the result of the REIT having bid on such property at foreclosure, or having otherwise reduced such property to ownership or possession by agreement or process of law, after there was a default or default was imminent on a lease of such property or on indebtedness that such property secured;

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for which the related loan was acquired by the REIT at a time when the default was not imminent or anticipated; and

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for which the REIT makes a proper election to treat the property as foreclosure property.

However, a REIT will not be considered to have foreclosed on a property where the REIT takes control of the property as a mortgagee-in-possession and cannot receive any profit or sustain any loss except as a creditor of the mortgagor. Property generally ceases to be foreclosure property at the end of the third taxable year following the taxable year in which the REIT acquired the property, earlier or longer if an extension is granted by the Secretary of the Treasury. However, this grace period terminates and foreclosure property ceases to be foreclosure property on the first day:

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on which a lease is entered into for the property that, by its terms, will give rise to income that does not qualify for purposes of the 75% gross income test, or any amount is received or accrued, directly or indirectly, pursuant to a lease entered into on or after such day that will give rise to income that does not qualify for purposes of the 75% gross income test;

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on which any construction takes place on the property, other than completion of a building or any other improvement, where more than 10% of the construction was completed before default became imminent; or

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which is more than 90 days after the day on which the REIT acquired the property and the property is used in a trade or business which is conducted by the REIT, other than through an independent contractor from whom the REIT itself does not derive or receive any income.

Failure to Satisfy Gross Income Tests

If we fail to satisfy one or both of the gross income tests for any taxable year, we nevertheless may qualify as a REIT for that year if we qualify for relief under certain provisions of the federal income tax laws. Those relief provisions generally will be available if:

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our failure to meet such tests is 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 tax return; and

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any incorrect information on the schedule was not due to fraud with intent to evade tax.

We cannot predict, however, whether in all circumstances we would qualify for the relief provisions. In addition, as discussed above in “Material Federal Income Tax Consequences – Taxation of our Company,” even if the relief provisions apply, we would incur a 100% tax on the gross income attributable to the greater of the amount by which we fail the 75% gross income test and the amount by which 90% of our gross income exceeds the amount of income qualifying under the 95% gross income test, multiplied by, in either case, a fraction intended to reflect our profitability.

Asset Tests

To maintain our qualification as a REIT, we also must satisfy the following asset tests at the end of each quarter of each taxable year.

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First, at least 75% of the value of our total assets must consist of:

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interests in real property, including leaseholds and options to acquire real property and leaseholds;

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interests in mortgages on real property;

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stock in other REITs;

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investments in stock or debt instruments during the one-year period following our receipt of new capital received either through equity offerings, or offerings of public debt with at least a five-year maturity;

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cash or cash items, including certain receivables; and

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government securities.

Second, except with respect to the securities of a TRS and the securities described in the first test above:

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the value of our interest in any one issuer’s securities may not exceed 5% of the value of our total assets; and

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we may not own more than 10% of the voting power or value of any one issuer’s outstanding securities.

Third, no more than 20% of the value of our total assets may consist of the securities of one or more TRSs.

Fourth, no more than 25% of the value of our total assets may consist of the securities of TRSs, other taxable subsidiaries and other assets that are not qualifying assets for purposes of the 75% asset test.

For purposes of the second asset test, the term “securities” does not include stock in another REIT, equity or debt securities of a qualified REIT subsidiary or TRS, mortgage loans that constitute real estate assets, or equity interests in a partnership. The term “securities,” however, generally includes debt securities issued by a partnership or another REIT, except that certain “straight debt” securities are not treated as “securities” for purposes of the 10% value test (for example, qualifying debt securities of a partnership or REIT in which we own no equity interest or of a partnership if we own at least a 20% profits interest in the partnership).

We will monitor the status of our assets for purposes of the various asset tests and will manage our portfolio in order to comply at all times with such tests. If we fail to satisfy the asset tests at the end of a calendar quarter, we will not lose our REIT status if:

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we satisfied the asset tests at the end of the preceding calendar quarter; and

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the discrepancy between the value of our assets and the asset test requirements arose from changes in the market values of our assets and was not wholly or partly caused by the acquisition of one or more non-qualifying assets.

If we did not satisfy the condition described in the second item, above, we still could avoid disqualification by eliminating any discrepancy within 30 days after the close of the calendar quarter in which it arose.

Distribution Requirements

Each taxable year, we must distribute dividends, other than capital gain dividends and deemed dividends of retained capital gain, to our stockholders in an aggregate amount at least equal to:

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the sum of

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90% of our “REIT taxable income,” computed without regard to the dividends paid deduction and our net capital gain or loss, and

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90% of our after-tax net income, if any, from foreclosure property, minus

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the sum of certain items of non-cash income in excess of 5% of our REIT taxable income, computed without regard to the dividends paid deduction.

We must pay such distributions in the taxable year to which they relate, or in the following taxable year if we declare the distribution before we timely file our federal income tax return for the year and pay the distribution on or before the first regular dividend payment date after such declaration.

We will pay federal income tax on taxable income, including net capital gain, that we do not distribute to stockholders. Furthermore, if we fail to distribute during a calendar year, or by the end of January following the calendar year in the case of distributions with declaration and record dates falling in the last three months of the calendar year, at least the sum of:

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85% of our REIT ordinary income for such year,

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95% of our REIT capital gain income for such year, and

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any undistributed taxable income from prior periods,

we will incur a 4% nondeductible excise tax on the excess of such required distribution over the amounts we actually distribute. We may elect to retain and pay income tax on the net long-term capital gain we receive in a taxable year. See “Material Federal Income Tax Consequences – Taxation of Taxable U.S. Stockholders.” If we so elect, we will be treated as having distributed any such retained amount for purposes of the 4% nondeductible excise tax described above. We intend to make timely distributions sufficient to satisfy the annual distribution requirements and to avoid corporate income tax and the 4% nondeductible excise tax.

It is possible that, from time to time, we may experience timing differences between the actual receipt of income and actual payment of deductible expenses and the inclusion of that income and deduction of such expenses in arriving at our REIT taxable income. For example, we may not deduct recognized capital losses from our “REIT taxable income.” Further, it is possible that, from time to time, we may be allocated a share of net capital gain attributable to the sale of depreciated property that exceeds our allocable share of cash attributable to that sale. As a result of the foregoing, we may have less cash than is necessary to distribute all of our taxable income and thereby avoid corporate income tax and the excise tax imposed on certain undistributed income. In such a situation, we may need to borrow funds or issue additional common or preferred stock to enable us to make the required distribution.

Under certain circumstances, we may be able to correct a failure to meet the distribution requirement for a year by paying “deficiency dividends” to our stockholders in a later year. We may include such deficiency dividends in our deduction for dividends paid for the earlier year. Although we may be able to avoid income tax on amounts distributed as deficiency dividends, we will be required to pay interest to the Internal Revenue Service based upon the amount of any deduction we take for deficiency dividends.

Recordkeeping Requirements

We must maintain certain records in order to qualify as a REIT. In addition, to avoid a monetary penalty, we must request on an annual basis information from our stockholders designed to disclose the actual ownership of our outstanding stock. We intend to comply with these requirements.

Failure to Qualify

If we fail to qualify as a REIT in any taxable year, and no relief provision applies, we would be subject to federal income tax and any applicable alternative minimum tax on our taxable income at regular corporate rates. In calculating our taxable income in a year in which we fail to qualify as a REIT, we would not be able to deduct amounts paid out to stockholders. In fact, we would not be required to distribute any amounts to stockholders in that year. In such event, to the extent of our current and accumulated earnings and profits, all distributions to

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stockholders would be taxable as dividend income. Subject to certain limitations of the federal income tax laws, domestic corporate stockholders might be eligible for the dividends received deduction. Unless we qualified for relief under specific statutory provisions, we also would be disqualified from taxation as a REIT for the four taxable years following the year during which we ceased to qualify as a REIT. We cannot predict whether in all circumstances we would qualify for such statutory relief.

Taxable REIT Subsidiaries

As described above, we may own up to 100% of the stock of one or more taxable REIT subsidiaries. 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 provide services to our lessees and perform activities unrelated to our lessees, 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 our corporate subsidiary must elect for the subsidiary 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.

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 one TRS, MHI TRS, to be the holding company for our TRS Lessee and any TRS we form in the future. Our TRS Lessee is a single member limited liability company owned by our TRS and is disregarded as an entity separate from our TRS for federal income tax purposes. Our TRS Lessee will engage independent hotel managers to operate the related hotels on their behalf. Furthermore, we have represented that, with respect to properties that we lease to a TRS in the future, each such TRS will engage an “eligible independent contractor” to manage and operate the hotels leased by such TRS. MHI Hotels Services will qualify as “eligible independent contractor.”

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. Further, the rules impose 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 will be conducted on an arm’s-length basis.

Taxation of Taxable U.S. Stockholders

The term “U.S. stockholder” means a beneficial owner of our common stock that, 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 corporation (including an entity treated as a corporation for U.S. federal income tax purposes) created or organized under the laws of the United States or of a political subdivision of the United States;

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an estate whose income is subject to U.S. federal income taxation regardless of its source; or

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any trust if (1) a U.S. court is able to exercise primary supervision over the administration of such trust and one or more U.S. persons have the authority to control all substantial decisions of the trust or (2) it has a valid election in place to be treated as a U.S. person.

If a partnership or an entity treated as a partnership for federal income tax purposes holds shares of our common stock, the federal income tax treatment of a partner in the partnership will generally depend on the status of the partner and the activities of the partnership. If you are a partner in a partnership holding shares of our common stock, you should consult your own tax advisor regarding the consequences of the ownership and disposition of shares of our common stock by the partnership.

As long as we qualify as a REIT, a taxable “U.S. stockholder” must generally take into account as ordinary income distributions made out of our current or accumulated earnings and profits that we do not designate as capital gain dividends or retained long-term capital gain. A U.S. stockholder will not qualify for the dividends received deduction generally available to corporations. In addition, dividends paid to a U.S. stockholder generally will not qualify for the new 15% tax rate for “qualified dividend income.”

The Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced the maximum tax rate for qualified dividend income from 38.6% to 15% for tax years 2003 through 2008. Without future congressional action, the maximum tax rate on qualified dividend income will move to 35% in 2009 and 39.6% in 2011. Qualified dividend income generally includes dividends paid to individuals, trusts and estates by domestic C corporations and certain qualified foreign corporations. Because we are not generally subject to federal income tax on the portion of our REIT taxable income distributed to our stockholders (see “Taxation of our Company” above), our dividends generally will not be eligible for the new 15% rate on qualified dividend income. As a result, our ordinary REIT dividends will continue to be taxed at the higher tax rate applicable to ordinary income.

Currently, the highest marginal individual income tax rate on ordinary income is 35%. However, the 15% tax rate for qualified dividend income will apply to our ordinary REIT dividends (i) attributable to dividends received by us from non-REIT corporations, such as a taxable REIT subsidiary, (ii) to the extent attributable to income upon which we have paid corporate income tax (e.g., to the extent that we distribute less than 100% of our taxable income). In general, to qualify for the reduced tax rate on qualified dividend income, a stockholder must hold our common stock for more than 60 days during the 120-day period beginning on the date that is 60 days before the date on which our common stock become ex-dividend.

We may elect to retain and pay income tax on the net long-term capital gain that we receive in a taxable year. In that case, a U.S. stockholder would be taxed on its proportionate share of our undistributed long-term capital gain. The U.S. stockholder would receive a credit or refund for its proportionate share of the tax we paid. The U.S. stockholder would increase the basis in its common stock by the amount of its proportionate share of our undistributed long-term capital gain, minus its share of the tax we paid.

A U.S. stockholder will not incur tax on a distribution in excess of our current and accumulated earnings and profits if the distribution does not exceed the adjusted basis of the U.S. stockholder’s common stock. Instead, the distribution will reduce the adjusted basis of such common stock. A U.S. stockholder will recognize a distribution in excess of both our current and accumulated earnings and profits and the U.S. stockholder’s adjusted basis in his or her common stock as long-term capital gain, or short-term capital gain if the common stock has been held for one year or less, assuming the common stock is a capital asset in the hands of the U.S. stockholder. In addition, if we declare a distribution in October, November, or December of any year that is payable to a U.S. stockholder of record on a specified date in any such month, such distribution shall be treated as both paid by us and received by the U.S. stockholder on December 31 of such year, provided that we actually pay the distribution during January of the following calendar year.

U.S. stockholders may not include in their individual income tax returns any of our net operating losses or capital losses. Instead, these losses are generally carried over by us for potential offset against our future income.

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Taxable distributions from us and gain from the disposition of the common stock will not be treated as passive activity income and, therefore, stockholders generally will not be able to apply any “passive activity losses,” such as losses from certain types of limited partnerships in which the stockholder is a limited partner, against such income. In addition, taxable distributions from us and gain from the disposition of our common stock generally will be treated as investment income for purposes of the investment interest limitations. We will notify stockholders after the close of our taxable year as to the portions of the distributions attributable to that year that constitute ordinary income, return of capital, and capital gain.

Taxation of U.S. Stockholders on the Disposition of Common Stock

In general, a U.S. stockholder who is not a dealer in securities must treat any gain or loss realized upon a taxable disposition of our common stock as long-term capital gain or loss if the U.S. stockholder has held the common stock for more than one year and otherwise as short-term capital gain or loss. However, a U.S. stockholder must treat any loss upon a sale or exchange of common stock held by such stockholder for six-months or less as a long-term capital loss to the extent of capital gain dividends and any other actual or deemed distributions from us that such U.S. stockholder treats as long-term capital gain. All or a portion of any loss that a U.S. stockholder realizes upon a taxable disposition of our common stock may be disallowed if the U.S. stockholder purchases other shares of our common stock within 30 days before or after the disposition.

Capital Gains and Losses

The tax rate differential between capital gain and ordinary income for non-corporate taxpayers may be significant. A U.S. stockholder generally must hold a capital asset for more than one year for gain or loss derived from its sale or exchange to be treated as long-term capital gain or loss. The highest marginal individual income tax rate currently is 35%. The maximum tax rate on long-term capital gain applicable to non-corporate U.S. stockholders currently is 15% for sales and exchanges of assets held for more than one year. The maximum tax rate on long-term capital gain from the sale or exchange of “section 1250 property,” or depreciable real property, is 25% to the extent that such gain would have been treated as ordinary income if the property were “section 1245 property.” With respect to distributions that we designate as capital gain dividends and any retained capital gain that we are deemed to distribute, we generally may designate whether such a distribution is taxable to our non-corporate stockholders at a 15% or 25% rate. In addition, the characterization of income as capital gain or ordinary income may affect the deductibility of capital losses. A non-corporate U.S. stockholder may deduct capital losses not offset by capital gains against its ordinary income only up to a maximum annual amount of $3,000. A non-corporate U.S. stockholder may carry forward unused capital losses indefinitely. A corporate U.S. stockholder must pay tax on its net capital gain at ordinary corporate rates. A corporate U.S. stockholder can deduct capital losses only to the extent of capital gains, with unused losses being carried back three years and forward five years.

Information Reporting Requirements and Backup Withholding

We will report to our stockholders and to the Internal Revenue Service the amount of distributions we pay during each calendar year, and the amount of tax we withhold, if any. Under the backup withholding rules, a U.S. stockholder may be subject to backup withholding at a rate of up to 28% with respect to distributions unless the holder:

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is a corporation or comes within certain other exempt categories and, when required, demonstrates this fact; or

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provides a taxpayer identification number, certifies as to no loss of exemption from backup withholding, and otherwise complies with the applicable requirements of the backup withholding rules.

A U.S. stockholder who does not provide us with its correct taxpayer identification number also may be subject to penalties imposed by the Internal Revenue Service. Any amount paid as backup withholding will be

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creditable against the U.S. stockholder’s income tax liability. In addition, we may be required to withhold a portion of capital gain distributions to any U.S. stockholders who fail to certify their non-foreign status to us. For a discussion of the backup withholding rules as applied to non-U.S. stockholders. See the section entitled “Material Federal Income Tax Considerations – Taxation of Non-U.S. Stockholders” in this prospectus.

Taxation of Tax-Exempt Stockholders

Tax-exempt entities, including qualified employee pension and profit sharing trusts and individual retirement accounts, generally are exempt from federal income taxation. However, they are subject to taxation on their unrelated business taxable income. While many investments in real estate generate unrelated business taxable income, the Internal Revenue Service has issued a ruling that dividend distributions from a REIT to an exempt employee pension trust do not constitute unrelated business taxable income so long as the exempt employee pension trust does not otherwise use the shares of the REIT in an unrelated trade or business of the pension trust. Based on that ruling, amounts that we distribute to tax-exempt stockholders generally should not constitute unrelated business taxable income. However, if a tax-exempt stockholder were to finance its acquisition of common stock with debt, a portion of the income that it receives from us would constitute unrelated business taxable income pursuant to the “debt-financed property” rules. Furthermore, social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts and qualified group legal services plans that are exempt from taxation under special provisions of the federal income tax laws are subject to different unrelated business taxable income rules, which generally will require them to characterize distributions that they receive from us as unrelated business taxable income. Finally, in certain circumstances, a qualified employee pension or profit sharing trust that owns more than 10% of our stock must treat a percentage of the dividends that it receives from us as unrelated business taxable income. Such percentage is equal to the gross income we derive from an unrelated trade or business, determined as if we were a pension trust, divided by our total gross income for the year in which we pay the dividends. That rule applies to a pension trust holding more than 10% of our stock only if:

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the percentage of our dividends that the tax-exempt trust must treat as unrelated business taxable income is at least 5%;

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we qualify as a REIT by reason of the modification of the rule requiring that no more than 50% of our stock be owned by five or fewer individuals that allows the beneficiaries of the pension trust to be treated as holding our stock in proportion to their actuarial interests in the pension trust; and

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either

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one pension trust owns more than 25% of the value of our stock; or

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a group of pension trusts individually holding more than 10% of the value of our stock collectively owns more than 50% of the value of our stock.

Taxation of Non-U.S. Stockholders

The rules governing U.S. federal income taxation of our stockholders who are beneficial owners of our common stock and who are not U.S. stockholders, such as nonresident alien individuals, foreign corporations, foreign partnerships, and other foreign stockholders (“Non-U.S. stockholders”), are complex. This section is only a summary of such rules. We urge Non-U.S. stockholders to consult their own tax advisors to determine the impact of federal, state, and local income tax laws on ownership of the common stock, including any reporting requirements.

A Non-U.S. stockholder that receives a distribution that is not attributable to gain from our sale or exchange of United States real property interests, as defined below, and that we do not designate as a capital gain dividend or retained capital gain will recognize ordinary income to the extent that we pay the distribution out of our current or accumulated earnings and profits. A withholding tax equal to 30% of the gross amount of the distribution ordinarily will apply unless an applicable tax treaty reduces or eliminates the tax. However, if a

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distribution is treated as effectively connected with the Non-U.S. stockholder’s conduct of a U.S. trade or business, the Non-U.S. stockholder generally will be subject to federal income tax on the distribution at graduated rates, in the same manner as U.S. stockholders are taxed on distributions and also may be subject to the 30% branch profits tax in the case of a corporate Non-U.S. stockholder. We plan to withhold U.S. income tax at the rate of 30% on the gross amount of any distribution paid to a Non-U.S. stockholder unless either:

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a lower treaty rate applies and the Non-U.S. stockholder files an IRS Form W-8BEN evidencing eligibility for that reduced rate with us; or

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the Non-U.S. stockholder files an IRS Form W-8ECI with us claiming that the distribution is effectively connected income.

A Non-U.S. stockholder will not incur tax on a distribution in excess of our current and accumulated earnings and profits if the excess portion of the distribution does not exceed the adjusted basis of its common stock. Instead, the excess portion of the distribution will reduce the adjusted basis of that common stock. A Non-U.S. stockholder will be subject to tax on a distribution that exceeds both our current and accumulated earnings and profits and the adjusted basis of the common stock, if the Non-U.S. stockholder otherwise would be subject to tax on gain from the sale or disposition of its common stock, as described below. Because we generally cannot determine at the time we make a distribution whether the distribution will exceed our current and accumulated earnings and profits, we normally will withhold tax on the entire amount of any distribution at the same rate as we would withhold on a dividend. However, a Non-U.S. stockholder may obtain a refund of amounts that we withhold if we later determine that a distribution in fact exceeded our current and accumulated earnings and profits.

We are required to withhold 10% of any distribution that exceeds our current and accumulated earnings and profits. Consequently, although we intend to withhold at a rate of 30% on the entire amount of any distribution, to the extent that we do not do so, we will withhold at a rate of 10% on any portion of a distribution not subject to withholding at a rate of 30%.

For any year in which we qualify as a REIT, a Non-U.S. stockholder will incur tax on distributions that are attributable to gain from our sale or exchange of “United States real property interests” under special provisions of the federal income tax laws known as “FIRPTA.” The term “United States real property interests” includes interests in real property and shares in corporations at least 50% of whose assets consist of interests in real property. Under those rules, a Non-U.S. stockholder is taxed on distributions attributable to gain from sales of United States real property interests as if the gain were effectively connected with a U.S. business of the Non-U.S. stockholder. A Non-U.S. stockholder thus would be taxed on such a distribution at the normal capital gain rates applicable to U.S. stockholders, subject to applicable alternative minimum tax and a special alternative minimum tax in the case of a nonresident alien individual. A non-U.S. corporate stockholder not entitled to treaty relief or exemption also may be subject to the 30% branch profits tax on such a dividend. We must withhold 35% of any distribution that we could designate as a capital gain distribution. A Non-U.S. stockholder may receive a credit against its tax liability for the amount we withhold.

A Non-U.S. stockholder generally will not incur tax under FIRPTA on a sale or other disposition of our stock as long as during the five-year period ending on the date of the distribution or disposition non-U.S. persons hold, directly or indirectly, less than 50% in value of our stock. We cannot assure you that this test will be met. However, a Non-U.S. stockholder that owned, actually or constructively, 5% or less of our common stock at all times during a specified testing period will not incur tax under FIRPTA on a sale or other disposition of our common stock if the common stock is “regularly traded” on an established securities market. Because our common stock is expected to be regularly traded on an established securities exchange, a Non-U.S. stockholder should not incur tax under FIRPTA as long as it owns, actually or constructively, no more than 5% of our common stock. If the gain on the sale of the common stock were taxed under FIRPTA, a Non-U.S. stockholder would be taxed on that gain in the same manner as U.S. stockholders subject to applicable alternative minimum tax, a special alternative minimum tax in the case of nonresident alien individuals, and the possible application of

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the 30% branch profits tax in the case of Non-U.S. corporations. In addition, the proceeds of any sale or other disposition of our common stock to which FIRPTA applies would be subject to withholding equal to 10% of such proceeds. Furthermore, a Non-U.S. stockholder generally will incur tax on gain not subject to FIRPTA if:

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the gain is effectively connected with the Non-U.S. stockholder’s U.S. trade or business, in which case the Non-U.S. stockholder will be subject to the same treatment as U.S. stockholders with respect to such gain, or

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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, in which case the Non-U.S. stockholder will incur a 30% tax on his or her capital gains.

Tax Aspects of Our Investments in Our Operating Partnership

The following discussion summarizes certain federal income tax considerations applicable to our direct or indirect investments in MHI Hospitality, L.P., our operating partnership, and any subsidiary partnerships or limited liability companies that we form or acquire (each individually a “Partnership” and, collectively, the “Partnerships”). The discussion does not cover state or local tax laws or any federal tax laws other than income tax laws.

Classification as Partnerships

We are entitled to include in our income our distributive share of each Partnership’s income and to deduct our distributive share of each Partnership’s losses only if such Partnership is classified for federal income tax purposes as a partnership (or an entity that is disregarded for federal income tax purposes if the entity has only one owner or member), rather than as a corporation or an association taxable as a corporation. An unincorporated entity with at least two owners or members will be classified as a partnership, rather than as a corporation, for federal income tax purposes if it:

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is treated as a partnership under the Treasury regulations relating to entity classification (the “check-the-box regulations”); and

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is not a “publicly traded” partnership.

Under the check-the-box regulations, an unincorporated entity with at least two owners or members may elect to be classified either as an association taxable as a corporation or as a partnership. If such an entity fails to make an election, it generally will be treated as a partnership for federal income tax purposes. It is anticipated that each Partnership intends to be classified as a partnership for federal income tax purposes (or an entity that is disregarded for federal income tax purposes if the entity has only one owner or member), and no Partnership will elect to be treated as an association taxable as a corporation under the check-the-box regulations.

A publicly traded partnership is a partnership whose interests are traded on an established securities market or are readily tradable on a secondary market or the substantial equivalent thereof. A publicly traded partnership will not, however, be treated as a corporation for any taxable year if 90% or more of the partnership’s gross income for each taxable year beginning after December 31, 1987 in which it was classified as a publicly traded partnership consisted of certain passive-type income, including real property rents, gains from the sale or other disposition of real property, interest and dividends (the “90% passive income exception”).

Treasury regulations provide limited safe harbors from the definition of a publicly traded partnership. Pursuant to one of those safe harbors (the “private placement exclusion”), interests in a partnership will not be treated as readily tradable on a secondary market or the substantial equivalent thereof if (1) all interests in the partnership were issued in a transaction or transactions that were not required to be registered under the Securities Act of 1933, as amended, and (2) the partnership does not have more than 100 partners at any time during the partnership’s taxable year. In determining the number of partners in a partnership, a person owning an interest in a partnership, grantor trust, or S corporation that owns an interest in the partnership is treated as a partner in such partnership only if (1) substantially all of the value of the owner’s interest in the entity is

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attributable to the entity’s direct or indirect interest in the partnership and (2) a principal purpose of the use of the entity is to permit the partnership to satisfy the 100-partner limitation. Each Partnership is expected to qualify for the private placement exclusion.

We have not requested, and do not intend to request, a ruling from the Internal Revenue Service that the Partnerships will be classified as partnerships for federal income tax purposes. If for any reason a Partnership were taxable as a corporation, rather than as a partnership, for federal income tax purposes, we would not be able to qualify as a REIT. See “Material Federal Income Tax Considerations - Income Tests” and “- Asset Tests” in this prospectus. In addition, any change in a Partnership’s status for tax purposes might be treated as a taxable event, in which case we might incur tax liability without any related cash distribution. See “Material Federal Income Tax Considerations - Distribution Requirements” in this prospectus. Further, items of income and deduction of such Partnership would not pass through to its partners, and its partners would be treated as stockholders for tax purposes. Consequently, such Partnership would be required to pay income tax at corporate rates on its net income, and distributions to its partners would constitute dividends that would not be deductible in computing such Partnership’s taxable income.

Income Taxation of the Partnerships and their Partners

Partners, Not the Partnerships, Subject to Tax

A partnership is not a taxable entity for federal income tax purposes. Rather, we are required to take into account our allocable share of each Partnership’s income, gains, losses, deductions, and credits for any taxable year of such Partnership ending within or with our taxable year, without regard to whether we have received or will receive any distribution from such Partnership.

Partnership Allocations

Although a partnership agreement generally will determine the allocation of income and losses among partners, such allocations will be disregarded for tax purposes if they do not comply with the provisions of the federal income tax laws governing partnership allocations. If an allocation is not recognized for federal income tax purposes, the item subject to the allocation will be reallocated in accordance with the partners’ interests in the partnership, which will be determined by taking into account all of the facts and circumstances relating to the economic arrangement of the partners with respect to such item. Each Partnership’s allocations of taxable income, gain and loss are intended to comply with the requirements of the federal income tax laws governing partnership allocations.

Tax Allocations With Respect to Contributed Properties

Income, gain, loss and deduction attributable to appreciated or depreciated property that is contributed to a partnership in exchange for an interest in the partnership must be allocated in a manner such that the contributing partner is charged with, or benefits from, respectively, the unrealized gain or unrealized loss associated with the property at the time of the contribution. The amount of such unrealized gain or unrealized loss (“built-in gain” or “built-in loss”) is generally equal to the difference between the fair market value and the adjusted tax basis of the contributed property at the time of contribution (a “book-tax difference”). Such allocations are solely for federal income tax purposes and do not affect the book capital accounts or other economic or legal arrangements among the partners. The U.S. Treasury Department has issued regulations requiring partnerships to use a “reasonable method” for allocating items with respect to which there is a book-tax difference and outlining several reasonable allocation methods. It is expected that MHI Hospitality, L.P., our operating partnership, generally will use the “traditional method” for making such allocations.

Under our operating partnership’s partnership agreement, depreciation or amortization deductions of the operating partnership generally will be allocated among the partners in accordance with their respective interests in the operating partnership, except to the extent that the operating partnership is required under the federal

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income tax laws governing partnership allocations to use a method for allocating tax depreciation deductions attributable to contributed properties that results in our receiving a disproportionate share of such deductions. With respect to contributed properties that have a tax basis that is lower than their capital account value, the operating partnership will use the “ traditional method “ under Section 704(c) of the Code for allocating depreciation deductions. As a result of the operating partnership’s use of the traditional method, our tax depreciation deductions attributable to properties contributed to our operating partnership by other partners may be lower and gain on a sale of such property may be higher than they would have been if our operating partnership had acquired those properties for cash. If we receive lower tax depreciation deductions from contributed properties, we would recognize increased taxable income, which could increase the annual distributions that we are required to make under the federal income tax rules applicable to REITs or cause a higher portion of our distributions to be treated as taxable dividend income instead of a tax-free return of capital or a capital gain. See “Material Federal Income Tax Consequences - Taxation of U.S. Taxable Stockholders.” In addition, gain or loss on the sale of a property that has been contributed, in whole or in part, to the operating partnership will be specially allocated to the contributing partners to the extent of any built-in gain or loss with respect to such property for federal income tax purposes.

Basis in Partnership Interest

Our adjusted tax basis in our partnership interest in MHI Hospitality, L.P., our operating partnership, generally is equal to:

•

the amount of cash and the basis of any other property contributed by us to our operating partnership;

•

increased by our allocable share of our operating partnership’s income and our allocable share of indebtedness of our operating partnership (which cannot include the debt allocated to our contributors under the tax indemnity and debt maintenance agreement and related guaranty); and

•

reduced, but not below zero, by our allocable share of the operating partnership’s loss and the amount of cash distributed to us, and by constructive distributions resulting from a reduction in our share of indebtedness of our operating partnership.

If the allocation of our distributive share of our operating partnership’s loss would reduce the adjusted tax basis of our partnership interest below zero, the recognition of such loss will be deferred until such time as the recognition of such loss would not reduce our adjusted tax basis below zero. To the extent that our operating partnership’s distributions, or any decrease in our share of the indebtedness of our operating partnership, which is considered a constructive cash distribution to the partners, reduce our adjusted tax basis below zero, such distributions will constitute taxable income to us. Such distributions and constructive distributions normally will be characterized as long-term capital gain. However, it is unlikely that our adjusted tax basis will be reduced below zero because, as a general partner, our basis will be adjusted to reflect our share of any of the partnership’s liabilities.

Depreciation Deductions Available to Our Operating Partnership

To the extent that MHI Hospitality, L.P., our operating partnership, acquires its properties in exchange for cash, its initial basis in such properties for federal income tax purposes generally will be equal to the purchase price paid by the operating partnership. Our operating partnership generally will depreciate such property for federal income tax purposes under the modified accelerated cost recovery system of depreciation (“MACRS”). Under MACRS, our operating partnership generally will depreciate furnishings and equipment over a seven-year recovery period using a 200% declining balance method and a half-year convention. If, however, our operating partnership places more than 40% of its furnishings and equipment in service during the last three months of a taxable year, a mid-quarter depreciation convention must be used for the furnishings and equipment placed in service during that year.

A first-year “bonus” depreciation deduction equal to 50% of the adjusted basis of qualified property is available for qualified property placed in service after May 5, 2003, which includes qualified leasehold

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improvement property and property with a recovery period of less than 20 years, such as furnishings and equipment at our hotels. “Qualified leasehold improvement property” generally includes improvements made to the interior of nonresidential real property that are placed in service more than three years after the date the building was placed in service. Under MACRS, our operating partnership generally will depreciate buildings and improvements over either a 39-year or 40-year recovery period using a straight line method and a mid-month convention.

Our operating partnership’s initial basis in properties acquired in exchange for units should be the same as the transferor’s basis in such properties on the date of acquisition by our operating partnership. Although the law is not entirely clear, our operating partnership generally will depreciate such property for federal income tax purposes over the same remaining useful lives and under the same methods used by the transferors. Our operating partnership’s tax depreciation deductions will be allocated among the partners in accordance with their respective interests in our operating partnership, except to the extent that our operating partnership is required under the federal income tax laws governing partnership allocations to use a method for allocating tax depreciation deductions attributable to contributed properties that results in our receiving a disproportionate share of such deductions to the extent available.

Sale of a Partnership’s Property

Generally, any gain realized by a Partnership on the sale of property held by the Partnership for more than one year will be long-term capital gain, except for any portion of such gain that is treated as depreciation or cost recovery recapture. Any gain or loss recognized by a Partnership on the disposition of contributed properties will be allocated first to the partners of the Partnership who contributed such properties to the extent of their built-in gain or loss on those properties for federal income tax purposes. The partners’ built-in gain or loss on such contributed properties will equal the difference between the partners’ proportionate share of the book value of those properties and the partners’ tax basis allocable to those properties at the time of the contribution, subject to certain adjustments over time. Any remaining gain or loss recognized by the Partnership on the disposition of the contributed properties, and any gain or loss recognized by the Partnership on the disposition of the other properties, will be allocated among the partners in accordance with their respective percentage interests in the Partnership.

Our share of any gain realized by a Partnership on the sale of any property held by the Partnership as inventory or other property held primarily for sale to customers in the ordinary course of the Partnership’s trade or business will be treated as income from a prohibited transaction that is subject to a 100% penalty tax. Such prohibited transaction income also may have an adverse effect upon our ability to satisfy the income tests for REIT status. See “Material Federal Income Tax Considerations - Income Tests” in this prospectus. We, however, do not presently intend to acquire or hold or to allow any Partnership to acquire or hold any property that represents inventory or other property held primarily for sale to customers in the ordinary course of our or such Partnership’s trade or business.

State and Local Taxes

We and/or our stockholders may be subject to taxation by various states and localities, including those in which we or a stockholder transacts business, owns property or resides. The state and local tax treatment may differ from the federal income tax treatment described above. Consequently, stockholders should consult their own tax advisors regarding the effect of state and local tax laws upon an investment in the common stock.

Proposed Legislation

The U.S. Congress recently passed the American Jobs Creation Act of 2004 (the “Jobs Act”), which would amend certain rules relating to REITs. As of the date hereof, the President has not signed the Jobs Act into law. The Jobs Act would, among other things, amend the following REIT rules.

•

As discussed above under “—Asset Tests,” we may not own more than 10% by vote or value of any one issuer’s securities and not more than 5% of our assets may consist of the securities of any one issue. If

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we fail to meet these tests at the end of any quarter and such failure is not cured within 30 days thereafter, we would fail to qualify as a REIT. Under the Jobs Act, after the 30-day cure period, a REIT could dispose of sufficient assets to cure such a violation that does not exceed the lesser of 1% of the REIT’s assets at the end of the relevant quarter or $10,000,000. For violations due to reasonable cause that are larger than this amount, the REIT could avoid disqualification, after the 30 day cure period, by taking steps including the disposition of sufficient assets to meet the asset test and paying a tax equal to the greater of $50,000 or the highest corporate tax rate multiplied by the net income generated by the non-qualifying assets.

•

The Jobs Act would expand the straight debt safe harbor under which certain types of securities are disregarded as securities when calculating the 10% value limitation discussed above.

•

The Jobs Act would change the formula for calculating the tax imposed for certain violations of the 75% and 95% gross income tests described above under “—Income Tests” and would make certain changes to the requirements for availability of the applicable relief provisions for failure to meet such tests.

•

The Jobs Act would provide additional relief in the event that we violate a provision of the Code that would result in our failure to qualify as a REIT if (i) the violation is due to reasonable cause, (ii) we pay a penalty of $50,000 for each failure to satisfy the provision, and (iii) the violation does not include a violation described in the first and third bullet points above.

•

As discussed above under the heading “—Taxation of Non-U.S. Stockholders,” we are required to withhold 35% of any distribution to non-U.S. stockholders that is designated as a capital gain dividend or, if greater, 35% of a distribution to non-U.S. stockholders that could have been designated as a capital gain dividend. The Jobs Act would eliminate this 35% withholding tax on any capital gain dividend with respect to any class of stock that is regularly traded on an established securities market located in the United States if the non-U.S. stockholder did not own more than 5% of such class of stock at any time during the taxable year. Instead, any capital gain dividend will be treated as an ordinary distribution subject to the rules discussed above under “—Taxation of Non-U.S. Stockholders.”

The foregoing is a non-exhaustive list of changes that would be made by the Jobs Act. The provisions contained in the Jobs Act relating to expansion of the straight debt safe harbor would apply to taxable years beginning after December 31, 2000, and the remaining provisions described above generally would apply to taxable years beginning after the date the Jobs Act is enacted. As of the date hereof, it is not possible to predict with any certainty whether the President will sign the Jobs Act into law.

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UNDERWRITING

Under the terms and subject to the conditions contained in an underwriting agreement dated the date of this prospectus, the underwriters named below, for whom BB&T Capital Markets, a division of Scott & Stringfellow, Inc., is acting as representative, have severally agreed to purchase, and we have agreed to sell to them, severally, the number of shares of common stock indicated below:


Underwriter		Number of Shares of Common Stock
BB&T Capital Markets, a division of Scott & Stringfellow, Inc.


Total		6,000,000

The underwriting agreement provides that the obligations of the several underwriters to pay for and accept delivery of the shares of common stock offered hereby are subject to the approval of certain legal matters by their counsel and to certain other conditions. The underwriters are severally obligated to take and pay for all shares of common stock offered hereby (other than those covered by the underwriters’ over-allotment option described below) if any such shares are taken.

The underwriters initially propose to offer the shares directly to the public at the public offering price set forth on the cover page of this prospectus and to certain dealers at a price that represents a concession not in excess of $ per share below the public offering price. Any underwriters may allow, and such dealers may re-allow, a concession not in excess of $ per share to other underwriters or to certain dealers. After the initial offering of the shares, the offering price and other selling terms may from time to time be varied by the representative.

We have granted to the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase up to an aggregate of 900,000 additional shares of common stock at the public offering price set forth on the cover page hereof, less underwriting discounts and commissions. The underwriters may exercise this option solely for the purpose of covering over-allotments, if any, made in connection with the offering of the shares of common stock offered hereby. To the extent such option is exercised, each underwriter will become obligated, subject to certain conditions, to purchase approximately the same percentage of such additional shares of common stock as the number set forth next to such underwriter’s name in the preceding table bears to the total number of shares set forth next to the names of all underwriters in the preceding table.

Prior to the offering, there has been no public market for our common stock. The initial public offering price was determined by negotiation between us and the underwriters. The principal factors considered in determining the public offering price include the following:

•

the information set forth in this prospectus and otherwise available to the underwriters,

•

market conditions for initial public offerings,

•

the prospects for the industry in which we operate,

•

an assessment of the ability of our management,

•

our prospects for future earnings,

•

the present state of our development and our current financial condition,

•

the general condition of the securities markets at the time of this offering, and

•

the recent market prices of, and demand for, publicly traded common stock of generally comparable entities.

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The following table provides information regarding the amount of the discount and other items of underwriting compensation, as determined in accordance with the Conduct Rules of the National Association of Securities Dealers, Inc., to be paid to the underwriters by us:

Discount Per Share

Total Discount and

Other Compensation

Without Exercise of

Over-allotment

Option

Total Discount and
Other Compensation
With Full Exercise of
Over-allotment
Option ⁽¹⁾

Underwriting discounts and commissions payable by us

In addition, we will pay BB&T Capital Markets a financial advisory fee in the amount of 1.0% of the aggregate offering proceeds, less $50,000, for financial advisory services.

We estimate that the total expenses of the offering, excluding the underwriting discounts and commissions, will be approximately $ million.

We have agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act.

We have filed an application to list the shares of our common stock on the AMEX under the proposed symbol “MDH.”

In connection with this offering, the underwriters may purchase and sell shares of our common stock in the open market. These transactions may include over-allotment, syndicate covering transactions and stabilizing transactions. An over-allotment involves syndicate sales of shares in excess of the number of shares to be purchased by the underwriters in the offering, which creates a syndicate short position. Syndicate covering transactions involve purchases of shares in the open market after the distribution has been completed in order to cover syndicate short positions.

Stabilizing transactions consist of some bids or purchases of shares of our common stock made for the purpose of preventing or slowing a decline in the market price of the shares while the offering is in progress.

In addition, the underwriters may impose penalty bids, under which they may reclaim the selling concession from a syndicate member when the shares of our common stock originally sold by that syndicate member are purchased in a stabilizing transaction or syndicate covering transaction to cover syndicate short positions.

Similar to other purchase transactions, these activities may have the effect of raising or maintaining the market price of the common stock or preventing or slowing a decline in the market price of the common stock. As a result, the price of the common stock may be higher than the price that might otherwise exist in the open market.

Neither we nor the underwriters make any representation or prediction as to the direction or magnitude of any effect that the transactions described above may have on the price of the shares. In addition, neither we nor the underwriters make any representation that the underwriters will engage in these transactions or that these transactions, once commenced, will not be discontinued without notice.

We, and our executive officers and directors, have agreed that for a period of 180 days from the date of this prospectus we will not, without the prior written consent of BB&T Capital Markets, directly or indirectly, issue, sell, offer to sell, grant any option for the sale of, or otherwise dispose of any securities that are substantially similar to the common stock or any preferred shares that rank on a parity with or senior to the common stock, including, but not limited to, any securities that are convertible into or exchangeable for, or that represent the right to receive any such substantially similar securities. BB&T Capital Markets may, in its sole discretion, allow

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any of these parties to dispose of common stock or other securities prior to the expiration of the 180-day period. However, there are no agreements between BB&T Capital Markets and the parties that would allow them to do so as of the date of this prospectus.

The underwriters or their affiliates from time to time provide and may in the future provide investment banking, commercial banking and financial advisory services to us, for which they have received and may receive customary compensation. An affiliate of BB&T Capital Markets is the lender under a mortgage loan secured by the Holiday Inn Brownstone hotel that we will acquire in the formation transactions. We will use a portion of the proceeds of the offering to repay this mortgage loan.

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EXPERTS

The balance sheet of MHI Hospitality Corporation as of August 25, 2004 and the combined financial statements and schedule of real estate and accumulated depreciation of MHI Hotels Services Group (the predecessor) as of December 31, 2003 and 2002, and for each of the years in the three-year period ended December 31, 2003, and the financial statements and schedule of real estate and accumulated depreciation of Accord, LLC as of December 31, 2003 and 2002, and for the years then ended, and the combined financial statements and schedule of real estate and accumulated depreciation of Elpizo Limited Partnership as of December 31, 2003 and 2002, and for the years then ended have been included herein and in the registration statement in reliance upon the reports of Witt, Mares & Company, PLC, independent accountants, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing.

The market data collected and/or prepared by Smith Travel Research for the U.S. lodging industry has been included herein and in the registration statement with the consent of Smith Travel Research.

LEGAL MATTERS

The validity of the shares of our common stock to be issued in the offering will be passed upon for us by Baker & McKenzie LLP. Certain legal matters in connection with this offering will be passed upon for the underwriters by Hunton & Williams LLP.

WHERE YOU CAN FIND MORE INFORMATION

We have filed a registration statement on Form S-11 with the SEC with respect to the shares of our common stock to be issued in the offering. This prospectus is a part of that registration statement and, as allowed by SEC rules, does not include all of the information you can find in the registration statement or the exhibits to the registration statement. For additional information relating to us, we refer you to the registration statement and the exhibits to the registration statement. Statements contained in this prospectus as to the contents of any contract or document referred to are not necessarily complete and in each instance, if the contract or document is filed as an exhibit to the registration statement, we refer you to the copy of the contract or document filed as an exhibit to the registration statement.

After the offering, we will file annual, quarterly and special reports, proxy statements and other information with the SEC. We intend to furnish our stockholders with annual reports containing consolidated financial statements certified by an independent public accounting firm. The registration statement is, and any of these future filings with the SEC will be, available to the public over the Internet at the SEC’s website at http://www.sec.gov . You may read and copy any filed document at the SEC’s public reference room in Washington, D.C. at 450 Fifth Street, N.W., Judiciary Plaza, Washington D.C. Please call the SEC at (800) SEC-0330 for further information about the public reference rooms. In addition, since we expect that our common stock will be listed on the American Stock Exchange, you will be able to inspect and copy similar information about us at the offices of the American Stock Exchange, 86 Trinity Place, New York, NY 10006.

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Index to Financial Statements


		Page
Financial Statement of MHI Hospitality Corporation
Report of Independent Registered Public Accounting Firm		F-2
Balance Sheet at August 25, 2004		F-3
Notes to Balance Sheet		F-4
Combined Financial Statements of MHI Hotels Services Group
Report of Independent Registered Public Accounting Firm		F-7
Combined Balance Sheets at December 31, 2002 and 2003, and June 30, 2004 (unaudited)		F-8
Combined Statements of Operations and Partners’/Members’ Equity (Deficit) for the years ended December 31, 2003, 2002 and 2001 and the six months ended June 30, 2003 and 2004 (unaudited)		F-9
Combined Statements of Cash Flows for the years ended December 31, 2001, 2002 and 2003 and for the six months ended June 30, 2003 and 2004 (unaudited)		F-10
Notes to Combined Financial Statements		F-11
Schedule III – Real Estate and Accumulated Depreciation		F-23
Combined Financial Statements of Elpizo Limited Partnership
Report of Independent Registered Public Accounting Firm		F-24
Combined Balance Sheets at December 31, 2002 and 2003, and June 30, 2004 (unaudited)		F-25
Combined Statements of Operations and Partners’ Capital for the years ended December 31, 2002 and 2003 and for the six months ended June 30, 2003 and 2004 (unaudited)		F-26
Combined Statements of Cash Flows for the years ended December 31, 2002 and 2003 and for the six months ended June 30, 2003 and 2004 (unaudited)		F-27
Notes to Combined Financial Statements		F-28
Schedule III – Real Estate and Accumulated Depreciation		F-34
Financial Statements of Accord, LLC
Report of Independent Registered Public Accounting Firm		F-35
Balance Sheets at December 31, 2002 and 2003, and June 30, 2004 (unaudited)		F-36
Statements of Operations and Members’ Equity (Deficit) for the years ended December 31, 2002 and 2003 and for the six months ended June 30, 2003 and 2004 (unaudited)		F-37
Statements of Cash Flows for the years ended December 31, 2002 and 2003 and for the six months ended June 30, 2003 and 2004 (unaudited)		F-38
Notes to Financial Statements		F-39
Schedule III – Real Estate and Accumulated Depreciation		F-43
Pro Forma Consolidated Financial Information
Pro Forma Consolidated Balance Sheet at June 30, 2004 (unaudited)		F-45
Pro Forma Consolidated Balance Sheet at December 31, 2003 (unaudited)		F-46
Notes to Pro Forma Consolidated Balance Sheet s		F-47
Pro Forma Consolidated Statements of Operations for the six months ended June 30, 2004 (unaudited)		F-52
Pro Forma Consolidated Statements of Statement of Operations for the year ended December 31, 2003 (unaudited)		F-53
Notes to Pro Forma Consolidated Statements of Operations		F-54

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

MHI Hospitality Corporation

Williamsburg, Virginia

We have audited the accompanying balance sheet of MHI Hospitality Corporation as of August 25, 2004. The balance sheet is the responsibility of the Company’s management. Our responsibility is to express an opinion on the balance sheet based on our audit.

We conducted our audit 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 balance sheet is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the balance sheet. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall balance sheet presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the balance sheet referred to above presents fairly, in all material respects, the financial position of MHI Hospitality Corporation as of August 25, 2004, in conformity with accounting principles generally accepted in the United States of America.

/s/ Witt, Mares & Company, PLC

Williamsburg, Virginia

August 25, 2004

F-2

MHI HOSPITALITY CORPORATION

Balance Sheet

August 25, 2004


Asset
Cash	$	1,000


Stockholder’s Equity
Preferred stock, $.01 par value, authorized—1,000,000 shares; no shares issued and outstanding	$	—
Common stock, $.01 par value, authorized—9,000,000 shares; 100 shares issued and outstanding		1
Additional paid-in capital		999

Total stockholder’s equity	$	1,000

The accompanying notes to the balance sheet are an integral part of this statement.

F-3

MHI HOSPITALITY CORPORATION

NOTES TO BALANCE SHEET

August 25, 2004

NOTE A—ORGANIZATION

MHI Hospitality Corporation (the “Company”) was incorporated in Delaware on August 20, 2004 but has had no operations to date other than matters relating to its organization and the issuance of 100 shares of common stock, par value $.01 per share (“Common Stock”), to its initial stockholder for $10.00 per share. The Company and its initial stockholder have agreed that such initial 100 shares will be redeemed by the Company for the original purchase price simultaneously with the closing of the offering (as defined below.)

The Company is being formed to acquire the properties known as MHI Hotels Services Group and other properties.

NOTE B—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Accounting

The books and records of the Company are maintained on the accrual basis of accounting in accordance with generally accepted accounting principles.

Income Taxes

The Company intends to elect to be taxed as a real estate investment trust (“REIT”) and to comply with the provisions of the Internal Revenue Code of 1986, as amended, with respect thereto. Accordingly, the Company will not be subject to federal income tax to the extent of its distributions to stockholders.

Profit and Loss Allocations and Distributions

As a REIT, the Company intends to declare regular quarterly dividends in order to distribute substantially all of its taxable income to stockholders each year.

Consolidation Policy

The Company’s consolidated financial statements include wholly-owned subsidiaries and those subsidiaries in which it owns a majority voting interest with the ability to control operations of the subsidiaries and where no approval, veto or other important rights have been granted to the minority equity owners. Upon the closing of the Offering (as defined below), the Operating Partnership (as defined below) will be the only subsidiary in which the Company owns a majority voting interest with the ability to control its operations and where no approval, veto or other important rights have been granted to minority equity owners. All significant intercompany transactions and accounts will be eliminated for presentation purposes in the consolidation.

NOTE C—FORMATION TRANSACTIONS

The Company plans to file a Registration Statement on Form S-11 with the SEC with respect to a public offering of its common stock (the “Offering”). Upon completion of the offering, it is expected that the Company will be the general partner of, and hold a controlling interest in, MHI Hospitality, L.P., a Delaware limited partnership (the “Operating Partnership”). Upon consummation of the offering, the Operating Partnership will acquire four hotels owned by entities directly or indirectly controlled by MHI Hotel Services, LLC and its owners and two hotels from third parties. The Company will be self-administered and will conduct all of its business activities through the Operating Partnership.

The following transactions will occur at or shortly prior to the closing of the Offering

•

The Company will contribute the net proceeds of the offering to the Operating Partnership in exchange for 6,000,000 operating partnership units, which will represent an approximate 61.1% initial interest in the Operating Partnership. The Company will act as sole general partner of the Operating Partnership.

F-4

MHI HOSPITALITY CORPORATION

NOTES TO BALANCE SHEET—(Continued)

August 25, 2004

•

Four of the six initial hotel properties will be contributed to the Operating Partnership in exchange for an aggregate of 3,084,783 units and $1.0 million in cash and the assumption of $35.5 million in debt.

•

The Operating Partnership will acquire the Hilton Philadelphia Airport property in exchange for 732,254 units and $1.8 million in cash and the assumption of $15.2 million in debt. The entity that owns this property may receive additional units in exchange for the contribution of the property. In the event that the initial offering price of our common stock is less than $9.50 per share, the number of additional units to be issued to this entity will be increased to reflect the difference between the offering price and $9.50 per share multiplied by 732,254.

•

The Operating Partnership will also acquire the Maryland Inn for a cash payment of $12.2 million.

•

Upon completion of the offering and the formation transactions, the Company’s executive officers, directors, their affiliates and family members, including MHI Hotels Services will beneficially own in the aggregate an approximate 29.2% equity interest in the Company on a fully diluted basis.

•

The Operating Partnership expects to use approximately $25.1 million of the net proceeds of the offering to repay the outstanding indebtedness on three of the initial hotel properties, including $2.0 million that will be used to pay two outstanding construction loans on the Holiday Inn Brownstone Hotel. In connection with this debt repayment, the two entities that will contribute their ownership interest in the Brownstone Hotel will enter into debt allocation and tax indemnity agreements and will guaranty a portion of the debt on one other hotel property.

•

The Operating Partnership will use approximately $2.0 million of the net proceeds of the offering to compensate MHI Hotels Services for the restructuring of existing management agreements relating to five of the initial hotel properties. The Company’s taxable REIT subsidiary will enter into a new management agreement with MHI Hotels Services upon completion of the offering that will cover all of the initial hotel properties and any future hotels managed by MHI Hotels Services.

•

The Operating Partnership will acquire two space leases for the common areas of Shell Island Resort, a condominium resort property located in Wrightsville Beach, North Carolina. One of the leases will be acquired from MHI Hotels Two, Inc. for $0.5 million in cash and the other space lease will be acquired from MHI Hotels LLC for $3.0 million in cash. The Operating Partnership will enter into a sublease agreement with each of MHI Hotels Two, Inc. and MHI Hotels LLC with respect to such property.

•

The Operating Partnership will lease each of the initial hotel properties to one of its wholly-owned taxable REIT subsidiaries.

NOTE D—ORGANIZATIONAL, OFFERING, GENERAL AND ADMINISTRATIVE COSTS

The Company will be required to pay all of its organizational and offering expenses.

NOTE E—RESTRICTED STOCK

Upon consummation of the initial public offering of its common stock, the Company will issue to its independent directors an aggregate of 4,000 shares of restricted stock under a long-term incentive plan to be adopted by its stockholder. All of the shares of restricted stock will vest on the first anniversary of the date of grant. Dividends will be paid on all restricted stock, whether or not vested, at the same rate and on the same date as on shares of common stock.

F-5

MHI HOSPITALITY CORPORATION

NOTES TO BALANCE SHEET—(Continued)

August 25, 2004

NOTE F—COMMITMENTS AND CONTINGENCIES

After the offering, the Company expects to make quarterly distributions to its stockholders. The Company’s ability to make such quarterly distributions will depend upon cash the Company expects to receive from cash generated by the operations of the Operating Partnership.

NOTE G—MANAGEMENT AGREEMENT, STRATEGIC ALLIANCE AGREEMENT AND RELATED PARTIES

The Company has an agreement with MHI Hotels Services to operate the initial hotel properties pursuant to the terms of the master management agreement, which the Company will enter into in connection with the closing of the offering. Pursuant to the terms of the master management agreement, MHI Hotels Services will receive a base management fee and, if the hotels exceed certain financial thresholds, an incentive management fee. The Company has also entered into a strategic alliance agreement with its operating partnership, MHI Hospitality L.P., and MHI Hotels Services whereby the Company has agreed to engage MHI Hotels services for the management of the Company’s future hotels, and MHI Hotels Services will refer to the Company any future acquisition opportunities, with both conditions subject to certain exceptions. In addition, the Company has entered into tax indemnification agreements with three of the entities that are contributing four of the initial hotel properties that are affiliated with the Company.

Andrew M. Sims, our Chief Executive Officer and Chairman of the Board, and William J. Zaiser, Executive Vice President and Chief Financial Officer of the Company, are currently officers and directors of MHI Hotels Services. Upon completion of the offering, Mr. Sims and Mr. Zaiser will resign as officers of MHI Hotels Services, however, Mr. Sims and Mr. Zaiser will remain as members of MHI Hotels Services’ Board of Directors.

F-6

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

MHI Hospitality Corporation

Williamsburg, Virginia

We have audited the accompanying combined balance sheets of MHI Hotels Services Group as of December 31, 2003 and 2002, and the related combined statements of operations and partners’/members’ equity and cash flows for each of the years in the three-year period ended December 31, 2003. In connection with our audits of the combined financial statements, we have also audited the financial statement schedule of real estate and accumulated depreciation. These combined financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these combined financial statements and financial statement 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 financials 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 financial position of MHI Hotels Services Group as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule referred to above, 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.

/s/ Witt, Mares & Company, PLC

Williamsburg, Virginia

August 24, 2004

F-7

MHI HOTELS SERVICES GROUP

Combined Balance Sheets

June 30, 2004 (Unaudited) and

December 31, 2003 and 2002


	December 31,						June 30,
	2002			2003			2004
ASSETS							(unaudited)
Current Assets
Cash and cash equivalents	$	163,561		$	76,545		$	143,530
Reserves and escrows		1,492,737			728,452			990,691
Accounts receivable		866,591			769,276			1,186,172
Accounts receivable-affiliate		739,914			1,031,566			2,344,466
Inventories		136,338			139,953			153,789
Prepaid expenses		138,526			127,545			148,188

Total current assets		3,537,667			2,873,337			4,966,836
Property & Equipment (at cost)
Land and improvements		2,439,054			2,439,054			2,442,704
Building and improvements		33,378,733			33,905,177			34,033,130
Furniture, fixtures and equipment		12,840,356			12,320,425			12,892,705

Total property & equipment		48,658,143			48,664,656			49,368,539
Less: accumulated depreciation		(12,658,840	)		(13,713,550	)		(14,945,037	)

Property & equipment, net		35,999,303			34,951,106			34,423,502
Other Assets
Deferred costs and other assets (net of amortization of $324,377 and $208,060 in 2003 and 2002, respectively) (net of amortization of $361,002 for the six months ended June 30, 2004)		433,361			406,738			422,389

TOTAL ASSETS	$	39,970,331		$	38,231,181		$	39,812,727

LIABILITIES AND PARTNERS’/MEMBERS’ EQUITY
Current Liabilities
Current portion of long term debt	$	1,131,924		$	1,220,020		$	1,294,811
Current portion of long term related party debt		300,000			—			—
Current portion of long term capital lease obligation		191,608			63,965			38,062
Short term notes/lines of credit		2,299,910			450,296			1,092,500
Accounts payable		1,815,081			2,079,405			1,830,968
Accrued expenses		1,457,114			1,027,904			1,852,231
Advance deposits		112,913			150,144			235,562

Total current liabilities		7,308,550			4,991,734			6,344,134
Long Term Liabilities
Long term debt		34,970,733			33,319,065			32,643,216
Long term portion of capital lease obligation		93,384			29,420			20,473

Total long term liabilities		35,064,117			33,348,485			32,663,689
Total liabilities		42,372,667			38,340,219			39,007,823
Minority interest		(754,231	)		327,263			500,392
Partners’/Members’ Equity(Deficit)
Partners’/members’ equity accounts		(1,648,105	)		(436,301	)		304,512

Total partners’/members’ equity(deficit)		(1,648,105	)		(436,301	)		304,512

TOTAL LIABILITIES AND PARTNERS’/MEMBERS’ EQUITY	$	39,970,331		$	38,231,181		$	39,812,727

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

F-8

MHI HOTELS SERVICES GROUP

Combined Statements of Operations and Partners’/Members’ Equity(Deficit)

For the six months ended June 30, 2004 and 2003 (unaudited) and

the years ended December 31, 2003, 2002 and 2001


	Year Ended December 31,									Six Months Ended June 30,
	2001			2002			2003			2003			2004
										(unaudited)
Operating Revenue
Rooms department	$	18,575,737		$	18,676,756		$	18,942,658		$	9,669,240		$	10,447,519
Food and beverage department		8,485,786			8,800,274			9,265,350			4,604,168			4,853,244
Other operating departments		1,016,587			1,044,497			978,180			492,774			512,016

Total operating revenue		28,078,110			28,521,527			29,186,188			14,766,182			15,812,779
Operating Expenses
Rooms department		4,975,130			5,004,766			5,185,431			2,531,435			2,691,523
Food and beverage department		6,570,642			6,380,692			6,632,713			3,279,347			3,474,827
Other operating departments		512,410			516,367			501,541			251,554			272,142
Selling, general and administrative expense		9,822,691			10,082,306			10,430,984			5,116,687			5,382,916
Management fees—related party		1,005,275			1,017,889			1,052,670			529,758			565,125
Depreciation and amortization		2,711,124			2,699,925			2,578,297			1,263,380			1,269,145

Total operating expenses		25,597,272			25,701,945			26,381,636			12,972,161			13,655,678

Net Operating Income		2,480,838			2,819,582			2,804,552			1,794,021			2,157,101
Other Income (Expense)
Interest expense		(3,046,309	)		(2,884,263	)		(2,697,793	)		(1,386,091	)		(1,252,751	)
Interest income		105,575			33,584			13,152			2,068			430
Gain (loss) on disposal of assets		(690,106	)		—			(2,313	)		—			—
Minority interest		681,282			147,202			77,809			(58,268	)		(168,551	)

Net Income (Loss)		(468,720	)		116,105			195,407			351,730			736,229
Partners’/Members’ Equity (Deficit), beginning of period		(755,588	)		(1,364,308	)		(1,648,105	)		(1,648,105	)		(436,301	)
Partners’/Members’ equity contributed		100,000			200,098			1,422,094			—			30,000
Partners’/Members’ equity distributed		(240,000	)		(600,000	)		(405,697	)		—			(25,416	)

Partners’/Members’ Equity (Deficit), end of period	$	(1,364,308	)	$	(1,648,105	)	$	(436,301	)	$	(1,296,375	)	$	304,512

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

F-9

MHI HOTELS SERVICES GROUP

Combined Statements of Cash Flows

For the six months ended June 30, 2004 and 2003 (unaudited) and

the years ended December 31, 2003, 2002 and 2001


	Year Ended December 31,									Six Months Ended June 30,
	2001			2002			2003			2003			2004
										(unaudited)
Cash Flows from Operating Activities:
Net Income (Loss)	$	(468,720	)	$	116,105		$	195,407		$	351,730		$	736,229
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		2,711,124			2,699,925			2,578,297			1,263,380			1,269,145
(Gain)/Loss on disposal of property and equipment		690,105			—			2,313			—			—
Minority interest		(681,282	)		(147,202	)		(77,809	)		58,268			168,551
(Increase) decrease in:
Restricted escrows		97,798			(99,244	)		764,285			(246,229	)		(262,239	)
Accounts receivable		156,064			(153,592	)		92,884			(31,926	)		(417,546	)
Inventories and prepaid expenses		49,021			(123,891	)		11,796			29,435			(33,827	)
Other assets, net of accumulated amortization		(106,000	)		(17,184	)		(88,701	)		(47,310	)		(53,310	)
Increase (decrease) in:
Accounts payable		1,205,180			(287,641	)		252,749			(96,338	)		(248,437	)
Accrued expenses		459,368			153,813			(417,889	)		82,993			824,325
Advance deposits		(10,581	)		20,739			37,232			66,037			85,417

Net cash provided by operating activities		4,102,077			2,161,828			3,350,564			1,430,040			2,068,308

Cash Flows from Investing Activities:
Capital expenditures		(2,936,253	)		(1,809,355	)		(1,419,999	)		(524,600	)		(703,883	)
Proceeds from sale of assets		—			—			11,300			—			—

Net cash used in investing activities		(2,936,253	)		(1,809,355	)		(1,408,699	)		(524,600	)		(703,883	)

Cash Flows from Financing Activities:
Members’ capital contributed		100,000			200,098			1,422,094			—			30,000
Minority partners’ contributions		287,500			125,000			1,265,000			—			30,000
Members’ capital distributed		(240,000	)		(600,000	)		(405,697	)		—			(25,416	)
Minority partners’ distributions		(60,000	)		(150,000	)		(105,697	)		—			(25,421	)
Proceeds (payment) of related party loans		(1,927,118	)		810,110			(290,841	)		(452,013	)		(1,312,900	)
Proceeds from borrowing		2,235,410			264,500			5,124,095			3,351,816			650,000
Payment of loans		(839,730	)		(1,154,344	)		(8,847,115	)		(3,590,402	)		(597,484	)
Proceeds from capital lease obligations		250,001			44,512			—			—			—
Payment of capital lease obligations		(215,780	)		(231,579	)		(190,720	)		(113,449	)		(46,219	)

Net cash used in financing activities		(409,717	)		(691,703	)		(2,028,881	)		(804,048	)		(1,297,440	)

Net increase (decrease) in cash and cash equivalents		756,107			(339,230	)		(87,016	)		101,392			66,985
Cash and cash equivalents at the beginning of the period		(253,316	)		502,791			163,561			163,561			76,545

Cash and cash equivalents at the end of the period	$	502,791		$	163,561		$	76,545		$	264,953		$	143,530

Supplemental disclosures:
Cash paid during the period for interest	$	3,046,309		$	2,884,263		$	2,697,793		$	1,386,091		$	1,252,751

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

F-10

MHI HOTELS SERVICES GROUP

NOTES TO COMBINED FINANCIAL STATEMENTS

June 30, 2004 and 2003 (unaudited) and

December 31, 2003, 2002 and 2001

NOTE A—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Basis of Presentation

This summary of significant accounting policies of MHI Hotels Services Group (the “Company”) is presented to assist in understanding the Company’s financial statements. The financial statements and notes are representations of management, which is responsible for their integrity and objectivity. These accounting policies conform to generally accepted accounting principles applied in the preparation of the financial statements. MHI Hotels Services Group is not a legal entity, but rather a combination of four hotels that are owned by various limited liability companies and a limited liability partnership that are controlled by the owners of MHI Hotels Services, LLC (“MHI Services”). For accounting and financial reporting purposes, MHI Hotels Services Group is assumed to have acquired 100% of the equity of the limited liability companies and the limited liability partnership and represents the predecessor to the operations of MHI Hospitality Corporation. These combined financial statements include the accounts of Capitol Hotel Associates LP, LLP (Holiday Inn Downtown Williamsburg and Wilmington Riverside Hilton), Brownestone Partners, LLC (Holiday Inn Brownstone, Raleigh Downtown) and Savannah Hotel Associates, LLC (Savannah DeSoto Hilton), collectively “MHI Hotels Services Group.” All significant intercompany transactions among these entities have been eliminated. MHI Hotels Services, LLC, a successor to MHI Hotels, LLC, manages all the hotels.

Business Activity

Capitol Hotel Associates, LP, LLP, a limited liability partnership, was formed on March 17, 1994 to own and operate real estate related to its predecessor entity. The partnership owns the Holiday Inn Downtown Williamsburg, a 137 room, full-service hotel located in Williamsburg, Virginia and the Wilmington Riverside Hilton, a 276 room, full-service hotel located in Wilmington, North Carolina. Income, loss and cash flow are allocated and/or distributed to the partners in accordance with their agreement.

Brownestone Partners, LLC was formed on August 7, 1998 to purchase the Holiday Inn Brownstone, Raleigh Downtown, a 191 room, full-service hotel located in Raleigh, North Carolina. Income, loss and cash flow are allocated and/or distributed to the members in accordance with their agreement.

Savannah Hotel Associates, LLC was formed on April 18, 1996 to purchase the Savannah DeSoto Hilton, a 246 room, full-service hotel located in Savannah, Georgia. Income, loss and cash flow are allocated and/or distributed to the members in accordance with their agreement.

Principles of Combination

The accompanying combined financial statements reflect the activity of MHI Hotels Services Group, which include the financial statements of Brownestone Partners, LLC, Capitol Hotel Associates LP, LLP and Savannah Hotel Associates, LLC and are presented on a combined basis as a result of common ownership and control by the single group of owners of MHI Hotels Services, LLC. The properties are all managed under management agreements with MHI Hotels Services. All significant intercompany accounts and transactions among these entities have been eliminated in the combined financial statements.

F-11

MHI HOTELS SERVICES GROUP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003, 2002 and 2001

MHI Hotels Services owns a direct interest in the entities that own the hotels listed below. Additionally, affiliates of MHI Hotels Services own interests in the entities that own the hotels. The direct ownership and affiliate ownership equals the total beneficial ownership.


Property	MHI Direct Ownership	Affiliate Ownership	Total Beneficial Ownership
Holiday Inn Williamsburg	25.0%	45.1%	70.1%
Hilton Wilmington Riverside	25.0%	45.1%	70.1%
Hilton Savannah DeSoto	80.0%	—	80.0%
Holiday Inn Brownstone	50.0%	—	50.0%

Use of Estimates in Financial Statements

In preparing financial statements in conformity with generally accepted accounting principles, management of MHI Hotels Services Group 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, as well as the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents

For purposes of the statement of cash flows, management of MHI Hotels Services Group considers all investments in certificates of deposit purchased with an original maturity of three months or less to be cash equivalents.

Escrow and Reserve Accounts

Escrow accounts are held by the lenders for the purpose of paying real estate taxes. Reserve accounts are held by the Company in a separate bank account. Disbursements from reserve accounts are for capital items approved by the lender.

Accounts Receivable

Management of MHI Hotels Services Group considers accounts receivable to be fully collectible; accordingly, no allowance for doubtful accounts is required. If the amounts become uncollectible, they are charged to operations when that determination is made.

Inventories

Inventories are stated at the lower of cost or market and consist primarily of food and beverages and gift shop merchandise. Cost is determined by the first-in, first-out method.

Property & Equipment

F-12

MHI HOTELS SERVICES GROUP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003, 2002 and 2001

$1,231,487 and $1,231,487, respectively, and for the years ended December 31, 2003, 2002 and 2001 was $2,462,973, $2,631,816 and $2,622,025, respectively.

Expenditures which materially increase values or extend lives are capitalized, while replacements, maintenance and repairs which do not improve or extend the lives of the respective assets are charged against earnings as incurred. In August 2001 the Financial Accounting Standards Board (“FASB”) issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The provisions of SFAS No. 144 are effective as of January 1, 2002. SFAS No. 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets for Long-Lived Assets to be Disposed Of.” SFAS No. 144 also established a single accounting model for long-lived assets to be disposed of by sale. Adoption of the Statement did not have a material effect on the financial condition or results of operations for 2002.

Management of MHI Hotels Services Group reviews a hotel property for impairment whenever events or changes in circumstances indicate the carrying value of the hotel property may not be recoverable. Events or circumstances that may cause a review include, but are not limited to, adverse changes in the demand for lodging at the property due to declining national or local economic conditions and/or new hotel construction in the market where the hotel is located. When such conditions exist, management performs an analysis to determine if the estimated undiscounted future cash flows from operating activities and the proceeds from the ultimate disposition of the hotel property exceed its carrying value. If the estimated undiscounted future cash flows are less than the carrying amount of the asset, an adjustment to reduce the carrying amount to the hotel property’s estimated fair market value is recorded and an impairment loss is recognized.

Fair values of hotel properties are estimated through a discounted cash flow analysis taking into account each property’s expected cash flow generated from operations, holding period and ultimate proceeds from disposition. In projecting the expected cash flows from operating activities of the asset, the estimates are based upon future projected earnings before interest expense, income taxes, depreciation and amortization, or EBITDA, and deduct expected capital expenditure requirements. Growth assumptions are applied to project these amounts over the holding period of the asset. The growth assumptions are based upon estimated inflationary increases in room rates and expenses and the demand for lodging at the property, as impacted by local and national economic conditions and estimated or known future new hotel supply. The estimated proceeds from disposition are judgmentally determined based on a combination of anticipated cash flow in the year of disposition, capitalization rate, ratio of selling price to gross hotel revenues and selling price per room.

Management of MHI Hotels Services Group has assessed the operations of the hotel properties, and the fair market value of the hotel properties based on undiscounted cash flows and other models, and has noted no impairment in such assets for all years presented.

If actual conditions differ from the assumption, the actual results of each property’s future operations and fair market value could be significantly different from the estimated results and value used in the analysis.

The properties were not held for sale as of June 30, 2004 or December 31, 2003, 2002 and 2001, as defined within the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

Deferred Costs

Deferred franchise fees consist of the initial fees paid to Hilton Inns, Inc. to operate the Savannah DeSoto Hilton and to Holiday Inn to operate the Holiday Inn Downtown Williamsburg and the Holiday Inn Brownstone, Raleigh Downtown. Amortization of the fees began upon commencement of hotel operations. The fees are being amortized over the term of the franchise agreement. The application fee is the standard initial fee charged by the

F-13

MHI HOTELS SERVICES GROUP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003, 2002 and 2001

franchisor. It is based upon the number of rooms in the hotel. This fee is being amortized over the life of the franchise license contract.

Loan fees include direct costs incurred to obtain financing for the Holiday Inn Downtown Williamsburg, the Holiday Inn Brownstone, Downtown Raleigh and the Savannah DeSoto Hilton. These costs are being amortized over the terms of the respective debt agreements.

Purchase Accounting for Acquisition of Additional Interests in Real Estate Entities

Purchase accounting was applied to the assets and liabilities related to real estate entities for which MHI Hotels Services Group acquired additional interests. Ownership interests acquired from the control group are accounted for at their historical cost basis. Acquisitions of ownership interests of other parties are accounted for at fair value. For purchases of additional interests that were consummated subsequent to June 30, 2001, the effective date of Statement of Financial Accounting Standards No. 141, “Business Combinations,” the fair value of the real estate acquired was determined on an as if vacant building basis. That value is allocated between land and building based on managements’ estimate of the fair value of those components for each property. There have been no acquisitions of additional interests in real estate entities during the six months ended June 30, 2004 and the years ended December 31, 2003, 2002 and 2001.

Income Taxes

The entities that own the hotels in the MHI Hotels Services Group are limited liability companies and a limited liability partnership, which file tax returns for which the members/partners are taxed on their respective shares of the entity’s income, and accordingly, no provision for income taxes is included in the financial statements.

Recognition of Revenue

Revenue associated with room rental, food and beverage sales and other hotel revenues are recognized as the related services are provided.

Application of New Accounting Standards

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.” SFAS No. 145 amends existing guidance on reporting gains and losses on the extinguishments of debt to prohibit the classification of the gain or loss as extraordinary, as the use of such extinguishments have become part of the risk management strategy of many companies. SFAS No. 145 also amends SFAS No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback transactions. The provisions of the Statement related to the rescission of Statement No. 4 are applied in fiscal years beginning after May 15, 2002. Management adopted SFAS No. 145 as of May 15, 2002 and it has had no material effect on the financial statements. The provisions of the Statement related to the rescission of Statement No. 13 were effective for transactions occurring after May 15, 2002. During 2003, MHI Hotels Services Group refinanced certain mortgage notes. Deferred loan costs of $49,493 were written off in 2003 in connection with the refinancing.

F-14

MHI HOTELS SERVICES GROUP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003, 2002 and 2001

Group, with a variable interest in a variable interest entity created before February 1, 2003, the Interpretation is applied to the enterprise no later than the end of the first annual reporting period beginning after June 30, 2003. Management adopted FIN 46(R) as of January 1, 2003. The application of this Interpretation is not expected to have a material effect on the group’s financial statements. The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that MHI Hotels Services Group will consolidate or disclose information about variable interest entities when the Interpretation becomes effective. Management does not believe that it is reasonably possible that the FIN 46(R) will result in the consolidation of any of its equity investees in the future.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which clarifies certain implementation issues raised by constituents and amends SFAS No. 133, “ Accounting for Derivative Instruments and Hedging Activities, “ to include the conclusions reached by the FASB on certain FASB Staff Implementation issues; amends SFAS No. 133’s discussion of financial guarantee contracts and the application of the shortcut method to an interest rate swap agreement that includes an embedded option and amends other pronouncements. The guidance in SFAS No. 149 is effective for new contracts entered into or modified after June 30, 2003 and for hedging relationships designated after that date. Management adopted SFAS No. 149 as of July 1, 2003 and it has had no material effect on the financial statements.

NOTE B—LONG-TERM DEBT AND SHORT TERM NOTES/LINES OF CREDIT

Long-term debt of MHI Hotels Services Group consisted of the following as of December 31, 2003 and 2002 and June 30, 2004.


	As of
	December 31,				June 30,
	2002		2003		2004
					(unaudited)
Mortgage notes on hotels:
First mortgage payable with Wachovia Bank, NA in monthly installments of principal payments plus interest at fixed rate of 7.93% amortized over a 20-year schedule. The loan is collateralized by all real and personal property of the Holiday Inn Downtown Williamsburg and is guaranteed by the members of Capitol Hotel Associates LP, LLP. This note was paid in full in 2003.	$	2,870,306	$	—	$	—
First mortgage payable with TowneBank in monthly installments of principal payments plus interest at the Federal Home Loan Bank of Atlanta’s 36 month cost of funds index rate (2.60% at December 31, 2003) plus 3.00%. Unless sooner paid in full, the note is due January 10, 2023. The loan is collateralized by all real and personal property of the Holiday Inn Downtown Williamsburg and is guaranteed by the members of Capitol Hotel Associates LP, LLP.		—		3,017,491		2,973,487

F-15

MHI HOTELS SERVICES GROUP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003, 2002 and 2001


	As of
	December 31,				June 30,
	2002		2003		2004
					(unaudited)
First mortgage payable with The Mutual Life Insurance Company of New York (“MONY”) in equal monthly installments of $146,657, principal and interest at a fixed rate of 8.22% amortized over a 20-year schedule. Unless sooner paid in full, the note is due September 1, 2008. The loan is collateralized by all real and personal property of the Wilmington Riverside Hilton and is guaranteed by the members of Capitol Hotel Associates LP, LLP.		16,016,136		15,513,401		15,266,872
First mortgage payable with Wachovia Bank, N.A. in monthly installments of fixed principal payments of $12,750 in 2002, $13,750 in 2003 and $14,900 in 2004 plus interest at the Monthly LIBOR Index rate (1.38% at December 31, 2002) plus 2.40%. Unless sooner paid in full, the note is due November 19, 2019. The lender may, at its sole discretion upon at least thirty days’ prior written notice, declare the outstanding principal and accrued interest to be due and payable in full at any time after December 1, 2004. The loan is collateralized by all real and personal property of the Holiday Inn Brownstone, Raleigh Downtown and is guaranteed by the members of Brownestone Partners, LLC. This note was paid in full in 2003.		5,764,210		—		—
First mortgage payable with Branch Banking and Trust Company in monthly installments of fixed principal payments of $16,000 in 2004, $17,500 in 2005, $19,000 in 2006, $20,000 in 2007 and $21,500 in 2008 plus interest at a floating rate per annum of the Lender’s prime rate (4.00% at December 31, 2003 and 4.25% at June 30, 2004) plus 0.25%. Unless sooner paid in full, the note is due December 3, 2008. The loan is collateralized by all real and personal property of the Holiday Inn Brownstone, Raleigh Downtown and is guaranteed by the members of Brownestone Partners, LLC.		—		4,934,000		4,838,000

First mortgage payable with The Mutual Life Insurance Company of New York (“MONY”) dated September 25, 1998 in equal monthly installments of $103,038, principal and interest at a fixed rate of 7.49% based upon a 20-year amortization schedule. Unless sooner paid in full, the note is due November 1, 2008. The loan is collateralized by all real and personal property of the Savannah DeSoto Hilton and is guaranteed by the members of Savannah Hotel Associates, LLC.		11,446,754		11,020,536		10,811,786

Total Mortgage Debt	$	36,097,406	$	34,485,428	$	33,890,145
Other Long Term Debt:
Equipment obligation payable in 60 monthly payments of $690, due September 3, 2003, bearing interest at a rate of 8.50%. The note is collateralized by a vehicle.		5,251		—		—
Equipment obligation payable in 60 monthly payments of $610, due December 8, 2008, bearing interest at a rate of 5.35%. The note is collateralized by a vehicle.		—		31,499		28,655
Equipment obligation payable in 48 monthly payments of $522, due August 28, 2007, bearing interest at a rate of 1.95%. The note is collateralized by a vehicle.		—		22,158		19,227

Total long-term debt	$	36,102,657	$	34,539,085	$	33,938,027

F-16

MHI HOTELS SERVICES GROUP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003, 2002 and 2001


	As of
	December 31,				June 30,
	2002		2003		2004
					(unaudited)
Short-term notes/Lines of Credit:
Promissory Note payable in monthly installments of interest only, due August 4, 2003, bearing interest at a variable rate of the Wall Street Journal Index (4.25% at December 31, 2002) plus 1.00%.	$	1,999,910	$	296	$	—
Line of Credit payable in monthly installments of interest only, due December 2, 2004, bearing interest at a variable rate of the Wall Street Journal Index (4.25% at December 31, 2002, 4.00% at December 31, 2003 and June 30, 2004) plus 1.00%		150,000		250,000		250,000
Line of Credit payable in monthly installments of interest only, due January 8, 2005, bearing interest at a variable rate of the Wall Street Journal Index (4.00% June 30, 2004) plus 0.50%		—		—		150,000
Line of Credit payable in monthly installments of interest only, due October 7, 2004, bearing interest at a variable rate of the Wall Street Journal Index plus 1.00%, but not less than the minimum simple rate of 7.50% per annum or more than the maximum rate allowed by applicable law.		150,000		200,000		200,000
Line of Credit payable in monthly installments of $2,500 principal plus interest, due October 31, 2004, bearing interest at a variable rate of the SunTrust Bank prime rate (4.50 % at June 30, 2004) plus 0.50%		—		—		492,500

Total short-term debt	$	2,299,910	$	450,296	$	1,092,500

Total long-term debt and short term notes/lines of credit	$	38,402,567	$	34,989,381	$	35,030,527


	At December 31, 2003
Current maturities of long-term debt are as follows:
Due in:
2004	$	1,220,020
2005		1,329,839
2006		1,444,689
2007		1,562,257
2008		26,563,225
2009 and thereafter		2,419,055

	$	34,539,085

NOTE C—RELATED PARTY TRANSACTIONS

Capitol Hotel Associates LP, LLP entered into an Amended Hotel Management Agreement with MHI Hotels Services, LLC, a limited liability company affiliated through common ownership, to operate the Holiday Inn Downtown Williamsburg through August 31, 2006. MHI Hotels Services, LLC has a 25% ownership interest in Capitol Hotel Associates LP, LLP. The management company receives a base fee equivalent to 3% of gross revenue and an incentive fee equivalent to 10% of gross operating profit. Management fees expensed for the six months ended June 30, 2004 and 2003 and the years ended December 31, 2003, 2002 and 2001 under the management contract totaled $42,804, $49,354, $106,181, $105,483 and $101,976, respectively. At June 30, 2004 and at December 31, 2003 and 2002, amounts included in current liabilities related to the above transaction were $0.

F-17

MHI HOTELS SERVICES GROUP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003, 2002 and 2001

Capitol Hotel Associates LP, LLP entered into an Amended Hotel Management Agreement with MHI Hotels Services, LLC, a limited liability company affiliated through common ownership, to operate the Wilmington Riverside Hilton through January 1, 2008 and automatically renewing for one subsequent five-year term unless terminated in writing by either party prior to ninety days of the renewal date. MHI Hotels Services, LLC has a 25% ownership interest in Capitol Hotel Associates LP, LLP. The management company receives a base fee equivalent to 4.5% of gross sales revenue. Management fees expensed for the six months ended June 30, 2004 and 2003 and the years ended December 31, 2003, 2002 and 2001 under the management contract totaled $251,761, $241,008, $484,023, $439,949 and $457,345, respectively. At June 30, 2004 and at December 31, 2003 and 2002, amounts included in current liabilities related to the above transaction were $0.

Brownestone Partners, LLC entered into an Amended Hotel Management Agreement with MHI Hotels Services, LLC, a limited liability company affiliated through common ownership, through August 31, 2008 and automatically renewing for subsequent five-year terms unless terminated in writing by either party prior to ninety days of the renewal date. KDCA Partnership has a 50% ownership interest in Brownestone Partners, LLC and is 99% owned by MHI Hotels Services, LLC. The management company receives a base fee equivalent to 3% of gross sales revenue. Management fees expensed for the six months ended June 30, 2004 and 2003 and the years ended December 31, 2003, 2002 and 2001 under the management contract totaled $76,080, $71,509, $142,528, $136,767 and $118,810, respectively. At June 30, 2004 and at December 31, 2003 and 2002, amounts included in current liabilities related to the above transaction were $0, $0 and $74,344, respectively.

Savannah Hotel Associates, LLC entered into an Amended Hotel Management Agreement with MHI Hotels Services, LLC, a limited liability company affiliated through common ownership, through May 31, 2006 and automatically renewing for subsequent five-year terms unless terminated in writing by either party prior to ninety days of the renewal date. MHI Hotels Services, LLC has an 80% ownership interest in Savannah Hotel Associates, LLC. The management company receives a base fee equivalent to 2.5% of gross sales revenue. Management fees expensed for the six months ended June 30, 2004 and 2003 and the years ended December 31, 2003, 2002 and 2001 under the management contract totaled $194,480, $167,887, $319,938, $335,690 and $327,144, respectively. At June 30, 2004 and at December 31, 2003 and 2002, amounts included in current liabilities related to the above transaction were $0.

NOTE D—CAPITALIZED LEASES

Certain equipment has been leased for which the minimum lease rentals have been capitalized. The leases, which are non-cancelable, expire on various dates ranging from March, 2003 to January, 2005. The following is a schedule of leased equipment under capital leases:


	As of
	December 31,						June 30,
	2002			2003			2004 (unaudited)
Equipment	$	1,214,144		$	1,214,144		$	1,214,144
Less accumulated depreciation		(968,477	)		(1,134,537	)		(1,164,584	)

Net	$	245,667		$	79,607		$	49,560

F-18

MHI HOTELS SERVICES GROUP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003, 2002 and 2001

The following is a schedule by years of future minimum lease payments under the capital leases:


	As of
	December 31,				June 30,
	2002		2003		2004 (unaudited)
Total minimum lease payments	$	324,351	$	109,470	$	69,455
Less amount representing interest		39,359		16,085		10,920

Present value of net minimum lease payments	$	284,992	$	93,385	$	58,535

Current portion	$	191,608	$	63,965	$	38,062
Non-current portion		93,384		29,420		20,473

Total	$	284,992	$	93,385	$	58,535

NOTE E—COMMITMENTS AND CONTINGENCIES

Leases:

Capitol Hotel Associates LP, LLP leases office equipment under a three year operating lease, which expires January 14, 2005. Rent expense for all operating leases for the six months ended June 30, 2004 and 2003 was $750 and $625, respectively, and for the years ended December 31, 2003, 2002 and 2001, was $1,375, $4,851 and $37,345, respectively.

Brownestone Partners, LLC leases land adjacent to the hotel property for use as a parking lot. The land is leased under a second amendment, dated April 28, 1998, to a ground lease originally dated May 25, 1966. The original lease is a 50-year operating lease, which expires August 31, 2016. There is a renewal option for up to three additional 10-year periods expiring August 31, 2026, August 31, 2036, and August 31, 2046, respectively. Brownestone Partners, LLC holds an exclusive and irrevocable option to purchase the leased premises at fair market value at the end of the original term of the lease, subject to payment of an annual fee of $9,000, and other conditions. Rent expense for all operating leases for the six months ended June 30, 2004 and 2003 was $38,052, and for the years ended December 31, 2003, 2002 and 2001, was $76,104.

Savannah Hotel Associates, LLC leases 2,086 square feet of commercial space next to the hotel property for use as an office, retail or conference space or for any related or ancillary purposes for the hotel and/or atrium space. The space is leased under a six-year operating lease, which expires October 31, 2006. There is a renewal option for up to three additional five-year periods expiring October 31, 2011, October 31, 2016, and October 31, 2021, respectively. Rent expense for all operating leases for the six months ended June 30, 2004 and 2003 was $18,774 and for the years ended December 31, 2003, 2002, 2001 was $37,548.

Savannah Hotel Associates, LLC leases, as landlord, the premises being the entire fourteenth floor to The Chatham Club, Inc. under a ninety-nine year lease expiring July 31, 2086. This lease was assumed upon the purchase of the building under the terms and conditions agreed to by the previous owner of the property. No rental income is recognized under the terms of this lease as the original lump sum rent payment of $990 was received by the previous owner and not prorated over the life of the lease.

F-19

MHI HOTELS SERVICES GROUP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003, 2002 and 2001

Franchise Agreements:

Holiday Inn Downtown Williamsburg:

Capitol Hotel Associates LP, LLP signed a license agreement with Holiday Hospitality Franchising, Inc. on May 15, 2004, that provides use of the Holiday Inn name, reservation system, training, operating methods, and sales and marketing programs. Capitol Hotel Associates LP, LLP pays Holiday Inn a franchise fee of 5% of gross rooms revenue. The agreement expires in 2015. This agreement succeeds the original license agreement with Holiday Inns Franchising, Inc. signed on September 18, 1995 and was set to expire in 2005. Fees expensed under this agreement totaled $43,534 and $51,424 for the six months ended June 30, 2004 and 2003, respectively, and $107,239, $108,347 and $106,907 for the years ended December 31, 2003, 2002 and 2001, respectively.

Wilmington Riverside Hilton:

Capitol Hotel Associates LP, LLP signed a license agreement with Hilton Inns, Inc. on March 23, 1998, that provides use of the Hilton Inn name, reservation system, training, operating methods, and sales and marketing programs. Capitol Hotel Associates LP, LLP pays Hilton a franchise fee of 5.0% of gross rooms revenue and an advertising fee of 1.0% of gross rooms revenue not to exceed $100,000 in the first year of the agreement with annual increases in the cap equal to percentage increases in the Consumer Price Index. Fees expensed under this agreement totaled $175,004 and $161,272 for the six months ended June 30, 2004 and 2003, respectively, and $324,479, $301,714 and $320,768 for the years ended December 31, 2003, 2002 and 2001, respectively. The agreement expires in 2008.

Holiday Inn Brownstone, Downtown Raleigh:

Brownestone Partners, LLC signed a license agreement with Holiday Hospitality Franchising, Inc. on March 30, 2001, that provides use of the Holiday Inn name, reservation system, training, operating methods, and sales and marketing programs. Brownestone Partners, LLC pays Holiday Inn a franchise fee of 5% of gross rooms revenue. Fees expensed under this agreement totaled $83,262 and $78,362 for the six months ended June 30, 2004 and 2003, respectively, and $153,629, $148,059 and $0 for the years ended December 31, 2003, 2002 and 2001, respectively. The agreement expires in 2011.

Savannah DeSoto Hilton:

Savannah Hotel Associates, LLC signed an amended license agreement with Hilton Inns, Inc. on September 29, 1998, that provides use of the Hilton name, reservation system, training, operating methods, and sales and marketing programs. Savannah Hotel Associates, LLC pays Hilton a franchise fee of 2.5% of gross rooms revenue. Fees expensed under this agreement totaled $220,905 and $187,465 for the six months ended June 30, 2004 and 2003, respectively, and $385,017, $380,225 and $357,687 for the years ended December 31, 2003, 2002 and 2001, respectively. The agreement expires in 2008.

F-20

MHI HOTELS SERVICES GROUP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003, 2002 and 2001

NOTE F—RETIREMENT PLAN

MHI Hotels Services Group participates in a 401(k) Plan, administered by the management company (MHI Hotels Services, LLC) for those employees who meet the eligibility requirements set forth in the plan. Capitol Hotel Associates LP, LLP matches 10% of the employee contributions up to a total match of 1.5% of employee’s wages. All employees who have at least one year of service and who have attained the age of 21 are eligible. Employees are vested automatically with respect to employee contributions. Vesting for employer contributions, based upon years of service, is as follows:


Years of Service	Vested Percentage
Less than two	0	%
Two but less than three	20	%
Three but less than four	40	%
Four but less than five	60	%
Five but less than six	80	%
Six or more	100	%

NOTE G—QUARTERLY FINANCIAL INFORMATION (unaudited)


	2003
	First Quarter			Second Quarter		Third Quarter		Fourth Quarter			Fiscal Year

Operating revenue	$	6,422,767		$	8,343,415	$	7,541,522	$	6,878,484		$	29,186,188
Operating expense		6,113,394			6,865,333		6,844,342		6,558,567			26,381,636
Net income (loss)		(227,552	)		577,688		47,811		(202,540	)		195,407

	2002
	First Quarter			Second Quarter		Third Quarter		Fourth Quarter			Fiscal Year

Operating revenue	$	5,722,402		$	8,801,004	$	7,356,535	$	6,641,586		$	28,521,527
Operating expense		5,611,041			7,077,430		6,546,288		6,467,186			25,701,945
Net income (loss)		(367,734	)		767,913		81,356		(365,430	)		116,105

NOTE H—SEGMENT INFORMATION

The group operates in one segment, full-service hotels. All of MHI Hotels Services Group’s properties are located in the Southeastern region of the United States of America. As of December 31, 2003 and 2002, MHI Hotels Services Group had no single significant customer.

F-21

MHI HOTELS SERVICES GROUP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003, 2002 and 2001

NOTE I—SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Supplemental disclosures of cash flow information for the years ended December 31 and the six months ended June 30 are as follows:


	December 31, 2001		December 31, 2002		December 31, 2003		June 30, 2004
							(unaudited)
Cash paid for interest	$	3,042,079	$	2,882,368	$	2,697,333	$	1,252,685
Non-cash investing and financing activities:
Acquisition of capital assets under lease obligations	$	—	$	43,893	$	—	$	—

NOTE J—SUBSEQUENT EVENTS

As of the date of the issuance of these financial statements, there have been no significant transactions or events that have had a material effect on the financial position or results of operations of MHI Hotels Services Group.

F-22

Schedule III

MHI HOTELS SERVICES GROUP

REAL ESTATE AND ACCUMULATED DEPRECIATION

December 31, 2003


						Initial Costs						Gross Amount at Year End
Description	Location	Date Acquired	Type	Encumbrances at December 31, 2003		Land		Building and Improvements		Net Improvements Since Acquisition		Land		Building and Improvements		Accumulated Depreciation		Depreciation Life in Years
814 Capitol Landing Rd	Williamsburg, VA	April 1, 1994	Hotel	$	3,017,491	$	428,400	$	3,917,300	$	283,066	$	428,400	$	4,200,366	$	1,014,394	7-39
15 East Liberty St	Savannah, GA	June 3, 1996	Hotel		11,020,536		500,000		3,009,410		3,965,044		500,000		6,974,454		1,172,249	7-39
301 North Water St.	Wilmington, NC	April 1, 1994	Hotel		15,513,401		608,700		5,478,297		10,924,997		608,700		16,403,294		2,523,233	7-39
1707 Hillsborough St	Raleigh, NC	September 1, 1997	Hotel		4,934,000		750,000		4,250,000		2,229,017		750,000		6,479,017		724,001	7-39

			Totals	$	34,485,428	$	2,287,100	$	16,655,007	$	17,402,124	$	2,287,100	$	34,057,131	$	5,433,877

F-23

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

MHI Hospitality Corporation

Williamsburg, Virginia

We have audited the accompanying combined balance sheets of Elpizo Limited Partnership as of December 31, 2003 and 2002, and the related combined statements of operations and stockholders’ equity/partners’ capital (deficit) and cash flows for the years then ended. In connection with our audits of the combined financial statements, we have also audited the financial statement schedule of real estate and accumulated depreciation. These combined financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these combined financial statements and financial statement schedule based on our audits.

In our opinion, the combined financial statements referred to above present fairly, in all material respects, the financial position of Elpizo Limited Partnership as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule referred to above, 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.

/s/ Witt, Mares & Company, PLC

Williamsburg, Virginia

August 24, 2004

F-24

ELPIZO LIMITED PARTNERSHIP

Combined Balance Sheets

June 30, 2004 (Unaudited) and

December 31. 2003 and 2002


	December 31,						June 30,
	2002			2003			2004
							(unaudited)
ASSETS
Current Assets
Cash	$	743,740		$	177,190		$	565,978
Restricted real estate tax escrows		389,174			429,103			221,757
Accounts receivable		710,434			448,207			573,988
Inventories		282,168			277,733			295,934
Prepaid expenses		158,489			161,549			547,262

Total current assets		2,284,005			1,493,782			2,204,919
Property & Equipment (at cost)
Land and improvements		2,095,099			2,095,099			2,095,099
Building and improvements		21,422,258			21,426,528			21,440,164
Furniture, fixtures and equipment		10,388,212			10,587,263			10,611,419

Total Property & Equipment		33,905,569			34,108,890			34,146,682
Less: Accumulated Depreciation		(19,720,838	)		(20,681,808	)		(21,155,742	)

Property & Equipment, net		14,184,731			13,427,082			12,990,940
Other Assets
Deferred charges and other assets (net of amortization of $50,017 and $40,457 in 2003 and 2002, respectively) (net of amortization of $55,594 for the six months ended June 30, 2004)		28,495			23,375			18,595

TOTAL ASSETS	$	16,497,231		$	14,944,239		$	15,214,454

LIABILITIES AND STOCKHOLDERS’ EQUITY/PARTNERS’ CAPITAL
Current Liabilities
Current portion of long term debt	$	371,391		$	430,497		$	508,043
Accounts payable		431,434			171,869			173,831
Due to affiliate		70,927			81,265			33,107
Accrued expenses		662,148			567,284			871,631
Accrued expenses-related party		150,513			168,885			178,071
Advance deposits		106,243			105,752			178,016

Total current liabilities		1,792,656			1,525,552			1,942,699
Long Term Liabilities
Long term debt		15,542,983			15,112,486			14,837,476
Long term portion of related party debt		232,714			232,714			232,714

Total long term liabilities		15,775,697			15,345,200			15,070,190
Total liabilities		17,568,353			16,870,752			17,012,889
Stockholders’ equity
Common stock		1,000			1,000			1,000
Additional paid in capital		586,990			586,990			586,990

Total stockholders’ equity		587,990			587,990			587,990
General partners’ capital		(16,591	)		(25,145	)		(23,864	)
Limited partners’ capital		(1,642,521	)		(2,489,358	)		(2,362,561	)

Total stockholders’ equity and partners’ capital (deficit)		(1,071,122	)		(1,926,513	)		(1,798,435	)

Total liabilities, stockholders’ equity and partners’ capital	$	16,497,231		$	14,944,239		$	15,214,454

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

F-25

ELPIZO LIMITED PARTNERSHIP

Combined Statements of Operations and Stockholders’ Equity/Partners’ Capital (Deficit)

For the six months ended June 30, 2004 and 2003 (unaudited)

and the years ended December 31, 2003 and 2002


	Year Ended December 31						Six Months Ended June 30,
	2002			2003			2003			2004
							(unaudited)
Operating Revenue
Rooms department	$	7,949,689		$	7,458,474		$	3,595,217		$	4,221,318
Food and beverage department		3,851,925			3,798,338			2,060,951			1,940,703
Other operating departments		342,048			283,548			239,132			134,933

Total operating revenue		12,143,662			11,540,360			5,895,300			6,296,954
Operating Expenses
Rooms department		2,252,139			2,203,972			1,073,095			1,170,882
Food and beverage department		2,575,910			2,671,710			1,474,343			1,466,863
Other operating departments		125,058			124,453			165,527			59,513
Selling, general and administrative expense		4,619,145			4,295,522			2,140,828			2,252,682
Management fees		217,673			173,031			84,080			93,255
Depreciation and amortization		963,491			966,090			479,723			478,714

Total operating expenses		10,753,416			10,434,778			5,417,596			5,521,909

Net Operating Income		1,390,246			1,105,582			477,704			775,045
Other Income (Expense)
Interest expense		(1,365,158	)		(1,317,473	)		(653,367	)		(646,967	)
Other income (expense)—net		(23,570	)		—			—			—

Net Income (Loss)		1,518			(211,891	)		(175,663	)		128,078
Stockholders’ equity and partners’ capital (deficit), beginning of period		(1,072,640	)		(1,071,122	)		(1,071,122	)		(1,926,513	)
Partners’ Capital Contributed		—			—			—			—
Partners’ Capital Distributed		—			(643,500	)		(643,500	)		—

Stockholders’ equity and partners’ capital (deficit), end of period	$	(1,071,122	)	$	(1,926,513	)	$	(1,890,285	)	$	(1,798,435	)

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

F-26

ELPIZO LIMITED PARTNERSHIP

Combined Statements of Cash Flows

For the six months ended June 30, 2004 and 2003 (unaudited)

and the years ended December 31, 2003 and 2002


	Year Ended December 31						Six Months Ended June 30,
	2002			2003			2003			2004
							(unaudited)
*Cash Flows from Operating Activities:*
Net Income (Loss)	$	1,518		$	(211,891	)	$	(175,663	)	$	128,078
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		963,491			966,090			479,723			478,714
Loss on disposal of property and equipment		23,570			—			—			—
(Increase) decrease in:
Restricted escrows		(24,279	)		(39,929	)		184,701			207,346
Accounts receivable		(331,494	)		262,227			47,834			(125,781	)
Inventories and prepaid expenses		(66,072	)		1,375			(295,918	)		(403,914	)
Increase (decrease) in:
Accounts payable		267,990			(259,565	)		276,517			1,962
Accrued expenses		(19,203	)		(76,492	)		(34,777	)		313,533
Advance deposits		58,443			(491	)		—			72,264

Net cash provided by operating activities		873,964			641,324			482,417			672,202

*Cash Flows from Investing Activities:*
Capital expenditures		(439,119	)		(203,321	)		(127,846	)		(37,792	)

Net cash used in investing activities		(439,119	)		(203,321	)		(127,846	)		(37,792	)

*Cash Flows from Financing Activities:*
Partners’ capital distributed		—			(643,500	)		(643,500	)		—
Proceeds (payment) of related party loans		59,604			10,338			(34,090	)		(48,158	)
Payment of loans		(342,077	)		(371,391	)		(181,878	)		(197,464	)

Net cash used in financing activities		(282,473	)		(1,004,553	)		(859,468	)		(245,622	)

Net increase (decrease) in cash		152,372			(566,550	)		(504,897	)		388,788
Cash at the beginning of the period		591,368			743,740			743,740			177,190

*Cash at the end of the period*	$	743,740		$	177,190		$	238,843		$	565,978

*Supplemental disclosures:*
Cash paid during the period for interest	$	1,365,158		$	1,317,473		$	653,367		$	646,967

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

F-27

ELPIZO LIMITED PARTNERSHIP

NOTES TO COMBINED FINANCIAL STATEMENTS

June 30, 2004 and 2003 (unaudited) and

December 31, 2003 and 2002

NOTE A—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

This summary of significant accounting policies of Elpizo Limited Partnership (the “Company”) is presented to assist in understanding the Company’s financial statements. The financial statements and notes are representations of management, which is responsible for their integrity and objectivity. These accounting policies conform to generally accepted accounting principles applied in the preparation of the financial statements.

Business Activity

Elpizo Limited Partnership was formed on March 26, 1986 to purchase the Philadelphia Airport Hilton, a 331 room, full-service hotel located in Philadelphia, Pennsylvania. Income, loss and cash flow are allocated and/or distributed to the members in accordance with their agreement.

Principles of Combination

The accompanying combined financial statements reflect the total activity of Elpizo Limited Partnership, which include the financial statements of Elpizo Limited Partnership and Phileo Land Corporation presented on a combined basis as a result of common ownership and control by a single group of owners. The properties are all managed under management agreements with MHI Hotels Services, LLC. All significant inter-affiliate accounts and transactions among the entities have been eliminated in the combined financial statements.

Use of Estimates in Financial Statements

In preparing financial statements in conformity with generally accepted accounting principles, management of Elpizo Limited Partnership 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, as well as the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Accounts Receivable

Management of Elpizo Limited Partnership considers accounts receivable to be fully collectible; accordingly, no allowance for doubtful accounts is required. If the amounts become uncollectible, they are charged to operations when that determination is made.

Inventories

Inventories are stated at the lower of cost or market and consist primarily of food and beverages and gift shop merchandise. Cost is determined by the first-in, first-out method.

Property & Equipment

Property and equipment are stated at cost and are depreciated on a straight-line basis over their estimated useful lives as follows: hotel buildings and improvements - seven to thirty-nine years, and furniture, fixtures and equipment - five to seven years. Depreciation and amortization expense for the periods ending June 30, 2004 and 2003 was $473,137 and $474,943, respectively, and for the years ended December 31, 2003, 2002 and 2001 was $956,530, $953,931 and $1,060,734, respectively.

F-28

ELPIZO LIMITED PARTNERSHIP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003 and 2002

Expenditures which materially increase values or extend lives are capitalized, while replacements, maintenance and repairs which do not improve or extend the lives of the respective assets are charged against earnings as incurred. In August, 2001 the Financial Accounting Standards Board (“FASB”) issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The provisions of SFAS No. 144 are effective as of January 1, 2002. SFAS No. 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets for Long-Lived Assets to be Disposed Of.” SFAS No. 144 also established a single accounting model for long-lived assets to be disposed of by sale. Adoption of the Statement did not have a material effect on the financial condition or results of operations for 2002. Management of Elpizo Limited Partnership has assessed the operations of the hotel property and the fair market value of the hotel property based on undiscounted cash flows and other models and has noted no impairment in such assets for all years presented.

Management of Elpizo Limited Partnership reviews the hotel property for impairment whenever events or changes in circumstances indicate the carrying value of the hotel property may not be recoverable. Events or circumstances that may cause a review include, but are not limited to, adverse changes in the demand for lodging at the property due to declining national or local economic conditions and/or new hotel construction in the market where the hotel is located. When such conditions exist, management performs an analysis to determine if the estimated undiscounted future cash flows from operating activities and the proceeds from the ultimate disposition of the hotel property exceed its carrying value. If the estimated undiscounted future cash flows are less than the carrying amount of the asset, an adjustment to reduce the carrying amount to the hotel property’s estimated fair market value is recorded and an impairment loss is recognized.

Fair value of the hotel property is estimated through a discounted cash flow analysis taking into account the property’s expected cash flow generated from operations, holding period and ultimate proceeds from disposition. In projecting the expected cash flows from operating activities of the property, the estimates are based upon future projected earnings before interest expense, income taxes, depreciation and amortization, or EBITDA, and deduct expected capital expenditure requirements. Growth assumptions are applied to project these amounts over the holding period of the property. The growth assumptions are based upon estimated inflationary increases in room rates and expenses and the demand for lodging at the property, as impacted by local and national economic conditions and estimated or known future new hotel supply. The estimated proceeds from disposition are judgmentally determined based on a combination of anticipated cash flow in the year of disposition, capitalization rate, ratio of selling price to gross hotel revenues and selling price per room.

If actual conditions differ from the assumption, the actual results of the property’s future operations and fair market value could be significantly different from the estimated results and value used in the analysis.

The property was not held for sale as of June 30, 2004 or December 31, 2003 and 2002, as defined within the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

Deferred Franchise Fees

Deferred franchise fees consist of the initial fees paid to Hilton Inns, Inc. to operate the Philadelphia Airport Hilton. Amortization of the fees began upon commencement of hotel operations. The fees are being amortized over the term of the franchise agreement, which commenced on March 30, 2001, and runs for a term of 10 years. The agreement is carried at a cost of $42,300 as of June 30, 2004, December 31, 2003 and 2002. Accumulated amortization at June 30, 2004 was $41,595 and at December 31, 2003 and 2002 was $39,127 and $34,897,

F-29

ELPIZO LIMITED PARTNERSHIP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003 and 2002

respectively. Management of Elpizo Limited Partnership has assessed the fair market value of the asset and no impairment of any franchise fee was noted during any period presented.

Loan Fees

Loan fees include direct costs incurred in order to obtain financing. These costs are being amortized over the term of the debt agreement. The loan fees are carried at a cost of $22,239 as of June 30, 2004 and December 31, 2003 and 2002. Accumulated amortization at June 30, 2004 was $13,999 and at December 31, 2003 and 2002 were $10,890 and $5,560, respectively.

Income Taxes

Elpizo Limited Partnership is a limited partnership, which files tax returns for which the partners are taxed on their respective shares of the entity’s income, and accordingly, no provision for income taxes is included in the financial statements.

Recognition of Revenue

Revenue associated with room rental, food and beverage sales and other hotel revenues are recognized as the related services are provided.

Application of New Accounting Standards

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.” SFAS No. 145 amends existing guidance on reporting gains and losses on the extinguishments of debt to prohibit the classification of the gain or loss as extraordinary, as the use of such extinguishments have become part of the risk management strategy of many companies. SFAS No. 145 also amends SFAS No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback transactions. The provisions of the Statement related to the rescission of Statement No. 4 are applied in fiscal years beginning after May 15, 2002. Management adopted SFAS No. 145 as of May 15, 2002 and it has had no material effect on the financial statements. The provisions of the Statement related to the rescission of Statement No. 13 were effective for transactions occurring after May 15, 2002.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities (revised), an Interpretation of ARB No. 51, Consolidated Financial Statements.” FIN 46(R) revises the requirements for consolidation by business enterprises of variable business entities with specific characteristics. FIN 46(R) is effective immediately for variable interests created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. For nonpublic entities, such as Elpizo Limited Partnership, with a variable interest in a variable interest entity created before February 1, 2003, the Interpretation is applied to the enterprise no later than the end of the first annual reporting period beginning after June 30, 2003. Management adopted FIN 46(R) as of January 1, 2003. The application of this Interpretation is not expected to have a material effect on Elpizo Limited Partnership’s financial statements. The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that Elpizo Limited Partnership will consolidate or disclose information about variable interest entities when the Interpretation becomes effective. Management does not believe that it is reasonably possible that the adoption of FIN 46(R) will result in the consolidation of any of its equity investees in the future.

F-30

ELPIZO LIMITED PARTNERSHIP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003 and 2002

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement”, 133 on Derivative Instruments and Hedging Activities, “ which clarifies certain implementation issues raised by constituents and amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, to include the conclusions reached by the FASB on certain FASB Staff Implementation issues; amends SFAS No. 133’s discussion of financial guarantee contracts and the application of the shortcut method to an interest rate swap agreement that includes an embedded option and amends other pronouncements. The guidance in SFAS No. 149 is effective for new contracts entered into or modified after June 30, 2003 and for hedging relationships designated after that date. Management adopted SFAS No. 149 as of July 1, 2003 and it has had no material effect on the financial statements.

NOTE B—LONG-TERM DEBT

Long-term debt of Elpizo Limited Partnership consisted of the following as of December 31, 2003 and 2002 and June 30, 2004.


	As of
	December 31,				June 30,
	2002		2003		2004
					(unaudited)
Mortgage notes on hotels:
First mortgage payable with Midland Loan Services in monthly installments of fixed payments of principal and interest at a fixed rate per annum of 8.25% amortized under a 25-year schedule. Unless sooner paid in full, the note is due September 10, 2006. The loan is collateralized by all real and personal property of the Philadelphia Airport Hilton and is guaranteed by the members of Elpizo Limited Partnership.	$	15,914,374	$	15,542,983	$	15,345,519

Total Mortgage Debt	$	15,914,374	$	15,542,983	$	15,345,519
Other Long Term Debt:
Loan payable to Sunleigh LTD, with no due date and payments based upon available cash flow, bearing interest at a rate of 8.50%. The note is uncollateralized		232,714		232,714		232,714

Total long-term debt	$	16,147,088	$	15,775,697	$	15,578,233

F-31

ELPIZO LIMITED PARTNERSHIP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003 and 2002

Long-term debt matures as follows:


	At December 31, 2003
Due in:
2004	$	430,497
2005		599,558
2006		14,512,928
2007 and thereafter		232,714

	$	15,775,697

NOTE C—RELATED PARTY TRANSACTIONS

The Company is the obligor on a note described in NOTE B that is payable to Sunleigh LTD., which is wholly owned by one of the partners of Elpizo Limited Partnership.

NOTE D—COMMITMENTS AND CONTINGENCIES

Franchise Agreements:

Elpizo Limited Partnership signed a license agreement with Hilton Inns, Inc. on December 3, 1994, that provides use of the Hilton name, reservation system, training, operating methods, and sales and marketing programs. Elpizo Limited Partnership pays Hilton a franchise fee of 2.5% of gross rooms revenue. Fees expensed under this agreement totaled $212,211 and $183,555 for the six months ended June 30, 2004 and 2003, respectively, and $376,718, $397,485 and $364,949 for the years ended December 31, 2003, 2002 and 2001, respectively. The agreement expires in December 2004 and the renewal is currently being negotiated.

NOTE E—RETIREMENT PLAN

Elpizo Limited Partnership participates in a 401(k) Plan, administered by the management company (MHI Hotels, LLC) for those employees who meet the eligibility requirements set forth in the plan. Elpizo Limited Partnership matches 10% of the employee contributions up to a total match of 1.5% of employee’s wages. All employees who have at least one year of service and who have attained the age of 21 are eligible. Employees are vested automatically with respect employee contributions. Vesting for employer contributions, based upon years of service, is as follows:


Years of Service	Vested Percentage
Less than two	0	%
Two but less than three	20	%
Three but less than four	40	%
Four but less than five	60	%
Five but less than six	80	%
Six or more	100	%

F-32

ELIPIZO LIMITED PARTNERSHIP

NOTES TO COMBINED FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003 and 2002

NOTE F—QUARTERLY FINANCIAL INFORMATION (unaudited)


	2003
	First Quarter			Second Quarter		Third Quarter			Fourth Quarter			Fiscal Year
Operating revenue	$	2,613,204		$	2,997,118	$	2,874,579		$	3,055,459		$	11,540,360
Operating expense		2,536,413			2,596,879		2,547,825			2,753,661			10,434,778
Net income (loss)		(250,827	)		74,490		2,913			(38,467	)		(211,891	)

	2002
	First Quarter			Second Quarter		Third Quarter			Fourth Quarter			Fiscal Year
Operating revenue	$	2,621,302		$	3,216,213	$	2,938,658		$	3,367,489		$	12,143,662
Operating expense		2,468,956			2,587,975		2,624,791			3,071,694			10,753,416
Net income (loss)		(182,377	)		295,238		(17,376	)		(93,967	)		1,518

NOTE G—SEGMENT INFORMATION

Elpizo Limited Partnership operates in one segment, full-service hotels. The property is located in the Mid-Atlantic region of the United States of America. As of December 31, 2003 and 2002, Elpizo Limited Partnership had no single significant customer.

NOTE H—SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Supplemental disclosures of cash flow information for the years ended December 31 are as follows:


	2002		2003
Cash paid for interest	$	1,365,158	$	1,317,473

NOTE I—SUBSEQUENT EVENTS

F-33

Schedule III

COMBINED ELPIZO LIMITED PARTNERSHIP AND PHILEO LAND CORPORATION

REAL ESTATE AND ACCUMULATED DEPRECIATION

December 31, 2003


						Initial Costs						Gross Amount at Year End
Description	Location	Date Acquired	Type	Encumbrances at December 31, 2003		Land		Building and Improvements		Net Improvements Since Acquisition		Land		Building and Improvements		Accumulated Depreciation		Depreciation Life in Years
4509 Island Avenue	Philadelphia PA	January 1, 1986	Hotel	$	15,542,983	$	2,066,249	$	18,442,915	$	3,012,463	$	2,066,249	$	21,455,378	$	11,109,515	7-39

F-34

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

MHI Hospitality Corporation

Williamsburg, Virginia

We have audited the accompanying balance sheets of Accord, LLC as of December 31, 2003 and 2002, and the related statements of operations and members’ equity and cash flows for the years then ended. In connection with our audits of the financial statements, we have also audited the financial statement schedule of real estate and accumulated depreciation. These financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Accord, LLC as of December 31, 2003 and 2002, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ Witt, Mares & Company, PLC

Williamsburg, Virginia

August 24, 2004

F-35

ACCORD, LLC

Balance Sheets

June 30, 2004 (Unaudited) and

December 31, 2003 and 2002


	December 31,						June 30,
	2002			2003			2004
ASSETS							(unaudited)
Current Assets
Cash and cash equivalents	$	100,931		$	137,739		$	101,693
Restricted real estate tax escrows		86,822			114,830			166,348
Accounts receivable		66,290			199,889			284,397
Prepaid expenses		37,643			41,959			79,698

Total current assets		291,686			494,417			632,136

Property & Equipment (at cost)
Land and improvements		897,747			897,747			897,747
Building and improvements		9,073,683			9,066,972			9,139,017
Furniture, fixtures and equipment		1,141,317			1,064,987			1,111,311

Total property & equipment		11,112,747			11,029,706			11,148,075
Less: accumulated depreciation		(4,454,723	)		(4,654,602	)		(4,800,690	)

Property & equipment, net		6,658,024			6,375,104			6,347,385

Other Assets
Deferred charges and other assets (net of amortization of $121,327 and $102,757 in 2003 and 2002, respectively) (net of amortization of $130,612 for the six months ended June 30, 2004)		94,164			75,593			66,308


TOTAL ASSETS	$	7,043,874		$	6,945,114		$	7,045,829


LIABILITIES AND MEMBERS’ EQUITY

Current Liabilities
Current portion of long term debt	$	100,000		$	100,000		$	100,000
Accounts payable		158,899			156,675			246,832
Due to affiliate		728			1,112			—
Accrued expenses		101,968			49,228			113,968
Accrued expenses-related party		426,702			595,870			595,870
Advance deposits		11,555			8,472			10,404

Total current liabilities		799,852			911,357			1,067,074

Long Term Liabilities
Long term debt		7,010,132			6,879,644			6,813,574
Long term portion of related party debt		2,080,000			2,185,000			2,137,550

Total long term liabilities		9,090,132			9,064,644			8,951,124


TOTAL LIABILITIES		9,889,984			9,976,001			10,018,198

Members’ Equity (Deficit)
Members’ equity accounts		(2,846,110	)		(3,030,887	)		(2,972,369	)


TOTAL MEMBERS’ EQUITY (DEFICIT)		(2,846,110	)		(3,030,887	)		(2,972,369	)


TOTAL LIABILITIES AND MEMBERS’ EQUITY	$	7,043,874		$	6,945,114		$	7,045,829

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

F-36

ACCORD, LLC.

Statements of Operations and Members’ Equity (Deficit)

For the six months ended June 30, 2004 and 2003 (unaudited) and

the years ended December 31, 2003 and 2002


	Year Ended December 31,						Six Months Ended June 30,
	2002			2003			2003			2004
							(unaudited)
Operating Revenue
Rooms department	$	3,086,362		$	2,967,718		$	1,491,085		$	1,671,427
Lease income—related party		84,000			84,000			42,000			42,000
Other operating departments		277,920			232,321			127,803			135,129

Total operating revenue		3,448,282			3,284,039			1,660,888			1,848,556

Operating Expenses
Rooms department		828,963			769,122			372,406			430,095
Other operating departments		221,800			109,894			53,360			24,807
Selling, general and administrative expense		1,474,940			1,318,965			652,806			717,295
Management fees—related party		84,037			79,784			40,487			45,339
Depreciation and amortization		326,795			333,365			154,683			155,373

Total operating expenses		2,936,535			2,611,130			1,273,742			1,372,909


Net Operating Income		511,747			672,909			387,146			475,647

Other Income (Expense)
Interest expense		(658,515	)		(647,876	)		(322,646	)		(318,792	)
Interest expense—related party		(189,215	)		(195,667	)		(97,342	)		(98,337	)
Other income (expense)—net		(497	)		(14,143	)		—			—


Net Income (Loss)		(336,480	)		(184,777	)		(32,842	)		58,518

Members’ Equity (Deficit), beginning of period		(2,509,630	)		(2,846,110	)		(2,846,110	)		(3,030,887	)
Members’ equity contributed		—			—			—			—
Members’ equity distributed		—			—			—			—


Members’ Equity (Deficit), end of period	$	(2,846,110	)	$	(3,030,887	)	$	(2,878,952	)	$	(2,972,369	)

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

F-37

ACCORD, LLC

Statements of Cash Flows

For the six months ended June 30, 2004 and 2003 (unaudited) and

the years ended December 31, 2003 and 2002


	Year Ended December 31,						Six Months Ended June 30,
	2002			2003			2003			2004
							(unaudited)
Cash Flows from Operating Activities:
Net Income (Loss)	$	(336,480	)	$	(184,777	)	$	(32,842	)	$	58,518
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		326,795			333,365			154,683			155,373
Loss on disposal of property and equipment		497			14,143			—			—
(Increase) decrease in:
Restricted escrows		(14,441	)		(28,008	)		(60,226	)		(51,518	)
Accounts receivable		21,252			(133,599	)		(225,559	)		(84,508	)
Prepaid expenses		3,020			(9,909	)		74,890			(37,739	)
Increase (decrease) in:
Accounts payable		(18,327	)		(2,224	)		32,985			90,157
Due to affiliate		728			384			988			(1,112	)
Accrued expenses		182,074			116,428			129,617			64,740
Advance deposits		(16,947	)		(3,083	)		4,505			1,932

Net cash provided by operating activities		148,171			102,720			79,041			195,843

Cash Flows from Investing Activities:
Capital expenditures		(143,880	)		(40,424	)		(12,344	)		(118,369	)

Net cash used in investing activities		(143,880	)		(40,424	)		(12,344	)		(118,369	)

Cash Flows from Financing Activities:
Proceeds (Payments) from (to) related party loans		80,000			105,000			—			(47,450	)
Payment of loans		(110,347	)		(130,488	)		(59,661	)		(66,070	)

Net cash used in financing activities		(30,347	)		(25,488	)		(59,661	)		(113,520	)

Net increase (decrease) in cash and cash equivalents		(26,056	)		36,808			7,036			(36,046	)
Cash and cash equivalents at the beginning of the period		126,987			100,931			100,931			137,739

Cash and cash equivalents at the end of the period	$	100,931		$	137,739		$	107,967		$	101,693

Supplemental disclosures:
Cash paid during the period for interest	$	658,515		$	647,876		$	322,646		$	318,792

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

F-38

ACCORD, LLC

NOTES TO FINANCIAL STATEMENTS

June 30, 2004 and 2003 (unaudited) and

December 31, 2003 and 2002

NOTE A—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

This summary of significant accounting policies of Accord, LLC (the “Company”) is presented to assist in understanding the Company’s financial statements. The financial statements and notes are representations of management, which is responsible for their integrity and objectivity. These accounting policies conform to generally accepted accounting principles applied in the preparation of the financial statements.

Business Activity

Accord, LLC was formed on June 6, 1997 to purchase the Best Western Maryland Inn—Laurel, a 207 room, full-service hotel located in Laurel, Maryland. Income, loss and cash flow are allocated and/or distributed to the members in accordance with their agreement.

Use of Estimates in Financial Statements

In preparing financial statements in conformity with generally accepted accounting principles, management of Accord, LLC 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, as well as the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Accounts Receivable

Management of Accord, LLC considers accounts receivable to be fully collectible; accordingly, no allowance for doubtful accounts is required. If the amounts become uncollectible, they are charged to operations when that determination is made.

Property & Equipment

Property and equipment are stated at cost and are depreciated on a straight-line basis over their estimated useful lives as follows: hotel buildings and improvements - seven to thirty-nine years, and furniture, fixtures and equipment - five to seven years. Depreciation and amortization expense for the periods ending June 30, 2004 and 2003 was $146,088 and $145,398, respectively, and for the years ended December 31, 2003 and 2002 was $314,795 and $308,225, respectively.

Expenditures which materially increase values or extend lives are capitalized, while replacements, maintenance and repairs which do not improve or extend the lives of the respective assets are charged against earnings as incurred. In August, 2001 the Financial Accounting Standards Board (“FASB”) issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The provisions of SFAS No. 144 are effective as of January 1, 2002. SFAS No. 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets for Long-Lived Assets to be Disposed Of.” SFAS No. 144 also established a single accounting model for long-lived assets to be disposed of by sale. Adoption of the Statement did not have a material effect on the financial condition or results of operations for 2002. Management of Accord, LLC has assessed the operations of the hotel property and the fair market value of the hotel property based on undiscounted cash flows and other models and has noted no impairment in such assets for all years presented.

Management of Accord, LLC reviews the hotel property for impairment whenever events or changes in circumstances indicate the carrying value of the hotel property may not be recoverable. Events or circumstances that may cause a review include, but are not limited to, adverse changes in the demand for lodging at the property

F-39

ACCORD, LLC

NOTES TO FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003 and 2002

due to declining national or local economic conditions and/or new hotel construction in the market where the hotel is located. When such conditions exist, management performs an analysis to determine if the estimated undiscounted future cash flows from operating activities and the proceeds from the ultimate disposition of the hotel property exceed its carrying value. If the estimated undiscounted future cash flows are less than the carrying amount of the asset, an adjustment to reduce the carrying amount to the hotel property’s estimated fair market value is recorded and an impairment loss is recognized.

Loan Fees

Loan fees include direct costs incurred in order to obtain financing. These costs are being amortized over the terms of the respective debt agreements. The loan fees are carried at a cost of $185,795 as of June 30, 2004 and December 31, 2003 and 2002. Accumulated amortization at June 30, 2004 was $130,612 and at December 31, 2003 and 2002 was $121,327 and $102,757, respectively.

Income Taxes

Accord, LLC is a limited liability company, which files tax returns for which the members are taxed on their respective shares of the entity’s income, and accordingly, no provision for income taxes is included in the financial statements.

Recognition of Revenue

Revenue associated with room rental and other hotel revenues are recognized as the related services are delivered.

Application of New Accounting Standards

F-40

ACCORD, LLC

NOTES TO FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003 and 2002

extraordinary, as the use of such extinguishments have become part of the risk management strategy of many companies. SFAS No. 145 also amends SFAS No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback transactions. The provisions of the Statement related to the rescission of Statement No. 4 are applied in fiscal years beginning after May 15, 2002. Management adopted SFAS No. 145 as of May 15, 2002 and it has had no material effect on the financial statements. The provisions of the Statement related to the rescission of Statement No. 13 were effective for transactions occurring after May 15, 2002.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities (revised), an Interpretation of ARB No. 51, Consolidated Financial Statements.” FIN 46(R) revises the requirements for consolidation by business enterprises of variable business entities with specific characteristics. FIN 46(R) is effective immediately for variable interests created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. For nonpublic entities, such as Accord, LLC, with a variable interest in a variable interest entity created before February 1, 2003, the Interpretation is applied to the enterprise no later than the end of the first annual reporting period beginning after June 30, 2003. Management adopted FIN 46(R) as of January 1, 2003. The application of this Interpretation is not expected to have a material effect on Accord, LLC’s financial statements. The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that Accord, LLC will consolidate or disclose information about variable interest entities when the Interpretation becomes effective. Management does not believe that it is reasonably possible that the adoption of FIN 46(R) will result in the consolidation of any of its equity investees in the future.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities, “ which clarifies certain implementation issues raised by constituents and amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, to include the conclusions reached by the FASB on certain FASB Staff Implementation issues; amends SFAS No. 133’s discussion of financial guarantee contracts and the application of the shortcut method to an interest rate swap agreement that includes an embedded option and amends other pronouncements. The guidance in SFAS No. 149 is effective for new contracts entered into or modified after June 30, 2003 and for hedging relationships designated after that date. Management adopted SFAS No. 149 as of July 1, 2003 and it has had no material effect on the financial statements.

F-41

ACCORD, LLC

NOTES TO FINANCIAL STATEMENTS—(Continued)

June 30, 2004 and 2003 (unaudited) and

December 31, 2003 and 2002

NOTE B—LONG-TERM DEBT

Long-term debt of Accord, LLC consisted of the following as of December 31, 2003 and 2002 and June 30, 2004.


	As of
	December 31,				June 30,
	2002		2003		2004
					(unaudited)
Mortgage notes on hotels:
First mortgage payable with Suburban Capital Markets, Inc. in monthly installments of principal plus interest at a 9.07% rate per annum amortized over a 25-year schedule. Unless sooner paid in full, the note is due June 30, 2007. The loan is collateralized by all real and personal property of the Best Western Maryland Inn—Laurel of Accord, LLC.	$	7,110,132	$	6,979,644	$	6,913,574

Total mortgage debt	$	7,110,132	$	6,979,644	$	6,913,574
Other Related Party Long Term Debt:
Promissory notes payable to the Estate of Walter L. Green, with no due date, bearing interest at a rate of 9.00%. The loans are uncollateralized.		2,080,000		2,185,000		2,137,550

Total long-term debt	$	9,190,132	$	9,164,644	$	9,051,124

Long-term debt matures as follows:


	At December 31, 2003
Due in:
2004	$	100,000
2005		100,000
2006		6,779,644
2007 and thereafter		2,185,000

	$	9,164,644

NOTE C—COMMITMENTS AND CONTINGENCIES

Membership Agreements:

Accord, LLC signed a membership agreement with Best Western, Inc. on September 8, 1994, that provides use of the Best Western name, reservation system, training, operating methods, and sales and marketing programs. Accord, LLC pays Best Western a membership fee of approximately 3.5% of gross rooms revenue. This membership fee is based on annual fees charged by Best Western, Inc., based on the number of rooms and number of room reservations at the property. Fees expensed under this agreement totaled $56,583 and $52,758 for the six months ended June 30, 2004 and 2003, respectively, and $110,659 and $107,397 for the years ended December 31, 2003 and 2002, respectively. The agreement expires in 2005.

F-42

Schedule III

ACCORD LLC

REAL ESTATE AND ACCUMULATED DEPRECIATION

December 31, 2003


						Initial Costs						Gross Amount at Year End
Description	Location	Date Acquired	Type	Encumbrances at 12/31/2003		Land		Building & Improvements		Net Improvements Since Acquisition		Land		Building & Improvements		Accumulated Depreciation		Depreciation Life in Years
15101 Sweitzer Lane	Laurel, MD	January 1, 1985	Hotel	$	6,979,644	$	889,813	$	4,643,478	$	4,431,428	$	889,813	$	9,074,906	$	3,951,403	7-39

F-43

MHI Hospitality Corporation

Pro Forma Consolidated Financial Information

(Unaudited)

The accompanying unaudited Pro Forma Consolidated Financial Statements are presented to reflect the initial public offering of common stock by MHI Hospitality Corporation (the Company), the contribution of four initial properties constituting the MHI Hotels Services Group, the pending acquisitions of two hotels owned by Elpizo Limited Partnership and Accord, LLC and application of the net proceeds as described in “Use of Proceeds.” The contribution of the four initial properties from MHI Hotels Services Group is considered a reorganization of entities under common control and the acquisition of the third parties’ interests in such entities is treated as the acquisition of minority interests. Accordingly, the contribution of majority interests in MHI Hotels Services Group are recorded at historical cost basis. Minority interests in such entities are marked up to reflect acquisition costs. The acquisitions of the two hotels acquired from Elpizo Limited Partnership and Accord, LLC are accounted for at their acquisition cost.

The unaudited Pro Forma Consolidated Balance Sheet as of June 30, 2004 is presented for illustrative purposes only and is not necessarily indicative of what the actual financial position would have been had the common stock offering and the contributions of the four hotels and the acquisitions of the assets of the two entities described above occurred on June 30, 2004, nor does it purport to represent the future financial position of the Company.

The unaudited Pro Forma Consolidated Statements of Operations for the six months ended June 30, 2004 and the year ended December 31, 2003 are presented for illustrative purposes only and are not necessarily indicative of what the actual results of operations would have been had the common stock offering and the contributions of the four hotels and the acquisitions of the two entities described above occurred as of the beginning of each of the periods presented, nor does it purport to represent the future results of operations of the Company.

The Pro Forma Consolidated Financial Statements assume an initial public offering of 6,000,000 shares at $10.00 per share with net proceeds of $54,600,000. The net proceeds will be contributed to MHI Hospitality, L.P., the operating partnership, and will represent a 61.1% ownership interest in the operating partnership. The remaining 38.9% of the operating partnership will be owned by the current owners of the initial hotel properties along with the owners of the Hilton Philadelphia Airport.

F-44

MHI Hospitality Corporation

Pro Forma Consolidated Balance Sheet

June 30, 2004

(unaudited)


	MHI Hotels Services Group Historical			Elpizo LP (Hilton Philadelphia Airport) Historical			Accord LLC (Maryland Inn) Historical			Pre-formation MHI Hospitality Corporation Historical			Pro Forma Adjustments			Use of Proceeds			MHI Hospitality Corporation Pro Forma
*Current Assets*
Cash and cash equivalents	$	143,530		$	565,978		$	101,693		$	811,201		$	4,511,950	(a)	$	(243,875	)(j)	$	5,079,276
Cash reserved for renovations		—			—			—			—			—			7,850,000	(j)		7,850,000
Restricted real estate tax escrows		990,691			221,757			166,348			1,378,796			—			—			1,378,796
Account receivable		1,186,173			573,988			284,397			2,044,558			—			—			2,044,558
Accounts receivable-affliates		2,344,466			—			—			2,344,466			—			—			2,344,466
Inventories		153,790			295,934			—			449,724			—			—			449,724
Prepaid expenses		148,187			547,262			79,698			775,147			—			—			775,147

Total current assets		4,966,837			2,204,919			632,136			7,803,892			4,511,950			7,606,125			19,921,967

*Property & Equipment (at cost)*
Land and improvements		2,442,704			2,095,099			897,747			5,435,550			307,843	(b)		—			5,743,393
Building and improvements		34,033,131			21,440,164			9,139,017			64,612,312			10,681,308	(b)		—			75,293,620
Furniture, fixtures and equipment		12,892,704			10,611,419			1,111,311			24,615,434			(9,488,343	)(b)		—			15,127,091

Total property & equipment		49,368,539			34,146,682			11,148,075			94,663,296			1,500,808			—			96,164,104
Less: accumulated depreciation		(14,945,037	)		(21,155,742	)		(4,800,690	)		(40,901,469	)		24,015,893	(b)		—			(16,885,577	)

Total property & equipment, net		34,423,502			12,990,940			6,347,385			53,761,827			25,516,701			—			79,278,528

*Other Assets*
Shell Island Resort leases and management agreement restructuring		—			—			—			—			—			5,500,000	(i/j)		5,500,000
Less: accumulated amortization		—			—			—			—			(883,334	)(c)		—			(883,334	)
Deferred charges and other assets, net		422,389			18,595			66,308			507,292			—			—			507,292

Total other assets		422,389			18,595			66,308			507,292			(883,334	)		5,500,000			5,123,959


*TOTAL ASSETS*	$	39,812,728		$	15,214,454		$	7,045,829		$	62,073,011		$	29,145,317		$	13,106,125		$	104,324,453


LIABILITIES AND OWNERS’ EQUITY
*Current Liabilities*
Current portion of long term debt	$	1,294,811		$	508,043		$	100,000		$	1,902,854		$	(800,000	)(d)		—		$	1,102,854
Current portion of long term debt-related party		—			—			—			—			—			—			—
Current portion of long term lease obligation		38,062			—			—			38,062			—			—			38,062
Short term debt/lines of credit		1,092,500			—			—			1,092,500			—			—			1,092,500
Accounts payable		1,830,969			173,831			246,832			2,251,632			—			—			2,251,632
Due to affiliate		—			33,107			—			33,107			(33,107	)(e)		—			—
Accrued expenses		1,852,228			871,631			113,968			2,837,827			—			—			2,837,827
Accrued expenses-related party		—			178,071			595,870			773,941			(773,941	)(f)		—			—
Advance deposits		235,562			178,016			10,404			423,982			—			—			423,982

Total current liabilities		6,344,132			1,942,699			1,067,074			9,353,905			(1,607,048	)		—			7,746,857

*Long Term Liabilities*
Long term debt		32,643,216			14,837,476			6,813,574			54,294,266			(4,022,172	)(d)		(25,495,175	)(j)		24,776,919
Long term portion of related party debt		—			232,714			2,137,550			2,370,264			(2,370,264	)(d)		—			—
Long term portion of capital lease obligation		20,473			—			—			20,473			—			—			20,473

Total long term liabilities		32,663,689			15,070,190			8,951,124			56,685,003			(6,392,436	)		(25,495,175	)		24,797,392

*Minority Interest*		500,392			—			—			500,392			(500,392	)(g)		27,922,499	(h)		27,922,499

*Owners’ Equity*
Partners’/Members’ equity		304,515			(2,386,425	)		(2,972,369	)		(5,054,279	)		38,233,183	(g)		(33,178,904	)(h)		—
Common stock		—			1,000			—			1,000			(1,000	)(g)		—			—
Additional paid in capital		—			586,990			—			586,990			(586,990	)(g)		—			—
Equity of MHI Hospitality Corporation		—			—			—			—			—			43,857,705	(h)		43,857,705

Total owners’ equity		304,515			(1,798,435	)		(2,972,369	)		(4,466,289	)		37,645,193			10,678,801			43,857,705

*TOTAL LIABILITIES AND OWNERS’ EQUITY*	$	39,812,728		$	15,214,454		$	7,045,829		$	62,073,011		$	29,145,317		$	13,106,125		$	104,324,453

F-45

MHI Hospitality Corporation

Pro Forma Consolidated Balance Sheet

December 31, 2003

(unaudited)


	MHI Hotels Services Group Historical			Elpizo LP (Hilton Philadelphia Airport) Historical			Accord LLC (Maryland Inn) Historical			Pre-formation MHI Hospitality Corporation Historical			Pro Forma Adjustments			Use of Proceeds			MHI Hospitality Corporation Pro Forma
*Current Assets*
Cash and cash equivalents	$	76,545		$	177,190		$	137,739		$	391,474		$	2,821,735	(a)	$	(243,875	)(j)	$	2,969,334
Cash reserved for renovations		—			—			—			—			—			7,850,000	(j)		7,850,000
Restricted real estate tax escrows		728,452			429,103			114,830			1,272,385			—			—			1,272,385
Account receivable		769,276			448,207			199,889			1,417,373			—			—			1,417,373
Accounts receivable—affiliates		1,031,566			—			—			1,031,566			—			—			1,031,566
Inventories		139,955			277,733			—			417,686			—			—			417,686
Prepaid expenses		127,546			161,549			41,959			331,054			—			—			331,054

Total current assets		2,873,337			1,493,782			494,417			4,861,538			2,821,735			7,606,125			15,289,398

*Property & Equipment (at cost)*
Land and improvements		2,439,054			2,095,099			897,747			5,431,900			307,843	(b)		—			5,739,743
Building and improvements		33,905,177			21,426,528			9,066,972			64,398,677			10,681,308	(b)		—			75,079,985
Furniture, fixtures and equipment		12,320,425			10,587,263			1,064,987			23,972,675			(9,488,343	)(b)		—			14,484,331

Total property & equipment		48,664,656			34,108,890			11,029,706			93,803,251			1,500,808			—			95,304,059
Less: accumulated depreciation		(13,713,550	)		(20,681,808	)		(4,654,602	)		(39,049,961	)		23,972,799	(b)		—			(15,077,162	)

Total property & equipment, net		34,951,106			13,427,082			6,375,104			54,753,290			25,473,607			—			80,226,897

*Other Assets*
Shell Island leases and management agreement restructuring		—			—			—			—			—			5,500,000	(i/j)		5,500,000
Less: accumulated amortization		—			—			—			—			(588,889	)(c)		—			(588,889	)
Deferred charges and other assets, net		406,738			23,375			75,593			505,705			—			—			505,705

Total other assets		406,738			23,375			75,593			505,705			(588,889	)		5,500,000			5,416,816

TOTAL ASSETS	$	38,231,181		$	14,944,239		$	6,945,114		$	60,120,533		$	27,706,453		$	13,106,125		$	100,933,111


LIABILITIES AND OWNERS’ EQUITY
*Current Liabilities*
Current portion of long term debt	$	1,220,020		$	430,497		$	100,000		$	1,750,517		$	(800,000	)(d)	$	—		$	950,517
Current portion of long term debt-related party		—			—			—			—			—			—			—
Current portion of long term lease obligation		63,965			—			—			63,965			—			—			63,965
Short term debt/lines of credit		450,296			—			—			450,296			—			—			450,296
Accounts payable		2,079,405			171,869			156,675			2,407,949			—			—			2,407,949
Due to affiliate		—			81,265			1,112			82,377			(82,377	)(e)		—			—
Accrued expenses		1,027,904			567,284			49,228			1,644,414			—			—			1,644,414
Accrued expenses-related party		—			168,885			595,870			764,754			(764,754	)(f)		—			—
Advance deposits		150,144			105,752			8,472			264,368			—			—			264,368

Total current liabilities		4,991,734			1,525,552			911,357			7,428,640			(1,647,131	)		—			5,781,511

*Long Term Liabilities*
Long term debt		33,319,065			15,112,486			6,879,644			55,311,195			(4,178,943	)(d)		(25,495,175	)(j)		25,637,077
Long term portion of related party debt		—			232,714			2,185,000			2,417,714			(2,417,714	)(d)		—			—
Long term portion of capital lease obligation		29,420			—			—			29,420			—			—			29,420

Total long term liabilities		33,348,485			15,345,200			9,064,644			57,758,329			(6,596,657	)		(25,495,175	)		25,666,497

*Minority Interest*		327,263			—			—			327,263			(327,263	)(g)		27,029,706	(h)		27,029,706

*Owners’ Equity*
Partners’/Members’ equity		(436,301	)		(2,514,503	)		(3,030,887	)		(5,981,691	)		5,981,691	(g)		—			—
Common stock		—			1,000			—			1,000			(1,000	)(g)		—			—
Additional paid in capital		—			586,990			—			586,990			(586,990	)(g)		—			—
Equity of MHI Hospitality Corporation		—			—			—			—			30,883,804	(g)		11,571,594	(h)		42,455,399

Total owners’ equity		(436,301	)		(1,926,513	)		(3,030,887	)		(5,393,701	)		36,277,504			11,571,594			42,455,399

*TOTAL LIABILITIES AND OWNERS’ EQUITY*	$	38,231,181		$	14,944,239		$	6,945,114		$	60,120,533		$	27,706,453		$	13,106,125		$	100,933,111

F-46

MHI HOSPITALITY CORPORATION

NOTES TO PRO FORMA CONSOLIDATED BALANCE SHEETS

The accompanying unaudited Pro Forma Consolidated Balance Sheet as of June 30, 2004 is based on the Historical Balance Sheet of the MHI Hotels Services Group, adjusted to reflect the impact of the transactions described below.

The Pro Forma Consolidated Balance Sheets for MHI Hospitality Corporation reflect the assumption that the following occurred June 30, 2004:

•

An initial public offering of 6,000,000 shares at $10.00 per share with net proceeds of $54,600,000 net of underwriting discounts, transaction and transfer costs of $6.4 million. Contribution of the net proceeds to MHI Hospitality, L.P. in exchange for a 61.1% ownership interest in the operating partnership. The remaining 38.9% of the partnership will be owned by the contributors of the initial properties along with the owners of the Hilton Philadelphia Airport Hotel.

•

Acquisition of the following initial hotels:


Property	Cash ⁽¹⁾		Debt		Units
Hilton Philadelphia Airport	$	2,838,700	$	15,250,000	732,254
Holiday Inn Brownstone		1,000,000		6,800,000	159,612
Hilton Savannah DeSoto		—		10,625,0000	1,665,494
Maryland Inn Laurel		12,200,000		—	—
Holiday Inn Downtown – Williamsburg ⁽²⁾		—		3,025,000	200,000
Hilton Wilmington Riverside ⁽²⁾		—		15,050,000	1,059,676

⁽¹⁾	Cash includes the following transaction costs: Hilton Philadelphia at $990,000 and Maryland Inn Laurel at $250,000.

⁽²⁾	Holiday Inn Downtown and Hilton Wilmington Riverside are owned by Capitol Hotel Associates. The aggregate debt to be assumed in connection with the contribution of Capitol Hotels Associates is $18,075,000 and the aggregate number of units to be issued will be 1,259,676.

•

Amendment and restructuring of the management agreements between MHI Hotels Services and the acquired hotels to run concurrently for 10 years in exchange for a cash payment of $2.0 million to MHI Hotels Services.

•

Purchase of two lease agreements relating to the Shell Island resort for $3.5 million in cash. These leases have a remaining life of nine years.

•

Repayment of approximately $25.1 million in existing debt on the Holiday Inn Williamsburg, Hilton Philadelphia Airport and the Holiday Inn Brownstone from the proceeds of the offering.

In the opinion of management, all material adjustments to reflect the effects of the preceding transactions have been made. The unaudited Pro Forma Consolidated Balance Sheets are presented for illustrative purposes only and are not necessarily indicative of what the actual results of operations would have been had the transactions described above occurred as of June 30, 2004, nor does it purport to represent future results of operations.

F-47

MHI HOSPITALITY CORPORATION

Notes and Management Assumptions:

(a)	Reflects the following cash adjustments:

Cash Adjustments


	December 31, 2003			June 30, 2004
MHI Hotels Services Group
Savannah Hotel Associates, LLC
Distribution	$	500,000		$	—
Management fees		106,687			65,477
Capitol Hotels Associates, LP, LLP
Interest		201,104			90,215
Management fees		314,752			158,032
Brownestone Partners LLC
Distribution/(Contribution)		(675,000	)		9,163
Interest		328,371			108,924
Additional Principal		—			72,375
Management fees		47,508			25,360

MHI Hotels Services Group Total—Year		823,422			529,546
Prior Year		—			823,422

MHI Hotels Services Group Total Adjustment		823,422			1,352,968
Elpizo Limited Partnership
Distribution		643,500			—
Interest		1,317,473			646,967
Additional Principal		(482,864	)		38,972
Management fees		(57,776	)		(32,684	)

Elpizo Limited Partnership Total—Year		1,420,333			653,255
Prior Year		—			1,420,333

Elpizo Limited Partnership Total Adjustment		1,420,333			2,073,588
Accord, LLC
Interest		647,877			417,129
Additional Principal		—			123,917
Management fees		14,103			8,368
Restaurant Lease		(84,000	)		(42,000	)

Accord, LLC Total		577,980			507,414
Prior Year		—			577,980

Accord, LLC Total Adjustment		577,980			1,085,394

Cash Adjustment—Pro Forma	$	2,821,735		$	4,511,950

F-48

MHI HOSPITALITY CORPORATION

(b)

As indicated in the preliminary notes to the Pro Forma Consolidated Financial Information of the Company, this footnote reflects the mark up of assets to reflect the purchase price for the assets of Accord, LLC and Elpizo Limited Partnership and the minority interest in the remaining hotels of MHI Hotels Services Group.

Adjustments to Assets and Capital Accounts


	Historical Capital Account Opening Balance at January 1, 2003			Adjustments			Purchase Price (Closing Balance)
Savannah Hotel Associates, LLC
Capital Account-Krischman interest	$	(231,513	)	$	3,562,503		$	3,330,990
Property Plant and Equipment
Land		500,000			100,000			600,000
Building and Improvements		6,974,454			3,462,503			10,436,957
Accumulated Depreciation		(5,736,738	)		(91,346	)		(5,828,084	)
Capital Hotel Associates, LP, LLP
Capital Account-Wilmington Hotel Association Corporation interest	$	(558,894	)	$	4,337,924		$	3,779,030
Property Plant and Equipment
Land		1,124,396			150,000			1,274,396
Building and Improvements		20,516,364			4,187,924			24,704,288
Accumulated Depreciation		(6,017,016	)		(103,537	)		(6,126,553	)
Brownestone Partners LLC
Capital Account-MAVAS interest	$	36,176		$	964,824		$	1,001,000
Property Plant and Equipment
Building and Improvements		6,414,359			964,824			7,379,183
Accumulated Depreciation		(1,959,797	)		(24,738	)		(1,984,535	)
Elpizo Limited Partnership
Capital Account-owners	$	(1,071,122	)	$	10,242,362		$	9,171,240
Property Plant and Equipment
Furniture and Fixtures		10,587,263			(8,623,356	)		1,963,907
Accumulated Depreciation		(20,681,808	)		19,851,852			(829,956	)
Accord, LLC
Property Plant and Equipment
Land	$	897,747		$	57,843		$	955,590
Building and Improvements		9,066,972			2,066,057			11,133,029
Furniture and Fixtures		1,064,987			(864,987	)		200,000
Accumulated Depreciation		(4,654,601	)		4,340,568			(314,033	)

Adjustments to Land				$	307,843
Adjustments to Building				$	10,681,308
Adjustments to Furniture				$	(9,488,343	)
Adjustments to Accumulated Depreciation				$	23,972,799

(c)

Reflects the amortization of the purchase of leases at Shell Island over nine years ($388,889 annually) and the amortization of the management fee restructuring over 10 years ($200,000 annually). At December 31, 2003, accumulated amortization was $588,889. At June 30, 2004 Pro Forma accumulated amortization was $883,334.

F-49

MHI HOSPITALITY CORPORATION

(d)	Reflects adjustments to debt

Adjustments to Debt


	December 31, 2003			June 30, 2004
MHI Hotels Services Group
Brownestone Partners, LLC reversal of principal paydown in 2003	$	2,000,701		$	2,000,701
Principal payments in 2003		—			90,702
Accord, LLC
Long term debt		(6,879,644	)		(6,813,574	)
Related party debt		(2,185,000	)		(2,137,550	)
Current portion of debt		(100,000	)		(100,000	)
Elpizo Limited Partnership
Related party debt		(232,714	)		(232,714	)

Adjustment long term debt	$	(4,178,943	)	$	(4,022,171	)
Adjustment long term debt-related	$	(2,417,714	)	$	(2,370,264	)
Adjustment to current portion long term debt	$	(800,000	)	$	(800,000	)

(e)	Reflects the elimination of related party debt in Laurel and Philadelphia.

Adjustments to Related Party Accruals


	December 31, 2003		June 30, 2004
Accord, LLC
(e) Due to affiliate	$	1,112	$	—
(f) Accrued related party debt		595,870		595,870

Total	$	596,982	$	595,870

Elpizo Limited Partnership
(e) Due to affiliate		81,265		33,107
(f) Accrued related party debt		168,885		178,071

Total	$	250,150	$	211,178


Adjustments—note E	$	82,377	$	33,107
Adjustments—note F	$	764,755	$	773,941

(f)	Reflects the adjustments to accrued related party debt (see table above).

(g)	Reflects the elimination of the equity accounts of the predecessor group and the establishment of a 38.9% minority interest representing the unit holders.

(h)	Adjustments to equity reflect the minority interest of 38.9%.

(i)	Reflects the acquisition of the Shell Island leases for $3.5 million dollars and the restructuring of the management agreements for $2.0 million.

F-50

MHI HOSPITALITY CORPORATION

(j)	Reflects the use of proceeds as described below.

Use of Proceeds


Net proceeds from offering	$	54,600,000
less repayment of debt in Elpizo Limited Partnership		(15,542,983	)
repayment of debt in Capitol Hotel Associates, LP, LLP (Holiday Inn Downtown Williamsburg)		(3,017,491	)
repayment of debt in Brownestone Partners, LLC		(6,934,701	)
termination of management contracts		(2,000,000	)
purchase Shell Island Resort leases		(3,500,000	)
purchase MAVAS interest in Brownestone Partners, LLC		(1,000,000	)
purchase Accord, LLC		(11,950,000	)
transfer taxes Elpizo Limited Partnership and Accord, LLC.		(1,200,000	)
purchase minority interest Elpizo Limited Partnership		(1,848,700	)
create reserve for renovations		(7,850,000	)

	$	(243,875	)

F-51

MHI HOSPITALITY CORPORATION

Pro Forma Consolidated Statement of Operations

For the Six Months Ended

June 30, 2004

(unaudited)


	MHI Hotels Services Group Historical			Elpizo LP (Hilton Philadelphia Airport) Historical			Accord LLC (Maryland Inn) Historical			Pre-formation MHI Hospitality Corporation Historical			Pro Forma Adjustments			MHI Hospitality Corporation Pro Forma
*Revenue*
Rooms department	$	10,447,519		$	4,221,318		$	1,671,427		$	16,340,264		$	—		$	16,340,264
Food and beverage department		4,853,244			1,940,703			—			6,793,947			—			6,793,947
Other operating departments		512,016			134,933			135,129			782,078			—			782,078
Lease income		—			—			42,000			42,000			278,000	(a)		320,000

Total revenues		15,812,779			6,296,954			1,848,556			23,958,289			278,000			24,236,289
*Operating Expenses*
Rooms department		2,691,523			1,170,882			430,095			4,292,500			—			4,292,500
Food and beverage department		3,474,827			1,466,863			—			4,941,690			—			4,941,690
Other operating departments		272,142			59,513			24,807			356,462			—			356,462
Lease expense		—			—			—			—			50,000	(a)		50,000
Selling, general and administrative		5,382,916			2,252,682			717,295			8,352,893			550,000	(b)		8,902,893
Management fee—related parties		565,125			93,255			45,339			703,719			(224,552)	(c)		479,167
Depreciation and amortization		1,269,145			478,714			155,373			1,903,232			242,064	(d)		2,145,296

Total operating expenses		13,655,678			5,521,909			1,372,909			20,550,496			617,512			21,168,008

Net Operating Income		2,157,101			775,045			475,647			3,407,793			(339,512	)		3,068,281

*Other Income (Expenses)*
Interest expense		(1,252,751	)		(646,967	)		(318,792	)		(2,218,510	)		1,164,898	(e)		(1,053,612	)
Interest expense-related party		—			—			(98,337	)		(98,337	)		98,337	(e)		—
Interest income		430			—			—			430			—			430
Gain (Loss) on disposal of asset		—			—			—			—			—			—
Minority interest		(168,551	)								(168,551	)		(615,323)	(f)		(783,874	)
Other income—net		—			—			—			—			—			—

Total other income (expense)		(1,420,872	)		(646,967	)		(417,129	)		(2,484,968	)		647,912			(1,837,056	)

Net Income (Loss)	$	736,229		$	128,078		$	58,518		$	922,825		$	308,400		$	1,231,225

*Earnings per share*
Basic and diluted																$	0.21
*Common shares outstanding*
Basic and diluted																	6,004,000

F-52

MHI HOSPITALITY CORPORATION

Pro Forma Consolidated Statement of Operations

For the year ended

December 31, 2003

(unaudited)


	MHI Hotels Services Group Historical			Elpizo LP (Hilton Philadelphia Airport) Historical			Accord LLC (Maryland Inn) Historical			Pre-formation MHI Hospitality Corporation Historical			Pro Forma Adjustments			MHI Hospitality Corporation Pro Forma
*Revenue*
Rooms department	$	18,942,658		$	7,458,474		$	2,967,718		$	29,368,850		$	—		$	29,368,850
Food and beverage department		9,265,350			3,798,338			—			13,063,688			—			13,063,688
Other operating departments		978,180			283,548			232,321			1,494,049			—			1,494,049
Lease income		—			—			84,000			84,000			556,000	(a)		640,000

Total revenues		29,186,188			11,540,360			3,284,039			44,010,587			556,000			44,566,587

*Operating Expenses*
Rooms department		5,185,431			2,203,972			769,122			8,158,525			—			8,158,525
Food and beverage department		6,632,713			2,671,710			—			9,304,423			—			9,304,423
Other operating departments		501,541			124,453			109,894			735,888			—			735,888
Lease expense		—			—			—			—			100,000	(a)		100,000
Selling, general and administrative		10,430,984			4,295,522			1,318,965			16,045,471			1,100,000	(b)		17,145,471
Management fees—related parties		1,052,670			173,031			79,784			1,305,485			(425,274)	(c)		880,211
Depreciation and amortization		2,578,297			966,090			333,365			3,877,752			653,046	(d)		4,530,798

Total operating expenses		26,381,636			10,434,778			2,611,130			39,427,544			1,427,772			40,855,316

Net Operating Income		2,804,552			1,105,582			672,909			4,583,043			(871,772	)		3,711,271

*Other Income (Expenses)*
Interest expense		(2,697,793	)		(1,317,473	)		(647,876	)		(4,663,142	)		2,494,824	(e)		(2,168,318	)
Interest expense-related party		—			—			(195,667	)		(195,667	)		195,667	(e)		—
Interest income		13,152			—			—			13,152			—			13,152
Gain(Loss) on disposal of asset		(2,313	)		—			—			(2,313	)		—			(2,313	)
Minority interest		77,809			—			—			77,809			(676,732)	(f)		(598,923	)
Other Income—net		—			—			(14,143	)		(14,143	)		—			(14,143	)

Total other income (expense)		(2,609,145	)		(1,317,473	)		(857,686	)		(4,784,304	)		2,013,759			(2,770,545	)

Net Income (Loss)	$	195,407		$	(211,891	)	$	(184,777	)	$	(201,261	)	$	1,141,987		$	940,726

*Earnings Per Share*
Basic and diluted																$	0.16
*Common shares outstanding*
Basic and diluted																	6,004,000

F-53

MHI HOSPITALITY CORPORATION

NOTES TO PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying unaudited Pro Forma Consolidated Statements of Operations for the six months period ended June 30, 2004 and the year ended December 31, 2003 are based upon the historical statements of operations of the MHI Hotels Services Group, adjusted to reflect the impact of the transactions described below.

The Pro Forma Consolidated Statements of Operations for the six months ended June 30, 2004 and the year ended December 31, 2003 assumes the following occurred on January 1, 2003:

•

Initial public offering of 6,000,000 shares of common stock at $10.00 per share with net proceeds of $54,600,000. Net proceeds from the offering will be contributed to MHI Hospitality, L.P. (the Operating Partnership) in exchange for units representing a 61.1% interest in the Operating Partnership;

•

Issuance of 3,817,036 units in exchange for 100% of the existing properties controlled by the MHI Hotels Services Group and 80% of the Hilton Philadelphia Airport. Of the 3,817,036 units, 732,254 will be exchanged for 80% of the Hilton Philadelphia Airport, 325,464 will be exchanged for the minority interest in the Hilton Savannah DeSoto and 377,903 will be exchanged for the minority interest in Capitol Hotel Associates, owner of the Hilton Wilmington Riverside and the Holiday Inn Downtown Williamsburg. The remaining 2,381,415 units be exchanged for 100% of the majority interest in the MHI Hotels Services Group;

•

Acquisition of the remaining 20% of the Hilton Philadelphia Airport will be exchanged for $1,848,700 in cash;

•

Acquisition of the leases for the common area of the Shell Island Resort for $3.5 million in cash;

•

Restructuring of the existing management agreements with MHI Hotels Services for five of the initial properties, the Hilton Savannah DeSoto, the Hilton Philadelphia Airport, the Hilton Wilmington Riverside, the Holiday Inn Brownstone and the Holiday Inn Downtown Williamsburg, for a fee of $2.0 million in cash;

•

Acquisition of the MAVAS interests in the Holiday Inn Brownstone for $2.0 million in cash, of which $1.0 million will be used to repay a construction loan, and 100 units;

•

Repayment of approximately $25.1 million in existing debt on the Holiday Inn Downtown Williamsburg, Hilton Philadelphia Airport and the Holiday Inn Brownstone from the proceeds of the offering;

•

Transaction and transfer costs of $6.4 million were netted from the proceeds;

•

An increase in general and administrative costs of approximately $1.1 million;

In the opinion of management, all material adjustments to reflect the effects of the preceding transactions have been made. The unaudited Pro Forma Consolidated Statements of Operations are presented for illustrative purposes only and are not necessarily indicative of what the actual results of operations would have been had the transactions described above occurred as of the beginning of each of the periods presented, nor does it purport to represent future results of operations.

Notes and Management Assumptions:

(a)

Reflects the initial annual revenue from the sub-leases on the Shell Island Resort of $640,000 with related lease expenses of $100,000 in 2003 and the termination of the Brass Duck restaurant lease located in the Maryland Inn in the amount of $84,000. For the six months ended June 30, 2004, the adjustments are half the 2003 totals.

F-54

MHI HOSPITALITY CORPORATION

(b)	Reflects the estimated increase in general and administrative costs of $1.1 million and includes salaries, office space, legal and accounting fees commensurate with the operations of MHI Hospitality Corporation.

(c)

Reflects the reduction of management fees for each hotel described in the table below to 2.0% of gross revenue down from 4.5% for Hilton Wilmington Riverside, 3.5% for Holiday Inn Downtown Williamsburg, 3.0% for Holiday Inn Brownstone and Hilton Savannah DeSoto and 2.5% for Maryland Inn. The Hilton Philadelphia Airport’s management fee increased from 1.5% to 2.0%.


Management Fee Adjustments:	Historic Year ended December 31, 2003		Pro Forma Year ended December 31, 2003			Historic Six months ended June 30, 2004		Pro Forma Six months ended June 30, 2004
Hilton Savannah Desoto	$	319,938	$	213,251		$	194,480	$	129,003
Capitol Hotels (Holiday Inn Downtown Williamsburg and Hilton Wilmington Riverside)		590,205		277,770			294,564		136,532
Hilton Philadelphia Airport		173,031		230,807			93,255		125,939
Maryland Inn		82,101		65,681			45,339		36,971
Holiday Inn Brownstone		142,528		95,020			76,080		50,720

Total management fees	$	1,307,803	$	882,529		$	703,718	$	479,166

Total			$	(425,274	)			$	(224,552	)

(d)

Reflects change in depreciation expense due to the acquisition of the minority interests in existing hotels, the acquisition of the Maryland Inn and Hilton Philadelphia Airport. Amortization expense is due to the amortization of the leases at Shell Island Resort and the management fee restructuring payment. The Shell Island lease purchase of $3.5 million is being amortized over nine years and the $2.0 million for the restructuring of the management agreements is being amortized over 10 years. The total amortization for the first nine years is $588,889 per year.


Depreciation Adjustments:	Year ended December 31, 2003			Six months ended June 30, 2004
Hilton Savannah DeSoto	$	91,346		$	45,673
Capitol Hotels (Holiday Inn Downtown Williamsburg and Hilton Wilmington Riverside)		103,537			51,768
Hilton Philadelphia Airport		(136.134	)		(68,067	)
Maryland Inn		(19,331	)		5,876
Holiday Inn Brownstone		24,739			12,370

Total	$	64,157		$	1,947


Amortization Adjustments:	Year ended December 31, 2003		Six months ended June 30, 2004
Shell Island Resort Leases	$	388,889	$	194,444
Management Fee Restructuring		200,000		100,000

Total	$	588,889	$	294,444

F-55

MHI HOSPITALITY CORPORATION

(e)	Reflects the following decrease in interest expense due to the reduction in existing debt with proceeds of the offering.


Interest Adjustments:	Year ended December 31, 2003			Six months ended June 30, 2004
Holiday Inn Downtown Williamsburg	$	(201,104	)	$	(90,215	)
Hilton Philadelphia Airport		(1,317,473	)		(646,967	)
Maryland Inn		(843,543	)		(417,129	)
Holiday Inn Brownstone		(328,371	)		(108,924	)

Total	$	(2,690,491	)	$	(1,263,235	)

(f)

Reflects the adjustment required to establish a minority interest of 38.9% which represents the units held by the majority owners’ of the initial hotels. Minority interest is calculated by multiplying the percentage of the units in the Operating Partnership not owned by MHI Hospitality Corporation (3,817,036 units or 38.9% of the total 9,821,036 units) by the equity balance of the Operating Partnership.

F-56

6,000,000 Shares

LOGO

MHI

HOSPITALITY

CORPORATION

Common Stock

PROSPECTUS

BB&T CAPITAL MARKETS

, 2004

PART II. INFORMATION NOT REQUIRED IN PROSPECTUS

Item 31. Other Expenses of Issuance and Distribution.

The following table sets forth the costs and expenses of the sale and distribution of the securities being registered (assuming no exercise of the underwriter’s over-allotment option), all of which are being borne by the Registrant.


Securities and Exchange Commission registration fee	$	9,617

NASD filing fee		8,090
AMEX listing fee		50,000

Printing and engraving fees		100,000
Legal fees and expenses		650,000
Accounting fees and expenses		220,000
Blue sky fees and expenses		5,000
Transfer Agent and Registrar fees		5,000
Advisory fee		550,000
Miscellaneous		202,293

Total	$	1,800,000

To be filed by amendment.

All expenses, except the Securities and Exchange Commission registration fee and the NASD filing fee, are estimated.

Item 32. Sales To Special Parties.

Except for the sale of 100 shares to Andrew Sims, our chairman, president and chief executive officer, at an aggregate price of 1,000 in connection with the Registrant’s formation in August 2004, there have been no sales of unregistered securities by the Registrant in the last six months. These 100 shares will be redeemed for the same price as the purchase price immediately prior to the completion of the Registrant’s initial public offering. These shares were sold in accordance with the exemption from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.

Item 33. Recent Sales of Unregistered Securities.

Except for the sale of 100 shares to Andrew Sims, our chairman, president and chief executive officer, at an aggregate price of $1,000 in connection with the Registrant’s formation in August 2004, there have been no sales of unregistered securities by the Registrant in the last three years. These 100 shares will be redeemed for the same price as the purchase price immediately prior to the completion of the Registrant’s initial public offering. These shares were sold in accordance with the exemption from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.

Item 34. Indemnification of Directors and Officers.

The Maryland General Corporation 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 or deliberate dishonesty established by a final judgment as being material to the cause of action. Our charter contains a provision which limits the liability of our directors and officers to the maximum extent permitted by Maryland law.

II-1

Our charter permits us, to the maximum extent permitted by Maryland law, to indemnify and to pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (a) any present or former director or officer or (b) any individual who, while a director and at our request, serves or has served another real estate investment trust, corporation, partnership, joint venture, trust, employee benefit plan or any other enterprise as a trustee, director, officer or partner of such real estate investment trust, corporation, partnership, joint venture, trust, employee benefit plan or other enterprise from and against any claim or liability to which such person may become subject or which such person may incur by reason of his status as a present or former director or officer of our company. Our bylaws obligate us, to the maximum extent permitted by Maryland law, to indemnify and to pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (a) any present or former director who is made a party to the proceeding by reason of his service in that capacity or (b) any individual who, while a trustee or officer of our company and at our request, serves or has served another real estate investment trust, corporation, partnership, joint venture, trust, employee benefit plan or other enterprise and who is made a party to the proceeding by reason of his service in that capacity, against any claim or liability to which he may become subject by reason of such status. Our charter and bylaws also permit us to indemnify and advance expenses to any person who served a predecessor of our company in any of the capacities described above and to any employee or agent of our company or a predecessor of our company. Maryland law requires us to indemnify a director or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he is made a party by reason of his service in that capacity.

The Maryland General Corporation Law permits a Maryland corporation to indemnify and advance expenses to its directors, officers, employees and agents. The Maryland General Corporation 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 a party by reason of their service in those or other capacities unless it is established that (a) the act or omission if the director or officer was material to the matter giving rise to the proceeding and (i) was committed in bad faith or (ii) was a 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 has reasonable cause to believe that the act or omission was unlawful. However, a Maryland corporation may not indemnify for an adverse judgment in a suit by or in the right if the corporation or if the director or officer was adjudged to be liable for an improper personal benefit. In accordance with the Maryland General Corporation Law and our bylaws, our bylaws require us, as a condition to advancing expenses, to obtain (a) a written affirmation by the director or officer of his good faith belief that he has met the standard of conduct necessary for indemnification and (b) a written statement by or on his behalf to repay the amount paid or reimbursed by us if it shall ultimately be 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 the Registration Statement.

(b) Exhibits. The following exhibits are filed as part of, or incorporated by reference into, this registration statement on Form S-11:


Exhibits
1.1*		Form of Underwriting Agreement by and among MHI Hospitality Corporation, MHI Hospitality, L.P. and BB&T Capital Markets and the Underwriters named herein.
3.1		Articles of Amendment and Restatement of MHI Hospitality Corporation.
3.2		Bylaws of MHI Hospitality Corporation.
3.3*		Form of Amended and Restated Agreement of Limited Partnership of MHI Hospitality, L.P.
5.1*		Opinion of Baker & McKenzie LLP, with respect to the legality of the shares being registered.
8.1*		Tax Opinion of Baker & McKenzie LLP.
10.1*		MHI Hospitality Corporation 2004 Omnibus Stock Incentive Plan.
10.2*		Form of Executive Employment Agreement between MHI Hospitality Corporation and Andrew M. Sims.
10.3*		Form of Executive Employment Agreement between MHI Hospitality Corporation and William J. Zaiser.
10.4		Form of Strategic Alliance Agreement dated , 2004 between MHI Hospitality Corporation, MHI Hospitality, L.P. and MHI Hotels Services LLC.
10.5*		Form of Master Management Agreement with MHI Hotels Services LLC.
10.6		Contribution Agreement dated August 23, 2004 by and between the owners of Capitol Hotel Associates L.P., L.L.P. and MHI Hospitality, L.P.
10.7		Contribution Agreement dated August 23, 2004 by and between the owners of Savannah Hotel Associates LLC and MHI Hospitality, L.P.
10.8		Contribution Agreement dated August 23, 2004 by and between KDCA Partnership, MAVAS LLC, and MHI Hospitality, L.P.
10.9		Contribution Agreement dated September 8, 2004 by and between Elpizo Limited Partnership, Phileo Land Corporation and MHI Hospitality, L.P.
10.10		Asset Purchase Agreement dated August 19, 2004 by and between Accord LLC, West Laurel Corporation and MHI Hotels Services, LLC.
10.11*		Lease Assignment Agreement dated , 2004 by and between MHI Hospitality L.P. and MHI Hotels, LLC.
10.12*		Lease Assignment Agreement dated , 2004 by and between MHI Hospitality L.P. and MHI Hotels Two, Inc.
10.13		Form of Lease Agreement with MHI Hospitality TRS, LLC.
21*		List of Subsidiaries of MHI Hospitality Corporation.
23.1		Witt Mares & Company, PLC Consent.
23.2*		Baker & McKenzie LLP Consent (included in Exhibits 5.1 and 8.1).
23.3†		Smith Travel Research Consent.
24.1*		Power of Attorney.
99.1†		Consent of Kim E. Sims to being named as a director nominee.
99.2†		Consent of Christopher L. Sims to being named as a director nominee.
99.3†		Consent of Edward S. Stein to being named as a director nominee.
99.4†		Consent of David J. Beatty to being named as a director nominee.
99.5†		Consent of J. Paul Carey to being named as a director nominee.
99.6		Consent of General Anthony C. Zinni (USMC Ret.) to being named as a director nominee.

*	To be filed by amendment.

†	Previously filed.

II-3

Item 37. Undertakings.

(a) The undersigned registrant hereby undertakes to provide to the underwriters at the closing specified in the underwriting agreements certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser.

(b) Insofar as indemnification for liabilities arising under the Securities Act of 1933, as amended, may be permitted to trustees, officers or controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933, as amended, 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 the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933, as amended, and will be governed by the final adjudication of such issue.

(1) For purposes of determining any liability under the Securities Act of 1933, as amended, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a 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 part of this registration statement as of the time it was declared effective.

(2) For the purpose of determining any liability under the Securities Act of 1933, as amended, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered herein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, as amended, the undersigned 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 Pre-Effective Amendment No. 1 to this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Williamsburg, Commonwealth of Virginia on the 19th day of October, 2004.


MHI HOSPITALITY CORPORATION

By:		/s/ Andrew M. Sims
		Andrew M. Sims President and Chief Executive Officer

Pursuant to the requirements of the Securities Act of 1933, as amended, this registration statement has been signed by the following persons in the capacities and on the dates indicated.




By:	/s/ William J. Zaiser	By:	/s/ Andrew M. Sims
	William J. Zaiser Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)		Andrew M. Sims President, Chief Executive Officer and Chairman of the Board (Principal Executive Officer)

II-4

EXHIBIT 3.1

MHI HOSPITALITY CORPORATION

ARTICLES OF AMENDMENT AND RESTATEMENT

FIRST : MHI Hospitality Corporation, a Maryland corporation (the “Corporation”), desires to amend and restate its charter as currently in effect and as hereinafter amended.

SECOND : The following provisions are all the provisions of the charter currently in effect and as hereinafter amended:

ARTICLE I

INCORPORATION

The undersigned, Andrew M. Sims, whose address is 6411 Ivy Lane, Suite 510, Greenbelt, Maryland 20770, being at least eighteen (18) years of age, does hereby form a corporation under the general laws of the State of Maryland.

ARTICLE II

NAME

The name of the corporation (which is hereinafter called the “Corporation”) is:

MHI Hospitality Corporation

ARTICLE III

PURPOSE

The purposes for which the Corporation is formed are to engage in any lawful act or activity (including, without limitation or obligation, engaging in business as a real estate investment trust under the Internal Revenue Code of 1986, as amended, or any successor statute (the “Code”)) for which corporations may be organized under the general laws of the State of Maryland as now or hereafter in force. For purposes of these Articles, “REIT” means a real estate investment trust under Sections 856 through 860 of the Code.

ARTICLE IV

RESIDENT AGENT AND PRINCIPAL OFFICE IN MARYLAND

The address of the principal office of the Corporation in this State is c/o The Corporation Trust Incorporated, 300 East Lombard Street, Baltimore, Maryland 21202. The name and address of the resident agent of the Corporation are The Corporation Trust

Incorporated, 300 East Lombard Street, Baltimore, Maryland 21202. The resident agent is a Maryland corporation.

ARTICLE V

PROVISIONS FOR DEFINING, LIMITING

AND REGULATING CERTAIN POWERS OF THE

CORPORATION AND OF THE STOCKHOLDERS AND DIRECTORS

Section 5.1 Number of Directors . The business and affairs of the Corporation shall be managed under the direction of the Board of Directors. The initial number of directors of the Corporation shall be one (1), which number may be increased or decreased pursuant to the Bylaws of the Corporation (the “Bylaws”), but shall never be less than the minimum number required by the Maryland General Corporation Law (the “MGCL”). The name of the director who shall serve until the first annual meeting of stockholders and until his successor is duly elected and qualify is:

Andrew M. Sims

This director may increase the number of directors and may fill any vacancy, whether resulting from an increase in the number of directors or otherwise, on the Board of Directors occurring before the first annual meeting of stockholders in the manner provided in the Bylaws.

The Corporation elects, at such time as it becomes eligible to make the election provided for under Section 3-802(b) of the MGCL, that, except as may be provided by the Board of Directors in setting the terms of any class or series, any and all vacancies on the Board of Directors may be filled only by the affirmative vote of a majority of the remaining directors in office, even if the remaining directors do not constitute a quorum, and any director elected to fill a vacancy shall serve for the remainder of the full term of the directorship in which such vacancy occurred.

Section 5.2 Extraordinary Actions . Except as specifically provided in Section 5.8 (relating to removal of directors) and in Article VIII, notwithstanding any provision of law permitting or requiring any action to be taken or approved by the affirmative vote of the holders of shares entitled to cast a greater number of votes, any such action shall be effective and valid if taken or approved by the affirmative vote of holders of shares entitled to cast a majority of all the votes entitled to be cast on the matter.

Section 5.3 Authorization by Board of Stock Issuance . The Board of Directors may authorize the issuance from time to time of shares of stock of the Corporation of any class or series, whether now or hereafter authorized, or securities or rights convertible into shares of its stock of any class or series, whether now or hereafter authorized, for such consideration as the Board of Directors may deem advisable (or without consideration in the case of a stock split or stock dividend), subject to such

restrictions or limitations, if any, as may be set forth in the articles of incorporation of the Corporation (the “Charter”) or the Bylaws.

Section 5.4 Preemptive Rights and Appraisal Rights . Except as may be provided by the Board of Directors in setting the terms of classified or reclassified shares of stock pursuant to Section 6.4 or as may otherwise be provided by contract, no holder of shares of stock of the Corporation shall, as such holder, have any preemptive right to purchase or subscribe for any additional shares of stock of the Corporation or any other security of the Corporation which it may issue or sell. Holders of shares of stock shall not be entitled to exercise any rights of an objecting stockholder provided for under Title 3, Subtitle 2 of the MGCL unless the Board of Directors, upon the affirmative vote of a majority of the entire Board of Directors, shall determine that such rights apply, with respect to all or any classes or series of stock, to a particular transaction or all transactions occurring after the date of such determination in connection with which holders of such shares would otherwise be entitled to exercise such rights.

Section 5.5 Indemnification . The Corporation shall have the power, to the maximum extent permitted by Maryland law in effect from time to time, to obligate itself to indemnify, and to pay or reimburse reasonable expenses in advance of final disposition of a proceeding to, (a) any individual who is a present or former director or officer of the Corporation or (b) any individual who, while a director of the Corporation and at the request of the Corporation, serves or has served as a director, officer, partner or trustee of another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or any other enterprise from and against any claim or liability to which such person may become subject or which such person may incur by reason of his status as a present or former director or officer of the Corporation. The Corporation shall have the power, with the approval of the Board of Directors, to provide such indemnification and reimbursement of reasonable expenses in advance of final disposition of a proceeding to a person who served a predecessor of the Corporation in any of the capacities described in (a) or (b) above and to any employee or agent of the Corporation or a predecessor of the Corporation.

Section 5.6 Determinations by Board . The determination as to any of the following matters, made in good faith by or pursuant to the direction of the Board of Directors consistent with the Charter and in the absence of actual receipt of an improper benefit in money, property or services or active and deliberate dishonesty established by a court, shall be final and conclusive and shall be binding upon the Corporation and every holder of shares of its stock: the amount of the net income of the Corporation for any period and the amount of assets at any time legally available for the payment of dividends, redemption of its stock or the payment of other distributions on its stock; the amount of paid-in surplus, net assets, other surplus, annual or other net profit, net assets in excess of capital, undivided profits or excess of profits over losses on sales of assets; the amount, purpose, time of creation, increase or decrease, alteration or cancellation of any reserves or charges and the propriety thereof (whether or not any obligation or liability for which such reserves or charges shall have been created shall have been paid or discharged); the fair value, or any sale, bid or asked price to be applied in determining

the fair value, of any asset owned or held by the Corporation; any matter relating to the acquisition, holding and disposition of any assets by the Corporation; or any other matter relating to the business and affairs of the Corporation.

Section 5.7 REIT Qualification . If the Board of Directors determines that it is no longer in the best interests of the Corporation to continue to be qualified as a REIT, the Board of Directors may revoke or otherwise terminate the Corporation’s REIT election pursuant to Section 856(g) of the Code. The Board of Directors also may determine that compliance with any restriction or limitation on stock ownership and transfers set forth in Article VII is no longer required for REIT qualification.

Section 5.8 Removal of Directors . Subject to the rights of holders of one or more classes or series of Preferred Stock to elect or remove one or more directors, any director, or the entire Board of Directors, may be removed from office at any time but only by the affirmative vote of at least two-thirds of the votes entitled to be cast generally in the election of directors.

ARTICLE VI

STOCK

Section 6.1 Authorized Shares . The Corporation has authority to issue 50,000,000 shares of stock, consisting of 49,000,000 shares of Common Stock, $0.01 par value per share (“Common Stock”), and 1,000,000 shares of Preferred Stock, $0.01 par value per share (“Preferred Stock”). The aggregate par value of all authorized shares of stock having par value is $500,000. If shares of one class of stock are classified or reclassified into shares of another class of stock pursuant to this Article VI, the number of authorized shares of the former class shall be automatically decreased and the number of shares of the latter class shall be automatically increased, in each case by the number of shares so classified or reclassified, so that the aggregate number of shares of stock of all classes that the Corporation has authority to issue shall not be more than the total number of shares of stock set forth in the first sentence of this paragraph. To the extent permitted by Maryland law, the Board of Directors, without any action by the stockholders of the Corporation, may amend the Charter from time to time to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that the Corporation has authority to issue.

Section 6.2 Common Stock . Subject to the provisions of Article VII, each share of Common Stock shall entitle the holder thereof to one vote. The Board of Directors may reclassify any unissued shares of Common Stock from time to time in one or more classes or series of stock.

Section 6.3 Preferred Stock . The Board of Directors may classify any unissued shares of Preferred Stock and reclassify any previously classified but unissued shares of Preferred Stock of any series from time to time, in one or more classes or series of stock.

Section 6.4 Classified or Reclassified Shares . Prior to issuance of classified or reclassified shares of any class or series, the Board of Directors by resolution shall: (a) designate that class or series to distinguish it from all other classes and series of stock of the Corporation; (b) specify the number of shares to be included in the class or series; (c) set or change, subject to the provisions of Article VII and subject to the express terms of any class or series of stock of the Corporation outstanding at the time, the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms and conditions of redemption for each class or series; and (d) cause the Corporation to file articles supplementary with the State Department of Assessments and Taxation of Maryland (“SDAT”). Any of the terms of any class or series of stock set or changed pursuant to clause (c) of this Section 6.4 may be made dependent upon facts or events ascertainable outside the Charter (including determinations by the Board of Directors or other facts or events within the control of the Corporation) and may vary among holders thereof, provided that the manner in which such facts, events or variations shall operate upon the terms of such class or series of stock is clearly and expressly set forth in the articles supplementary filed with the SDAT.

Section 6.5 Charter and Bylaws . All persons who shall acquire stock in the Corporation shall acquire the same subject to the provisions of the Charter and the Bylaws.

ARTICLE VII

RESTRICTION ON TRANSFER AND OWNERSHIP OF SHARES

Section 7.1 Definitions . For the purpose of this Article VII, the following terms shall have the following meanings:

Aggregate Stock Ownership Limit . The term “Aggregate Stock Ownership Limit” shall mean not more than nine and nine-tenths percent (9.9%) in value of the aggregate of the outstanding shares of Capital Stock. The value of the outstanding shares of Capital Stock shall be determined by the Board of Directors of the Corporation in good faith, which determination shall be conclusive for all purposes hereof.

AMEX . The term “AMEX” shall mean the American Stock Exchange.

Beneficial Ownership . The term “Beneficial Ownership” shall mean ownership of Capital Stock by a Person, whether the interest in the shares of Capital Stock is held directly or indirectly (including by a nominee), and shall include interests that would be treated as owned through the application of Section 544 of the Code, as modified by Section 856(h)(1)(B) of the Code. The terms “Beneficial Owner,” “Beneficially Owns” and “Beneficially Owned” shall have the correlative meanings.

Business Day . The term “Business Day” shall mean any day, other than a Saturday or Sunday, that is neither a legal holiday nor a day on which banking

institutions in New York City are authorized or required by law, regulation or executive order to close.

Capital Stock . The term “Capital Stock” shall mean all classes or series of stock of the Corporation, including, without limitation, Common Stock and Preferred Stock.

Charitable Beneficiary . The term “Charitable Beneficiary” shall mean one or more beneficiaries of the Trust as determined pursuant to Section 7.3.6, provided that each such organization must be described in Section 501(c)(3) of the Code and contributions to each such organization must be eligible for deduction under one of Sections 170(b)(1)(A), 2055 and 2522 of the Code.

Charitable Trust . The term “Charitable Trust” shall mean any trust provided for in Section 7.3.1.

Charter . The term “Charter” shall mean the Charter of the Corporation, as such term is defined in the MGCL.

Code . The term “Code” shall mean the Internal Revenue Code of 1986, as amended from time to time.

Common Stock Ownership Limit . The term “Common Stock Ownership Limit” shall mean not more than nine and nine-tenths percent (9.9%) of the aggregate number of the outstanding shares of Common Stock of the Corporation excluding any outstanding shares of Common Stock not treated as outstanding for federal income tax purposes. The number of outstanding shares of Common Stock of the Corporation shall be determined by the Board of Directors of the Corporation in good faith, which determination shall be conclusive for all purposes hereof.

Constructive Ownership . The term “Constructive Ownership” shall mean ownership of Capital Stock by a Person, whether the interest in the shares of Capital Stock is held directly or indirectly (including by a nominee), and shall include interests that would be treated as owned through the application of Section 318(a) of the Code, as modified by Section 856(d)(5) of the Code. The terms “Constructive Owner,” “Constructively Owns” and “Constructively Owned” shall have the correlative meanings.

Excepted Holder . The term “Excepted Holder” shall mean a stockholder of the Corporation for whom an Excepted Holder Limit is created by the Charter or by the Board of Directors pursuant to Section 7.2.6.

Excepted Holder Limit . The term “Excepted Holder Limit” shall mean, provided that the affected Excepted Holder agrees to comply with the requirements established by the Board of Directors pursuant to Section 7.2.6, and subject to adjustment pursuant to Section 7.2.7, the percentage limit established by the Board of Directors pursuant to Section 7.2.6.

Initial Date . The term “Initial Date” shall mean the date of issuance of Common Stock pursuant to the initial underwritten public offering of Common Stock.

Market Price . The term “Market Price” on any date shall mean, with respect to any class or series of outstanding shares of Capital Stock, the Closing Price for such Capital Stock on such date. The “Closing Price” on any date shall mean the last reported sale price for such Capital Stock, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, for such Capital Stock, in either case as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the AMEX or, if such Capital Stock is not listed or admitted to trading on theAMEX, as reported on the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which such Capital Stock is listed or admitted to trading or, if such Capital Stock is not listed or admitted to trading on any national securities exchange, the last quoted price, or, if not so quoted, the average of the high bid and low asked prices in the over-the-counter market, as reported by the National Association of Securities Dealers, Inc. Automated Quotation System or, if such system is no longer in use, the principal other automated quotation system that may then be in use or, if such Capital Stock is not quoted by any such organization, the average of the closing bid and asked prices as furnished by a professional market maker making a market in such Capital Stock selected by the Board of Directors of the Corporation or, in the event that no trading price is available for such Capital Stock, the fair market value of the Capital Stock, as determined in good faith by the Board of Directors of the Corporation.

Person . The term “Person” shall mean an individual, corporation, partnership, estate, trust (including a trust qualified under Sections 401(a) or 501(c)(17) of the Code), a portion of a trust permanently set aside for or to be used exclusively for the purposes described in Section 642(c) of the Code, association, private foundation within the meaning of Section 509(a) of the Code, joint stock company or other entity and also includes a “group” as that term is used for purposes of Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, and a group to which an Excepted Holder Limit applies.

Prohibited Owner . The term “Prohibited Owner” shall mean, with respect to any purported Transfer, any Person who, but for the provisions of Section 7.2.1, would Beneficially Own or Constructively Own shares of Capital Stock in violation of the provisions of Section 7.2.1(a), and if appropriate in the context, shall also mean any Person who would have been the record owner of the shares of Capital Stock that the Prohibited Owner would have so owned.

REIT . The term “REIT” shall mean a real estate investment trust within the meaning of Section 856 of the Code.

Restriction Termination Date . The term “Restriction Termination Date” shall mean the first day after the Initial Date on which the Board of Directors of the Corporation determines that it is no longer in the best interests of the Corporation to

attempt to, or continue to, qualify as a REIT or that compliance with the restrictions and limitations on Beneficial Ownership, Constructive Ownership and Transfers of shares of Capital Stock set forth herein is no longer required in order for the Corporation to qualify as a REIT.

Transfer . The term “Transfer” shall mean any issuance, sale, transfer, gift, assignment, devise or other disposition, as well as any other event that causes any Person to acquire Beneficial Ownership or Constructive Ownership, or any agreement to take any such actions or cause any such events, of Capital Stock or the right to vote or receive dividends on Capital Stock, including (a) the granting or exercise of any option (or any disposition of any option), (b) any disposition of any securities or rights convertible into or exchangeable for Capital Stock or any interest in Capital Stock or any exercise of any such conversion or exchange right and (c) Transfers of interests in other entities that result in changes in Beneficial or Constructive Ownership of Capital Stock; in each case, whether voluntary or involuntary, whether owned of record, Constructively Owned or Beneficially Owned and whether by operation of law or otherwise. The terms “Transferring” and “Transferred” shall have the correlative meanings.

Trustee . The term “Trustee” shall mean the Person unaffiliated with the Corporation and a Prohibited Owner, that is appointed by the Corporation to serve as trustee of the Charitable Trust.

Section 7.2 Capital Stock .

Section 7.2.1 Ownership Limitations . During the period commencing on the Initial Date and prior to the Restriction Termination Date:

(a) Basic Restrictions .

(i) (1) No Person, other than an Excepted Holder, shall Beneficially Own or Constructively Own shares of Capital Stock in excess of the Aggregate Stock Ownership Limit, (2) no Person, other than an Excepted Holder, shall Beneficially Own or Constructively Own shares of Common Stock in excess of the Common Stock Ownership Limit and (3) no Excepted Holder shall Beneficially Own or Constructively Own shares of Capital Stock in excess of the Excepted Holder Limit for such Excepted Holder.

(ii) Except as provided in Section 7.2.6 hereof, no Person shall Beneficially Own shares of Capital Stock to the extent that such Beneficial Ownership of Capital Stock would result in the Corporation being “closely held” within the meaning of Section 856(h) of the Code (without regard to whether the ownership interest is held during the last half of a taxable year).

(iii) Except as provided in Section 7.2.6 hereof, notwithstanding any other provisions contained herein, no person shall Transfer shares of Capital Stock (whether or not such Transfer is the result of a transaction entered into

through the facilities of the AMEX or any other national securities exchange or automated inter-dealer quotation system) to the extent such transfer would result in the Capital Stock being beneficially owned by less than one hundred (100) Persons (determined under the principles of Section 856(a)(5) of the Code).

(iv) Except as provided in Section 7.2.6 hereof, no person shall Beneficially or Constructively Own shares of Capital Stock to the extent such Beneficial or Constructive Ownership would cause the Corporation to Constructively Own ten percent (10%) or more of the ownership interests in a tenant of the Corporation’s real property, within the meaning of Section 856(d)(2)(B) of the Code (if the effect of such ownership would be to cause the Company to fail to qualify as a REIT).

(v) Except as provided in Section 7.2.6 hereof, notwithstanding any other provisions contained herein, no person shall Constructively Own shares of Capital Stock to the extent such Constructive Ownership would cause any “eligible independent contractor” that operates a “qualified lodging facility” on behalf of a “taxable REIT subsidiary” of the Corporation (as such terms are defined in Section 856(d)(9)(A), Section 856(d)(9)(D) and Section 856(l) of the Code, respectively) to fail to qualify as such.

(b) Transfer in Trust . If any Transfer of shares of Capital Stock (whether or not such Transfer is the result of a transaction entered into through the facilities of the AMEX or any other national securities exchange or automated inter-dealer quotation system) occurs which, if effective, would result in any Person Beneficially Owning or Constructively Owning shares of Capital Stock in violation of Section 7.2.1(a)(i), (ii), (iii), (iv), or (v),

(i) then that number of shares of the Capital Stock the Beneficial or Constructive Ownership of which otherwise would cause such Person to violate Section 7.2.1(a)(i), (ii), (iii), (iv) or (v) (rounded to the nearest whole share) shall be automatically transferred to a Charitable Trust for the benefit of a Charitable Beneficiary, as described in Section 7.3, effective as of the close of business on the Business Day prior to the date of such Transfer, and such Person shall acquire no rights in such shares of Capital Stock; or

(ii) if the transfer to the Trust described in clause (i) of this sentence would not be effective for any reason to prevent the violation of Section 7.2.1(a)(i), (ii), (iii), (iv) or (v) then the Transfer of that number of shares of Capital Stock that otherwise would cause any Person to violate Section 7.2.1(a)(i), (ii), (iii), (iv) or (v) shall be void ab initio , and the intended transferee shall acquire no rights in such shares of Capital Stock.

Section 7.2.2 Remedies for Breach . If the Board of Directors of the Corporation or any duly authorized committee thereof or other designees if permitted by

the MGCL shall at any time determine in good faith that a Transfer or other event has taken place that results in a violation of Section 7.2.1 or that a Person intends to acquire or has attempted to acquire Beneficial or Constructive Ownership of any shares of Capital Stock in violation of Section 7.2.1 (whether or not such violation is intended), the Board of Directors or a committee thereof or other designees if permitted by the MGCL shall take such action as it deems advisable to refuse to give effect to or to prevent such Transfer or other event, including, without limitation, causing the Corporation to redeem shares of Capital Stock, refusing to give effect to such Transfer on the books of the Corporation or instituting proceedings to enjoin such Transfer or other event; provided , however , that any Transfers or attempted Transfers or other events in violation of Section 7.2.1 shall automatically result in the transfer to the Charitable Trust described above, and, where applicable, such Transfer (or other event) shall be void ab initio as provided above irrespective of any action (or non-action) by the Board of Directors or a committee thereof.

Section 7.2.3 Notice of Restricted Transfer . Any Person who acquires or attempts or intends to acquire Beneficial Ownership or Constructive Ownership of shares of Capital Stock that will or may violate Section 7.2.1(a) or any Person who would have owned shares of Capital Stock that resulted in a transfer to the Charitable Trust pursuant to the provisions of Section 7.2.1(b) shall immediately give written notice to the Corporation of such event, or in the case of such a proposed or attempted transaction, give at least fifteen (15) days prior written notice, and shall provide to the Corporation such other information as the Corporation may request in order to determine the effect, if any, of such Transfer on the Corporation’s status as a REIT.

Section 7.2.4 Owners Required To Provide Information . From the Initial Date and prior to the Restriction Termination Date:

(a) Every owner of more than five percent (5%) (or such lower percentage as required by the Code or the Treasury Regulations promulgated thereunder) of the outstanding shares of Capital Stock, within thirty (30) days after the end of each taxable year, shall give written notice to the Corporation stating the name and address of such owner, the number of shares of Capital Stock Beneficially Owned and a description of the manner in which such shares are held. Each such owner shall provide to the Corporation such additional information as the Corporation may request in order to determine the effect, if any, of such Beneficial Ownership on the Corporation’s status as a REIT and to ensure compliance with the Aggregate Stock Ownership Limit and the Common Stock Ownership Limit; and

(b) Each Person who is a Beneficial or Constructive Owner of Capital Stock and each Person (including the stockholder of record) who is holding Capital Stock for a Beneficial or Constructive Owner shall provide to the Corporation such information as the Corporation may request, in good faith, in order to determine the Corporation’s status as a REIT and to comply with requirements of any taxing authority or governmental authority or to determine such compliance and to ensure compliance with the Aggregate Stock Ownership Limit and the Common Stock Ownership Limit.

Section 7.2.5 Remedies Not Limited . Subject to Section 5.7 of the Charter, nothing contained in this Section 7.2 shall limit the authority of the Board of Directors of the Corporation to take such other action as it deems necessary or advisable to protect the Corporation and the interests of its stockholders in preserving the Corporation’s status as a REIT.

Section 7.2.6 Exceptions .

(a) The Board of Directors of the Corporation, in its sole discretion, may exempt a Person from the Aggregate Stock Ownership Limit, the Common Stock Ownership Limit and/or the restrictions contained in Section 7.2.1(a)(ii), (iii), or (iv), as the case may be, and may establish or increase an Excepted Holder Limit for such Person if the Board of Directors obtains such representations, covenants and undertakings as the Board of Directors may deem appropriate in order to conclude that granting the exemption and/or establishing or increasing the Excepted Holder Limit, as the case may be, will not cause the Corporation to lose its status as a REIT.

(b) Prior to granting any exception pursuant to Section 7.2.6(a), the Board of Directors of the Corporation may require a ruling from the Internal Revenue Service, or an opinion of counsel, in either case in form and substance satisfactory to the Board of Directors in its sole discretion, as it may deem necessary or advisable in order to determine or ensure the Corporation’s status as a REIT. Notwithstanding the receipt of any ruling or opinion, the Board of Directors may impose such conditions or restrictions as it deems appropriate in connection with granting such exception.

(c) Subject to Section 7.2.1.(a)(ii), an underwriter, placement agent or initial purchaser in a Rule 144A transaction that participates in a public offering or a private placement of Capital Stock (or securities convertible into or exchangeable for Capital Stock) may Beneficially Own or Constructively Own shares of Capital Stock (or securities convertible into or exchangeable for Capital Stock) in excess of the Aggregate Stock Ownership Limit, the Common Stock Ownership Limit, or both such limits, but only to the extent necessary to facilitate such public offering or private placement or immediate resale of such Capital Stock in a Rule 144A transaction and provided that the restrictions contained in Section 7.2.1(a) will not be violated following the distribution by such underwriter, placement agent or initial purchaser of such shares of Capital Stock.

Section 7.2.7 Change in Aggregate Stock Ownership and Common Stock Ownership Limits. The Board of Directors may from time to time increase or decrease the Common Stock Ownership Limit, the Aggregate Stock Ownership Limit, or an Excepted Holder Limit.

Section 7.2.8 Legend . Each certificate for shares of Capital Stock shall bear a legend in substantially the following form:

The shares represented by this certificate are subject to restrictions on Beneficial and Constructive Ownership and Transfer. 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 nine and nine-tenths percent (9.9%) 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 nine and nine-tenths percent (9.9%) 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 Internal Revenue Code of 1986, as amended (the “Code”) or otherwise cause the Corporation to fail to qualify as a REIT; (iv) no Person may Transfer Capital Stock to the extent such transfer would result in the Capital Stock of the Corporation being beneficially owned by fewer than one hundred (100) Persons (determined without reference to any rules of attribution), (v) no person may Constructively Own shares of Capital Stock that would cause the Corporation to Constructively Own ten percent (10%) or more of the ownership interests in a tenant of the Corporation’s real property, with the meaning of Section 856(d)(2)(B) of the Code and (vi) no person shall Constructively Own shares of Capital Stock to the extent such Constructive Ownership would cause any “eligible independent contractor” that operates a “qualified lodging facility” on behalf of a “taxable REIT subsidiary” of the Corporation (as such terms are defined in Section 856(d)(9)(A), Section 856(d)(9)(D) and Section 856(l) of the Code, respectively) to fail to qualify as such. 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 Charitable Trust for the benefit of one or more Charitable Beneficiaries. In addition, upon the occurrence of certain events, attempted Transfers in violation of the restrictions described above may be void abinitio . 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.

Instead of the foregoing legend, the certificate may state that the Corporation will furnish a full statement about certain restrictions on transferability to a stockholder on request and without charge.

Section 7.3 Transfer of Capital Stock in Trust.

Section 7.3.1 Ownership in Trust . Upon any purported Transfer or other event described in Section 7.2.1(b) that would result in a transfer of shares of

Capital Stock to a Charitable Trust, such shares of Capital Stock shall be deemed to have been transferred to the Trustee as trustee for the exclusive benefit of one or more Charitable Beneficiaries. Such transfer to the Trustee shall be deemed to be effective as of the close of business on the Business Day prior to the purported Transfer or other event that results in the transfer to the Charitable Trust pursuant to Section 7.2.1(b). The Trustee shall be appointed by the Corporation and shall be a Person unaffiliated with the Corporation and any Prohibited Owner. Each Charitable Beneficiary shall be designated by the Corporation as provided in Section 7.3.6.

Section 7.3.2 Status of Shares Held by the Trustee . Shares of Capital Stock held by the Trustee shall be issued and outstanding shares of Capital Stock of the Corporation. The Prohibited Owner shall have no rights in the Capital Stock held by the Trustee. The Prohibited Owner shall not benefit economically from ownership of any shares held in trust by the Trustee, shall have no rights to dividends or other distributions and shall not possess any rights to vote or other rights attributable to the shares held in the Trust.

Section 7.3.3 Dividend and Voting Rights . The Trustee shall have all voting rights and rights to dividends or other distributions with respect to shares of Capital Stock held in the Charitable Trust, which rights shall be exercised for the exclusive benefit of the Charitable Beneficiary. Any dividend or other distribution paid to a Prohibited Owner prior to the discovery by the Corporation that the shares of Capital Stock have been transferred to the Trustee shall be paid with respect to such shares of Capital Stock by the Prohibited Owner to the Trustee upon demand and any dividend or other distribution authorized but unpaid shall be paid when due to the Trustee. Any dividends or distributions so paid over to the Trustee shall be held in trust for the Charitable Beneficiary. The Prohibited Owner shall have no voting rights with respect to shares held in the Charitable Trust and, subject to Maryland law, effective as of the date that the shares of Capital Stock have been transferred to the Trustee, the Trustee shall have the authority (at the Trustee’s sole discretion) (i) to rescind as void any vote cast by a Prohibited Owner prior to the discovery by the Corporation that the shares of Capital Stock have been transferred to the Trustee and (ii) to recast such vote in accordance with the desires of the Trustee acting for the benefit of the Charitable Beneficiary; provided , however , that if the Corporation has already taken irreversible corporate action, then the Trustee shall not have the authority to rescind and recast such vote. Notwithstanding the provisions of this Article VII, until the Corporation has received notification that shares of Capital Stock have been transferred into a Charitable Trust, the Corporation shall be entitled to rely on its share transfer and other stockholder records for purposes of preparing lists of stockholders entitled to vote at meetings, determining the validity and authority of proxies and otherwise conducting votes of stockholders.

Section 7.3.4 Sale of Shares by Trustee . Within twenty (20) days of receiving notice from the Corporation that shares of Capital Stock have been transferred to the Charitable Trust, the Trustee of the Charitable Trust shall sell the shares held in the Charitable Trust to a person, designated by the Trustee, whose ownership of the shares will not violate the ownership limitations set forth in Section 7.2.1(a). Upon such sale, the

interest of the Charitable Beneficiary in the shares sold shall terminate and the Trustee shall distribute the net proceeds of the sale to the Prohibited Owner and to the Charitable Beneficiary as provided in this Section 7.3.4. The Prohibited Owner shall receive the lesser of (1) the price paid by the Prohibited Owner for the shares or, if the Prohibited Owner did not give value for the shares in connection with the event causing the shares to be held in the Charitable Trust ( e.g. , in the case of a gift, devise or other such transaction), the Market Price of the shares on the day of the event causing the shares to be held in the Charitable Trust and (2) the price per share received by the Trustee from the sale or other disposition of the shares held in the Charitable Trust. Any net sales proceeds in excess of the amount payable to the Prohibited Owner shall be immediately paid to the Charitable Beneficiary. If, prior to the discovery by the Corporation that shares of Capital Stock have been transferred to the Trustee, such shares are sold by a Prohibited Owner, then (i) such shares shall be deemed to have been sold on behalf of the Trust and (ii) to the extent that the Prohibited Owner received an amount for such shares that exceeds the amount that such Prohibited Owner was entitled to receive pursuant to this Section 7.3.4, such excess shall be paid to the Trustee upon demand.

Section 7.3.5 Purchase Right in Stock Transferred to the Trustee . Shares of Capital Stock transferred to the Trustee shall be deemed to have been offered for sale to the Corporation, or its designee, at a price per share equal to the lesser of (i) the price per share in the transaction that resulted in such transfer to the Charitable Trust (or, in the case of a devise or gift, the Market Price at the time of such devise or gift) and (ii) the Market Price on the date the Corporation, or its designee, accepts such offer. The Corporation shall have the right to accept such offer until the Trustee has sold the shares held in the Charitable Trust pursuant to Section 7.3.4. Upon such a sale to the Corporation, the interest of the Charitable Beneficiary in the shares sold shall terminate and the Trustee shall distribute the net proceeds of the sale to the Prohibited Owner and any dividends or other distributions held by the Trustee shall be paid to the Charitable Beneficiary.

Section 7.3.6 Designation of Charitable Beneficiaries . By written notice to the Trustee, the Corporation shall designate one or more nonprofit organizations to be the Charitable Beneficiary of the interest in the Charitable Trust such that (i) the shares of Capital Stock held in the Charitable Trust would not violate the restrictions set forth in Section 7.2.1(a) in the hands of such Charitable Beneficiary and (ii) each such organization must be described in Section 501(c)(3) of the Code and contributions to each such organization must be eligible for deduction under one of Sections 170(b)(1)(A), 2055 and 2522 of the Code.

Section 7.4 AMEX Transactions . Nothing in this Article VII shall preclude the settlement of any transaction entered into through the facilities of the AMEX or any other national securities exchange or automated inter-dealer quotation system. The fact that the settlement of any transaction occurs shall not negate the effect of any other provision of this Article VII and any transferee in such a transaction shall be subject to all of the provisions and limitations set forth in this Article VII.

Section 7.5 Enforcement . The Corporation is authorized specifically to seek equitable relief, including injunctive relief, to enforce the provisions of this Article VII.

Section 7.6 Non-Waiver . No delay or failure on the part of the Corporation or the Board of Directors in exercising any right hereunder shall operate as a waiver of any right of the Corporation or the Board of Directors, as the case may be, except to the extent specifically waived in writing.

Section 7.7 Ambiguity . In the case of an ambiguity in the application of any of the provisions of this Article VII, including any definition contained in Section 7.1 of this Article VII, the Board of Directors shall have the power to determine the application of the provisions of this Article VII or any such definition with respect to any situation based on the facts known to it. In the event Section 7.2 or 7.3 requires an action by the Board of Directors and the Charter fails to provide specific guidance with respect to such action, the Board of Directors shall have the power to determine the action to be taken so long as such action is not contrary to the provisions of Sections 7.1, 7.2 or 7.3.

ARTICLE VIII

AMENDMENTS

The Corporation reserves the right from time to time to make any amendment to its Charter, now or hereafter authorized by law, including any amendment altering the terms or contract rights, as expressly set forth in the Charter, of any shares of outstanding stock. All rights and powers conferred by the Charter on stockholders, directors and officers are granted subject to this reservation. Except as otherwise provided in the Charter, any amendment to the Charter shall be valid only if approved by the affirmative vote of the holders of a majority of all the votes entitled to be cast on the matter. However, any amendment to Section 5.8, Section 6.3, Section 6.4, Article VII or to this sentence of the Charter shall be valid only if approved by the affirmative vote of the holders of two-thirds of all the votes entitled to be cast on the matter.

ARTICLE IX

LIMITATION OF LIABILITY

To the maximum extent that Maryland law in effect from time to time permits limitation of the liability of directors and officers of a corporation, no director or officer of the Corporation shall be liable to the Corporation or its stockholders for money damages. Neither the amendment nor repeal of this Article IX, nor the adoption or amendment of any other provision of the Charter or Bylaws inconsistent with this Article IX, shall apply to or affect in any respect the applicability of the preceding sentence with respect to any act or failure to act which occurred prior to such amendment, repeal or adoption.

THIRD : The amendment to and restatement of the charter as hereinabove set forth have been duly advised by the Board of Directors and approved by the stockholders of the Corporation as required by law.

FOURTH : The current address of the principal office of the Corporation is as set forth in Article IV of the foregoing amendment and restatement of the charter.

FIFTH : The name and address of the Corporation’s current resident agent is as set forth in Article IV of the foregoing amendment and restatement of the charter.

SIXTH : The number of directors of the Corporation and the names of those currently in office are as set forth in Article V of the foregoing amendment and restatement of charter.

SEVENTH : The total number of shares of stock which the Corporation had authority to issue immediately prior to this amendment and restatement was 10,000,000 shares, $.01 par value per share. The aggregate par value of all shares of stock having par value was $100,000.

EIGHTH : The total number of shares of stock which the Corporation has authority to issue pursuant to the foregoing amendment and restatement of the charter is 50,000,000, consisting of 49,000,000 shares of Common Stock, $.01 par value per share, and 1,000,000 shares of Preferred Stock, $.01 par value per share. The aggregate par value of all authorized shares of stock having par value is $500,000

NINTH : The undersigned President acknowledges these Articles of Amendment and Restatement to be the corporate act of the Corporation and as to all matters or facts required to be verified under oath, the undersigned President acknowledges that, to the best of his knowledge, information and belief, these matters and facts are true in all material respects and that this statement is made under the penalties for perjury.

IN WITNESS WHEREOF, the Corporation has caused these Articles of Amendment and Restatement to be signed in its name and on its behalf by its President and attested to by its Secretary on this 19th day of October, 2004.


ATTEST:	MHI Hospitality Corporation

/ S / W ILLIAM Z AISER	By:	/ S / A NDREW M. S IMS
William Zaiser, Secretary		Andrew M. Sims, President

Exhibit 3.2

MHI HOSPITALITY CORPORATION

BYLAWS

ARTICLE I

OFFICES

Section 1. PRINCIPAL OFFICE . The principal office of MHI Hospitality Corporation (the “Corporation”) in the State of Maryland shall be located at such place as the Board of Directors may designate.

Section 2. ADDITIONAL OFFICES . The Corporation may have additional offices, including a principal executive office, at such places as the Board of Directors may from time to time determine or the business of the Corporation may require.

ARTICLE II

MEETINGS OF STOCKHOLDERS

Section 1. PLACE . All meetings of stockholders shall be held at the principal executive office of the Corporation or at such other place as shall be set by the Board of Directors and stated in the notice of the meeting.

Section 2. ANNUAL MEETING . An annual meeting of the stockholders for the election of Directors and the transaction of any business within the powers of the Corporation shall be held on a date and at the time set by the Board of Directors.

Section 3. SPECIAL MEETINGS .

(a) General . The chairman of the Board of Directors, the president, the chief executive officer or a majority of the Board of Directors may call a special meeting of the stockholders. Subject to subsection (b) of this Section 3, a special meeting of stockholders shall also be called by the secretary of the Corporation upon the written request of the stockholders entitled to cast not less than a majority of all the votes entitled to be cast at such meeting. Except as provided in paragraph (4) of Section 3(b), any special meeting shall be held at such place, date and time as may be designated by the president, chief executive officer or Board of Directors, whoever has called the meeting. In fixing a date for any special meeting, the president, chief executive officer or Board of Directors may consider such factors as he, she or it deems relevant within the good faith exercise of business judgment, including, without limitation, the nature of the matters to be considered, the facts and circumstances surrounding any request for a meeting and any plan of the Board of Directors to call an annual meeting or a special meeting.

(b) Stockholder Requested Special Meetings . (1) Any stockholder of record seeking to have stockholders request a special meeting shall, by sending written notice to the secretary of the Corporation (the “Record Date Request Notice”) by registered mail, return receipt requested, request the Board of Directors to fix a record date to determine the stockholders entitled to request a special meeting (the “Request Record Date”). The Record Date Request Notice shall set forth in reasonable detail the purpose of the meeting and the matters proposed to be acted on at it, shall be signed by one or more stockholders of record as of the date of signature (or their agents duly authorized in writing), shall bear the date of signature of each such stockholder (or such agent) and shall set forth all information relating to each such stockholder that must be disclosed in solicitations of proxies for election of Directors in an election contest (even if an election contest is not involved), or is otherwise required, in each case pursuant to Regulation 14A (or any successor provision) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the rules promulgated thereunder. Upon receiving the Record Date Request Notice, the Board of Directors may fix a Request Record Date. The Request Record Date shall not precede, and shall not be more than, ten days after the close of business on the date on which the resolution fixing the Request Record Date is adopted by the Board of Directors. If the Board of Directors, within ten days after the date on which a valid Record Date Request Notice is received, fails to adopt a resolution fixing the Request Record Date and make a public announcement of such Request Record Date, the Request Record Date shall be the close of business on the tenth day after the first date on which the Record Date Request Notice is received by the secretary.

(2) In order for any stockholder to request a special meeting, one or more written requests for a special meeting signed by stockholders of record (or their agents duly authorized in a writing accompanying the request) as of the Request Record Date entitled to cast not less than a majority (the “Special Meeting Percentage”) of all of the votes entitled to be cast at such meeting (the “Special Meeting Request”) shall be delivered to the secretary. In addition, the Special Meeting Request (a) shall set forth in reasonable detail the purpose of the meeting and the matters proposed to be acted on at it (which shall be limited to the matters set forth in the Record Date Request Notice received by the secretary), (b) shall bear the date of signature of each such stockholder (or such agent) signing the Special Meeting Request, (c) shall set forth the name and address, as they appear in the Corporation’s books, of each stockholder signing such request (or on whose behalf the Special Meeting Request is signed), the class, series and number of all shares of stock of the Corporation which are owned by each such stockholder and the name and address of the nominee holder for, and class, series and number of, shares owned by such stockholder beneficially but not of record, (d) shall be sent to the secretary by registered mail, return receipt requested, and (e) shall be received by the secretary within sixty (60) days after the Request Record Date. Any requesting stockholder (or agent duly authorized in a writing accompanying the revocation for the Special Meeting Request) may revoke his, her or its request for a special meeting at any time by written revocation delivered to the secretary.

(3) The requesting stockholders shall pay all costs of preparing and mailing the notice of meeting (including the Corporation’s proxy materials) and any other

notices required under these Bylaws. The secretary shall inform the requesting stockholders of the estimation of such costs. The secretary shall not be required to call a special meeting upon stockholder request and such meeting shall not be held unless, in addition to the documents required by paragraph (2) of this Section 3(b), the secretary receives payment from such requesting stockholder of such reasonably estimated cost prior to the preparation, printing and mailing of any notice of the meeting.

(4) In the case of any special meeting called by the secretary upon the request of stockholders (a “Stockholder Requested Meeting”), such meeting shall be held at such place, date and time as may be designated by the Board of Directors; provided , however , that the date of any Stockholder Requested Meeting shall be not more than ninety (90) days after the record date for such meeting (the “Meeting Record Date”); and provided further that if the Board of Directors fails to designate, within ten (10) days after the date that a valid Special Meeting Request is actually received by the secretary (the “Delivery Date”), a date and time for a Stockholder Requested Meeting, then such meeting shall be held at 2:00 p.m. local time on the ninetieth (90 ^th ) day after the Meeting Record Date or, if such ninetieth (90 ^th ) day is not a Business Day (as defined below), on the first preceding Business Day (as defined below); and provided further that in the event that the Board of Directors fails to designate a place for a Stockholder Requested Meeting within ten (10) days after the Delivery Date, then such meeting shall be held at the principal executive offices of the Corporation. In the case of any Stockholder Requested Meeting, if the Board of Directors fails to fix a Meeting Record Date that is a date within thirty (30) days after the Delivery Date, then the close of business on the thirtieth (30 ^th ) day after the Delivery Date shall be the Meeting Record Date. The Board of Directors may revoke the notice for any Shareholder Requested Meeting in the event that the requesting stockholders fail to comply with the provisions of paragraph (3) of this Section 3(b).

(5) If written revocations of requests for the special meeting have been delivered to the secretary and the result is that stockholders of record (or their agents duly authorized in writing), as of the Request Record Date, entitled to cast less than the Special Meeting Percentage have delivered, and not revoked, requests for a special meeting to the secretary, the secretary shall: (i) if the notice of meeting has not already been mailed, refrain from mailing the notice of the meeting and send to all requesting stockholders who have not revoked such requests written notice of any revocation of a request for the special meeting., or (ii) if the notice of meeting has been mailed and if the secretary first sends to all requesting stockholders who have not revoked requests for a special meeting written notice of any revocation of a request for the special meeting and written notice of the secretary’s intention to revoke the notice of the meeting, revoke the notice of the meeting at any time before ten days before the commencement of the meeting. Any request for a special meeting received after a revocation by the secretary of a notice of a meeting shall be considered a request for a new special meeting.

(6) The chairman of the Board of Directors, the chief executive officer, the president or the Board of Directors may appoint regionally or nationally recognized independent inspectors of elections (who may be the transfer agent for shares of the

Corporation, or an affiliate thereof) to act as the agent of the Corporation for the purpose of promptly performing a ministerial review of the validity of any purported Special Meeting Request received by the secretary. For the purpose of permitting the inspectors to perform such review, no such purported Special Meeting Request shall be deemed to have been delivered to the secretary until the earlier of (i) ten (10) Business Days after receipt by the secretary of such purported Special Meeting Request and (ii) such date as the independent inspectors certify to the Corporation that the valid Special Meeting Requests received by the secretary represent as of the Request Record Date at least a majority of the votes entitled to be cast at such meeting. Nothing contained in this paragraph (6) shall in any way be construed to suggest or imply that the Corporation or any stockholder shall not be entitled to contest the validity of any request, whether during or after such ten (10) Business Day period, or to take any other action (including, without limitation, the commencement, prosecution or defense of any litigation with respect thereto, and the seeking of injunctive relief in such litigation).

(7) For purposes of these Bylaws, “Business Day” shall mean any day other than a Saturday, a Sunday or a day on which banking institutions in New York City are authorized or obligated by law, regulation or executive order to close.

(8) Unless requested by the stockholders entitled to cast a majority of all the votes entitled to be cast at such meeting, no Stockholder Requested Meeting shall be called to consider any matter which is substantially the same as a matter voted on at any meeting of stockholders held during the preceding twelve (12) months.

Section 4. NOTICE . Not less than ten (10) nor more than ninety (90) days before each meeting of stockholders, the secretary shall give to each stockholder entitled to vote at such meeting and to each stockholder not entitled to vote who is entitled to notice of the meeting written or printed notice stating the time and place of the meeting and, in the case of a special meeting or as otherwise may be required by law, the purpose for which the meeting is called, either by mail, by presenting it to such stockholder personally, by leaving it at the stockholder’s residence or usual place of business or by any other means permitted by Maryland law. If mailed, such notice shall be deemed to be given when deposited in the United States mail addressed to the stockholder at the stockholder’s address as it appears on the records of the Corporation, with postage thereon prepaid.

Subject to Section 11(a) of this Article II, any business of the Corporation may be transacted at an annual meeting of stockholders without being specifically designated in the notice, except such business as is required by any statute to be stated in such notice. No business shall be transacted at a special meeting of stockholders except as specifically designated in the notice.

Section 5. ORGANIZATION AND CONDUCT . Every meeting of stockholders shall be conducted by an individual appointed by the Board of Directors to be chairman of the meeting or, in the absence of such appointment, by the chairman of the Board of Directors or, in the case of a vacancy in the office or absence of the

chairman of the Board of Directors, by one of the following officers present at the meeting: the vice chairman of the Board of Directors, if there be one, the president, the vice presidents in their order of rank and seniority, or, in the absence of such officers, a chairman chosen by the stockholders by the vote of a majority of the votes cast by stockholders present in person or by proxy. The secretary, or, in the secretary’s absence, an assistant secretary, or in the absence of both the secretary and assistant secretaries, an individual appointed by the Board of Directors or, in the absence of such appointment, an individual appointed by the chairman of the meeting shall act as secretary. In the event that the secretary presides at a meeting of the stockholders, an assistant secretary, or in the absence of assistant secretaries, an individual appointed by the Board of Directors or, in the absence of such appointments the chairman of the meeting, shall record the minutes of the meeting. The order of business and all other matters of procedure at any meeting of stockholders shall be determined by the chairman of the meeting. The chairman of the meeting may prescribe such rules, regulations and procedures and take such action as, in the discretion of such chairman, are appropriate for the proper conduct of the meeting, including, without limitation, (a) restricting admission to the time set for the commencement of the meeting; (b) limiting attendance at the meeting to stockholders of record of the Corporation, their duly authorized proxies or other such individuals as the chairman of the meeting may determine; (c) limiting participation at the meeting on any matter to stockholders of record of the Corporation entitled to vote on such matter, their duly authorized proxies or other such individuals as the chairman of the meeting may determine; (d) limiting the time allotted to questions or comments by participants; (e) determining when the polls should be opened and closed; (f) maintaining order and security at the meeting; (g) removing any stockholder or any other individual who refuses to comply with meeting procedures, rules or guidelines as set forth by the chairman of the meeting; and (h) recessing or adjourning the meeting to a later date and time and place announced at the meeting. Unless otherwise determined by the chairman of the meeting, meetings of stockholders shall not be required to be held in accordance with the rules of parliamentary procedure.

Section 6. QUORUM . At any meeting of stockholders, the presence in person or by proxy of stockholders entitled to cast a majority of all the votes entitled to be cast at such meeting shall constitute a quorum; but this section shall not affect any requirement under any statute or the Articles of Incorporation (the “Charter”) of the Corporation for the vote necessary for the adoption of any measure. If, however, such quorum shall not be present at any meeting of the stockholders, the chairman of the meeting shall have the power to adjourn the meeting from time to time to a date not more than one hundred twenty (120) days after the original record date without notice other than announcement at the meeting. At such adjourned meeting at which a quorum shall be present, any business may be transacted which might have been transacted at the meeting as originally notified.

The stockholders present either in person or by proxy, at a meeting which has been duly called and convened, may continue to transact business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum.

Section 7. VOTING . A plurality of all the votes cast at a meeting of stockholders duly called and at which a quorum is present shall be sufficient to elect a director. Each share may be voted for as many individuals as there are Directors to be elected and for whose election the share is entitled to be voted. A majority of the votes cast at a meeting of stockholders duly called and at which a quorum is present shall be sufficient to approve any other matter which may properly come before the meeting, unless more than a majority of the votes cast is required by statute or by the Charter of the Corporation. Unless otherwise provided in the Charter, each outstanding share of stock, regardless of class, shall be entitled to one vote on each matter submitted to a vote at a meeting of stockholders.

Section 8. PROXIES . A stockholder may cast the votes entitled to be cast by the shares of stock owned of record by the stockholder in person or by proxy executed by the stockholder or by the stockholder’s duly authorized agent in any manner permitted by law. Such proxy or evidence of authorization of such proxy shall be filed with the secretary of the Corporation before or at the meeting. No proxy shall be valid more than eleven months after its date, unless otherwise provided in the proxy.

Section 9. VOTING OF SHARES BY CERTAIN HOLDERS . Shares of stock of the Corporation registered in the name of a corporation, partnership, trust or other entity, if entitled to be voted, may be voted by the chief executive officer, president or a vice president, a general partner or trustee thereof, as the case may be, or a proxy appointed by any of the foregoing individuals, unless some other person who has been appointed to vote such shares pursuant to a bylaw or a resolution of the governing body of such corporation or other entity or agreement of the partners of a partnership presents a certified copy of such bylaw, resolution or agreement, in which case such person may vote such shares. Any fiduciary may vote shares of stock registered in his or her name as such fiduciary, either in person or by proxy.

Shares of stock of the Corporation directly or indirectly owned by it shall not be voted at any meeting and shall not be counted in determining the total number of outstanding shares entitled to be voted at any given time, unless they are held by it in a fiduciary capacity, in which case they may be voted and shall be counted in determining the total number of outstanding shares at any given time.

The Board of Directors may adopt by resolution a procedure by which a stockholder may certify in writing to the Corporation that any shares of stock registered in the name of the stockholder are held for the account of a specified person other than the stockholder. The resolution shall set forth the class of stockholders who may make the certification, the purpose for which the certification may be made, the form of certification and the information to be contained in it; if the certification is with respect to a record date or closing of the share transfer books, the time after the record date or closing of the share transfer books within which the certification must be received by the Corporation; and any other provisions with respect to the procedure which the Board of Directors considers necessary or desirable. On receipt of such certification, the person specified in the certification shall be regarded as, for the purposes set forth in the

certification, the stockholder of record of the specified shares of stock in place of the stockholder who makes the certification.

Section 10. INSPECTORS . The Board of Directors, in advance of any meeting, may, but need not, appoint one or more individual inspectors or one or more entities that designate individuals as inspectors to act at the meeting or any adjournment thereof. If an inspector or inspectors are not appointed, the individual presiding at the meeting may, but need not, appoint one or more inspectors. In case any person who may be appointed as an inspector fails to appear or act, the vacancy may be filled by appointment made by the Board of Directors in advance of the meeting or at the meeting by the chairman of the meeting. The inspectors, if any, shall determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, the validity and effect of proxies, and shall receive votes, ballots or consents, hear and determine all challenges and questions arising in connection with the right to vote, count and tabulate all votes, ballots or consents, determine the result, and do such acts as are proper to conduct the election or vote with fairness to all stockholders. Each such report shall be in writing and signed by him or her or by a majority of them if there is more than one inspector acting at such meeting. If there is more than one inspector, the report of a majority shall be the report of the inspectors. The report of the inspector or inspectors on the number of shares represented at the meeting and the results of the voting shall be prima facie evidence thereof.

Section 11. ADVANCE NOTICE OF STOCKHOLDER NOMINEES FOR DIRECTOR AND OTHER PROPOSALS BY STOCKHOLDERS .

(a) Annual Meetings of Stockholders . (1) Nominations of individuals for election to the Board of Directors and the proposal of business to be considered by the stockholders may be made at an annual meeting of stockholders (i) pursuant to the Corporation’s notice of meeting, (ii) by or at the direction of the Board of Directors or (iii) by any stockholder of the Corporation who was a stockholder of record both at the time of giving of notice by the stockholder provided for in this Section 11(a) and at the time of the annual meeting, who is entitled to vote at the meeting and who complied with this Section 11(a).

(2) For nominations for election to the Board of Directors or other business to be properly brought before an annual meeting by a stockholder pursuant to clause (iii) of paragraph (a)(1) of this Section 11, the stockholder must have given timely notice thereof in writing to the secretary of the Corporation and shall set forth in such notice all information required under this Section 11 and such other business shall otherwise be a proper matter for action by stockholders. To be timely, a stockholder’s notice shall set forth all information required under this Section 11 and shall be delivered to the secretary at the principal executive office of the Corporation not later than 5:00 pm, Eastern Time, on the ninetieth (90 ^th ) day prior to the first (1 ^st ) anniversary of the date of mailing of the notice for the preceding year’s annual meeting of stockholders nor earlier than 5:00 pm, Eastern Time, on the one hundred twentieth (120 ^th ) day prior to the first (1 ^st ) anniversary of the date of mailing of the notice for the preceding year’s annual

meeting of stockholders; provided, however, that in the event that the date of the mailing of the notice for the annual meeting of stockholders is advanced or delayed by more than thirty (30) days from the first (1 ^st ) anniversary of the date of the preceding year’s annual meeting of stockholders, notice by the stockholder to be timely must be so delivered not earlier than 5:00 pm, Eastern Time, on the one hundred twentieth (120 ^th ) day prior to the date of mailing of the notice for such annual meeting of stockholders and not later than 5:00 pm, Eastern Time, on the later of the ninetieth (90 ^th ) day prior to the date of mailing of the notice for such annual meeting of stockholders or the tenth (10 ^th ) day following the day on which public announcement of the date of the annual meeting of stockholders is first made by the Corporation. In no event shall the public announcement of a postponement of an annual meeting of stockholders to a later date or time commence a new time period for the giving of a stockholder’s notice as described above. Such stockholder’s notice shall set forth (i) as to each individual whom the stockholder proposes to nominate for election or reelection as a director (A) the name, age, business address and residence address of such person, (B) the class, series and number of shares of stock of the Corporation that are beneficially owned by such individual, (C) the date such shares were acquired and the investment intent of such acquisition and (D) all other information relating to such person that is required to be disclosed in solicitations of proxies for election of Directors in an election contest (even if an election contest is not involved), or is otherwise required, in each case pursuant to Regulation 14A (or any successor provision) under the Exchange Act and the rules promulgated thereunder (including such individual’s written consent to being named in the proxy statement as a nominee and to serving as a director if elected); (ii) as to any other business that the stockholder proposes to bring before the meeting, a description in reasonable detail of the business desired to be brought before the meeting, the complete text of any resolutions intended to be presented at the annual meeting, the reasons for proposing such business at the meeting and any material interest in such business of such stockholder and any Stockholder Associated Person (as defined below), individually or in the aggregate, including any anticipated benefit to the stockholder and the Stockholder Associated Person therefrom, (iii) as to the stockholder giving the notice and Stockholder Associated Person, the class, series and number of all shares of stock of the Corporation which are owned by such stockholder and by such Stockholder Associated Person, if any, and the nominee holder for, and number of, shares owned beneficially but not of record by such stockholder and by any such Stockholder Associated Person; (iv) as to the stockholder giving the notice and any Stockholder Associated Person covered by clauses (ii) or (iii) of this paragraph (2) of this Section 11(a), the name and address of such stockholder as they appear on the Corporation’s stock ledger and current name and address, if different, and of such Stockholder Associated Person; (v) a representation that the stockholder giving the notice intends to appear at the meeting in person or by proxy to submit the business specified in such notice; (vi) to the extent known by the stockholder giving the notice, the name and address of any other stockholder supporting the nominee for election or reelection as a director or the proposal of other business on the date of such stockholder’s notice; and (vii) all other information relating to the nomination or proposed business which may be required to be disclosed under applicable law. In addition, a stockholder seeking to submit such nominations or business at the meeting shall promptly provide any other information reasonably requested by the Corporation.

(3) Notwithstanding anything in this subsection(a) of this Section 11 to the contrary, in the event the Board of Directors increases or decreases the maximum or minimum number of directors in accordance with Article III, Section 2 of these Bylaws, and there is no public announcement of such action at least one hundred (100) days prior to the first (1 ^st ) anniversary of the date of mailing of the notice of the preceding year’s annual meeting of stockholders, a stockholder’s notice required by this Section 11(a) shall also be considered timely, but only with respect to nominees for any new positions created by such increase, if the notice is delivered to the secretary at the principal executive offices of the Corporation not later than 5:00 pm, Eastern Time, on the tenth (10 ^th ) day immediately following the day on which such public announcement is first made by the Corporation.

(4) For purposes of this Section 11, “Stockholder Associated Person” of any stockholder shall mean (i) any person controlling, directly or indirectly, or acting in concert with, such stockholder, (ii) any beneficial owner of shares of stock of the Corporation owned of record or beneficially by such stockholder and (iii) any person controlling, controlled by or under common control with such Stockholder Associated Person.

(b) Special Meetings of Stockholders . Only such business shall be conducted at a special meeting of stockholders as shall have been brought before the meeting pursuant to the Corporation’s notice of meeting. Nominations of individuals for election to the Board of Directors may be made at a special meeting of stockholders at which Directors are to be elected (i) pursuant to the Corporation’s notice of meeting, (ii) by or at the direction of the Board of Directors or (iii) provided that the Board of Directors has determined that Directors shall be elected at such special meeting, by any stockholder of the Corporation who is a stockholder of record both at the time of giving of notice by the stockholders provided for in this Section 11(b) and at the time of the special meeting, who is entitled to vote at the meeting and who complied with this Section 11(b). In the event the Corporation calls a special meeting of stockholders for the purpose of electing one or more individuals to the Board of Directors, any such stockholder may nominate an individual or individuals (as the case may be) for election as a Director as specified in the Corporation’s notice of meeting, if the stockholder’s notice containing the information required by paragraph (a)(2) of this Section 11 shall be delivered to the secretary at the principal executive offices of the Corporation not earlier than 5:00 pm, Eastern Time, on the one hundred twentieth (120 ^th ) day prior to such special meeting and not later than 5:00 pm, Eastern Time, on the later of the ninetieth (90 ^th ) day prior to such special meeting or the tenth (10 ^th ) day following the day on which public announcement is first made of the date of the special meeting and the nominees proposed by the Board of Directors to be elected at such meeting. In no event shall the public announcement of a postponement or adjournment of a special meeting to a later date or time commence a new time period for the giving of a stockholder’s notice as described above.

(c) General . (1) Upon written consent by the secretary or the Board of Directors or any committee thereof, any stockholder proposing a nominee for election as a director

or any proposal for other business at a meeting of stockholders shall provide, within five (5) Business Days of delivery of such request (or such other period as may be specified in such request), written verification, satisfactory, in the discretion of the Board of Directors or any committee thereof or any authorized officer of the Corporation, to demonstrate the accuracy of any information submitted by the stockholder pursuant to this Section 11. If a stockholder fails to provide such written verification within such period, the information as to which written verification was requested may be deemed not to have been provided in accordance with this Section 11.

(2) Only such individuals who are nominated by stockholders in accordance with the procedures set forth in this Section 11 shall be eligible to serve as Directors, and only such business shall be conducted at a meeting of stockholders as shall have been brought before the meeting in accordance with this Section 11. The chairman of the meeting shall have the power and duty to determine whether a nomination or any other business proposed to be brought before the meeting was made or proposed, as the case may be, in accordance with this Section 11 and, if any proposed nomination or business is not in compliance with this Section 11, to declare that such defective nomination or proposal shall be disregarded.

(3) For purposes of this Section 11, (a) the “date of mailing of the notice” shall mean the date of the proxy statement for the solicitation of proxies for election of Directors and (b) “public announcement” shall mean disclosure (i) in a press release transmitted to the principal securities exchange on which the Corporation’s common shares are traded or reported by a recognized news service or (ii) in a document publicly filed by the Corporation with the United States Securities and Exchange Commission pursuant to the Exchange Act.

(4) Notwithstanding the foregoing provisions of this Section 11, a stockholder shall also comply with all applicable requirements of state law and of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Section 11. Nothing in this Section 11 shall be deemed to affect any right of a stockholder to request inclusion of a proposal in, nor the right of the Corporation to omit a proposal from, the Corporation’s proxy statement pursuant to Rule 14a-8 (or any successor provision) under the Exchange Act. Subject to the foregoing provisions of this Section 11, a resolution or motion shall be considered for vote only if proposed by a stockholder or a duly authorized proxy and seconded by a stockholder or duly authorized proxy other than the individual who proposed the resolution or motion.

Section 12. VOTING BY BALLOT . Voting on any question or in any election may be viva voce unless the presiding officer shall order or any stockholder shall demand that voting be by ballot.

Section 13. WRITTEN CONSENT BY STOCKHOLDERS . Any action required or permitted to be taken at a meeting of stockholders may be taken without a meeting if a consent in writing, setting forth such action, is signed by each stockholder entitled to vote on the matter and any other stockholder entitled to notice of a meeting of

stockholders (but not to vote thereof) has waived in writing any right to dissent from such action, and such consent and waiver are filed with the minutes of proceedings of the stockholders.

Section 14. CONTROL SHARE ACQUISITION ACT . Notwithstanding any other provision of the Charter of the Corporation or these Bylaws, Title 3, Subtitle 7 of the Maryland General Corporation Law (the “MGCL”) (or any successor statute) shall not apply to any acquisition by any person of shares of stock of the Corporation. This section may be repealed, in whole or in part, at any time, whether before or after an acquisition of control shares and, upon such repeal, may, to the extent provided by any successor bylaw, apply to any prior or subsequent control share acquisition.

ARTICLE III

DIRECTORS

Section 1. GENERAL POWERS . The business and affairs of the Corporation shall be managed under the direction of its Board of Directors.

Section 2. NUMBER, TENURE AND QUALIFICATIONS . At any regular meeting or at any special meeting called for that purpose, a majority of the entire Board of Directors may establish, increase or decrease the number of Directors; provided that the number thereof shall never be less than the minimum number required by the MGCL, nor more than fifteen (15); and further provided that the tenure of office of a director shall not be affected by any decrease in the number of directors. In case of failure to elect Directors at an annual meeting of the stockholders, the Directors holding over shall continue to direct the management of the business and affairs of the Corporation until their successors are elected and qualify. A Director shall be an individual at least 21 years of age who is not under legal disability. At least one-half of the Board of Directors shall be Directors whom the Board has determined are “independent” under the standards established by the Board of Directors and in accordance with the then applicable requirements of the American Stock Exchange. One Director shall be the Chief Executive Officer of the Corporation. All nominations, including the nomination of the Chief Executive Officer, to serve as Directors must be submitted through and approved by the Nominating and Corporate Governance Committee and follow the nominating process established by that committee for the nomination of Directors and must satisfy the standards for membership on the Board of Directors approved by that committee from time to time. This Section 2 may not be amended or deleted without the unanimous consent of the Board of Directors.

Section 3. ANNUAL AND REGULAR MEETINGS . An annual meeting of the Board of Directors shall be held immediately after and at the same place as the annual meeting of stockholders, no notice other than this Bylaw being necessary. In the event such meeting is not so held, the meeting may be held at such time and place as shall be specified in a notice given as hereinafter provided for special meetings of the Board of Directors. The Board of Directors may provide, by resolution, the time and place for the

holding of regular meetings of the Board of Directors without other notice than such resolution.

Section 4. SPECIAL MEETINGS . Special meetings of the Board of Directors may be called by or at the request of the chairman of the Board of Directors, the chief executive officer, the president or by a majority of the Directors then in office. The person or persons authorized to call special meetings of the Board of Directors may fix any place as the place for holding any special meeting of the Board of Directors called by them. The Board of Directors may provide, by resolution, the time and place for the holding of special meetings of the Board of Directors without notice other than such resolution.

Section 5. NOTICE . Notice of any special meeting of the Board of Directors shall be delivered personally or by telephone, electronic mail, facsimile transmission, United States mail or courier to each director at his or her business or residence address. Notice by personal delivery, telephone, electronic mail or facsimile transmission shall be given at least twenty four (24) hours prior to the meeting. Notice by United States mail shall be given at least three (3) days prior to the meeting. Notice by courier shall be given at least two (2) days prior to the meeting. Telephone notice shall be deemed to be given when the director or his or her agent is personally given such notice in a telephone call to which the director or his or her agent is a party. Electronic mail notice shall be deemed to be given upon transmission of the message to the electronic mail address given to the Corporation by the director. Facsimile transmission notice shall be deemed to be given upon completion of the transmission of the message to the number given to the Corporation by the director and receipt of a completed answer-back indicating receipt. Notice by United States mail shall be deemed to be given when deposited in the United States mail properly addressed, with postage thereon prepaid. Notice by courier shall be deemed to be given when deposited with or delivered to a courier properly addressed. Neither the business to be transacted at, nor the purpose of, any annual, regular or special meeting of the Board of Directors need be stated in the notice, unless specifically required by statute or these Bylaws.

Section 6. QUORUM . A majority of the Directors shall constitute a quorum for transaction of business at any meeting of the Board of Directors, provided that, if less than a majority of such Directors are present at said meeting, a majority of the Directors present may adjourn the meeting from time to time without further notice, and provided further that if, pursuant to applicable law, the Charter of the Corporation, or these Bylaws, or the provisions of any applicable committee charter, the vote of a majority of a particular group of Directors is required for action, a quorum must also include a majority of such group.

The Directors present at a meeting which has been duly called and convened may continue to transact business until adjournment, notwithstanding the withdrawal of enough Directors to leave less than a quorum.

Section 7. VOTING . The action of the majority of the Directors present at a meeting at which a quorum is present shall be the action of the Board of Directors, unless the concurrence of a greater proportion is required for such action by applicable law, the Charter or these Bylaws. If enough Directors have withdrawn from a meeting to leave less than a quorum but the meeting is not adjourned, the action of a majority of that number of Directors necessary to constitute a quorum at such meeting shall be the action of the Board of Directors, unless the concurrence of a greater proportion is required for such action by applicable law, the Charter or these Bylaws.

Section 8. ORGANIZATION . At each meeting of the Board of Directors, the chairman of the Board of Directors or, in the absence of the chairman, the vice chairman of the Board of Directors, if any, shall act as chairman of the meeting. In the absence of both the chairman and vice chairman of the Board of Directors, the chief executive officer or in the absence of the chief executive officer, the president or in the absence of the president, a director chosen by a majority of the Directors present, shall act as chairman of the meeting. The secretary or, in his or her absence, an assistant secretary of the Corporation, or in the absence of the secretary and all assistant secretaries, a person appointed by the chairman of the meeting, shall act as secretary of the meeting.

Section 9. TELEPHONE MEETINGS . Directors may participate in a meeting by means of a conference telephone or similar communications equipment if all persons participating in the meeting can hear each other at the same time. Participation in a meeting by these means shall constitute presence in person at the meeting.

Section 10. CONSENT BY DIRECTORS WITHOUT A MEETING . Any action required or permitted to be taken at any meeting of the Board of Directors may be taken without a meeting if a consent in writing or by electronic transmission to such action is given by each director and is filed with the minutes of proceedings of the Board of Directors.

Section 11. VACANCIES . If for any reason any or all the Directors cease to be Directors, such event shall not terminate the Corporation or affect these Bylaws or the powers of the remaining Directors hereunder (even if fewer than three Directors remain). Except as may be provided by the Board of Directors in setting the terms of any class or series of shares of preferred stock, any vacancy on the Board of Directors may be filled only by a majority of the remaining Directors and in accordance with the Director qualifications set forth in Section 2 of this Article III, even if the remaining Directors do not constitute a quorum. Any director elected to fill a vacancy shall serve for the remainder of the full term of the class in which the vacancy occurred and until a successor is elected and qualifies.

Section 12. COMPENSATION . Directors shall not receive any stated salary for their services as Directors, but, by resolution of the Directors, Directors that are not employed by the Corporation may receive compensation per year and/or per meeting and/or per visit to real property or other facilities owned, leased or to be acquired by the Corporation and for any service or activity they performed or engaged in as Directors.

Directors may be reimbursed for expenses of attendance, if any, at each annual, regular or special meeting of the Directors or of any committee thereof and for their expenses, if any, in connection with each property visit and any other service or activity they performed or engaged in as Directors; but nothing herein contained shall be construed to preclude any Directors from serving the Corporation in any other capacity and receiving compensation therefore.

Section 13. REMOVAL OF DIRECTORS . The stockholders may, at any time, remove any Director in the manner provided in the Charter.

Section 14. LOSS OF DEPOSITS . No Director shall be liable for any loss which may occur by reason of the failure of the bank, trust company, savings and loan association, or other institution with whom moneys or shares of stock have been deposited.

Section 15. SURETY BONDS . Unless required by law, no Director shall be obligated to give any bond or surety or other security for the performance of any of his or her duties.

Section 16. RELIANCE . Each Director, officer, employee and agent of the Corporation shall, in the performance of his or her duties with respect to the Corporation, be fully justified and protected with regard to any act or failure to act in reliance in good faith upon the books of account or other records of the Corporation, upon an opinion of counsel or upon reports made to the Corporation by any of its officers or employees or by the adviser, accountants, appraisers or other experts or consultants selected by the Board of Directors or officers of the Corporation, regardless of whether such counsel or expert may also be a Director, unless such Director, officer, employee or agent has any knowledge concerning the matter in question which would cause such reliance to be unwarranted. In addition, Directors may rely on information from others in performing their duties to the extent set forth in Section 2-405 (or any successor provision) of the MGCL.

Section 17. CERTAIN RIGHTS OF DIRECTORS, OFFICERS, EMPLOYEES AND AGENTS . The Directors that are not employed by the Corporation shall have no responsibility to devote their full time to the affairs of the Corporation. Any Director or officer, employee or agent of the Corporation, in his or her personal capacity or in a capacity as an affiliate, employee, or agent of any other person, or otherwise, may have business interests and engage in business activities similar to or in addition to or in competition with those of or relating to the Corporation provided such Director or officer, employee or agent complies with the applicable terms of the then existing conflicts of interest policy of the Corporation.

ARTICLE IV

COMMITTEES

Section 1. NUMBER, TENURE AND QUALIFICATIONS . The Board of Directors may appoint from among its members an Executive Committee, an Audit Committee, a Compensation Committee, a Nominating and Corporate Governance Committee and other committees composed of one or more Directors as required by applicable law or applicable listing standards, to serve at the pleasure of the Board of Directors.

Section 2. POWERS . The Board of Directors may delegate to committees appointed under Section 1 of this Article IV any of the powers of the Board of Directors, except as prohibited by law.

Section 3. MEETINGS . Notice of committee meetings shall be given in the same manner as notice for special meetings of the Board of Directors.

A majority of the members of any committee shall be present in person at any meeting of such committee in order to constitute a quorum for the transaction of business at such meeting, and the act of a majority of the committee members present shall be the act of such committee. The Board of Directors may designate a chairman of any committee, and such chairman or, in the absence of such chairman, any two members of any committee (if there are at least two members of the committee) may fix the time and place of its meeting unless the Board shall otherwise provide. In the absence or disqualification of any member of any such committee, the members thereof present at any meeting and not disqualified from voting, whether or not they constitute a quorum, may appoint another Director to act at the meeting in the place of such absent or disqualified member.

Each committee shall keep minutes of its proceedings and shall report the same to the Board of Directors at the next succeeding meeting, and any action by the committee shall be subject to revision and alteration by the Board of Directors, provided that no rights of third persons shall be affected by any such revision or alteration.

Section 4. TELEPHONE MEETINGS . Members of a committee of the Board of Directors may participate in a meeting by means of a conference telephone or similar communications equipment if all persons participating in the meeting can hear each other at the same time. Participation in a meeting by these means shall constitute presence in person at the meeting.

Section 5. CONSENT BY COMMITTEES WITHOUT A MEETING . Any action required or permitted to be taken at any meeting of a committee of the Board of Directors may be taken without a meeting, if a consent in writing or by electronic transmission to such action is given by each member of the committee and is filed with the minutes of proceedings of such committee.

Section 6. VACANCIES . Subject to the provisions hereof, the Board of Directors shall have the power at any time to change the membership of any committee,

to fill all vacancies, to designate alternate members to replace any absent or disqualified member or to dissolve any such committee.

ARTICLE V

OFFICERS

Section 1. GENERAL PROVISIONS . The officers of the Corporation shall include a president, a secretary and a treasurer and may include a chairman of the Board of Directors, a vice chairman of the Board of Directors, a chief executive officer, one or more vice presidents, a chief operating officer, a chief financial officer, one or more assistant secretaries and one or more assistant treasurers. In addition, the Board of Directors may from time to time elect such other officers with such powers and duties as it shall deem necessary or desirable. The officers of the Corporation shall be elected annually by the Board of Directors, except that the chief executive officer or president may from time to time appoint one or more vice presidents, assistant secretaries, assistant treasurers or other officers. Each officer shall hold office until his or her successor is elected and qualifies or until his or her death, or his or her resignation or removal in the manner hereinafter provided. Any two or more offices except president and vice president may be held by the same person. In its discretion, the Board of Directors may leave unfilled any office. Election of an officer or agent shall not of itself create contract rights between the Corporation and such officer or agent.

Section 2. REMOVAL AND RESIGNATION . Any officer or agent of the Corporation may be removed, with or without cause, by the Board of Directors if in its judgment the best interests of the Corporation would be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. Any officer of the Corporation may resign at any time by giving written notice of his or her resignation to the Board of Directors, the chairman of the Board of Directors, the president or the secretary. Any resignation shall take effect immediately upon its receipt or at such later time specified in the notice of resignation. The acceptance of a resignation shall not be necessary to make it effective unless otherwise stated in the resignation. Such resignation shall be without prejudice to the contract rights, if any, of the Corporation.

Section 3. VACANCIES . A vacancy in any office may be filled by the Board of Directors for the balance of the term.

Section 4. CHIEF EXECUTIVE OFFICER . The Board of Directors may designate a chief executive officer. In the absence of such designation, the chairman of the Board of Directors, if any, shall be the chief executive officer of the Corporation. The chief executive officer shall have general responsibility for implementation of the policies of the Corporation, as determined by the Board of Directors, and for the management of the business and affairs of the Corporation. He or she may execute any deed, mortgage, bond, contract or other instrument, except in cases where the execution thereof shall be expressly delegated by the Board of Directors or by these Bylaws to some other officer or agent of the Corporation or shall be required by law to be otherwise

executed; and in general shall perform all duties incident to the office of chief executive officer and such other duties as may be prescribed by the Board of Directors from time to time.

Section 5. CHIEF OPERATING OFFICER . The Board of Directors may designate a chief operating officer. The chief operating officer shall have the responsibilities and duties as set forth by the Board of Directors or the chief executive officer.

Section 6. CHIEF FINANCIAL OFFICER . The Board of Directors may designate a chief financial officer. The chief financial officer shall have the responsibilities and duties as set forth by the Board of Directors or the chief executive officer.

Section 7. CHAIRMAN OF THE BOARD . The Board of Directors may designate a chairman of the Board of Directors. The chairman of the Board of Directors shall preside over the meetings of the Board of Directors and of the stockholders at which he shall be present. The chairman of the Board of Directors shall perform such other duties as may be assigned to him or her by the Board of Directors.

Section 8. VICE CHAIRMAN OF THE BOARD . In the absence of the chairman of the board or in the event of a vacancy in such office, the vice chairman of the board (or in the event there be more than one vice chairman of the board, the vice chairman of the board in the order designated at the time of their election or, in the absence of any designation, then in the order of their election) shall perform the duties of the chairman of the board and when so acting shall have all the powers of and be subject to all the restrictions upon the chairman of the board; and shall perform such other duties as from time to time may be assigned to such vice chairman of the board by the chairman of the board or by the Board of Directors.

Section 9. PRESIDENT . In the absence of a chief executive officer, the president shall in general supervise and control all of the business and affairs of the Corporation. In the absence of a designation of a chief operating officer by the Board of Directors, the president shall be the chief operating officer. He or she may execute any deed, mortgage, bond, contract or other instrument, except in cases where the execution thereof shall be expressly delegated by the Board of Directors or by these Bylaws to some other officer or agent of the Corporation or shall be required by law to be otherwise executed; and in general shall perform all duties incident to the office of president and such other duties as may be prescribed by the Board of Directors from time to time.

Section 10. VICE PRESIDENTS . In the absence of the president or in the event of a vacancy in such office, the vice president (or in the event there be more than one vice president, the vice presidents in the order designated at the time of their election or, in the absence of any designation, then in the order of their election) shall perform the duties of the president and when so acting shall have all the powers of and be subject to all the restrictions upon the president; and shall perform such other duties as from time to

time may be assigned to such vice president by the chief executive officer, president or by the Board of Directors. The Board of Directors may designate one or more vice presidents as executive vice president or as vice president for particular areas of responsibility.

Section 11. SECRETARY . The secretary shall (a) keep the minutes of the proceedings of the stockholders, the Board of Directors and committees of the Board of Directors in one or more books provided for that purpose; (b) see that all notices are duly given in accordance with the provisions of these Bylaws or as required by law; (c) be custodian of the corporate records and of the seal of the Corporation, if any; (d) keep a register of the post office address of each stockholder which shall be furnished to the secretary by such stockholder; (e) have general charge of the stock transfer books of the Corporation; and (f) in general perform such other duties as from time to time may be assigned to him by the chief executive officer, the president or by the Board of Directors.

Section 12. TREASURER . The treasurer shall have the custody of the funds and securities of the Corporation and shall keep full and accurate accounts of receipts and disbursements in books belonging to the Corporation and shall deposit all moneys and other valuable effects in the name and to the credit of the Corporation in such depositories as may be designated by the Board of Directors. In the absence of a designation of a chief financial officer by the Board of Directors, the treasurer shall be the chief financial officer of the Corporation.

The treasurer shall disburse the funds of the Corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements, and shall render to the president and Board of Directors, at the regular meetings of the Board of Directors or whenever it may so require, an account of all his or her transactions as treasurer and of the financial condition of the Corporation.

If required by the Board of Directors, the treasurer shall give the Corporation a bond in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors for the faithful performance of the duties of his or her office and for the restoration to the Corporation, in case of his or her death, resignation, retirement or removal from office, of all books, papers, vouchers, moneys and other property of whatever kind in his or her possession or under his or her control belonging to the Corporation.

Section 13. ASSISTANT SECRETARIES AND ASSISTANT TREASURERS . The assistant secretaries and assistant treasurers, in general, shall perform such duties as shall be assigned to them by the secretary or treasurer, respectively, or by the chief executive officer, president or the Board of Directors. The assistant treasurers shall, if required by the Board of Directors, give bonds for the faithful performance of their duties in such sums and with such surety or sureties as shall be satisfactory to the Board of Directors.

Section 14. SALARIES . The salaries and other compensation of the officers shall be fixed from time to time by the Board of Directors or a committee thereof and no officer shall be prevented from receiving such salary or other compensation by reason of the fact that he is also a Director.

ARTICLE VI

CONTRACTS, LOANS, CHECKS AND DEPOSITS

Section 1. CONTRACTS . The Board of Directors or a committee thereof within the scope of its delegated authority may authorize any officer or agent to enter into any contract or to execute and deliver any instrument in the name of and on behalf of the Corporation and such authority may be general or confined to specific instances. Any agreement, deed, mortgage, lease or other document shall be valid and binding upon the Corporation when authorized or ratified by action of the Board of Directors or such committee and executed by an authorized person.

Section 2. CHECKS AND DRAFTS . All checks, drafts or other orders for the payment of money, notes or other evidences of indebtedness issued in the name of the Corporation shall be signed by such officer or agent of the Corporation in such manner as shall from time to time be determined by the Board of Directors.

Section 3. DEPOSITS . All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in such banks, trust companies or other depositories as the Board of Directors may designate.

ARTICLE VII

STOCK

Section 1. CERTIFICATES . Except as otherwise provided in these Bylaws, this Section shall not be interpreted to limit the authority of the Board of Directors to issue same or all of the Corporation’s classes or series without certificates. Each stockholder, upon written request to the secretary of the Corporation, shall be entitled to a certificate or certificates which shall represent and certify the number of shares of each class of stock held by him, her or it in the Corporation. Each certificate shall be signed by the chairman of the board, chief executive officer, the president or a vice president and countersigned by the secretary or an assistant secretary or the treasurer or an assistant treasurer and may be sealed with the seal, if any, of the Corporation. The signatures may be either manual or facsimile. Certificates shall be consecutively numbered; and if the Corporation shall, from time to time, issue several classes of shares of capital stock, each class may have its own number series. A certificate is valid and may be issued whether or not an officer who signed it is still an officer when it is issued. Each certificate representing shares of capital stock which are restricted as to their transferability or voting powers, which are preferred or limited as to their dividends or as to their allocable portion of the assets upon liquidation or which are redeemable at the option of the

Corporation, shall have a statement of such restriction, limitation, preference or redemption provision, or a summary thereof, plainly stated on the certificate. If the Corporation has authority to issue shares of beneficial interest of more than one class, the certificate shall contain on the face or back a full statement or summary of the designations and any preferences, conversion and other rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications and terms and conditions of redemption of each class of shares of beneficial interest and, if the Corporation is authorized to issue any preferred or special class in series, the differences in the relative rights and preferences between the shares of each series to the extent they have been set and the authority of the Board of Director to set the relative rights and preferences of subsequent series. In lieu of such statements or summaries, the Corporation may set forth upon the face or back of the certificate a statement that the Corporation will furnish to any stockholder, upon receipt of a written request and without charge, a full statement of such information.

Section 2. TRANSFERS . Upon surrender to the Corporation or the transfer agent of the Corporation of a stock certificate duly endorsed or accompanied by proper evidence of succession, assignment or authority to transfer, the Corporation shall issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books.

The Corporation shall be entitled to treat the holder of record of any share or shares of stock as the holder in fact thereof and, accordingly, shall not be bound to recognize any equitable or other claim to or interest in such share or on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of the State of Maryland.

Notwithstanding the foregoing, transfers of shares of any class of stock will be subject in all respects to the Charter of the Corporation and all of the terms and conditions contained therein.

Section 3. REPLACEMENT CERTIFICATE . Any officer designated by the Board of Directors may direct a new certificate to be issued in place of any certificate previously issued by the Corporation alleged to have been lost, stolen or destroyed upon the making of an affidavit of that fact by the person claiming the certificate to be lost, stolen or destroyed. When authorizing the issuance of a new certificate, an officer designated by the Board of Directors may, in his or her discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or the owner’s legal representative to advertise the same in such manner as he or she shall require and/or to give bond, with sufficient surety, to the Corporation to indemnify it against any loss or claim which may arise as a result of the issuance of a new certificate.

Section 4. CLOSING OF TRANSFER BOOKS OR FIXING OF RECORD DATE . The Board of Directors may set, in advance, a record date for the purpose of determining stockholders entitled to notice of or to vote at any meeting of stockholders or

determining stockholders entitled to receive payment of any dividend or the allotment of any other rights, or in order to make a determination of stockholders for any other proper purpose. Such date, in any case, shall not be prior to the close of business on the day the record date is fixed and shall be not more than ninety (90) days and, in the case of a meeting of stockholders, not less than ten (10) days, before the date on which the meeting or particular action requiring such determination of stockholders of record is to be held or taken.

In lieu of fixing a record date, the Board of Directors may provide that the stock transfer books shall be closed for a stated period but not longer than twenty (20) days. If the stock transfer books are closed for the purpose of determining stockholders entitled to notice of or to vote at a meeting of stockholders, such books shall be closed for at least ten (10) days before the date of such meeting.

Except as otherwise set forth in these Bylaws, if no record date is fixed and the stock transfer books are not closed for the determination of stockholders, (a) the record date for the determination of stockholders entitled to notice of or to vote at a meeting of stockholders shall be at 5:00 pm, Eastern Time, on the day on which the notice of meeting is mailed or the thirtieth (30 ^th ) day before the meeting, whichever is the closer date to the meeting; and (b) the record date for the determination of stockholders entitled to receive payment of a dividend or an allotment of any other rights shall be 5:00 pm, Eastern Time, on the day on which the resolution of the Directors, declaring the dividend or allotment of rights, is adopted.

When a determination of stockholders entitled to vote at any meeting of stockholders has been made as provided in this section, such determination shall apply to any adjournment thereof, except when (i) the determination has been made through the closing of the transfer books and the stated period of closing has expired or (ii) the meeting is adjourned to a date more than one hundred twenty (120) days after the record date fixed for the original meeting, in either of which case a new record date shall be determined as set forth herein.

Section 5. STOCK LEDGER . The Corporation shall maintain at its principal office or at the office of its counsel, accountants or transfer agent, an original or duplicate stock ledger containing the name and address of each stockholder and the number of shares of each class held by such stockholder.

Section 6. FRACTIONAL STOCK; ISSUANCE OF UNITS . The Board of Directors may issue fractional stock or provide for the issuance of scrip, all on such terms and under such conditions as they may determine. Notwithstanding any other provision of the Charter or these Bylaws, the Board of Directors may issue units consisting of different securities of the Corporation. Any security issued in a unit shall have the same characteristics as any identical securities issued by the Corporation, except that the Board of Directors may provide that for a specified period securities of the Corporation issued in such unit may be transferred on the books of the Corporation only in such unit.

ARTICLE VIII

ACCOUNTING YEAR

The Board of Directors shall have the power, from time to time, to fix the fiscal year of the Corporation by a duly adopted resolution.

ARTICLE IX

DISTRIBUTIONS

Section 1. AUTHORIZATION . Dividends and other distributions upon the stock of the Corporation may be authorized by the Board of Directors, subject to the provisions of law and the Charter of the Corporation. Dividends and other distributions may be paid in cash, property or shares of stock of the Corporation, subject to the provisions of law and the Charter.

Section 2. CONTINGENCIES . Before payment of any dividends or other distributions, there may be set aside out of any assets of the Corporation available for dividends or other distributions such sum or sums as the Board of Directors may from time to time, in its absolute discretion, think proper as a reserve fund for contingencies, for equalizing dividends or other distributions, for repairing or maintaining any property of the Corporation or for such other purpose as the Board of Directors shall determine to be in the best interest of the Corporation, and the Board of Directors may modify or abolish any such reserve.

ARTICLE X

INVESTMENT POLICIES

Subject to the provisions of the Charter, the Board of Directors may from time to time adopt, amend, revise or terminate any policy or policies with respect to investments by the Corporation as it shall deem appropriate in its sole discretion.

ARTICLE XI

PROHIBITED INVESTMENTS AND ACTIVITIES

Notwithstanding anything to the contrary in the Charter, the Corporation shall not enter into any transaction referred to in (i), (ii) or (iii) below which it does not believe is in the best interests of the Corporation, and will not, without the approval of a majority of the disinterested Directors, (i) acquire from or sell to any Director, officer or employee of the Corporation, any corporation, partnership, joint venture, trust, employee benefit plan or other enterprise in which a Director, officer or employee of the Corporation owns more than a 5% interest or any affiliate of any of the foregoing, any of the assets or other property of the Corporation, except for the acquisition directly or indirectly of certain

properties or interest therein, directly or indirectly, through entities in which it owns an interest in connection with the initial public offering of shares by the Corporation or pursuant to agreements entered into in connection with such offering, which properties shall be described in the prospectus relating to such initial public offering, (ii) make any loan to or borrow from any of the foregoing persons or (iii) engage in any other transaction with any of the foregoing persons. Each such transaction will be in all respects on such terms as are, at the time of the transaction and under the circumstances then prevailing, fair and reasonable to the Corporation. Subject to the provisions of the Charter, the Board of Directors may from time to time adopt, amend, revise or terminate any policy or policies with respect to investments by the Corporation as it shall deem appropriate in its sole discretion.

ARTICLE XII

SEAL

Section 1. SEAL . The Board of Directors may authorize the adoption of a seal by the Corporation. The seal shall have inscribed thereon the name of the Corporation and the year of its formation. The Board of Directors may authorize one or more duplicate seals and provide for the custody thereof.

Section 2. AFFIXING SEAL . Whenever the Corporation is permitted or required to affix its seal to a document, it shall be sufficient to meet the requirements of any law, rule or regulation relating to a seal to place the word “(SEAL)” adjacent to the signature of the person authorized to execute the document on behalf of the Corporation.

ARTICLE XIII

INDEMNIFICATION AND ADVANCE OF EXPENSES

To the maximum extent permitted by Maryland law in effect from time to time, the Corporation shall indemnify and, without requiring a preliminary determination of the ultimate entitlement to indemnification, shall pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (a) any individual who is a present or former director or officer of the Corporation and who is made a party to the proceeding by reason of his or her service in that capacity or (b) any individual who, while a director or officer of the Corporation and at the request of the Corporation, serves or has served as a director, officer, partner or trustee of a corporation, real estate investment trust, partnership, joint venture, trust, limited liability company, employee benefit plan or any other enterprise and who is made or threatened to be made a party to the proceeding by reason of his or her service in that capacity. The Corporation may, with the approval of its Board of Directors or any duly authorized committee thereof, provide such indemnification and pay or reimburse reasonable expenses in advance of final disposition of a proceeding to a person who served a predecessor of the Corporation in any of the capacities described in (a) or (b) above and to any employee or agent of the Corporation or a predecessor of the Corporation. The indemnification and payment or reimbursement

of expenses provided in these Bylaws shall not be deemed exclusive of or limit in any way other rights to which any person seeking indemnification or payment of expenses may be or may become entitled under any bylaw, regulation, insurance, agreement or otherwise.

Neither the amendment nor repeal of this Article, nor the adoption or amendment of any other provision of the Bylaws or Charter of the Corporation inconsistent with this Article, shall apply to or affect in any respect the applicability of the preceding paragraph with respect to any act or failure to act which occurred prior to such amendment, repeal or adoption.

Any indemnification or payment or reimbursement of the expenses permitted by their Bylaws shall be furnished in accordance with the procedures provided for indemnification or payment or reimbursement of expenses, as the case may be, under Section 2-418 of the MGCL for directors of Maryland Corporations.

ARTICLE XIV

WAIVER OF NOTICE

Whenever any notice is required to be given pursuant to the Charter of the Corporation or these Bylaws or pursuant to applicable law, a waiver thereof in writing, signed by the person or persons entitled to such notice, whether before or after the time stated therein, shall be deemed equivalent to the giving of such notice. Neither the business to be transacted at nor the purpose of any meeting need be set forth in the waiver of notice, unless specifically required by statute. The attendance of any person at any meeting shall constitute a waiver of notice of such meeting, except where such person attends a meeting for the express purpose of objecting to the transaction of any business on the ground that the meeting is not lawfully called or convened.

ARTICLE XV

AMENDMENT OF BYLAWS

The Board of Directors shall have the exclusive power to adopt, alter or repeal any provision of these Bylaws and to make new Bylaws.

EXHIBIT 10.4

STRATEGIC ALLIANCE AGREEMENT

THIS STRATEGIC ALLIANCE AGREEMENT (“Agreement”) is made and entered into as of the th day of 2004 (the “Effective Date”) by and among (i) MHI Hospitality, L.P., a Delaware limited partnership (the “Partnership”), (ii) MHI Hospitality Corporation, a Maryland corporation and the general partner of the Partnership (the “REIT”) (the REIT and the Partnership are sometimes collectively referred to herein as the “Company”), and (iii) MHI Hotels Services LLC (“MHI Hotels Services”).

RECITALS

THE PARTIES ENTER THIS AGREEMENT on the basis of the following facts, understandings and intentions:

A. The REIT proposes to undertake an underwritten initial public offering (the “Offering”) of shares of its common stock, par value $0.01 per share (“Shares”).

B. The REIT will serve as general partner of the Partnership and initially will own a majority interest in the Partnership.

C. The Company has designated MHI Hotels Services as its preferred hotel management company. In conjunction with the execution of this Agreement, MHI Hotels Services will amend and restructure its existing management agreements by entering into a master management agreement (the “Master Management Agreement”) with respect to certain of the initial hotel properties upon contribution of those assets to the Partnership in exchange for a cash payment of $2.0 million.

D. MHI Hotels Services desires to provide the Company, on an exclusive basis, with information regarding hotel investment opportunities that become known to MHI Hotels Services as set forth herein.

E. The parties have determined that, in connection with the Offering, it is desirable to set forth in this Agreement certain covenants and agreements among the parties.

AGREEMENTS

NOW THEREFORE, IN CONSIDERATION of the mutual covenants and promises of the parties provided for in this Agreement and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows:

ARTICLE I

1. Acquisition Opportunities .

(a) During the Term (as defined in Article V below), MHI Hotels Services agrees to promptly notify the Company, on an exclusive basis, of any opportunity to invest in, acquire or develop a property, whether in fee or leasehold, and, whether in whole or in part, that

is suitable for, the development or operation of a hotel (“Hotel Property”) which is presented to MHI Hotels Services or its subsidiaries and that meets the Company’s acquisition criteria, as the Company may communicate such acquisition criteria to MHI Hotels Services from time to time. For purposes of this Agreement, a Hotel Property includes, but is not limited to, full-service upper up-scale, up-scale and mid-scale hotels (as such terms are used by Smith Travel Research or similar industry source), whether or not such hotels are underperforming in their respective marketplace, or may be functionally obsolete. MHI Hotels Services shall promptly provide to the Company all information, materials and documents reasonably available to MHI Hotels Services or its subsidiaries with respect to such Hotel Property or opportunity, subject to the requirements of any confidentiality agreements with third parties, provided, however, that any confidentiality agreement must permit MHI Hotels Services to notify the Company of such hotel property investment, acquisition or development opportunity. Notwithstanding the foregoing, MHI Hotels Services shall refer any such opportunity directly to the Company prior to execution of a confidentiality agreement but otherwise will use its best efforts, at no additional out-of-pocket expense to MHI Hotels Services, to negotiate any confidentiality agreement so as to permit disclosure of the opportunity, and all information, materials and documents with respect thereto, to the Company.

(b) The Company shall notify MHI Hotels Services, within 10 business days following the Company’s receipt from MHI Hotels Services of the information with respect to a Hotel Property investment, acquisition or development opportunity as described in Section 2(a), whether the Company intends to pursue such opportunity. During such 10 day period, if the Company notifies MHI Hotels Services that the Company intends to pursue such opportunity, MHI Hotels Services shall not provide any information regarding such opportunity to any third party until otherwise notified by the Company, provided that the Company is making commercially reasonable efforts to conduct due diligence or is otherwise actively pursuing the investment, acquisition or development opportunity. If the Company (i) notifies MHI Hotels Services that the Company does not intend to pursue the opportunity, or (ii) fails to notify MHI Hotels Services by the end of the 10 business day period that the Company intends to pursue the opportunity, then, in either event, MHI Hotels Services may (A) pursue the opportunity on its own behalf or (B) notify other capital sources of the opportunity; provided, however, that, if MHI Hotels Services subsequently becomes aware that the price or other terms with respect to the opportunity previously presented to the Company have changed materially and MHI Hotels Services is pursuing the acquisition opportunity on its own behalf, rather than in conjunction with another capital source, MHI Hotels Services will notify the Company of any such change in terms with respect to such opportunity in accordance with the provisions of this Article I, Section 2 and agrees to provide the Company with another chance to pursue the opportunity in accordance with the provisions set forth in this Article I(b).

ARTICLE II

2. Management Agreements .

(a) Subject to the provisions of this Article II, the Company agrees to cause MHI Hospitality TRS, LLC (the “TRS Lessee”) to offer to MHI Hotels Services the opportunity to manage any Hotel Property acquired by the Company or one of its subsidiaries and leased to

TRS Lessee during the Term which meets any of the following criteria:

(i) the Hotel Property is not encumbered by a management contract that would continue beyond the date of the Company’s acquisition of the Hotel Property; or

(ii) no termination fee is payable by the Company in connection with termination of any then existing management contract for the Hotel Property; or

(iii) if the then existing management agreement for the Hotel Property can be terminated at the time of the Company’s purchase of the Hotel Property upon payment of a termination fee, MHI Hotels Services pays such termination fee.

(b) Not less than 30 days prior to the Company’s acquisition of a Hotel Property that meets the criteria described in Section 2(a) above, the Company will notify MHI Hotels Services of the Company’s proposed acquisition of the Hotel Property and will make available to MHI Hotels Services all information reasonably available to the Company with respect to the Hotel Property. MHI Hotels Services shall have 10 business days from receipt of such notice from the Company to notify the Company in writing that MHI Hotels Services elects to manage the Hotel Property pursuant to the master management agreement which is substantially in the form of Annex A (the “Master Management Agreement”). If MHI Hotels Services (i) notifies the Company that MHI Hotels Services does not intend to manage the Hotel Property or (ii) fails by the end of the 10 business day period to notify the Company of its election to manage the Hotel Property, then, in either event, the Company may offer management of the Hotel Property to other hotel management companies on such terms as the Company shall determine and MHI Hotels Services shall have no further rights with respect thereto.

(c) With respect to Hotel Properties acquired by the Company in the future, the parties intend to utilize the Master Management Agreement between the TRS Lessee and MHI Hotels Services. Notwithstanding the foregoing, any material change in the provisions of the Master Management Agreement, as they relate to the rights and obligations of the TRS Lessee, shall be subject to approval by a majority of the directors of the REIT who, at the time, are “independent” in accordance with rules promulgated from time to time by the American Stock Exchange (“AMEX”) for companies listed on the AMEX (“Independent Directors”).

(d) Notwithstanding the provisions of this Article II, if a majority of the Independent Directors in good faith conclude for valid business reasons that a management company other than MHI Hotels Services should manage one or more Hotel Properties, the Company shall so notify MHI Hotels Services and MHI Hotels Services shall not have the right to manage such Hotel Properties.

ARTICLE III

3. Right to Designate Director of the REIT .

(a) During the Term, MHI Hotels Services shall have the right to designate one (1) person (the “Designee”) as nominee for election to the Board of Directors of the REIT at each

meeting of stockholders of the REIT at which directors are elected (the “Designation Right”), for so long as Andrew Sims, Christopher Sims, Kim Sims, and their families and affiliates hold, in the aggregate, not less than 1.5 million units of operating partnership interest in the Partnership or shares of the Company’s common stock. MHI Hotels Services shall submit the name of the Designee to the REIT’s Corporate Governance and Nominating Committee of the Board of Directors (the “Nominating Committee”) not less than 90 days prior to the anniversary date of the prior year’s annual stockholder meeting of the REIT but no earlier than 120 days prior to the first anniversary of the date of the mailing notice for the preceding year’s annual meeting or, in the case of election of directors other than at the annual meeting of stockholders, not less than 60 days prior to the meeting date set by the Board of Directors of the REIT. The Designee shall satisfy the standards established by the Nominating Committee for membership on the Board of Directors of the REIT and shall provide to the REIT (i) a written consent to being named as a nominee for director of the REIT and to serving as a director if elected, (ii) a questionnaire prepared by the REIT and completed by the Designee, and (iii) such other information regarding the Designee as the REIT may reasonably request. A Designee shall not serve on the Nominating Committee and shall not automatically be deemed to be an Independent Director.

(b) The Nominating Committee shall respond to MHI Hotels Services as to whether the Nominating Committee approves the Designee for nomination within 20 days following MHI Hotels Services submission of the Designee’s name and the information described in Section 2(a) above. In the event the Designee is not approved and nominated by the Nominating Committee for election as a director of the REIT, MHI Hotels Services may submit to the Nominating Committee another Designee for approval and nomination by the Nominating Committee in accordance with Section 2(a) and the Nominating Committee will respond to any such new submission within 10 days thereafter. When a Designee is approved by the Nominating Committee as a nominee for election as a director, the REIT shall include such Designee in the proxy materials delivered to stockholders in connection with the meeting and shall recommend such Designee for election in the same manner as other nominees approved by the Nominating Committee.

(c) In the event that the Designee who is elected as a director resigns, refuses to stand for re-election, is removed, dies or becomes disabled while serving as a director, MHI Hotels Services shall submit a new Designee to the Nominating Committee and, upon approval by the Nominating Committee, such Designee shall be appointed by the Board of Directors to fill the resulting vacancy on the Board of Directors. Unless MHI Hotels Services otherwise submits a new Designee to the Nominating Committee in accordance with Section 2(a) above, such then current Designee shall be nominated by the Nominating Committee as a nominee for election at the next succeeding meeting of stockholders at which directors are to be elected.

(d) Notwithstanding the foregoing, (i) if MHI Hotels Services fails to designate a Designee who is approved by the Nominating Committee not less than 45 days prior to a meeting of stockholders at which directors are to be elected, the Designation Right with respect to directors to be elected at that meeting of stockholders shall terminate; provided, however, that if (A) the Designee is then serving on the REIT’s Board of Directors, and (B) the Designee continues to satisfy the standards established by the Nominating Committee for membership on the Board of Directors of the REIT, and consents to being named as a nominee for director of the

REIT, such Designee shall be the Designee for election at any such meeting of stockholders at which directors are to be elected notwithstanding that MHI Hotels Services has not formally submitted such Designee as a nominee in accordance with the procedures set forth herein.

ARTICLE IV

4. Termination

This Agreement may be terminated:

(a) by the Company, if the Master Management Agreement is terminated by the TRS Lessee, provided that the TRS Lessee has paid all required termination fees related to such termination;

(b) by MHI Hotels Services in the event that the Master Management Agreement is terminated by the TRS Lessee or by MHI Hotels Services as a result of a breach by the TRS Lessee or MHI Hotels Services or is otherwise terminated in accordance with its terms.

In the event of the termination of this Agreement pursuant to this Article 4, this Agreement shall become null and void.

ARTICLE V

5. Miscellaneous .

(a) The term of this Agreement shall commence on the date hereof and shall continue until the tenth anniversary of the date of closing of the Offering (the “Term”).

(b) This Agreement, and the other agreements and documents referred to herein, shall constitute the entire agreement among the parties with respect to the subject matter thereof and shall supersede all previous negotiations, commitments and writings with respect to such subject matter.

(c) This Agreement shall be governed by and construed in accordance with the laws of the jurisdiction of the State of Maryland without regard to the principles of conflicts of laws thereof.

(d) All notices and other communications required or permitted hereunder shall be in writing, shall be deemed duly given upon actual receipt, and shall be delivered (i) in person, (ii) by registered or certified mail (air mail if addressed to an address outside of the country in which mailed), postage prepaid, return receipt requested, or (iii) by facsimile or other generally accepted means of electronic transmission (provided that a copy of any notice delivered pursuant to this clause (iii) shall also be sent pursuant to clause (ii), addressed as follows (or to such other addresses as may be specified by like notice to the other parties):


To MHI Hotels Services:		MHI Hotels Services LLC 6411 Ivy Lane – Suite 510 Greenbelt, Maryland 20770 Attention Kim E. Sims

To the Company:		MHI Hospitality Corporation 814 Capitol Landing Road Williamsburg, Virginia 23185 Attention: Andrew M. Sims President and Chief Executive Officer

(e) No amendment, modification or supplement to this Agreement shall be binding on any of the parties hereto unless it is in writing and signed by the parties in interest at the time of the modification, and further provided any such modification is approved by a majority of the Independent Directors. No provision hereof may be waived except by a writing signed by the party against whom any such waiver is sought and further provided any such waiver by the Company is approved by a majority of the Independent Directors. The waiver by any party of a breach of any provision of this Agreement shall not operate as or be construed as a waiver of any subsequent breach.

(f) Neither this Agreement nor any rights or obligations hereunder shall be assignable by a party to this Agreement without the prior, express written consent of the other party and further provided any such assignment by MHI Hotels Services is approved by a majority of the Independent Directors. This Agreement and all of the provisions hereof shall be binding upon and inure to the benefit of the parties to this Agreement and their respective successors and permitted assigns.

(g) This Agreement is solely for the benefit of the parties to this Agreement and should not be deemed to confer upon third-parties any remedy, claim, liability, reimbursement, claims or action or other right in excess of those existing without reference to this Agreement.

(h) Titles and headings to sections in this Agreement are inserted for the convenience of reference only and are not intended to be a part of or to affect the meaning or interpretation of this Agreement.

(i) Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof. Any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. Without prejudice to any rights or remedies otherwise available to any party to this Agreement, each party hereto acknowledges that damages would not be an adequate remedy for any breach of the provisions of this Agreement and agrees that the obligations of the parties hereunder shall be specifically enforceable.

(j) The parties to this Agreement will execute and deliver or cause the execution and delivery of such further instruments and documents and will take such other

actions as any other party to the Agreement may reasonably request in order to effectuate the purpose of this Agreement and to carry out the terms hereof.

(k) This Agreement may be executed in counterparts, each of which shall be deemed an original but together shall be deemed one and the same Agreement.

(l) If any provision of this Agreement is held unenforceable, this Agreement shall be construed without such provision.

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their duly authorized officers, as of the Effective Date.


REIT:

MHI Hospitality Corporation a Maryland corporation

By:
		Andrew M. Sims President and Chief Executive Officer

MANAGER:

MHI HOTELS SERVICES LLC, a Maryland limited liability company

By:
		Kim E. Sims

OPERATING PARTNERSHIP

MHI Hospitality, L.P. a Delaware limited partnership

By:		MHI Hospitality Corporation
		its General Partner



		By:
				Andrew M. Sims
				President and Chief Executive Officer

Exhibit 10.6

Capitol Hotels Associates LP

CONTRIBUTION AGREEMENT

THIS CONTRIBUTION AGREEMENT (this “Agreement”) is made as of the 23rd day of August, 2004 (the “Effective Date”) by and among the entities identified on Schedule 1 attached hereto (each a “Contributor” and collectively, the “Contributors”), and MHI Hospitality LP, a Delaware limited partnership (the “Acquiror”).

RECITALS

A. Capitol Hotel Associates L.P., L.L.P. (the “Partnership”) is the owner of certain real property consisting of approximately 4.95 acres of land located in Williamsburg, Virginia (the “Virginia Property”) and the hotel improvements located thereon consisting of a 138 room hotel trading as Holiday Inn Downtown (the “Virginia Hotel”); as well as real property consisting of approximately 4.69 acres of land located in Wilmington, North Carolina (the “North Carolina Property” and with the Virginia Property, the “Properties”), and the hotel improvements located thereon consisting of a 274 room hotel trading as the Hilton Riverside (the “North Carolina Hotel” and, with the Virginia Hotel, the “Hotels”);

B. Contributors are the record and beneficial owners of 100% of the ownership interests of the Partnership (the “Contributed Assets”). MHI Hotels Services, LLC, one of the Contributors, is the general partner of the Partnership. The Contributors desire to contribute the Contributed Assets to the Acquiror, and the Acquiror desires to acquire the Contributed Assets from the Contributor, on the terms and conditions hereinafter set forth;

C. The Acquiror will be the operating partnership of a Maryland corporation to be formed which will seek to qualify as a real estate investment trust for Federal income tax purposes (the “REIT”) and will seek to complete an underwritten public offering of shares of its common stock (the “IPO”). The Contributors intend to contribute the Contributed Assets to the Acquiror in connection with the closing of the IPO.

AGREEMENT

NOW, THEREFORE, for and in consideration of the mutual covenants herein contained, the parties hereto agree as follows:

ARTICLE I

THE CONTRIBUTION

1.1 Contribution of Contributed Assets . The Contributors agree to contribute and transfer the Contributed Assets to the Acquiror, and the Acquiror agrees to accept transfer of the Contributed Assets pursuant to the terms and conditions set forth in this Agreement. The Contributed Assets shall be transferred to the Acquiror free and clear of all liens, encumbrances, security interests, prior assignments or conveyances, conditions, restrictions, claims, and other matters affecting title thereto.

1.2 Consideration . In exchange for the contribution and transfer by the Contributors of the Contributed Assets to the Acquiror, the Acquiror agrees, subject to the terms of this Agreement, to issue to the Contributors 1,259,676 units in the aggregate of limited partnership interests in the Acquiror (the “Units”). The number of Units to be issued to each Contributor is set forth in Schedule 1 attached hereto.

1.3 Issuance of Units . On the Closing Date (as defined below), the Acquiror shall issue to the Contributors certificates reflecting the Units in such amount as specified in Schedule 1. Such certificates shall bear appropriate legends indicating (i) that the Units have not been registered under the Securities Act of 1933, as amended (the “Securities Act”), and (ii) that the Acquiror’s agreement of limited partnership (the “Partnership Agreement”) will restrict the transfer of the Units. Immediately upon receipt of the Units, each Contributor shall accede to the Partnership Agreement as a limited partner of the Acquiror. The Contributor acknowledges and agrees that once Closing occurs, the Contributor shall no longer be a partner of the Partnership, shall no longer be entitled to receive any distributions from the Partnership, and shall have no further right, title or interest in the Partnership.

1.4 Adjustment . The term “Purchased Working Capital” shall mean the agreed upon sum of fifty thousand dollars ($50,000) which amount represents the Partnership’s good faith estimate of the Partnership’s current assets shown on the Hotels’ balance sheet (exclusive of any FF&E Reserves) less the Partnership’s current liabilities shown on the Hotels’ balance sheet at the close of business on the Closing Date. The Contributors shall be permitted an opportunity to review the books and records of the Partnership prior to the Closing Date (and for sixty (60) days thereafter) to verify the calculation of Purchased Working Capital and all other working capital as of the Closing Date. Within such sixty (60) day period, the parties hereto agree to calculate actual working capital as of the Closing Date (including any amounts in any escrow or reserve accounts as of the Closing Date). In the event that actual working capital at Closing is more or less than the Purchased Working Capital, then the Contributors shall pay to the Acquiror an amount equal to the amount by which actual working capital as of the Closing Date is less than the Purchased Working Capital, and the Acquiror will pay to the Contributors an amount equal to the amount by which actual working capital as of the Closing

Date exceeds the Purchased Working Capital. Any such amount payable by the Acquiror to the Contributors shall be allocated among the Contributors in proportion to the number of Units issuable to each Contributor pursuant to Schedule 1 hereof. Each Contributor shall bear its pro rata portion of any amount payable by the Contributors to the Acquiror on the basis of the number of Units issuable to each Contributor hereunder. Each Contributor (by its execution hereof) hereby acknowledges and agrees any such adjustments shall be paid in cash to the party entitled thereto, and such adjustments shall be deemed final. Payment, if any, shall be made within 15 days of calculating working capital as of the Closing Date.

1.5 Deposit . Within five (5) business days after the full execution of this Agreement, the Acquiror shall pay to each Contributor the sum of Ten Dollars ($10.00) (the “Deposit”) as consideration for such Contributor entering into this Agreement. The Deposit shall be deemed earned and non-refundable immediately upon payment of the Deposit (except if the Contributor defaults hereunder, in which event the Deposit shall be promptly refunded to the Acquiror).

1.6 Redemption Rights for Units . The Units shall be redeemable at the option of the holders of such Units and in accordance with, but subject to the restrictions contained in, the Partnership Agreement; provided, however, that such redemption option may not be exercised prior to the first anniversary of the Closing Date.

1.7 Tax Consequences to Contributors . Notwithstanding anything to the contrary contained in this Agreement, including without limitation the use of words and phrases such as “sell,” “sale,” purchase,” and “pay,” the parties hereto acknowledge and agree that it is their intent that the contribution transaction contemplated hereby with respect to the Contributed Assets shall be treated for federal income tax purposes pursuant to Section 721 of the Internal Revenue Code of 1986, as amended (the “Code”), as the contribution of the Contributed Assets by the Contributors to the Acquiror, in exchange for the Units, the Deposit and any payments made by Acquiror pursuant to Section 1.2 or Section 4.4, and not as a transaction in which any Contributor is acting other than in its capacity as a prospective partner in the Acquiror.

1.8 Tax Indemnity . In conjunction with the contributions contemplated by this Article I, each Contributor will execute and deliver the Tax Indemnity (as defined hereafter) in the form attached as Exhibit 1.8.

ARTICLE II

REPRESENTATIONS AND COVENANTS

2.1 Representations by Acquiror . The Acquiror hereby represents and warrants unto each Contributor that the following statements are true, correct, and complete as of the date of this Agreement and will be true, correct, and complete as of the Closing Date:

(a) Organization and Power . The Acquiror is duly organized, validly existing, and in good standing under the laws of the State of Delaware, and has full right, power, and authority to enter into this Agreement and to assume and perform all of its obligations under this Agreement; and, the execution and delivery of this Agreement and the performance by the Acquiror of its obligations hereunder have been duly authorized by all requisite action of the Acquiror and require no further action or approval of the Acquiror’s partners or of any other individuals or entities in order to constitute this Agreement as a binding and enforceable obligation of the Acquiror. This Agreement constitutes the legal, valid and binding obligation of Acquiror and is enforceable in accordance with its terms.

(b) Noncontravention . Neither the entry into nor the performance of, or compliance with, this Agreement by the Acquiror has resulted, or will result, in any violation of, or default under, or result in the acceleration of, any obligation under any existing certificate of limited partnership, partnership agreement, mortgage, indenture, lien agreement, note, contract, permit, judgment, decree, order, restrictive covenant, statute, rule, or regulation applicable to the Acquiror.

(c) Litigation . There is no action, suit, or proceeding, pending or known to be threatened, against or affecting the Acquiror in any court or before any arbitrator or before any federal, state, municipal, or other governmental department, commission, board, bureau, agency or instrumentality which (i) in any manner raises any question affecting the validity or enforceability of this Agreement, (ii) could materially and adversely affect the business, financial position, or results of operations of the Acquiror or the Partnership, (iii) could materially and adversely affect the ability of the Acquiror to perform its obligations hereunder, or under any document to be delivered pursuant hereto.

(d) Units Validly Issued . The Units, when issued, will have been duly and validly authorized and issued, free of any preemptive or similar rights, and will be fully paid and nonassessable, without any obligation to restore capital except as required by the Delaware Revised Uniform Limited Partnership Act (the “Limited Partnership Act”). Each Contributor shall be admitted as a limited partner of the Acquiror as of the Closing Date and shall be entitled to all of the rights and protections of a limited partner under the Limited Partnership Act and the provisions of the Partnership Agreement, with the same rights, preferences, and privileges as all other limited partners on a pari passu basis.

(e) Consents . Except as may otherwise be set forth in Schedule 2.1(e) hereof, each consent, approval, authorization, order, license, certificate, permit, registration, designation, or filing by or with any governmental agency or body necessary for the execution, delivery, and performance of this Agreement or the transactions contemplated hereby by the Acquiror has been obtained or will be obtained on or before the Closing Date.

(f) Brokerage Commission . The Acquiror has not engaged the services of any real estate agent, broker, finder or any other person or entity for any brokerage or finder’s fee, commission or other amount with respect to the transactions described herein on account of any action by the Acquiror. The Acquiror hereby agrees to indemnify and hold the Contributors and each of their employees, directors, members, partners, affiliates and agents harmless against any claims, liabilities, damages or expenses arising out of a breach of the foregoing. This indemnification shall survive Closing or any termination of this Agreement.

2.2 Representations by Contributors . Each Contributor (except as otherwise indicated herein), hereby represents and warrants unto the Acquiror, jointly and severally, that each and every one of the following statements is true, correct, and complete as of the date of this Agreement and will be true, correct, and complete as of the Closing Date.

(a) Organization and Power . Each of the Contributor and the Partnership is duly organized, validly existing, and in good standing under the laws of the state of its organization. The Contributor has full right, power, and authority to enter into this Agreement and to assume and perform all of its obligations under this Agreement; and the execution and delivery of this Agreement and the performance by the Contributor of its obligations hereunder have been duly authorized by all requisite action of Contributor and require no further action or approval of Contributor’s members or managers or directors or shareholders or partners, as the case may be, or of any other individuals or entities in order to constitute this Agreement as a binding and enforceable obligation of the Contributor. This Agreement constitutes the legal, valid and binding obligation of Contributors and is enforceable in accordance with its terms.

(b) Noncontravention . Neither the entry into nor the performance of, or compliance with, this Agreement by the Contributor has resulted, or will result, in any violation of, or default under, or result in the acceleration of, any obligation under the Contributor’s organizational documents, or any regulations, mortgage indenture, lien agreement, note, contract, permit, judgment, decree, order, restrictive covenant, statute, rule, or regulation applicable to Contributor or to the Contributed Assets.

(c) Litigation . There is no action, suit, or proceeding, pending or known to be threatened, against or affecting the Contributor, the Partnership or the Hotels in any court or before any arbitrator or before any federal, state, municipal, or other governmental department, commission, board, bureau, agency or instrumentality which (A) in any manner raises any question affecting the validity or enforceability of this Agreement, (B) could materially and adversely affect the business, financial position, or results of operations of the Hotels, or the Partnership, (C) could materially and adversely affect the ability of the Contributor to perform its obligations hereunder, or under any document to be delivered pursuant hereto, (D) could create a lien on the Contributed Assets, any part thereof, or any interest therein, or (E) could adversely affect the Contributed Assets, any part thereof, or any interest therein.

(d) Good Title . (A) The Contributor is the sole owner of the ownership interests in the Contributed Assets specified in Schedule 1 (the “Contributor’s Assets”), (B) the Contributor has good title to the Contributor’s Assets, (C) the Contributor’s Assets are free and clear of all liens, encumbrances, pledges, voting agreements and security interests whatsoever, and (D) the Contributor has not granted any other person or entity an option to purchase or a right of first refusal upon the Contributor’s Assets nor are there any agreements or understandings between Contributor and any other person or entity with respect to the disposition of the Contributor’s Assets, and Contributor has full power and authority to convey the Contributor’s Assets free and clear of any liens, claims and encumbrances and upon delivery of the Assignment attached hereto in the form of Exhibit A to Acquiror and Acquiror will acquire good title thereto, free and clear of any liens, claims and encumbrances. The Partnership owns the Hotels and the Properties beneficially and of record free and clear of any liens, claims, encumbrances, mortgages, security interests, deed of trust, easements, purchase rights or any other right of any nature of any third party except as set forth on Schedule 2.2(d).

(e) No Consents . Except as may otherwise be set forth in Schedule 2.2(e) hereof, each consent, approval, authorization, order, license, certificate, permit, registration, designation, or filing by or with any third party, including, but not limited to, lenders and franchisors, or any governmental agency or body necessary for the execution, delivery, and performance of this Agreement or the transactions contemplated hereby has been obtained or will be obtained on or before the Closing Date.

(f) Operation of Contributed Assets . Between the date hereof and the Closing Date, the Contributor will take such action as may be necessary to cause the Partnership (A) operate its business only in the usual, regular, and ordinary manner consistent with such entity’s prior practice and (B) maintain its books of account and records in the usual, regular, and ordinary manner, in accordance with sound accounting principles applied on a basis consistent with the basis used in keeping its books in prior years. Except as otherwise permitted hereby, from the date hereof until the Closing Date, the Contributor shall not take any action or fail to take any action the result of which would (1) have a material adverse effect on the Contributed Assets, the Contributor’s Assets, the Properties, the Hotels, or the Acquiror’s ability to continue the operation thereof after the Closing Date in substantially the same manner as presently conducted or (2) would cause any of the representations and warranties contained in this Section 2.2 to be untrue as of the Closing Date.

(g) Partnership Agreement . The Limited Partnership Agreement of the Partnership, (the “Capitol Hotel Partnership Agreement”) is in force and effect as of the date hereof, and has not been modified or amended and a true and accurate copy of such agreement as amended to date has been provided to Acquiror. The Contributor has performed all of its obligations under the Capitol Hotel Partnership Agreement.

(h) Securities Law Matters . (A) In acquiring the Units and engaging in this transaction, neither the Contributors nor any shareholder, partner or beneficiary of a Contributor is relying upon any representations made to it by the Acquiror, or any of its partners, officers, employees, or agents that are not contained herein. Contributor is aware of the risks involved in investing in the Units and in the shares of common stock (“Common Stock”) of the REIT, issuable upon redemption of such Units. Contributor has had an opportunity to ask questions of, and to receive answers from, the Acquiror or a person or persons authorized to act on its behalf, concerning the terms and conditions of this investment and the financial condition, affairs, and business of the Acquiror and the REIT. Contributor confirms that all documents, records, and information pertaining to its investment in the Acquiror that have been requested by it, including a complete copy of the form of the Partnership Agreement, have been made available or delivered to it prior to the date hereof. Contributor represents and warrants that it has reviewed and approved the form of the Partnership Agreement attached hereto as Exhibit B.

(B) Contributor and each shareholder, partner or beneficiary thereof understands that neither the Units nor the shares of Common Stock issuable upon redemption of the Units have been registered under the Securities Act or any state securities acts and are instead being offered and sold in reliance on an exemption from such registration requirements. The Units issuable to Contributor are being acquired solely for its own account, for investment, and are not being acquired with a view to, or for resale in connection with, any distribution, subdivision, or fractionalization thereof, in violation of such laws, and Contributor does not have any present intention to enter into any contract, undertaking, agreement, or arrangement with respect to any such resale; provided, however, that, at or following Closing, Contributor may distribute the Units to its shareholders, partners or members, as the case may be that (1) have represented and warranted to the Acquiror in writing that, as of the time of such distribution, such member, shareholder or partner, as the case may be, is an accredited investor as that term is defined in Rule 501 of Regulation D under the Securities Act, and (2) have executed the Partnership Agreement as limited partners. Contributor understands that any certificates evidencing the Units will contain appropriate legends reflecting the requirement that the Units not be resold by Contributor without registration under such laws or the availability of an exemption from such registration and that the Partnership Agreement will restrict transfer of the Units.

(i) Accredited Investor . Contributor is an accredited investor as that term is defined in Rule 501 of Regulation D under the Securities Act.

(j) Tax Matters . (A) The Partnership has filed within the time and in the manner prescribed by law all federal, state, and local tax returns and reports, including but not

limited to income, gross receipts, intangible, real property, excise, withholding, franchise, sales, use, employment, personal property, and other tax returns and reports, required to be filed by such entity under the laws of the United States and of each state or other jurisdiction in which such entity conducts business activities requiring the filing of tax returns or reports except for such terms or reports where the failure to file would not have a material adverse effect on the Partnership or the Contributed Assets. All tax returns and reports filed by the Partnership are true and correct in all material respects. The Partnership has paid in full all taxes of whatever kind or nature for the periods covered by such returns. The Partnership has not been delinquent in the payment of any tax, assessment, or governmental charge or deposit and has no tax deficiency or claim outstanding, assessed, threatened, or proposed against it. The charges, accruals, and reserves for unpaid taxes on the books and records of the Partnership as of the Closing Date are sufficient in all respects for the payment of all unpaid federal, state, and local taxes of the Partnership accrued for or applicable to all periods ended on or before the Closing Date. There are no tax liens, whether imposed by the United States, any state, local, or other taxing authority, outstanding against the Partnership or any of its assets. The federal, state, and local tax returns of the Partnership have not been audited, nor has the Partnership received any notice of any federal, state, or local audit.

(B) Each Contributor represents and warrants that it has obtained from its own counsel advice regarding the tax consequences of (i) the transfer of the Contributor’s Assets to the Acquiror and the receipt of Units as consideration therefor, (ii) Contributor’s admission as a limited partner of the Acquiror, and (iii) any other transaction contemplated by this Agreement. Each Contributor further represents and warrants that it has not relied on the Acquiror or the Acquiror’s representatives or counsel for such tax advice.

(k) Bankruptcy with respect to Contributor . No Act of Bankruptcy has occurred with respect to the Contributor or Partnership. As used herein, “Act of Bankruptcy” shall mean if a party hereto or any member, or manager, shareholder or director thereof, as the case may be, shall (A) apply for or consent to the appointment of, or the taking of possession by, a receiver, custodian, trustee or liquidator of itself or of all or a substantial part of its property, (B) admit in writing its inability to pay its debts as they become due, (C) make a general assignment for the benefit of its creditors, (D) file a voluntary petition or commence a voluntary case or proceeding under the Federal Bankruptcy Code (as now or hereafter in effect), (E) be adjudicated bankrupt or insolvent, (F) file a petition seeking to take advantage of any other law relating to bankruptcy, insolvency, reorganization, receivership, dissolution, winding-up or composition or adjustment of debts, (G) fail to controvert in a timely and appropriate manner, or acquiesce in writing to, any petition filed against it in an involuntary case or proceeding under the Federal Bankruptcy Code (as now or hereafter in effect), or (H) take any entity action for the purpose of effecting any of the foregoing.

(l) Brokerage Commission . The Contributor has not engaged the services of, any real estate agent, broker, finder or any other person or entity for any brokerage or

finder’s fee, commission or other amount with respect to the transactions described herein on account of any action by the Contributor. The Contributor hereby agrees to indemnify and hold the Acquiror and its employees, directors, members, partners, affiliates and agents harmless against any claims, liabilities, damages or expenses arising out of a breach of the foregoing. This indemnification shall survive Closing or any termination of this Agreement.

(m) Liabilities, Indebtedness . Except as set forth in Schedule 2.2(m), the Partnership has not incurred any indebtedness related to the Hotels or the Properties except in each instance for trade payables and other customary and ordinary expenses in the normal course of business.

(n) Leases . Schedule 2.2(n) attached hereto is a true, correct and complete schedule of all ground leases, restaurant leases, subleases and other rights of occupancy in effect with respect to the Hotels and the Properties (collectively, the “Leases”). Except as set forth on Schedule 2.2(n), there are no other leases, subleases, tenancies or other rights of occupancy in effect with respect to the Hotels or the Properties. True, correct and complete copies of the Leases, together with all amendments and supplements thereto and all other documents and correspondence relating thereto, have been delivered or made available to Acquiror. Except as set forth on Schedule 2.2(n), all such Leases are valid and enforceable and presently in full force and effect, and none of the Leases have been assigned and all brokerage commissions, if any, payable under any of the Leases have been paid or will be paid by the Partnership prior to the Closing. To the best knowledge of Contributor, no party to any Lease is in default under such Lease, and Contributor does not know of any event which, but for the passage of time or the giving of notice, or both, would constitute a default under such Leases, except such defaults that would not have a material adverse effect on the condition, financial or otherwise or on the earnings, business affairs or business prospects of the Partnership. No tenant under any of the Leases has an option or right of first refusal to purchase the premises demised under such Lease. The consummation of the transactions contemplated by this Agreement will not give rise to any breach, default or event of default under any of the Leases. None of the Leases requires the consent or approval of any party in connection with the transactions contemplated by this Agreement.

(o) Insurance . The Partnership currently maintains or causes to be maintained all of the public liability, casualty and other insurance coverage with respect to the Hotels as set forth on Schedule 2.2(o) attached hereto. All such insurance coverage shall be maintained in full force and effect through the Closing and all premiums due and payable thereunder have been, and shall be, fully paid when due.

(p) Personal Property . All equipment, fixtures and personal property located at the Hotels shall remain and not be removed prior to the Closing, except for equipment that becomes obsolete or unusable, which may be disposed of or replaced in the ordinary course of business.

(q) Environmental Conditions .

(A) As of the date of this Agreement and as of the Closing, and except as set forth in the environmental reports and materials previously delivered to Acquiror which are listed on Schedule 2.2(q) attached hereto (collectively, “Environmental Reports”), to the best of Contributors’ knowledge, information, and belief, the Properties (which for purposes of this Section 2.2(q) shall include all leased and vacant space, land surface water, groundwater and any and all improvements located on, in or under the Properties) are now and will be at the Closing free of all contamination which exists as or has arisen from, directly or indirectly:

(1) any “hazardous waste,” “underground storage tanks,” “petroleum,” “regulated substance,” or “used oil” as defined by the Resource Conservation and Recovery Act of 1976 (42 U.S.C. §6901, et seq.), as amended (“RCRA”), or by any regulations promulgated thereunder;

(2) any “hazardous substance” as defined by the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (42 U.S.C. § 9601, et seq.), as amended (“CERCLA”), or by any regulations promulgated thereunder (including without limitation asbestos, radon, mold and lead-based paint);

(3) any “oil” or other “hazardous substance” as defined by the Oil and Hazardous Substance Control Act of 1976, as amended, or by and regulations promulgated thereunder;

(4) any substance the presence of which on, in or under the Properties is prohibited or regulated by any federal, state or local environmental law (an “Environmental Law”); and

(5) any other hazardous materials as to which remedial action is required under applicable Environmental Laws (together with substances described in subsections (a) – (d), “Hazardous Materials”).

(B) To the best of Contributors’ knowledge, information, and belief, as of the date of this Agreement and as of the Closing, and except as set forth in the Environmental Reports:

(1) the Properties are now and will be at the Closing free from asbestos and any asbestos containing materials (including without limitation the presence of any asbestos in the insulation or other materials used comprising any part of the improvements), mold, radon and lead-based paint that would have a material adverse effect on the Properties;

(2) to the knowledge of Contributor, the Partnership has not placed, located, sited or buried any underground storage tanks at the Properties and to the knowledge of Contributor, no underground storage tanks are located on, at or under the Properties;

(3) to the knowledge of Contributor, the Properties do not appear on any state or federal CERCLA, RCRA, Superfund or other similar lists and, to the knowledge of Contributor, the Properties are not proposed to be included on any such list;

(4) to the knowledge of Contributor, the Partnership has never used any part of the Properties as a sanitary landfill, waste dump site or for the treatment, storage or disposal of hazardous waste as defined in RCRA and no part of the Properties have ever been used as a sanitary landfill, waste dump site or for the treatment, storage or disposal of hazardous waste as defined in RCRA;

(5) to the knowledge of Contributor, no notice of violation or other written communication has been received by the Partnership or any predecessor in title from a governmental agency or other entity or person, alleging or suggesting any violation of any Environmental Law on or with respect to the Properties;

(6) to the knowledge of Contributor, neither the Partnership nor any of such Partnership’s agents, licensees or invitees have placed or permitted the placement of any Hazardous Materials in, on, under or over the Properties in violation of any Environmental Law;

(7) to the knowledge of Contributor, no other party has placed any Hazardous Material in, on, under or over any of the Properties in violation of any Environmental Law; and

(8) to the knowledge of Contributor, the Properties are not subject to any federal, state or local lien (including any “Superfund” lien), proceedings, claim, liability, or action, or the threat or likelihood thereof, relating to the clean-up, removal or remediation of any Hazardous Material from the Properties and the Partnership has not received any request or information from the United States Environmental Protection Agency or any other public, governmental or quasi-governmental agency or authority with jurisdiction over any Environmental Law.

(r) Compliance With Laws . To the best of Contributors’ knowledge, information, and belief, the Partnership possesses such certificates, approvals, licenses,

authorities or permits issued by the appropriate local, state or federal agencies or bodies necessary to conduct the business to be conducted by it, and, to the knowledge of Contributor, the Partnership has not received any written notice of proceedings relating to the revocation or modification of any such certificate, approval, license, authority or permit which, singly or in the aggregate, if the subject of an unfavorable decision, ruling, or finding, would materially and adversely affect the condition, financial or otherwise, or the earnings, business affairs or business prospects of the Properties or the Hotels. To the best of Contributors’ knowledge, information, and belief, the Partnership has not received any written or other notice of any violation of any applicable zoning, building or safety code, rule, regulation or ordinance, or of any employment, environmental, wetlands or other regulatory law, order, regulation or other requirement, including without limitation the Americans With Disabilities Act (“ADA”) or any restrictive covenants or other easements, encumbrances or agreements, relating to the Properties or the Hotels, which remains uncured. The Properties and the Hotels have been constructed and is operated in accordance with all applicable laws, ordinances, rules and regulations. All approvals regarding zoning, land use, subdivision, environmental and building and construction laws, ordinances, rules and regulations have been obtained, and such approvals will not be invalidated by the consummation of the transactions contemplated by this Agreement; provided, however, the Properties and the Hotels (including, all improvements) are substantially in compliance with the ADA.

(s) Condemnation and Moratoria . Except as set forth on Schedule 2.2(s), to the best of Contributors’ knowledge, information and belief, there are (i) no pending or threatened condemnation or eminent domain proceedings, or negotiations for purchase in lieu of condemnation, which affect or would affect any portion of the Properties; (ii) no pending or, to the knowledge of Contributor, threatened moratoria on utility or public sewer hook-ups or the issuance of permits, licenses or other inspections or approvals necessary in connection with the construction or reconstruction of improvements, including without limitation tenant improvements, which affect or would affect any portion of the Properties; and (iii) no pending or, to the knowledge of Contributor, threatened proceeding to change adversely the existing zoning classification as to any portion of the Properties. No portion of the Properties are a designated historic property or located within a designated historic area or district and there are no graveyards or burial grounds located within the Properties.

(t) Condition of Improvements . To the best of Contributors’ knowledge, information and belief, there is no material defect in the condition of (i) the Properties or the Hotels, (ii) the improvements thereon, (iii) the roof, foundation, load-bearing walls or other structural elements thereof, or (iv) the mechanical, electrical, plumbing and, safety systems therein, nor any material damage from casualty or other cause, nor any soil condition of any nature that will not support all of the improvements thereon without the need for unusual or new subsurface excavations, fill, footings, caissons or other installations.

(u) Absence of Certain Changes . To the best of Contributors’ knowledge, information and belief, since December 31, 2003, except as set forth or referred to on Schedule 2.2(u), there has not been with respect to the Partnership:

(A) any material adverse change in the financial condition of the Partnership, the Hotels or the Properties;

(B) any change in the condition of the Properties, the Hotels or the business or liabilities of the Partnership except normal and usual changes in the ordinary course of business which have not been, individually or in the aggregate, materially adverse;

(C) any damage, destruction or loss, whether or not covered by insurance, individually or in the aggregate, materially and adversely affecting the Properties or the Hotels;

(D) any change in the accounting methods or practices with respect to the Hotels or the Properties or in depreciation or amortization policies theretofore used or adopted;

(E) any material liability with respect to the Hotels or the Properties, contingent or otherwise, other than for operating expenses, obligations under any executory contracts disclosed on Schedule 2.2(u) hereof incurred for fair consideration and taxes accrued with respect to operations during such period, all incurred in the ordinary course of business; or

(F) any other material change in the business of the Partnership.

(v) ERISA . The Partnership has no (i) labor agreement to which it is a party, or by which it is bound, including “employee pension benefit plans” as defined in Section 3(2) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”); (ii) employment, profit sharing, deferred compensation, bonus, pension, retainer, consulting, retirement, welfare or incentive plan, fund, program or contract to which it is a party, or by which it is bound; (iii) written or other formal personnel policies; or (iv) plan or agreement under which “fringe benefits” (including, but not limited to, vacation plans or programs, sick leave plans or programs, and related benefits) are afforded to its employees.

(w) No Contracts . No agreements, undertakings or contracts affecting the Hotels or the Properties, written or oral, will be in existence as of the Closing, except as set forth on Schedule 2.2(w) attached hereto, and true and correct copies of such contracts have been delivered to Acquiror. With respect to any such contracts set forth on Schedule 2.2(w), each such contract is valid and binding on the Partnership and is in full force and effect in all material respects. To the knowledge of Contributor, no party to any such contract has breached or defaulted under the terms of such contract, except for such breaches or defaults that would not, individually or in the aggregate, have a material adverse effect on the business or operations of the Hotels or the Properties.

(x) Disclosure . The representations and warranties contained in this Agreement (including Schedules and Exhibits) or in any information, statement, certificate or agreement furnished or to be furnished to Acquiror by Contributor in connection with the Closing pursuant to this Agreement, do not contain any untrue statement of a material fact or omit to state any material fact necessary to make the statements and information contained herein or therein, in light of the circumstances in which they are made, not misleading.

2.3 Satisfaction of Conditions . The Acquiror hereby covenants that the Acquiror shall use commercially reasonable efforts and diligence in order to satisfy all of the conditions set forth in Section 3.2 hereof; and the Contributors shall not have any obligation to consummate the Closing hereunder unless and until all such conditions have been satisfied or waived by the Contributor in writing. Each Contributor hereby covenants that it shall: (A) use commercially reasonable efforts and diligence in order to satisfy all of the conditions set forth in subsections 3.1(a), (b) and (c) hereof, and (B) cooperate and assist in the Acquiror’s efforts to satisfy the conditions set forth in subsection 3.1(g) hereof; and the Acquiror shall not have any obligation to consummate the Closing hereunder unless and until such conditions have been satisfied or waived by the Acquiror in writing.

2.4 Contributor’s Indemnity . Each Contributor agrees to indemnify and hold the Acquiror, the REIT, and their respective employees, directors, members, partners, affiliates and agents harmless of and from all liabilities, losses, damages, costs, and expenses (including reasonable attorneys’ fees) which the Acquiror or the REIT may suffer or incur by reason of any breach of its representations or warranties contained in this Agreement, and by reason of any act or cause of action occurring or accruing prior to the Closing Date and arising from the ownership of the Contributed Assets and in the operation of the Hotels prior to the Closing Date.

2.5 Acquiror’s Indemnity. The Acquiror agrees to indemnify and hold the Contributors and their employees, directors, members, partners, affiliates and agents harmless of and from all liabilities, losses, damages, costs, and expenses (including reasonable attorneys’ fees) which the Contributors may suffer or incur by reason of any breach of its representations or warranties contained in this Agreement, and by reason of any act or cause of action occurring or accruing subsequent to the Closing Date and arising from the ownership or operation of the Contributed Assets or the operation of the Hotels subsequent to the Closing Date.

ARTICLE III

CONDITIONS PRECEDENT TO THE CLOSING

3.1 Conditions to Acquiror’s Obligations . In addition to any other conditions set forth in this Agreement, the Acquiror’s obligation to consummate the Closing is subject to the timely satisfaction of each and every one of the conditions and requirements set forth in this Section 3.1, all of which shall be conditions precedent to the Acquiror’s obligations under this Agreement.

(a) Contributors’ Obligations . Each Contributor shall have performed all obligations of such Contributor hereunder which are to be performed prior to Closing, and shall have delivered or caused to be delivered to the Acquiror, all of the documents and other information required of the Contributor pursuant to Section 4.2.

(b) Contributors’ Representations and Warranties . The representations and warranties of the Contributors set forth in Section 2.2 shall be true and correct as if made again on the Closing Date.

(c) No Injunction . On the Closing Date, there shall be no effective injunction, writ, preliminary restraining order or other order issued by a court of competent jurisdiction restraining or prohibiting the consummation of the transactions contemplated hereby.

(d) No Material Adverse Change . Since the Effective Date, there shall have been no material adverse effect on, or a material adverse change in, the business, financial condition or operations of the Partnership or the Hotels as presently conducted.

(e) Completion of IPO . The IPO shall have been completed.

(f) Consent of Franchisor . The Franchisors of the Hotels shall have consented to the transaction contemplated herein on terms and conditions that are acceptable to Acquiror in its sole discretion.

(g) Third Party Consents . All required third party consents will have been obtained or otherwise waived.

3.2 Conditions to Contributors’ Obligations . In addition to any other conditions set forth in this Agreement, the obligations of the Contributors to consummate the Closing is subject to the timely satisfaction of each and every one of the conditions and requirements set forth in this Section 3.2, all of which shall be conditions precedent to the Contributor’s obligations under this Agreement.

(a) Acquiror’s Obligations . The Acquiror shall have performed all obligations of the Acquiror hereunder which are to be performed prior to Closing, and shall have delivered or caused to be delivered to the Contributor, all of the documents and other information required of the Acquiror pursuant to Section 4.3.

(b) Acquiror’s Representations and Warranties . The Acquiror’s representations and warranties set forth in Section 2.1 shall be true and correct as if made again on the Closing Date.

3.3 Restructuring . Upon the written request of Acquiror not less than ten days prior to Closing, Contributors shall take such action as may be reasonably requested by Acquiror to cause the Partnership to be converted into a limited liability company under the laws of such jurisdiction as may be identified by Acquiror. Following receipt of such notice and prior to the Closing Date, Contributors shall convert the Partnership to a limited liability company provided such conversion does not create a material federal, state or local tax liability to the Contributors unless Acquiror agrees to indemnify the Contributors against such tax liability.

ARTICLE IV

CLOSING AND CLOSING DOCUMENTS

4.1 Closing . The consummation and closing (the “Closing”) of the transactions contemplated under this Agreement shall take place at the offices of the Acquiror in Greenbelt, Maryland, or such other place as is mutually agreeable to the parties, on the date of the closing of the IPO (the “Closing Date”), or as otherwise set by agreement of the parties hereto. . If at any time the REIT determines in good faith to abandon or discontinue its efforts to engage in an IPO, Acquiror shall so advise each Contributor in writing and thereupon all parties hereto will be relieved of all obligations under this Agreement.

4.2 Contributor’s Deliveries . At the Closing, each Contributor shall deliver the following to the Acquiror in addition to all other items required to be delivered to the Acquiror by the Contributor:

(a) Assignment of Contributed Assets . Each Contributor shall have executed and delivered an Assignment, in substantially the form of Exhibit A attached hereto, granting and conveying to the Acquiror good and indefeasible title to the Contributor’s Assets, free and clear of all liens, encumbrances, security interests, prior assignments, conditions, restrictions, claims, and other matters affecting title thereto.

(b) Execution of Partnership Agreement . Signature pages of the Partnership Agreement (which Partnership Agreement shall be in substantially the form attached hereto as Exhibit B) duly executed by each Contributor, as limited partner.

(c) FIRPTA Certificate . An affidavit from each Contributor certifying pursuant to Section 1445 of the Code that the Contributor is not a foreign corporation, foreign partnership, foreign trust, foreign estate or foreign person (as those terms are defined in the Code and the Income Tax Regulations promulgated thereunder).

(d) Tax Indemnity . Each Contributor shall have executed a tax indemnity and debt maintenance agreement and related guaranty (the “Tax Indemnity”) to reflect the allocation of indebtedness to each Contributor in the form attached hereto as Exhibit 1.8 in an amount not to exceed such Contributor’s negative balance in the capital account maintained by the Partnership for such Contributor as of the Closing Date.

(e) Other Documents . Any other document or instrument reasonably requested by the Acquiror or required hereby.

4.3 Acquiror’s Deliveries . At the Closing, the Acquiror shall deliver the following to the Contributors:

(a) Certificates for Units . Certificates representing Units duly issued by the Acquiror in the name of the Contributor as of the Closing Date representing the Units to which the Contributor is entitled pursuant to Section 1.2 of this Agreement.

(b) Executed Partnership Agreement . Signature pages of the Partnership Agreement (which Partnership Agreement shall be in substantially the form attached hereto as Exhibit B) duly executed by its general partner.

(d) Other Documents . Any other document or instrument reasonably requested by a Contributor or required hereby.

Contributors. Each Contributor acknowledges and agrees, by executing this Agreement, that it will benefit from such an IPO and, as a consequence, the Partnership will bear a portion of its costs if such transaction is not completed.

4.5 Default Remedies . If the Closing fails to occur due to a default by the Acquiror, the Contributors shall retain the Deposit as such Contributor’s sole and exclusive remedy for such default, and the Contributor hereby waives any right it may have to damages (compensatory, consequential or otherwise) from the Acquiror as a result of such default. If a Contributor defaults in performing any of the Contributor’s obligations under this Agreement, the Acquiror shall have all rights and remedies available to it at law or in equity resulting from the Contributor’s default, including without limitation, the right to seek specific performance of this Agreement and the Contributor’s obligation to convey the Contributor’s Assets to the Acquiror hereunder. The parties acknowledge and agree that the failure of a condition precedent to occur, notwithstanding the good faith and commercially reasonable efforts of the applicable party, shall not be a default hereunder.

ARTICLE V

MISCELLANEOUS

5.1 Notices . Any notice provided for by this Agreement and any other notice, demand, or communication required hereunder shall be in writing and either delivered in person (including by confirmed facsimile transmission) or sent by hand delivered against receipt or sent by recognized overnight delivery service or by certified or registered mail, postage prepaid, with return receipt requested. All notices shall be addressed as follows:

Acquiror:

MHI Hospitality L.P.

814 Capitol Landing Road

Williamsburg, VA 23187

Attention: Mr. Andrew M. Sims

Fax No.: (757) 564-8801

Phone No.: (757) 229-5648

E-mail: drewsims@mhihotels.com

Notices to Contributors shall be sent to the addresses specified on Schedule 1.

deliver because of changed address of which no notice was given, or rejection or other refusal to accept any notice, demand or other communication, shall be deemed to be receipt of the notice, demand or other communication as of the date of such attempt to deliver or rejection or refusal to accept.

5.2 Entire Agreement; Modifications and Waivers; Cumulative Remedies . This Agreement supersedes any existing letter of intent between the parties hereto, constitutes the entire agreement among the parties hereto and may not be modified or amended except by instrument in writing signed by the parties hereto, and no provisions or conditions may be waived other than by a writing signed by the party waiving such provisions or conditions. No delay or omission in the exercise of any right or remedy accruing to the Contributor or the Acquiror upon any breach under this Agreement shall impair such right or remedy or be construed as a waiver of any such breach theretofore or thereafter occurring. The waiver by the Contributor or the Acquiror of any breach of any term, covenant, or condition herein stated shall not be deemed to be a waiver of any other breach, or of a subsequent breach of the same or any other term, covenant, or condition herein contained. All rights, powers, options, or remedies afforded to Contributor or the Acquiror either hereunder or by law shall be cumulative and not alternative, and the exercise of one right, power, option, or remedy shall not bar other rights, powers, options, or remedies allowed herein or by law, unless expressly provided to the contrary herein.

5.3 Exhibits . All exhibits referred to in this Agreement and attached hereto are hereby incorporated in this Agreement by reference.

5.4 Successors and Assigns . Except as set forth in this Article, this Agreement may not be assigned by the Acquiror or the Contributors without the prior approval of the other party hereto; provided, however, that the Acquiror may assign this entire agreement or a right to acquire all or any portion of the Contributed Assets to a direct or indirect subsidiary or affiliate of Acquiror and may assign the right to acquire the general partnership interest in the Partnership independent of any assignment of the right to purchase the limited partnership interests of the Partnership without approval of the Contributors provided in each case Acquiror shall remain obligated to issue the units to the Contributors at the Closing. This Agreement shall be binding upon, and inure to the benefit of, each Contributor, the Acquiror, and their respective legal representatives, successors, and permitted assigns.

5.5 Article Headings . Article headings and article and Section numbers are inserted herein only as a matter of convenience and in no way define, limit, or prescribe the scope or intent of this Agreement or any part hereof and shall not be considered in interpreting or construing this Agreement.

5.6 Governing Law . This Agreement shall be construed and interpreted in accordance with the laws of the Commonwealth of Virginia, without regard to conflicts of laws principles.

5.7 Counterparts . This Agreement may be executed in any number of counterparts and by any party hereto on a separate counterpart, each of which when so executed and delivered shall be deemed an original and all of which taken together shall constitute but one and the same instrument.

5.8 Survival . All representations and warranties contained in this Agreement, and all covenants and agreements contained in the Agreement which contemplate performance after the Closing Date (including, without limitation, those covenants and agreements contained in Section 1.2 hereof) shall survive the Closing.

5.9 Further Acts . In addition to the acts, instruments and agreements recited herein and contemplated to be performed, executed and delivered by the Acquiror and the Contributors, each of the Acquiror and each Contributor shall perform, execute, and deliver or cause to be performed, executed, and delivered at the Closing or after the Closing, any and all further acts, instruments, and agreements and provide such further assurances as the other party hereto may reasonably require to consummate the transaction contemplated hereunder.

5.10 Severability . In case any one or more of the provisions contained in this Agreement shall for any reason be held to be invalid, illegal, or unenforceable in any respect, such invalidity, illegality, or unenforceability shall not affect any other provision hereof, and this Agreement shall be construed as if such invalid, illegal, or unenforceable provision had never been contained herein.

with the terms of this Section 5.11. In the event that no such protective order or other remedy is obtained, or that the Acquiror waives compliance with the terms of this Section 5.11, the applicable member of the Information Group may furnish only that portion of the Information which it is advised by counsel is legally required and will exercise all reasonable efforts to obtain reliable assurance that confidential treatment will be accorded the Information. Each Contributor acknowledges that remedies at law may be inadequate to protect the Acquiror or the REIT against any actual or threatened breach of this Section 5.11, and, without prejudice to any other rights and remedies otherwise available, each Contributor agrees to the granting of injunctive relief in favor of the REIT and/or the Acquiror without proof of actual damages. Notwithstanding any other express or implied agreement to the contrary, the parties hereto agree and acknowledge that each of them and each of their employees, representatives, and other agents may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the transaction and all materials of any kind (including opinions or other tax analyses) that are provided to any of them relating to such tax treatment and tax structure, except to the extent that confidentiality is reasonably necessary to comply with U.S. federal or state securities laws. For purposes of this paragraph, the terms “tax treatment” and “tax structure” have the meanings specified in Treasury Regulation section 1.6011-4(c). Receipt of confidential information of Acquiror or any of its affiliates by Contributors constitutes each of Contributor’s acknowledgement that it is aware that applicable securities laws may impose restrictions on each of them from purchasing or selling securities of the REIT, and each Contributor agrees not to purchase or sell securities of the REIT, or any affiliate of the REIT, in violation of applicable securities laws.

[Signatures follow on next page]

The parties hereto have executed and delivered this Agreement as of the date indicated in the first sentence of this Agreement.


CONTRIBUTORS:

Wilmington Hotel Associates

By:		/s/ Andrew M. Sims
Name:		Andrew M. Sims
Its:		President

MHI Hotels Services, LLC

By:		/s/ Andrew M. Sims
Name:		Andrew M. Sims
Its:		President

Kim E. Sims Family Partnership

By:		/s/ Kim E. Sims
Name:		Kim E. Sims
Its:		Trustee

Andrew M. Sims Family Partnership

By:		/s/ Andrew M. Sims
Name:		Andrew M. Sims
Its:		Trustee

Christopher L. Sims Family Partnership

By:		/s/ Christopher L. Sims
Name:		Christopher L. Sims
Its:		Trustee


Edgar Sims Trust

By:		/s/ Andrew M. Sims
Name:		Andrew M. Sims
Its:		Trustee

ACQUIROR:

MHI Hospitality LP

By:		/s/ Andrew M. Sims
Name:		Andrew M. Sims
Its:		President

Exhibit 10.7

Savannah Hotel Associates LLC

CONTRIBUTION AGREEMENT

THIS CONTRIBUTION AGREEMENT (this “Agreement”) is made as of the 23 day of August, 2004 (the “Effective Date”) by and among the entities identified on Schedule 1 attached hereto (each a “Contributor” and collectively, the “Contributors”), and MHI Hospitality LP, a Delaware limited partnership (“Acquiror”).

RECITALS

A. Savannah Hotel Associates LLC (the “Company”) is the owner of certain real property consisting of approximately 1.03 acres of land located in Savannah, Georgia (the “Property”), and the hotel improvements located thereon consisting of 246 room hotel trading as the Hilton De Soto (the “Hotel”);

B. Contributors are the record and beneficial owners of 100% of the ownership interests of the Company (the “Contributed Assets”). The Contributors desire to contribute the Contributed Assets to the Acquiror, and the Acquiror desires to acquire the Contributed Assets from the Contributor, on the terms and conditions hereinafter set forth; and

AGREEMENT

NOW, THEREFORE, for and in consideration of the mutual covenants herein contained, the parties hereto agree as follows:

ARTICLE I

THE CONTRIBUTION

Contributed Assets shall be transferred to the Acquiror free and clear of all liens, encumbrances, security interests, prior assignments or conveyances, conditions, restrictions, claims, and other matters affecting title thereto.

1.2 Consideration . In exchange for the contribution and transfer by the Contributors of the Contributed Assets to the Acquiror, the Acquiror agrees, subject to the terms of this Agreement, to issue to the Contributors 1,665,494 units in the aggregate of limited partnership interests in the Acquiror (the “Units”). The number of Units to be issued to each Contributor is set forth in Schedule 1 attached hereto.

1.3 Issuance of Units . On the Closing Date (as defined below), the Acquiror shall issue to the Contributors certificates reflecting the Units in such amount as specified in Schedule 1. Such certificates shall bear appropriate legends indicating (i) that the Units have not been registered under the Securities Act of 1933, as amended (the “Securities Act”), and (ii) that the Acquiror’s agreement of limited partnership (the “Partnership Agreement”) will restrict the transfer of the Units. Immediately upon receipt of the Units, each Contributor shall accede to the Partnership Agreement as a limited partner of the Acquiror. Each Contributor acknowledges and agrees that once Closing occurs, the Contributor shall no longer be a member of the Company, shall no longer be entitled to receive any distributions from the Company, and shall have no further right, title or interest in the Company.

1.4 Adjustment . The term “Purchased Working Capital” shall mean the agreed upon sum of one hundred thousand dollars ($100,000) which amount represents the Company’s good faith estimate of the Company’s current assets shown on the Hotel balance sheet (exclusive of any FF&E Reserves) less the Company’s current liabilities shown on the Hotel balance sheet at the close of business on the Closing Date. The Contributors shall be permitted an opportunity to review the books and records of the Company prior to the Closing Date (and for sixty (60) days thereafter) to verify the calculation of Purchased Working Capital and all other working capital as of the Closing Date. Within such sixty (60) day period, the parties hereto agree to calculate actual working capital as of the Closing Date (including any amounts in any escrow or reserve accounts as of the Closing Date). In the event that actual working capital at Closing is more or less than the Purchased Working Capital, then the Contributors shall pay to the Acquiror an amount equal to the amount by which actual working capital as of the Closing Date is less than the Purchased Working Capital, and the Acquiror will pay to the Contributors an amount equal to the amount by which actual working capital as of the Closing Date exceeds the Purchased Working Capital. Any such amount payable by the Acquiror to the Contributors shall be allocated among the Contributors in proportion to the number of Units issuable to each Contributor pursuant to Schedule 1 hereof. Each Contributor shall bear its pro rata portion of any amount payable by the Contributors to the Acquiror on the basis of the number of Units issuable to each Contributor hereunder. Each Contributor (by its execution hereof) hereby acknowledges and agrees any such adjustments shall be paid in cash to the party entitled thereto, and such adjustments shall be deemed final. Payment, if any, shall be made within 15 days of calculating working capital as of the Closing Date.

1.7 Tax Consequences to Contributors . Notwithstanding anything to the contrary contained in this Agreement, including without limitation the use of words and phrases such as “sell,” “sale,” “purchase,” and “pay,” the parties hereto acknowledge and agree that it is their intent that the contribution transaction contemplated hereby with respect to the Contributed Assets shall be treated for federal income tax purposes pursuant to Section 721 of the Internal Revenue Code of 1986, as amended (the “Code”), as the contribution of the Contributed Assets by the Contributors to the Acquiror, in exchange for the Units, the Deposit and any payments made by Acquiror pursuant to Section 1.2 or Section 4.4, and not as a transaction in which any Contributor is acting other than in its capacity as a prospective partner in the Acquiror.

1.8 Tax Indemnity . In conjunction with the contributions contemplated by this Article I, each Contributor will execute and deliver the Tax Indemnity (as defined hereinafter) in the form attached as Exhibit 1.8.

ARTICLE II

REPRESENTATIONS AND COVENANTS

performance by the Acquiror of its obligations hereunder have been duly authorized by all requisite action of the Acquiror and require no further action or approval of the Acquiror’s partners or of any other individuals or entities in order to constitute this Agreement as a binding and enforceable obligation of the Acquiror. This Agreement constitutes the legal, valid and binding obligation of Acquiror and is enforceable in accordance with its terms.

(c) Litigation . There is no action, suit, or proceeding, pending or known to be threatened, against or affecting the Acquiror in any court or before any arbitrator or before any federal, state, municipal, or other governmental department, commission, board, bureau, agency or instrumentality which (i) in any manner raises any question affecting the validity or enforceability of this Agreement, (ii) could materially and adversely affect the business, financial position, or results of operations of the Acquiror, (iii) could materially and adversely affect the ability of the Acquiror to perform its obligations hereunder, or under any document to be delivered pursuant hereto.

2.2 Representations by Contributors . Each Contributor (except as otherwise indicated herein) hereby represents and warrants unto the Acquiror, jointly and severally, that each and every one of the following statements is true, correct, and complete as of the date of this Agreement and will be true, correct, and complete as of the Closing Date.

(a) Organization and Power . Each of the Contributor and the Company is duly organized, validly existing, and in good standing under the laws of the state of its organization. The Contributor has full right, power, and authority to enter into this Agreement and to assume and perform all of its obligations under this Agreement; and the execution and delivery of this Agreement and the performance by the Contributor of its obligations hereunder have been duly authorized by all requisite action of Contributor and require no further action or approval of Contributor’s members or managers or directors or shareholders or partners, as the case may be, or of any other individuals or entities in order to constitute this Agreement as a binding and enforceable obligation of the Contributor. This Agreement constitutes the legal, valid and binding obligation of each Contributor and is enforceable in accordance with its terms.

(c) Litigation . There is no action, suit, or proceeding, pending or known to be threatened, against or affecting the Contributor, the Company or the Hotel in any court or before any arbitrator or before any federal, state, municipal, or other governmental department, commission, board, bureau, agency or instrumentality which (A) in any manner raises any question affecting the validity or enforceability of this Agreement, (B) could materially and adversely affect the business, financial position, or results of operations of the Company or the Hotel, (C) could materially and adversely affect the ability of the Contributor to perform its obligations hereunder, or under any document to be delivered pursuant hereto, (D) could create a lien on the Contributed Assets, any part thereof, or any interest therein, or (E) could adversely affect the Contributed Assets, any part thereof, or any interest therein.

and (D) the Contributor has not granted any other person or entity an option to purchase or a right of first refusal upon the Contributor’s Assets nor are there any agreements or understandings between Contributor and any other person or entity with respect to the disposition of the Contributor’s Assets, and Contributor has full power and authority to convey the Contributor’s Assets free and clear of any liens, claims and encumbrances and upon delivery of the Assignment attached hereto in the form of Exhibit A to Acquiror and Acquiror will acquire good title thereto, free and clear of any liens, claims and encumbrances. The Company owns the Hotel and the Property beneficially and of record free and clear of any liens, claims, encumbrances, mortgages, security interests, deed of trust, easements, purchase rights or any other right of any nature of any third party except as set forth on Schedule 2.2(d).

(e) No Consents . Except as may otherwise be set forth in Schedule 2.2(e) hereof, each consent, approval, authorization, order, license, certificate, permit, registration, designation, or filing by or with any third party, including, but not limited to lenders and franchisors, or any governmental agency or body necessary for the execution, delivery, and performance of this Agreement or the transactions contemplated hereby has been obtained or will be obtained on or before the Closing Date.

(f) Operation of Contributed Assets . Between the date hereof and the Closing Date, the Contributor will take such action as may be necessary to cause the Company to (A) operate its business only in the usual, regular, and ordinary manner consistent with such entity’s prior practice and (B) maintain its books of account and records in the usual, regular, and ordinary manner, in accordance with sound accounting principles applied on a basis consistent with the basis used in keeping its books in prior years. Except as otherwise permitted hereby, from the date hereof until the Closing Date, the Contributor shall not take any action or fail to take any action the result of which would (1) have a material adverse effect on the Contributed Assets, the Property, the Hotel, or the Acquiror’s ability to continue the operation thereof after the Closing Date in substantially the same manner as presently conducted or (2) would cause any of the representations and warranties contained in this Section 2.2 to be untrue as of the Closing Date.

(g) Operating Agreement . The Limited Liability Company Agreement of the Company, dated as of April 25, 1996, and subsequently amended on May 1, 1996, September 23, 1998 and January 2, 2003 (the “Operating Agreement”) is in force and effect as of the date hereof, and has not been modified or amended and a true and accurate copy of such agreement as amended to date has been provided to Acquiror. The Contributor has performed all of its obligations under the Operating Agreement.

(h) Securities Law Matters . (A) In acquiring the Units and engaging in this transaction, neither the Contributors nor any member of a Contributor is relying upon any representations made to it by the Acquiror, or any of its partners, officers, employees, or agents that are not contained herein. Contributor is aware of the risks involved in investing in the

Units and in the shares of common stock (“Common Stock”) of the REIT, issuable upon redemption of such Units. Contributor has had an opportunity to ask questions of, and to receive answers from, the Acquiror or a person or persons authorized to act on its behalf, concerning the terms and conditions of this investment and the financial condition, affairs, and business of the Acquiror and the REIT. Contributor confirms that all documents, records, and information pertaining to its investment in the Acquiror that have been requested by it, including a complete copy of the form of the Partnership Agreement, have been made available or delivered to it prior to the date hereof. Contributor represents and warrants that it has reviewed and approved the form of the Partnership Agreement attached hereto as Exhibit B.

(B) Contributor and each member thereof understands that neither the Units nor the shares of Common Stock issuable upon redemption of the Units have been registered under the Securities Act or any state securities acts and are instead being offered and sold in reliance on an exemption from such registration requirements. The Units issuable to Contributor are being acquired solely for its own account, for investment, and are not being acquired with a view to, or for resale in connection with, any distribution, subdivision, or fractionalization thereof, in violation of such laws, and Contributor does not have any present intention to enter into any contract, undertaking, agreement, or arrangement with respect to any such resale; provided, however, that, at or following Closing, Contributor may distribute the Units to its members that (1) have represented and warranted to the Acquiror in writing that, as of the time of such distribution, such member is an accredited investor as that term is defined in Rule 501 of Regulation D under the Securities Act, and (2) have executed the Partnership Agreement as limited partners. Contributor understands that any certificates evidencing the Units will contain appropriate legends reflecting the requirement that the Units not be resold by Contributor without registration under such laws or the availability of an exemption from such registration and that the Partnership Agreement will restrict transfer of the Units.

(i) Accredited Investor . Contributor is an accredited investor as that term is defined in Rule 501 of Regulation D under the Securities Act.

(j) Tax Matters . (A) The Company has filed within the time and in the manner prescribed by law all material federal, state, and local tax returns and reports, including but not limited to income, gross receipts, intangible, real property, excise, withholding, franchise, sales, use, employment, personal property, and other tax returns and reports, required to be filed by such entity under the laws of the United States and of each state or other jurisdiction in which such entity conducts business activities requiring the filing of tax returns or reports except for such returns or reports where the failure to file would not have a material adverse effect on the Company or the Contributed Assets. All tax returns and reports filed by the Company are true and correct in all material respects. The Company has paid in full all taxes of whatever kind or nature for the periods covered by such returns. The Company has not been delinquent in the payment of any tax, assessment, or governmental charge or deposit and has no tax deficiency or claim outstanding, assessed, threatened, or proposed against it. The

charges, accruals, and reserves for unpaid taxes on the books and records of the Company as of the Closing Date are sufficient in all respects for the payment of all unpaid federal, state, and local taxes of the Company accrued for or applicable to all periods ended on or before the Closing Date. There are no tax liens, whether imposed by the United States, any state, local, or other taxing authority, outstanding against the Company or any of its assets. The federal, state, and local tax returns of the Company have not been audited, nor has the Company received any notice of any federal, state, or local audit.

(k) Bankruptcy with respect to Contributor . No Act of Bankruptcy has occurred with respect to the Contributor or the Company. As used herein, “Act of Bankruptcy” shall mean if a party hereto or any member or manager thereof shall (A) apply for or consent to the appointment of, or the taking of possession by, a receiver, custodian, trustee or liquidator of itself or of all or a substantial part of its property, (B) admit in writing its inability to pay its debts as they become due, (C) make a general assignment for the benefit of its creditors, (D) file a voluntary petition or commence a voluntary case or proceeding under the Federal Bankruptcy Code (as now or hereafter in effect), (E) be adjudicated bankrupt or insolvent, (F) file a petition seeking to take advantage of any other law relating to bankruptcy, insolvency, reorganization, receivership, dissolution, winding-up or composition or adjustment of debts, (G) fail to controvert in a timely and appropriate manner, or acquiesce in writing to, any petition filed against it in an involuntary case or proceeding under the Federal Bankruptcy Code (as now or hereafter in effect), or (H) take any entity action for the purpose of effecting any of the foregoing.

(l) Brokerage Commission . The Contributor has not engaged the services of, any real estate agent, broker, finder or any other person or entity for any brokerage or finder’s fee, commission or other amount with respect to the transactions described herein on account of any action by the Contributor. The Contributor hereby agrees to indemnify and hold the Acquiror and its employees, directors, members, partners, affiliates and agents harmless against any claims, liabilities, damages or expenses arising out of a breach of the foregoing. This indemnification shall survive Closing or any termination of this Agreement.

(m) Liabilities, Indebtedness . Except as set forth in Schedule 2.2(m), the Company has not incurred any indebtedness related to the Hotel or the Property except in each instance for trade payables and other customary and ordinary expenses in the normal course of business.

(n) Leases . Schedule 2.2(n) attached hereto is a true, correct and complete schedule of all ground leases, restaurant leases, subleases and other rights of occupancy in effect with respect to the Hotel and the Property (collectively, the “Leases”). Except as set forth on Schedule 2.2(n), there are no other leases, subleases, tenancies or other rights of occupancy in effect with respect to the Hotel or the Property. Except as set forth on Schedule 2.2(n), all such Leases are valid and enforceable and presently in full force and effect, and none of the Leases have been assigned and all brokerage commissions, if any, payable under any of the Leases have been paid or will be paid by the Company, prior to the Closing. To the best knowledge of Contributor, no party to any Lease is in default under such Lease, and Contributor does not know of any event which, but for the passage of time or the giving of notice, or both, would constitute a default under such Leases, except such defaults that would not have a material adverse effect on the condition, financial or otherwise or on the earnings, business affairs or business prospects of the Company. No tenant under any of the Leases has an option or right of first refusal to purchase the premises demised under such Lease. The consummation of the transactions contemplated by this Agreement will not give rise to any breach, default or event of default under any of the Leases. None of the Leases requires the consent or approval of any party in connection with the transactions contemplated by this Agreement.

(o) Insurance . The Company currently maintains or causes to be maintained all of the public liability, casualty and other insurance coverage with respect to the Hotel as set forth on Schedule 2.2(o) attached hereto. All such insurance coverage shall be maintained in full force and effect through the Closing and all premiums due and payable thereunder have been, and shall be, fully paid when due.

(p) Personal Property . All equipment, fixtures and personal property located at the Hotel shall remain and not be removed prior to the Closing, except for equipment that becomes obsolete or unusable, which may be disposed of or replaced in the ordinary course of business.

(q) Environmental Conditions .

(A) As of the date of this Agreement and as of the Closing, and except as set forth in the environmental reports and materials previously delivered to Acquiror which are listed on Schedule 2.2(q) attached hereto (collectively, “Environmental Reports”), to the best of Contributors’ knowledge, information and belief, the Property (which for purposes of this Section 2.2(q) shall include all leased and vacant space, land surface water, groundwater and any and all improvements located on, in or under the Property) is now and will be at the Closing free of all contamination which exists as or has arisen from, directly or indirectly:

(3) any “oil” or other “hazardous substance” as defined by the Oil and Hazardous Substance Control Act of 1976, as amended, or by and regulations promulgated thereunder;

(4) any substance the presence of which on, in or under the Property is prohibited or regulated by any federal, state or local environmental law (an “Environmental Law”); and

(B) To the best of Contributors’ knowledge, information, and belief, as of the date of this Agreement and as of the Closing, and except as set forth in the Environmental Reports:

(1) the Property is now and will be at the Closing free from asbestos and any asbestos containing materials (including without limitation the presence of any asbestos in the insulation or other materials used comprising any part of the improvements), mold, radon and lead-based paint that would have a material adverse effect on the Property;

(2) to the knowledge of Contributor, the Company has not placed, located, sited or buried any underground storage tanks at the Property and to the knowledge of Contributor, no underground storage tanks are located on, at or under the Property;

(3) to the knowledge of Contributor, the Property does not appear on any state or federal CERCLA, RCRA, Superfund or other similar lists and, to the knowledge of Contributor, the Property is not proposed to be included on any such list;

(4) to the knowledge of Contributor, the Company has never used any part of the Property as a sanitary landfill, waste dump site or for the treatment, storage or disposal of hazardous waste as defined in RCRA and no part of the Property has ever been used as a sanitary landfill, waste dump site or for the treatment, storage or disposal of hazardous waste as defined in RCRA;

(5) to the knowledge of Contributor, no notice of violation or other written communication has been received by the Company or any predecessor in title from a governmental agency or other entity or person, alleging or suggesting any violation of any Environmental Law on or with respect to the Property;

(6) to the knowledge of Contributor, neither the Company nor any of such Company’s agents, licensees or invitees have placed or permitted the placement of any Hazardous Materials in, on, under or over the Property in violation of any Environmental Law;

(7) to the knowledge of Contributor, no other party has placed any Hazardous Material in, on, under or over any of the Property in violation of any Environmental Law; and

(8) to the knowledge of Contributor, the Property is not subject to any federal, state or local lien (including any “Superfund” lien), proceedings, claim, liability, or action, or the threat or likelihood thereof, relating to the clean-up, removal or remediation of any Hazardous Material from the Property and the Company has not received any request or information from the United States Environmental Protection Agency or any other public, governmental or quasi-governmental agency or authority with jurisdiction over any Environmental Law.

(r) Compliance With Laws . To the best of Contributors’ knowledge, information, and belief, the Company possesses such certificates, approvals, licenses, authorities or permits issued by the appropriate local, state or federal agencies or bodies necessary to conduct the business to be conducted by it, and, to the knowledge of Contributor, the Company has not received any written notice of proceedings relating to the revocation or modification of any such certificate, approval, license, authority or permit which, singly or in the aggregate, if the subject of an unfavorable decision, ruling, or finding, would materially and adversely affect the condition, financial or otherwise, or the earnings, business affairs or business prospects of the Property or the Hotel. To the best of Contributors’ knowledge, information, and belief, the Company has not received any written or other notice of any violation of any applicable zoning, building or safety code, rule, regulation or ordinance, or of any employment, environmental, wetlands or other regulatory law, order, regulation or other requirement, including without limitation the Americans With Disabilities Act (“ADA”) or any restrictive covenants or other easements, encumbrances or agreements, relating to the Property

or the Hotel, which remains uncured. The Property and the Hotel have been constructed and is operated in accordance with all applicable laws, ordinances, rules and regulations. All approvals regarding zoning, land use, subdivision, environmental and building and construction laws, ordinances, rules and regulations have been obtained, and such approvals will not be invalidated by the consummation of the transactions contemplated by this Agreement; provided, however, the Property and the Hotel (including, all improvements) are substantially in compliance with the ADA.

(s) Condemnation and Moratoria . Except as set forth on Schedule 2.2(s), to the best of Contributors’ knowledge, information, and belief, there are (i) no pending or threatened condemnation or eminent domain proceedings, or negotiations for purchase in lieu of condemnation, which affect or would affect any portion of the Property; (ii) no pending or, to the knowledge of Contributor, threatened moratoria on utility or public sewer hook-ups or the issuance of permits, licenses or other inspections or approvals necessary in connection with the construction or reconstruction of improvements, including without limitation tenant improvements, which affect or would affect any portion of the Property; and (iii) no pending or, to the knowledge of Contributor, threatened proceeding to change adversely the existing zoning classification as to any portion of the Property. No portion of the Property is a designated historic property or located within a designated historic area or district and there are no graveyards or burial grounds located within the Property.

(t) Condition of Improvements . To the best of Contributors’ knowledge, information, and belief, there is no material defect in the condition of (i) the Property or the Hotel, (ii) the improvements thereon, (iii) the roof, foundation, load-bearing walls or other structural elements thereof, or (iv) the mechanical, electrical, plumbing and, safety systems therein, nor any material damage from casualty or other cause, nor any soil condition of any nature that will not support all of the improvements thereon without the need for unusual or new subsurface excavations, fill, footings, caissons or other installations.

(u) Absence of Certain Changes . To the best of Contributors’ knowledge, information, and belief, since December 31, 2003, except as set forth or referred to on Schedule 2.2(u), there has not been with respect to the Company:

(A) any material adverse change in the financial condition of the Company, Hotel or Property;

(B) any change in the condition of the Property, Hotel or the business or liabilities of the Company except normal and usual changes in the ordinary course of business which have not been, individually or in the aggregate, materially adverse;

(C) any damage, destruction or loss, whether or not covered by insurance, individually or in the aggregate, materially and adversely affecting the Property or Hotel;

(D) any change in the accounting methods or practices with respect to the Hotel or the Property or in depreciation or amortization policies theretofore used or adopted;

(E) any material liability with respect to the Hotel or the Property, contingent or otherwise, other than for operating expenses, obligations under any executory contracts disclosed on Schedule 2.2(u) hereof incurred for fair consideration and taxes accrued with respect to operations during such period, all incurred in the ordinary course of business; or

(F) any other material change in the business of the Company.

(v) ERISA . The Company has no (i) labor agreement to which it is a party, or by which it is bound, including “employee pension benefit plans” as defined in Section 3(2) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”); (ii) employment, profit sharing, deferred compensation, bonus, pension, retainer, consulting, retirement, welfare or incentive plan, fund, program or contract to which it is a party, or by which it is bound; (iii) written or other formal personnel policies; or (iv) plan or agreement under which “fringe benefits” (including, but not limited to, vacation plans or programs, sick leave plans or programs, and related benefits) are afforded to its employees.

(w) No Contracts . No agreements, undertakings or contracts affecting the Hotel or the Property, written or oral, will be in existence as of the Closing, except as set forth on Schedule 2.2(w) attached hereto, and true and correct copies of such contracts have been delivered to Acquiror. With respect to any such contracts set forth on Schedule 2.2(w), each such contract is valid and binding on the Company and is in full force and effect in all material respects. To the knowledge of Contributor, no party to any such contract has breached or defaulted under the terms of such contract, except for such breaches or defaults that would not, individually or in the aggregate, have a material adverse effect on the business or operations of the Hotel or the Property.

2.4 Contributor’s Indemnity . Each Contributor agrees to indemnify and hold the Acquiror, the REIT, and their respective employees, directors, members, partners, affiliates and agents harmless of and from all liabilities, losses, damages, costs, and expenses (including reasonable attorneys’ fees) which the Acquiror or the REIT may suffer or incur by reason of any breach of its representations or warranties contained in this Agreement, and by reason of any act or cause of action occurring or accruing prior to the Closing Date and arising from the ownership of the Contributed Assets and the operation of the Hotel prior to the Closing Date.

ARTICLE III

CONDITIONS PRECEDENT TO THE CLOSING

(b) Contributors’ Representations and Warranties . The representations and warranties of the Contributors set forth in Section 2.2 shall be true and correct as if made again on the Closing Date.

(e) Completion of IPO . The IPO shall have been completed.

(f) Consent of Franchisor . The Franchisor of the Hotel shall have consented to the transaction contemplated herein on terms and conditions that are acceptable to Acquiror in its sole discretion.

(g) Third Party Consents . All required third party consents will have been obtained or otherwise waived.

(b) Acquiror’s Representations and Warranties . The Acquiror’s representations and warranties set forth in Section 2.1 shall be true and correct as if made again on the Closing Date.

ARTICLE IV

CLOSING AND CLOSING DOCUMENTS

4.1 Closing . The consummation and closing (the “Closing”) of the transactions contemplated under this Agreement shall take place at the offices of the Acquiror in Greenbelt, Maryland, or such other place as is mutually agreeable to the parties, on the date of the closing of the IPO (the “Closing Date”), or as otherwise set by agreement of the parties hereto. If at any time the REIT determines in good faith to abandon or discontinue its efforts to engage in an IPO, Acquiror shall so advise each Contributor in writing and thereupon all parties hereto will be relieved of all obligations under this Agreement.

(d) Tax Indemnity . Each Contributor shall have executed a tax indemnity and debt maintenance agreement and related guaranty (the “Tax Indemnity”) in the form of Exhibit 1.8 to reflect the allocation of indebtedness to each Contributor in an amount not to exceed such Contributor’s negative balance in the capital account maintained by the Company for such Contributor as of the Closing Date.

(e) Other Documents . Any other document or instrument reasonably requested by the Acquiror or required hereby.

4.3 Acquiror’s Deliveries . At the Closing, the Acquiror shall deliver the following to the Contributors:

(d) Other Documents . Any other document or instrument reasonably requested by a Contributor or required hereby.

4.4 Fees and Expenses; Closing Costs . The Acquiror shall pay all fees, expenses and closing costs relating to the transactions contemplated by this Agreement; provided however, that each Contributor shall pay its own attorneys’ and consultants’ fees and expenses. In the event the Closing does not occur as a result of a failure to conclude an IPO, the Company agrees to pay to Acquiror 44.1% of the actual out-of-pocket costs incurred by Acquiror and its affiliates in connection with the proposed IPO of the REIT, which the Company agrees represents the pro rata share of the expected transaction costs of the Contributors; provided, however, that such payment shall not exceed $500,000. Each Contributor acknowledges and agrees, by executing this Agreement, that it will benefit from such an IPO and, as a consequence, the Company will bear a portion of its costs if such transaction is not completed.

ARTICLE V

MISCELLANEOUS

Acquiror:

MHI Hospitality L.P.

814 Capitol Landing Road

Williamsburg, VA 23187

Attention: Mr. Andrew M. Sims

Fax No.: (757) 564-8801

Phone No.: (757) 229-5648

E-mail: drewsims@mhihotels.com

Notices to Contributors shall be sent to the addresses specified on Schedule 1.

Any address or name specified above may be changed by a notice given by the addressee to the other party. Any notice, demand or other communication shall be deemed given and effective as of the date of delivery in person or receipt set forth on the return receipt. The inability to deliver because of changed address of which no notice was given, or rejection or other refusal to accept any notice, demand or other communication, shall be deemed to be receipt of the notice, demand or other communication as of the date of such attempt to deliver or rejection or refusal to accept.

cumulative and not alternative, and the exercise of one right, power, option, or remedy shall not bar other rights, powers, options, or remedies allowed herein or by law, unless expressly provided to the contrary herein.

5.3 Exhibits . All exhibits referred to in this Agreement and attached hereto are hereby incorporated in this Agreement by reference.

5.6 Governing Law . This Agreement shall be construed and interpreted in accordance with the laws of the Commonwealth of Virginia, without regard to conflicts of laws principles.

5.11 Confidentiality . The Contributor acknowledges that the matters relating to the REIT, the initial underwritten public offering of the REIT, this Agreement, and the other documents, terms, conditions and information related thereto (collectively, the “Information”) are confidential in nature. Therefore, each Contributor covenants and agrees to keep the Information confidential and will not (except as required by applicable law, regulation or legal process, and only after compliance with the provisions of this Section 5.11), without the Acquiror’s prior written consent, disclose any Information in any manner whatsoever; provided, however, that the Information may be revealed only to a Contributor’s key employees, legal counsel and financial advisors, each of whom shall be informed of the confidential nature of the Information and shall agree to act in accordance with the terms of this Section 5.11. In the event that a Contributor or its key employees, legal counsel or financial advisors (collectively, the “Information Group”) are requested pursuant to, or required by, applicable law, regulation or legal process to disclose any of the Information, the applicable member of the Information Group will notify the Acquiror promptly so that it may seek a protective order or other appropriate remedy or, in its sole discretion, waive compliance with the terms of this Section 5.11. In the event that no such protective order or other remedy is obtained, or that the Acquiror waives compliance with the terms of this Section 5.11, the applicable member of the Information Group may furnish only that portion of the Information which it is advised by counsel is legally required and will exercise all reasonable efforts to obtain reliable assurance that confidential treatment will be accorded the Information. Each Contributor acknowledges that remedies at law may be inadequate to protect the Acquiror or the REIT against any actual or threatened breach of this Section 5.11, and, without prejudice to any other rights and remedies otherwise available, each Contributor agrees to the granting of injunctive relief in favor of the REIT and/or the Acquiror without proof of actual damages. Notwithstanding any other express or implied agreement to the contrary, the parties hereto agree and acknowledge that each of them and each of their employees, representatives, and other agents may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the transaction and all materials of any kind (including opinions or other tax analyses) that are provided to any of them relating to such tax treatment and tax structure, except to the extent that confidentiality is reasonably necessary to comply with U.S. federal or state securities laws. For purposes of this paragraph, the terms “tax treatment” and “tax structure” have the meanings specified in Treasury Regulation section 1.6011-4(c). Receipt of confidential information of Acquiror or any of its affiliates by Contributors constitutes each of Contributor’s acknowledgement that it is aware that applicable securities laws may impose restrictions on each of them from purchasing or selling securities of the

REIT, and each Contributor agrees not to purchase or sell securities of the REIT, or any affiliate of the REIT, in violation of applicable securities laws.

[Signatures follow on next page]

The parties hereto have executed and delivered this Agreement as of the date indicated in the first sentence of this Agreement.


CONTRIBUTORS:

MHI Hotels Services LLC

By:		/s/ Andrew M. Sims
Name:		Andrew M. Sims
Its:		President

Krichman Revocable Trust

By:		/s/ Edward S. Stein
Name:		Edward S. Stein
Its:		Trustee

Krichman Charitable Trust

By:		/s/ Edward S. Stein
Name:		Edward S. Stein
Its:		Trustee

ACQUIROR:
ACQUIROR:

MHI Hospitality LP

By:		/s/ Andrew M. Sims
Name:		Andrew M. Sims
Its:		CEO

Exhibit 10.8

Brownestone

CONTRIBUTION AGREEMENT

THIS CONTRIBUTION AGREEMENT (this “Agreement”) is made as of the 23rd day of August, 2004 (the “Effective Date”) by and among KDCA Partnership, a Maryland general partnership (“KDCA”), MAVAS LLC, a Georgia limited liability company (“MAVAS”), and MHI Hospitality LP, a Delaware limited partnership (the “Acquiror”).

RECITALS

A. Brownestone Partners LLC (the “Company”) is the owner of certain real property consisting of approximately 3.8 acres of land located in Raleigh, North Carolina, and the hotel improvements located thereon consisting of a 188 room hotel trading as Holiday Inn Brownestone and an adjacent 18 unit apartment building, together with all furniture, fixtures, equipment, durable goods and inventory therein (the “Hotel”), as well as a land lease relating to certain real property that serves as a parking lot adjacent to the Hotel (the “Property”); and

B. MAVAS and KDCA (collectively, the “Contributors”) are the record and beneficial owners of 100% of the ownership interests of the Company (the “Assets”). The Contributors desire to contribute their ownership interest in the Company to the Acquiror for partnership interests in Acquiror following the payment of cash distributions to the Contributors by the Company in the amounts specified herein (the “Distributions”); and

C. The Acquiror will be the operating partnership of a Maryland corporation to be formed which will seek to qualify as a real estate investment trust for Federal income tax purposes (the “REIT”) and will seek to complete an underwritten public offering of shares of its common stock (the “IPO”). The Contributors intend to contribute the Assets to the Acquiror in connection with the closing of the IPO and immediately following payment of the Distributions.

AGREEMENT

NOW, THEREFORE, for and in consideration of the mutual covenants herein contained, the parties hereto agree as follows:

ARTICLE I

THE CONTRIBUTION

1.1 Contribution .

(a) KDCA agrees to contribute and transfer all of the membership interests in the Company owned by it (the “KDCA Assets”) to the Acquiror, and the Acquiror agrees to accept transfer of the KDCA Assets pursuant to the terms and conditions set forth in this Agreement. The KDCA Assets shall be transferred to the Acquiror free and clear of all liens, encumbrances, security interests, prior assignments or conveyances, conditions, restrictions, claims, and other matters affecting title thereto.

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(b) MAVAS agrees to contribute and transfer all of the membership interests in the Company owned by it (the “MAVAS Assets”) to the Acquiror, and the Acquiror agrees to accept the transfer of the MAVAS Assets pursuant to the terms and conditions set forth in this Agreement. The MAVAS Assets shall be transferred to the Acquiror free and clear of all liens, encumbrances, security interests, prior assignments or conveyances, conditions, restrictions, claims or other matters affecting title thereto.

1.2 Consideration for Assets .

(a) Consideration for KDCA Assets. In exchange for the contribution and transfer by KDCA of the KDCA Assets to the Acquiror, the Acquiror agrees, subject to the terms of this Agreement, to issue to KDCA 160,593 units of limited partnership interests in the Acquiror (the “KDCA Units”). In addition, immediately prior to the Closing, KDCA and MAVAS will cause the Company to make a cash distribution to KDCA in an amount equal to $1,000,000; provided that in the event the Closing has not occurred by October 31, 2004, such amount shall be increased by an amount equal to the interest on that certain loan obligation of KDCA owed to Darby Bank accrued from November 1 through to and including the Closing Date (as defined below) (the “KDCA Distribution”). Such distribution shall be funded by the proceeds of a loan to be incurred by the Aquiror which loan will be subject to the Guarantees (as hereinafter defined).

(b) Consideration for MAVAS Assets. In consideration of the contribution and transfer by MAVAS of the MAVAS Assets to the Acquiror, the Acquiror agrees, subject to the terms of this Agreement, to issue to MAVAS 100 units of limited partnership interests in the Acquiror (the “MAVAS Units” and together with the KDCA Units, the “Units”). In addition, immediately prior to the Closing, KDCA and MAVAS will cause the Company to make a cash distribution to MAVAS in an amount equal to $2,000,000; provided that in the event the Closing has not occurred by October 31, 2004, such amounts shall be increased by an amount equal to the interest on that certain loan obligation of MAVAS owed to Darby Bank accrued from November 1 through to and including the Closing Date (the “MAVAS Distribution”). Such distribution shall be funded by the proceeds of a loan to be incurred by the Aquiror which loan will be subject to the Guarantees.

1.3 Payment of Consideration . On the Closing Date, the Acquiror shall:

(a) issue to KDCA certificates reflecting the KDCA Units.

(b) issue to MAVAS certificates reflecting the MAVAS Units.

Certificates representing the Units shall bear appropriate legends indicating (i) that the Units have not been registered under the Securities Act of 1933, as amended (the “Securities Act”), and (ii) that the Acquiror’s agreement of limited partnership (the “Partnership Agreement”) will restrict the transfer of the Units. Immediately upon receipt of the Units, KDCA and MAVAS shall accede to the Partnership Agreement as limited partners of the Acquiror. KDCA and MAVAS each acknowledges and agrees that once Closing occurs, it shall no longer be a member of the Company, shall no longer be entitled to receive any distributions from the Company, and shall have no further right, title or interest in the Company.

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1.4 Adjustment . The term “Purchased Working Capital” shall mean the agreed upon sum of fifty thousand dollars ($50,000), which amount represents the Company’s good faith estimate of the Company’s current assets shown on the Hotel balance sheet (exclusive of any FF&E Reserves) less the Company’s current liabilities shown on the Hotel balance sheet at the close of business on the Closing Date. MAVAS and KDCA shall be permitted an opportunity to review the books and records of the Company prior to the Closing Date (and for sixty (60) days thereafter) to verify the calculation of Purchased Working Capital and all other working capital as of the Closing Date. Within such sixty (60) day period, the parties hereto agree to calculate actual working capital as of the Closing Date (including any amounts in any escrow or reserve accounts as of the Closing Date). In the event that actual working capital at Closing is more or less than the Purchased Working Capital, then MAVAS and KDCA shall each pay to the Acquiror 50% of the amount by which actual working capital as of the Closing Date is less than the Purchased Working Capital, and the Acquiror will pay to each of MAVAS and KDCA 50% of the amount by which actual working capital as of the Closing Date exceeds the Purchased Working Capital. MAVAS and KDCA (by its execution hereof) each hereby acknowledges and agrees any such adjustments shall be paid in cash to the party entitled thereto, and such adjustments shall be deemed final. Payment, if any, shall be made within 15 days of calculating working capital as of the Closing Date.

1.5 Deposit . Within five (5) business days after the full execution of this Agreement, the Acquiror shall pay to each of MAVAS and KDCA the sum of $10.00 (the “Deposit”) as consideration for such party entering into this Agreement. The Deposit shall be deemed earned and non-refundable immediately upon payment of the Deposit (except if the Contributor defaults hereunder, in which event the Deposit shall be promptly refunded to the Acquiror).

1.6 Redemption Rights for Units . The Units shall be redeemable at the option of the holders of such Units and in accordance with, but subject to the restrictions contained in, the Partnership Agreement; provided, however, that such redemption option may not be exercised prior to the first anniversary of the Closing Date.

1.7 Tax Consequences to Contributors . Notwithstanding anything to the contrary contained in this Agreement, including without limitation the use of words and phrases such as “sell,” “sale,” purchase,” and “pay,” the parties hereto acknowledge and agree that it is their intent that the contribution transaction contemplated hereby with respect to the Assets shall be treated for federal income tax purposes pursuant to Section 721 of the Internal Revenue Code of 1986, as amended (the “Code”), as the contribution of the Assets by the Contributors to the Acquiror, in exchange for the Units, the Deposit and any payments made by Acquiror pursuant to Section 1.2 or Section 4.4, and not as a transaction in which the Contributors are acting other than in their capacity as prospective partners in the Acquiror.

1.8. Bottom-Dollar Guarantee . In conjunction with the contributions contemplated by this Article I, KDCA and MAVAS will each execute and deliver the Bottom-Dollar Guarantees in the form attached as Exhibit 1.8. (the “Guarantees”).

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ARTICLE II

REPRESENTATIONS AND COVENANTS

2.1 Representations by Acquiror . The Acquiror hereby represents and warrants unto each Contributor that the following statements are true, correct, and complete as of the date of this Agreement and will be true, correct, and complete as of the Closing Date:

(c) Litigation . There is no action, suit, or proceeding, pending or known to be threatened, against or affecting the Acquiror in any court or before any arbitrator or before any federal, state, municipal, or other governmental department, commission, board, bureau, agency or instrumentality which (i) in any manner raises any question affecting the validity or enforceability of this Agreement, (ii) could materially and adversely affect the business, financial position, or results of operations of the Acquiror, (iii) could materially and adversely affect the ability of the Acquiror to perform its obligations hereunder, or under any document to be delivered pursuant hereto.

(d) Units Validly Issued . The Units, when issued, will have been duly and validly authorized and issued, free of any preemptive or similar rights, and will be fully paid and nonassessable, without any obligation to restore capital except as required by the Delaware Revised Uniform Limited Partnership Act (the “Limited Partnership Act”). The Contributors shall be admitted as limited partners of the Acquiror as of the Closing Date and shall be entitled to all of the rights and protections of a limited partner under the Limited Partnership Act and the provisions of the Partnership Agreement, with the same rights, preferences, and privileges as all other limited partners on a pari passu basis.

(e) Consents . Except as may otherwise be set forth in Schedule 3.1(e) hereof, each consent, approval, authorization, order, license, certificate, permit, registration, designation, or filing by or with any governmental agency or body necessary for the execution, delivery, and performance of this Agreement or the transactions contemplated hereby by the Acquiror has been obtained or will be obtained on or before the Closing Date.

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(f) Brokerage Commission . The Acquiror has not engaged the services of any real estate agent, broker, finder or any other person or entity for any brokerage or finder’s fee, commission or other amount with respect to the transactions described herein on account of any action by the Acquiror. The Acquiror hereby agrees to indemnify and hold the Contributors and their employees, directors, members, partners, affiliates and agents harmless against any claims, liabilities, damages or expenses arising out of a breach of the foregoing. This indemnification shall survive Closing or any termination of this Agreement.

2.2 Representations by Contributors . Each Contributor (except as otherwise indicated herein) hereby represents and warrants unto the Acquiror, jointly and severally, that each and every one of the following statements is true, correct, and complete as of the date of this Agreement and will be true, correct, and complete as of the Closing Date.

(a) Organization and Power . Each of the Contributor and the Company is duly organized, validly existing, and in good standing under the laws of the state of its organization. The Contributor has full right, power, and authority to enter into this Agreement and to assume and perform all of its obligations under this Agreement; and the execution and delivery of this Agreement and the performance by the Contributor of its obligations hereunder have been duly authorized by all requisite action of Contributor and require no further action or approval of Contributor’s members or managers or directors or shareholders or partners, as the case may be, or of any other individuals or entities in order to constitute this Agreement as a binding and enforceable obligation of the Contributor. This Agreement constitutes the legal, valid and binding obligation of Contributors and is enforceable in accordance with its terms.

(c) Litigation . There is no action, suit, or proceeding, pending or known to be threatened, against or affecting the Contributor, the Company or Hotel in any court or before any arbitrator or before any federal, state, municipal, or other governmental department, commission, board, bureau, agency or instrumentality which (A) in any manner raises any question affecting the validity or enforceability of this Agreement, (B) could materially and adversely affect the business, financial position, or results of operations of the Company or Hotel, (C) could materially and adversely affect the ability of the Contributor to perform its obligations hereunder, or under any document to be delivered pursuant hereto, (D) could create a lien on the Assets, any part thereof, or any interest therein, or (E) could adversely affect the Assets, any part thereof, or any interest therein.

(d) Good Title . The Contributor is the sole owner of the ownership interests specified in Schedule 1 (the “Contributor’s Assets”), the Contributor has good title to the Contributor’s Assets, the Contributor’s Assets are free and clear of all liens, encumbrances, pledges, voting agreements, and security interests whatsoever, and the Contributor has not granted any other person or entity an option to purchase or a right of first refusal upon the Contributor’s Assets nor are there any agreements or understandings between Contributor and

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any other person or entity with respect to the disposition of the Contributor’s Assets, and Contributor has full power and authority to convey the Contributor’s Assets free and clear of any liens, claims and encumbrances and upon delivery of the Assignment attached hereto in the form of Exhibit A to Acquiror and Acquiror will acquire good title thereto, free and clear of any liens, claims and encumbrances. The Company owns the Hotel and the Property beneficially and of record free and clear of any liens, claims, encumbrances, mortgages, security interests, deed of trust, easements, purchase rights or any other right of any nature of any third party except as set forth on Schedule 2.2(d).

(e) No Consents . Except as may otherwise be set forth in Section 3.1(d) hereof, each consent, approval, authorization, order, license, certificate, permit, registration, designation, or filing by or with any governmental agency or body necessary for the execution, delivery, and performance of this Agreement or the transactions contemplated hereby by the Contributor has been obtained or will be obtained on or before the Closing Date.

(f) Operation of Assets . Between the date hereof and the Closing Date, the Contributor will take such action as may be necessary to cause the Company to (A) operate its business only in the usual, regular, and ordinary manner consistent with such entity’s prior practice and (B) maintain its books of account and records in the usual, regular, and ordinary manner, in accordance with sound accounting principles applied on a basis consistent with the basis used in keeping its books in prior years. Except as otherwise permitted hereby, from the date hereof until the Closing Date, the Contributor shall not take any action or fail to take any action the result of which would (1) have a material adverse effect on the Assets, the Contributor’s Assets, the Property, the Hotel or the Acquiror’s ability to continue the operation thereof after the Closing Date in substantially the same manner as presently conducted or (2) would cause any of the representations and warranties contained in this Section 2.2 to be untrue as of the Closing Date.

(g) Operating Agreement . The Limited Liability Company Agreement of the Company (the “Operating Agreement”) is in force and effect as of the date hereof, and has not been modified or amended. The Contributor has performed all of its obligations under the Operating Agreement.

(h) Securities Law Matters . (A) In acquiring the Units and engaging in this transaction, neither Contributor nor any partner thereof is relying upon any representations made to it by the Acquiror, or any of its partners, officers, employees, or agents that are not contained herein. Contributor is aware of the risks involved in investing in the Units and in the shares of common stock (“Common Stock”) of the REIT, issuable upon redemption of such Units. Contributor has had an opportunity to ask questions of, and to receive answers from, the Acquiror or a person or persons authorized to act on its behalf, concerning the terms and conditions of this investment and the financial condition, affairs, and business of the Acquiror and the REIT. Contributor confirms that all documents, records, and information pertaining to its investment in the Acquiror that have been requested by it, including a complete copy of the form of the Partnership Agreement, have been made available or delivered to it prior to the date hereof. Contributor represents and warrants that it has reviewed and approved the form of the Partnership Agreement attached hereto as Exhibit B.

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(B) Contributor and each partner thereof understands that neither the Units nor the shares of Common Stock issuable upon redemption of the Units have been registered under the Securities Act or any state securities acts and are instead being offered and sold in reliance on an exemption from such registration requirements. The Units issuable to Contributor are being acquired solely for its own account, for investment, and are not being acquired with a view to, or for resale in connection with, any distribution, subdivision, or fractionalization thereof, in violation of such laws, and Contributor does not have any present intention to enter into any contract, undertaking, agreement, or arrangement with respect to any such resale; provided, however, that, at or following Closing, Contributor may distribute the Units to its partners that (1) have represented and warranted to the Acquiror in writing that, as of the time of such distribution, such partner is an accredited investor as that term is defined in Rule 501 of Regulation D under the Securities Act, and (2) have executed the Partnership Agreement as limited partners. Contributor understands that any certificates evidencing the Units will contain appropriate legends reflecting the requirement that the Units not be resold by Contributor without registration under such laws or the availability of an exemption from such registration and that the Partnership Agreement will restrict transfer of the Units.

(i) Accredited Investor . Contributor is an accredited investor as that term is defined in Rule 501 of Regulation D under the Securities Act.

(j) Tax Matters . (A) The Company has filed within the time and in the manner prescribed by law all material federal, state, and local tax returns and reports, including but not limited to income, gross receipts, intangible, real property, excise, withholding, franchise, sales, use, employment, personal property, and other tax returns and reports, required to be filed by the Company under the laws of the United States and of each state or other jurisdiction in which the Company conducts business activities requiring the filing of tax returns or reports. All tax returns and reports filed by the Company are true and correct in all material respects. The Company has paid in full all taxes of whatever kind or nature for the periods covered by such returns. The Company has not been delinquent in the payment of any tax, assessment, or governmental charge or deposit and has no tax deficiency or claim outstanding, assessed, threatened, or proposed against it. The charges, accruals, and reserves for unpaid taxes on the books and records of the Company as of the Closing Date are sufficient in all respects for the payment of all unpaid federal, state, and local taxes of the Company accrued for or applicable to all periods ended on or before the Closing Date. There are no tax liens, whether imposed by the United States, any state, local, or other taxing authority, outstanding against the Company or any of its assets. The federal, state, and local tax returns of the Company have not been audited, nor has the Company received any notice of any federal, state, or local audit.

(k) Bankruptcy with respect to Contributor . No Act of Bankruptcy has occurred with respect to the Contributor or Company. As used herein, “Act of Bankruptcy” shall mean if a party hereto or any partners thereof shall (A) apply for or consent to the appointment

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of, or the taking of possession by, a receiver, custodian, trustee or liquidator of itself or of all or a substantial part of its property, (B) admit in writing its inability to pay its debts as they become due, (C) make a general assignment for the benefit of its creditors, (D) file a voluntary petition or commence a voluntary case or proceeding under the Federal Bankruptcy Code (as now or hereafter in effect), (E) be adjudicated bankrupt or insolvent, (F) file a petition seeking to take advantage of any other law relating to bankruptcy, insolvency, reorganization, receivership, dissolution, winding-up or composition or adjustment of debts, (G) fail to controvert in a timely and appropriate manner, or acquiesce in writing to, any petition filed against it in an involuntary case or proceeding under the Federal Bankruptcy Code (as now or hereafter in effect), or (H) take any entity action for the purpose of effecting any of the foregoing.

(m) Liabilities, Indebtedness . Except as set forth in Schedule 2.2(a), the Company has not incurred any indebtedness related to the Hotel or the Property except in each instance for trade payables and other customary and ordinary expenses in the normal course of business that will be paid and discharged in full by the Company on or prior to the Closing.

(n) Leases . Schedule 2.2(o) attached hereto is a true, correct and complete schedule of all ground leases, restaurant leases, subleases and other rights of occupancy in effect with respect to the Hotel and the Property (collectively, the “Leases”). Except as set forth on Schedule 2.2(o), there are no other leases, subleases, tenancies or other rights of occupancy in effect with respect to the Hotel or the Property. True, correct and complete copies of the Leases, together with all amendments and supplements thereto and all other documents and correspondence relating thereto, have been delivered or made available to Acquiror. Except as set forth on Schedule 2.2(o), all such Leases are valid and enforceable and presently in full force and effect, and none of the Leases have been assigned and all brokerage commissions, if any, payable under any of the Leases have been paid or will be paid by the Company prior to Closing. To the best knowledge of Contributor, no party to any Lease is in default under such Lease, and Contributor does not know of any event which, but for the passage of time or the giving of notice, or both, would constitute a default under such Leases, except such defaults that would not have a material adverse effect on the condition, financial or otherwise or on the earnings, business affairs or business prospects of the Company. No tenant under any of the Leases has an option or right of first refusal to purchase the premises demised under such Lease. The consummation of the transactions contemplated by this Agreement will not give rise to any breach, default or event of default under any of the Leases. None of the Leases requires the consent or approval of any party in connection with the transactions contemplated by this Agreement.

(o) Insurance . The Company currently maintains or causes to be maintained all of the public liability, casualty and other insurance coverage with respect to the Hotel as set forth on Schedule 2.2(p) attached hereto. All such insurance coverage shall be maintained in full force and effect through the Closing and all premiums due and payable thereunder have been, and shall be, fully paid when due.

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(p) Personal Property . All equipment, fixtures and personal property located at the Hotel shall remain and not be removed prior to the IPO Closing, except for equipment that becomes obsolete or unusable, which may be disposed of or replaced in the ordinary course of business.

(q) Environmental Conditions .

(A) As of the date of this Agreement and as of the Closing, and except as set forth in the environmental reports and materials previously delivered to Acquiror which are listed on Schedule 2.2(r) attached hereto (collectively, “Environmental Reports”), to the best of the Contributors’ knowledge, information and belief, the Property (which for purposes of this Section 2.2(r) shall include all leased and vacant space, land surface water, groundwater and any and all improvements located on, in or under the Property) is now and will be at the Closing free of all contamination which exists as or has arisen from, directly or indirectly:

(3) any “oil” or other “hazardous substance” as defined by the Oil and Hazardous Substance Control Act of 1976, as amended, or by and regulations promulgated thereunder;

(4) any substance the presence of which on, in or under the Property is prohibited or regulated by any federal, state or local environmental law (an “Environmental Law”); and

(B) To the best of the Contributors’ knowledge, information and belief, as of the date of this Agreement and as of the Closing, and except as set forth in the Environmental Reports:

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(2) to the best of the Contributors’ knowledge, information and belief, the Company has not placed, located, sited or buried any underground storage tanks at the Property and to the knowledge of Contributor, no underground storage tanks are located on, at or under the Property;

(3) to the best of the Contributors’ knowledge, information and belief, the Property does not appear on any state or federal CERCLA, RCRA, Superfund or other similar lists and, to the knowledge of Contributor, the Property is not proposed to be included on any such list;

(4) to the best of the Contributors’ knowledge, information and belief, the Company has never used any part of the Property as a sanitary landfill, waste dump site or for the treatment, storage or disposal of hazardous waste as defined in RCRA and no part of the Property has ever been used as a sanitary landfill, waste dump site or for the treatment, storage or disposal of hazardous waste as defined in RCRA;

(5) to the best of the Contributors’ knowledge, information and belief, no notice of violation or other written communication has been received by the Company or any predecessor in title from a governmental agency or other entity or person, alleging or suggesting any violation of any Environmental Law on or with respect to the Property;

(6) to the best of the Contributors’ knowledge, information and belief, neither the Company nor any of such Company’s agents, licensees or invitees have placed or permitted the placement of any Hazardous Materials in, on, under or over the Property in violation of any Environmental Law;

(7) to the best of the Contributors’ knowledge, information and belief, no other party has placed any Hazardous Material in, on, under or over any of the Property in violation of any Environmental Law; and

(8) to the best of the Contributors’ knowledge, information and belief, the Property is not subject to any federal, state or local lien (including any “Superfund” lien), proceedings, claim, liability, or action, or the threat or likelihood thereof, relating to the clean-up, removal or remediation of any Hazardous Material from the Property and the Company has not received any request or information from the United States Environmental Protection Agency or any other public, governmental or quasi-governmental agency or authority with jurisdiction over any Environmental Law.

(r) Compliance With Laws . To the best of the Contributors’ knowledge, information and belief, the Company possesses such certificates, approvals, licenses, authorities or permits issued by the appropriate local, state or federal agencies or bodies necessary to conduct the business to be conducted by it, and the Company has not received any written notice of proceedings relating to the revocation or modification of any such certificate, approval, license, authority or permit which, singly or in the aggregate, if the subject of an unfavorable decision, ruling, or finding, would materially and adversely affect the condition, financial or otherwise, or the earnings, business affairs or business prospects of the Property. To the best of the Contributors’ knowledge, information and belief, the Company has not received any written or other notice of any violation of any applicable zoning, building or safety code, rule, regulation

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or ordinance, or of any employment, environmental, wetlands or other regulatory law, order, regulation or other requirement, including without limitation the Americans With Disabilities Act (“ADA”) or any restrictive covenants or other easements, encumbrances or agreements, relating to the Property, which remains uncured. The Property has been constructed and is operated in accordance with all applicable laws, ordinances, rules and regulations. All approvals regarding zoning, land use, subdivision, environmental and building and construction laws, ordinances, rules and regulations have been obtained, and such approvals will not be invalidated by the consummation of the transactions contemplated by this Agreement; provided, however, the Property (including, all improvements) is substantially in compliance with the ADA.

(s) Condemnation and Moratoria . Except as set forth on Schedule 2.2(t), to the best of the Contributors’ knowledge, information and belief, there are (i) no pending or threatened condemnation or eminent domain proceedings, or negotiations for purchase in lieu of condemnation, which affect or would affect any portion of the Property; (ii) no pending or threatened moratoria on utility or public sewer hook-ups or the issuance of permits, licenses or other inspections or approvals necessary in connection with the construction or reconstruction of improvements, including without limitation tenant improvements, which affect or would affect any portion of the Property; and (iii) no pending or threatened proceeding to change adversely the existing zoning classification as to any portion of the Property. No portion of the Property is a designated historic property or located within a designated historic area or district and there are no graveyards or burial grounds located within the Property.

(t) Condition of Improvements . To the best of the Contributors’ knowledge, information and belief, there is no material defect in the condition of (i) the Property, (ii) the improvements thereon, (iii) the roof, foundation, load-bearing walls or other structural elements thereof, or (iv) the mechanical, electrical, plumbing and, safety systems therein, nor any material damage from casualty or other cause, nor any soil condition of any nature that will not support all of the improvements thereon without the need for unusual or new subsurface excavations, fill, footings, caissons or other installations.

(u) Absence of Certain Changes . To the best of the Contributors’ knowledge, information and belief, since December 31, 2003, except as set forth or referred to on Schedule 2.2(v), there has not been with respect to the Company:

(A) any material adverse change in the financial condition of the Company or such the Property;

(B) any change in the condition of the Property or the business or liabilities of the Company except normal and usual changes in the ordinary course of business which have not been, individually or in the aggregate, materially adverse;

(C) any damage, destruction or loss, whether or not covered by insurance, individually or in the aggregate, materially and adversely affecting the Property;

(D) any change in the accounting methods or practices with respect to such the Property or in depreciation or amortization policies theretofore used or adopted;

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(E) any material liability with respect to the Property, contingent or otherwise, other than for operating expenses, obligations under any executory contracts disclosed on Schedule 2.2(x) hereof incurred for fair consideration and taxes accrued with respect to operations during such period, all incurred in the ordinary course of business; or

(F) any other material change in the business of the Company.

(v) ERISA . The Company Entity has no (i) labor agreement to which it is a party, or by which it is bound, including “employee pension benefit plans” as defined in Section 3(2) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”); (ii) employment, profit sharing, deferred compensation, bonus, pension, retainer, consulting, retirement, welfare or incentive plan, fund, program or contract to which it is a party, or by which it is bound; (iii) written or other formal personnel policies; or (iv) plan or agreement under which “fringe benefits” (including, but not limited to, vacation plans or programs, sick leave plans or programs, and related benefits) are afforded to its employees.

(w) No Contracts . No agreements, undertakings or contracts affecting the Property, written or oral, will be in existence as of the Closing, except as set forth on Schedule 2.2(x) attached hereto, and true and correct copies of such contracts have been delivered to Acquiror. With respect to any such contracts set forth on Schedule 2.2(x), each such contract is valid and binding on the Company and is in full force and effect in all material respects. To the knowledge of Contributor, no party to any such contract has breached or defaulted under the terms of such contract, except for such breaches or defaults that would not, individually or in the aggregate, have a material adverse effect on the business or operations of the Property.

2.3 Satisfaction of Conditions . The Acquiror hereby covenants that the Acquiror shall use commercially reasonable efforts and diligence in order to satisfy all of the conditions set forth in Section 3.2 hereof; and the Contributors shall not have any obligation to consummate the Closing hereunder unless and until all such conditions have been satisfied or waived by the Contributor in writing. Each Contributor hereby covenants that it shall: (A) use commercially reasonable efforts and diligence in order to satisfy all of the conditions set forth in subsections 3.1(a), (b) and (c) hereof, and (B) cooperate and assist in the Acquiror’s efforts to satisfy the conditions set forth in subsection 3.1(e) hereof; and the Acquiror shall not have any obligation to consummate the Closing hereunder unless and until such conditions have been satisfied or waived by the Acquiror in writing.

2.4 Contributor’s Indemnity . Each Contributor agrees to indemnify and hold the Acquiror, the REIT, and their respective employees, directors, members, partners, affiliates and agents harmless of and from all liabilities, losses, damages, costs, and expenses (including reasonable attorneys’ fees) which the Acquiror or the REIT may suffer or incur by reason of any breach of its representations or warranties contained in this Agreement, and by reason of any act or cause of action occurring or accruing prior to the Closing Date and arising from the ownership of the Assets in the operation of the Hotel prior to the Closing Date.

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2.5 Acquiror’s Indemnity . The Acquiror agrees to indemnify and hold the Contributors and their employees, directors, members, partners, affiliates and agents harmless of and from all liabilities, losses, damages, costs, and expenses (including reasonable attorneys’ fees) which the Contributors may suffer or incur by reason of any breach of its representations or warranties contained in this Agreement, and by reason of any act or cause of action occurring or accruing subsequent to the Closing Date and arising from the ownership or operation of the Assets or the operation of the Hotel subsequent to the Closing Date.

ARTICLE III

CONDITIONS PRECEDENT TO THE CLOSING

3.1 Conditions to Acquiror’s Obligations . In addition to any other conditions set forth in this Agreement, the Acquiror’s obligation to consummate the Closing is subject to the timely satisfaction of each and every one of the conditions and requirements set forth in this Section 3.1, all of which shall be conditions precedent to the Acquiror’s obligations under this Agreement.

(b) Contributors’ Representations and Warranties . The representations and warranties of the Contributors set forth in Section 2.2 shall be true and correct as if made again on the Closing Date.

(e) Third Party Consents . Receipt of written consent from the franchisor of the Hotel to the transfer of the license from the Company to an affiliate of the Acquiror to the extent required by applicable contractual provisions of the Franchise Agreement on terms and conditions that are acceptable to Acquiror in its sole discretion.

(f) Completion of IPO . The IPO shall have been completed.

(g) Distributions Paid . The Distributions shall have been paid to MAVAS and KDCA. Such Distributions shall be deemed to satisfy in full, and Contributors each agree that the distribution received by it shall satisfy in full, any and all loans and outstanding indebtedness and liabilities owed by the Company to each Contributor.

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3.2 Conditions to Contributors’ Obligations . In addition to any other conditions set forth in this Agreement, the obligations of the Contributors to consummate the Closing is subject to the timely satisfaction of each and every one of the conditions and requirements set forth in this Section 3.2, all of which shall be conditions precedent to the Contributor’s obligations under this Agreement.

(b) Acquiror’s Representations and Warranties . The Acquiror’s representations and warranties set forth in Section 2.1 shall be true and correct as if made again on the Closing Date.

(d) Distributions . The Company shall have paid the Distributions to MAVAS and KDCA.

(e) Release of Guarantees . The cross guarantees of indebtedness owed by the Company to BB&T Bank made by MAVAS, Mark V. Smith, MHI Hotels Services LLC, Andrew Sims, Kim Sims and Chris Sims shall have been released.

ARTICLE IV

CLOSING AND CLOSING DOCUMENTS

4.1 Closing . The consummation and closing (the “Closing”) of the transactions contemplated under this Agreement shall take place at the offices of the Acquiror in Greenbelt, Maryland, or such other place as is mutually agreeable to the parties, on the date of the closing of the IPO (the “Closing Date”), or as otherwise set by agreement of the parties hereto. If at any time the REIT determines in good faith to abandon or discontinue its efforts to engage in an IPO, Acquiror shall so advise each Contributor in writing and thereupon all parties hereto will be relieved of all obligations under this Agreement.

4.2 Contributor’s Deliveries . At the Closing, each Contributor shall deliver the following to the Acquiror in addition to all other items required to be delivered to the Acquiror by the Contributor:

(a) Assignment of Assets . Each Contributor shall have executed and delivered an Assignment, in substantially the form of Exhibit A attached hereto, granting and conveying to the Acquiror good and indefeasible title to the Contributor’s Assets, free and clear of all liens, encumbrances, security interests, prior assignments, conditions, restrictions, claims, and other matters affecting title thereto.

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(d) Execution of Tax Indemnity and Bottom Dollar Guarantee . Each Contributor shall have executed a tax indemnity and debt maintenance in the form of Exhibit 4.2 (the “Tax Indemnity”) and the attached Bottom Dollar Guarantee to reflect the allocation of indebtedness to each Contributor in an amount not to exceed such Contributor’s negative balance in the capital account maintained by the Company for such Contributor as of the Closing Date and after giving effect to the Distributions.

(e) Confirmation from Darby Bank . Confirmation from Darby Bank that the loan obligations of MAVAS and KDCA have been repaid and cross guarantees by MAVAS and KDCA have been released.

(f) Confirmation from Contributors . Confirmation from each of the Contributors that the advances and loans made to the Company by such Contributor have been fully satisfied by payment of the Distribution.

(g) Other Documents . Any other document or instrument reasonably requested by the Acquiror or required hereby.

4.3 Acquiror’s Deliveries . At the Closing, the Acquiror shall deliver the following to the Contributors:

(a) Certificates for Units . Certificates representing Units duly issued by the Acquiror in the name of the Contributor as of the Closing Date representing the Units to which each of KDCA and MAVAS are entitled pursuant to Section 1.2 of this Agreement.

(d) Confirmation from BB&T Bank . Confirmation from BB&T Bank that the indebtedness of the Company to such bank shall have been paid in full and/or the cross guarantees of MAVAS, Mark V. Smith, MHI Hotels Services LLC, Drew Sims, Kim Sims and Chris Sims shall have been released.

(e) Other Documents . Any other document or instrument reasonably requested by a Contributor or required hereby.

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4.4 Fees and Expenses; Closing Costs . The Acquiror shall pay all fees, expenses and closing costs relating to the transactions contemplated by this Agreement; provided however, that each Contributor shall pay its own attorneys’ and consultants’ fees and expenses. In the event the transactions contemplated herein are not concluded because of a failure of the REIT to complete the IPO prior to March 31, 2005, the Company shall pay to Acquiror $100,000 which shall represent the Contributors’ pro rata share of costs incurred in connection with such transaction; each Contributor acknowledges and agrees, by executing this Agreement, that it will benefit from such an IPO and, as a consequence, the Company will bear a portion of its costs if such transaction is not completed.

4.5 Default Remedies . If the Closing fails to occur due to a default by the Acquiror, the Contributors shall retain the Deposit as such Contributor’s sole and exclusive remedy for such default, and the Contributor hereby waives any right it may have to damages (compensatory, consequential or otherwise) from the Acquiror as a result of such default. If a Contributor defaults in performing any of the Contributor’s obligations under this Agreement, the Acquiror shall have all rights and remedies available to it at law or in equity resulting from the Contributor’s default, including without limitation, the right to seek specific performance of this Agreement and the Contributor’s obligation to convey the Contributor’s Assets to the Acquiror hereunder. The parties acknowledge and agree that the failure of a condition precedent to occur, notwithstanding the good faith and commercially reasonable efforts of the applicable party, shall not be a default hereunder.

4.6 Power of Attorney . Each Contributor hereby irrevocably appoints Acquiror, Andrew M. Sims and William J. Zaiser, and each of them individually and any successor thereof (such persons or Acquiror or any such successor of any of them acting in his, her or its capacity as attorney-in-fact pursuant hereto, the “Attorney-in-Fact”) as the true and lawful Attorney-In-Fact and agent of Contributor to act in the name, place and stead of such Contributor to take all steps deemed necessary or advisable to cause the Distributions to be made prior to the Closing and the obligations of KDCA and MAVAS to Darby Bank to be paid with a portion of such Distribution.

ARTICLE V

MISCELLANEOUS

5.1 Notices . Any notice provided for by this Agreement and any other notice, demand, or communication required hereunder shall be in writing and either delivered in person (including by confirmed facsimile transmission) or sent by hand delivered against receipt or sent by recognized overnight delivery service or by certified or registered mail, postage prepaid, with return receipt requested. All notices shall be addressed as follows:

Acquiror:

MHI Hospitality LP

814 Capitol Landing Road

Williamsburg, VA 23187

Attention: Mr. Andrew M. Sims

Fax No.: (757) 564-8801

Phone No.: (757) 229-5648

E-mail: drewsims@mhihotels.com

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Notices to Contributors shall be sent to the addresses specified on Schedule 1

5.2 Entire Agreement; Modifications and Waivers; Cumulative Remedies . This Agreement supersedes any existing letter of intent between the parties hereto, constitutes the entire agreement among the parties hereto and may not be modified or amended except by instrument in writing signed by the parties hereto, and no provisions or conditions may be waived other than by a writing signed by the party waiving such provisions or conditions. No delay or omission in the exercise of any right or remedy accruing to the Contributor or the Acquiror upon any breach under this Agreement shall impair such right or remedy or be construed as a waiver of any such breach theretofore or thereafter occurring. The waiver by the Contributor or the Acquiror of any breach of any term, covenant, or condition herein stated shall not be deemed to be a waiver of any other breach, or of a subsequent breach of the same or any other term, covenant, or condition herein contained. All rights, powers, options, or remedies afforded to Contributor or the Acquiror either hereunder or by law shall be cumulative and not alternative, and the exercise of one right, power, option, or remedy shall not bar other rights, powers, options, or remedies allowed herein or by law, unless expressly provided to the contrary herein.

5.3 Exhibits . All exhibits referred to in this Agreement and attached hereto are hereby incorporated in this Agreement by reference.

5.4 Successors and Assigns . Except as set forth in this Article, this Agreement may not be assigned by the Acquiror or the Contributors without the prior approval of the other party hereto; provided, however, that the Acquiror may assign this entire agreement or a right to acquire all or any portion of the Assets to a direct or indirect subsidiary or affiliate of Acquiror without approval of the Contributors. This Agreement shall be binding upon, and inure to the benefit of, each Contributor, the Acquiror, and their respective legal representatives, successors, and permitted assigns.

5.5 Article Headings . Article headings and article and Section numbers are inserted herein only as a matter of convenience and in no way define, limit, or prescribe the scope or intent of this Agreement or any part hereof and shall not be considered in interpreting or construing this Agreement.

5.6 Governing Law . This Agreement shall be construed and interpreted in accordance with the laws of the Commonwealth of Virginia, without regard to conflicts of laws principles.

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5.7 Counterparts . This Agreement may be executed in any number of counterparts and by any party hereto on a separate counterpart, each of which when so executed and delivered shall be deemed an original and all of which taken together shall constitute but one and the same instrument.

5.8 Survival . All representations and warranties contained in this Agreement, and all covenants and agreements contained in the Agreement which contemplate performance after the Closing Date (including, without limitation, those covenants and agreements contained in Section 1.2 hereof) shall survive the Closing.

5.9 Further Acts . In addition to the acts, instruments and agreements recited herein and contemplated to be performed, executed and delivered by the Acquiror and the Contributors, each of the Acquiror and each Contributor shall perform, execute, and deliver or cause to be performed, executed, and delivered at the Closing or after the Closing, any and all further acts, instruments, and agreements and provide such further assurances as the other party hereto may reasonably require to consummate the transaction contemplated hereunder.

5.10 Severability . In case any one or more of the provisions contained in this Agreement shall for any reason be held to be invalid, illegal, or unenforceable in any respect, such invalidity, illegality, or unenforceability shall not affect any other provision hereof, and this Agreement shall be construed as if such invalid, illegal, or unenforceable provision had never been contained herein.

5.11 Attorneys’ Fees . Should a party hereto employ an attorney or attorneys to enforce any of the provisions hereof or to protect its interest in any manner arising under this Agreement, or to recover damages for breach of this Agreement, any non-prevailing party in any action pursued in a court of competent jurisdiction (the finality of which is not legally contested) shall pay to the prevailing party all reasonable costs, damages, and expenses, including reasonable attorneys’ fees, expended or incurred in connection therewith.

5.12 Confidentiality . The Contributor acknowledges that the matters relating to the REIT, the initial underwritten public offering of the REIT, this Agreement, and the other documents, terms, conditions and information related thereto (collectively, the “Information”) are confidential in nature. Therefore, each Contributor covenants and agrees to keep the Information confidential and will not (except as required by applicable law, regulation or legal process, and only after compliance with the provisions of this Section 5.12), without the Acquiror’s prior written consent, disclose any Information in any manner whatsoever; provided, however, that the Information may be revealed only to a Contributor’s key employees, legal counsel and financial advisors, each of whom shall be informed of the confidential nature of the Information and shall agree to act in accordance with the terms of this Section 5.12. In the event that a Contributor or its key employees, legal counsel or financial advisors (collectively, the “Information Group”) are requested pursuant to, or required by, applicable law, regulation or legal process to disclose any of the Information, the applicable member of the Information Group will notify the Acquiror promptly so that it may seek a protective order or other appropriate remedy or, in its sole discretion, waive compliance with the terms of this Section 5.12. In the event that no such protective order or other remedy is obtained, or that the Acquiror waives compliance with the terms of this Section 5.12, the applicable member of the Information Group may furnish only that portion of the Information which it is advised by counsel is legally

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required and will exercise all reasonable efforts to obtain reliable assurance that confidential treatment will be accorded the Information. Each Contributor acknowledges that remedies at law may be inadequate to protect the Acquiror or the REIT against any actual or threatened breach of this Section 5.12, and, without prejudice to any other rights and remedies otherwise available, each Contributor agrees to the granting of injunctive relief in favor of the REIT and/or the Acquiror without proof of actual damages. Notwithstanding any other express or implied agreement to the contrary, the parties hereto agree and acknowledge that each of them and each of their employees, representatives, and other agents may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the transaction and all materials of any kind (including opinions or other tax analyses) that are provided to any of them relating to such tax treatment and tax structure, except to the extent that confidentiality is reasonably necessary to comply with U.S. federal or state securities laws. For purposes of this paragraph, the terms “tax treatment” and “tax structure” have the meanings specified in Treasury Regulation section 1.6011-4(c).

[Signatures follow on next page]

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The parties hereto have executed and delivered this Agreement as of the date indicated in the first sentence of this Agreement.


CONTRIBUTORS:

MAVAS LLC

By:		/s/ Mark V. Smith
Name:		Mark V. Smith
Title:		President

KDCA Partnership

By:		/s/ Andrew M. Sims
Name:		Andrew M. Sims
Title:		President of the GP

ACQUIROR:

MHI Hospitality LP

By:		/s/ Andrew M. Sims
Name:		Andrew M. Sims
Title:		CEO of the GP

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Exhibit 10.9

Philadelphia

CONTRIBUTION AGREEMENT

THIS CONTRIBUTION AGREEMENT (this “Agreement”) is made as of the 8th day of September, 2004 (the “Effective Date”) by and among Elpizo Limited Partnership, a Pennsylvania limited partnership (the “Partnership”), Phileo Land Corporation, a Delaware corporation (the “Company”) (each a “Seller” and collectively, the “Sellers”), and MHI Hospitality LP, a Delaware limited partnership (the “Buyer”).

RECITALS

A. The Partnership is the lessee of certain real property consisting of approximately 5.72 acres of land located in Philadelphia, Pennsylvania (the “Property”), and the owner of certain hotel improvements located thereon consisting of a 331 room hotel trading as the Hilton Philadelphia Airport Hotel together with all furniture, fixtures, equipment, durable goods and inventory therein (the “Hotel”);

B. The Company is the owner of the Property;

C. The Sellers desire to contribute the Assets (as defined below) to the Buyer in consideration of the issuance of ownership interests in the Buyer, on the terms and conditions hereinafter set forth; and

D. One of the limited partners of the Partnership, Juio K. Tan (“Tan”) would not agree to the transaction contemplated herein unless her interests in the Partnership were purchased for cash; and

E. In lieu of acquiring the Assets entirely for Units in the Buyer, the Buyer agreed to pay the cash portion of the Purchase Price set forth below to the Sellers in order for Tan’s interest in the Sellers to be purchased; and

F. The Buyer will be the operating partnership of a Maryland corporation to be formed which will seek to qualify as a real estate investment trust for Federal income tax purposes (the “REIT”) and will seek to complete an underwritten public offering of shares of its common stock (the “IPO”). The Sellers intend to sell the Assets to the Buyer concurrently with the closing of the IPO.

AGREEMENT

NOW, THEREFORE, for and in consideration of the mutual covenants herein contained, the parties hereto agree as follows:

ARTICLE I

CONTRIBUTION OF ASSETS

1.1 Assets to be Contributed . Upon the terms and subject to the conditions set forth in this Agreement, at the Closing Date (as defined below), Sellers shall contribute, convey, assign, transfer and deliver to Buyer, and Buyer shall acquire from Sellers, free and clear of any liens, encumbrances, security interests, prior assignments or conveyances, conditions, restrictions, claims and other matters affecting title thereto, except for Permitted Encumbrances (as defined below), all of Sellers’ right, title and interest in and to all of Sellers’ property and assets, real, personal or mixed, tangible and intangible, of every kind and description, wherever located, including, but not limited to, the following (but excluding the Excluded Assets):

A. The Property as further described in Schedule 1.1A and the Hotel improvements located thereon;

B. To the extent assignable, all of Sellers’ rights, title and interest in the Hilton license agreement relating to the Hotel;

C. All of the personal property and equipment owned by Sellers and located in or at the Hotel and used in connection therewith, including but not limited to, cleaning equipment, furniture, fixtures, carpets, rugs, draperies, mechanical and electrical equipment, office equipment, china, glassware, silver, cooking utensils, flatware, linens, and uniforms (collectively, the “Personal Property”);

D. To the extent owned by Sellers and relating to or located on or in the Hotel and transferable by Sellers, the telephone number for the Hotel, the Hotel directory listings, surveys, plans and specifications, licenses and permits, contractor and maintenance files, service manuals, notices of compliance with state and federal and all governmental agencies and regulations, estoppel certificates or affidavits, and guaranties and warranties as to Personal Property which pertain to the Hotel or are used in connection therewith;

E. All inventory located on the premises of the Hotel or on the Property as of Closing, including without limitation merchandise held for sale and reserve stocks of operating supplies on hand at Closing (“the Inventory”); and

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F. To the extent assignable by Sellers, all leases, lease-purchase agreements, warranties, management agreements, licenses, contracts and purchase agreements (the “Operating Agreements”) relating to the maintenance, use or occupancy of the Hotel.

The assets and property described in paragraphs A through F (the “Assets”) shall be transferred by Sellers to the Buyer free and clear of all liens, claims and encumbrances, except Permitted Encumbrances.

Notwithstanding the foregoing, the transfer of the Assets pursuant to this Agreement shall not include the assumption of any liability accruing prior to the Closing Date related to the Assets unless Buyer expressly assumes that liability pursuant to Section 1.6.

1.2 Excluded Assets . Notwithstanding anything to the contrary contained in Section 1.1 or elsewhere in this Agreement, all cash, cash equivalents, securities, notes, payable, bank accounts, accounts receivable for services performed or goods delivered prior to the Closing, and other payment obligations owed to Sellers that accrued prior to the Closing (collectively, the “Excluded Assets”) are not part of the sale and purchase contemplated hereunder, are excluded from the Assets and shall remain the property of Seller after the Closing.

1.3 Purchase Price . (a) The aggregate consideration to be paid by Buyer to Sellers on the Closing Date for the Assets (the “Purchase Price”) will be One Million Eight Hundred and Forty-Eight Thousand Seven Hundred Dollars ($1,848,700) and 732,254 units of limited partnership interests in the Buyer (the “Units”); provided, however, in the event the price per share of Common Stock offered to investors in the IPO (the “Offering Price”) is less than $9.50 per share, the number of Units shall be increased by that number of Units equal to the quotient realized by dividing (a) the difference between (i) $6,956,413 and (ii) the product of 732,254 and the Offering Price by (b) the Offering Price. The Purchase Price shall be allocated between the Sellers as set forth on Schedule 1.3 attached hereto.

(b) The Partnership agrees that it will dissolve immediately after the Closing and distribute the sum of $1,708,888.50 received as part of the Purchase Price to Tan.

1.4 Issuance of Units . On the Closing Date, the Buyer shall issue to the Sellers certificates reflecting the Units as specified in Schedule 1.3. Such certificates shall bear appropriate legends indicating (i) that the Units have not been registered under the Securities Act of 1933, as amended (the “Securities Act”), and (ii) that the Buyer’s agreement of limited partnership (the “Partnership Agreement”) will restrict the transfer of the Units. Immediately upon receipt of the Units, each Seller shall accede to the Partnership Agreement as a limited partner of the Buyer.

1.5 Redemption Rights for Units . The Units shall be redeemable at the option of the holders of such Units and in accordance with, but subject to the restrictions contained in, the Partnership Agreement including, without limitation, that such redemption option may not be exercised prior to the first anniversary of the Closing Date.

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1.6 Assumption of Liabilities . Sellers shall assign to Buyer, and Buyer shall assume, all rights and obligations of Sellers under any Operating Agreements accruing from and after the Closing Date. Buyer shall not, as a result of execution of this Agreement and consummation of the transaction contemplated hereby, assume or become liable for any of Seller’s liabilities, accounts payable, obligations, debts, contracts or commitments of any kind accruing or caused by Seller prior to the Closing Date.

1.7 Adjustments . Real estate taxes, personal property taxes, utilities, water and sewer charges, rents, other governmental assessments on the Hotel and the Property, income from the operation of the Hotel, expenses related to the operation of the Hotel, and all other income and expense relating to the Assets, shall be prorated between Buyer and Seller, based upon the fiscal year of the applicable taxing authority with respect to any property taxes, the billing period for any utility service or other expense, and the payment period for any income, as of the date of the Closing. In addition, Buyer shall pay to Seller the value of any inventory and stock in trade included within the Assets as of the Closing Date, calculated based upon Seller’s cost of purchasing same. Seller and Buyer shall cooperate to cause the existing property manager to prepare a statement of income and expense as of the Closing Date based upon the information that is available as of that date, and all pro-rations shall be based as of that date. No pro-ration shall be made for payments that have not been received as of the Closing Date, but such payments shall be pro-rated as they are received. Buyer shall promptly pay to Seller any accounts receivable or other payments that are payable to Seller hereunder that are received after the Closing Date. Within sixty (60) days after the Closing Date, Buyer and Seller shall cause the property manager to prepare a final accounting of all income and expenses relating to the Assets as of the Closing Date, and such amounts shall be re-adjusted. Any amount payable by the Buyer to the Sellers pursuant to this Section 1.7 shall be allocated among the Sellers in the manner designated by Seller. Each party (by its execution hereof) hereby acknowledges and agrees any such adjustments shall be paid in cash to the party entitled thereto. If after the Closing, the parties discover any errors in adjustments and apportionments, same shall be corrected as soon after their discovery as possible. Any payment made after the Closing, if any, shall be made within 15 days after the calculation of such payment. The provisions of this Section 1.7 shall survive the closing of title.

1.8 Tax Consequences to Sellers . (a) Notwithstanding anything to the contrary contained in this Agreement, including without limitation the use of words and phrases such as “sell,” “sale,” purchase,” and “pay,” except as set forth in subsection (b) below, the parties hereto acknowledge and agree that it is their intent that the contribution transaction contemplated hereby with respect to the Assets shall be treated for federal income tax purposes pursuant to Section 721 of the Internal Revenue Code of 1986, as amended (the “Code”), as the contribution of the Assets by the Sellers to the Buyer, in exchange for the Units, to the extent that Seller receives Units for the contribution of the Assets, and not as a transaction in which any Seller is acting other than in its capacity as a prospective partner in the Buyer.

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(b) The Buyer and the Partnership agree that, for federal income tax purposes, each will treat the transactions described in Sections 1.3(a) and (b) hereof as a sale of the interest in the Partnership currently held by Tan to Buyer for $1,708,888.50, as contemplated by Section 1.708-1(c)(4) of the Treasury Regulations.

ARTICLE II

CLOSING AND CLOSING DOCUMENTS

2.1 Closing . The consummation and closing (the “Closing”) of the transactions contemplated under this Agreement shall take place at the offices of the Buyer in Greenbelt, Maryland, or such other place as is mutually agreeable to the parties, on the date of the closing of the IPO (the “Closing Date”), or as otherwise set by agreement of the parties hereto. If at any time the REIT determines in good faith to abandon or discontinue its efforts to engage in an IPO, Buyer shall so advise each Seller in writing and thereupon all parties hereto will be relieved of all obligations under this Agreement.

2.2 Seller’s Deliveries . At the Closing, each Seller shall deliver the following to the Buyer in addition to all other items required to be delivered to the Buyer by the Seller:

(a) a special warranty deed conveying good, in record and in fact, marketable and fee simple title to the Property free and clear of any and all deeds of trust, mortgages or other liens or indebtedness, encumbrances, conditions, easements, rights of way, assessments and restrictions by the Company except Permitted Encumbrances,

(b) an assignment and assumption of the Operating Agreements;

(c) a bill of sale conveying to Buyer the Personal Property and Inventory free and clear of all liens, claims and encumbrances, other than equipment financing liens encumbering same identified on Schedule 2.2(c);

(d) Execution of Partnership Agreement . Signature pages of the Partnership Agreement (which Partnership Agreement shall be in substantially the form attached hereto as Exhibit A) duly executed by each Seller, as limited partner.

(e) FIRPTA Certificate . An affidavit from each Seller certifying pursuant to Section 1445 of the Code that the Seller is not a foreign corporation, foreign partnership, foreign trust, foreign estate or foreign person (as those terms are defined in the Code and the Income Tax Regulations promulgated thereunder).

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(f) Tax Indemnity . The Partnership shall have executed a tax indemnity and debt maintenance agreement in the form of Exhibit B (the “Tax Indemnity”) and a guaranty in the form of Exhibit C to reflect the allocation to the Partnership of that amount of indebtedness of Buyer or its affiliates to be agreed to by the parties and inserted in such guaranty in an amount not to exceed the Partnership’s aggregate negative balance in the capital account maintained by the Partnership as of the Closing Date.

(g) Other Documents . Any other document or instrument reasonably requested by the Buyer or required hereby.

2.3 Buyer’s Deliveries . At the Closing, the Buyer shall deliver the following to the Sellers:

(a) Certificates for Units . Certificates representing Units duly issued by the Buyer in the name of the Seller as of the Closing Date representing the Units to which the Seller is entitled pursuant to Section 1.3 of this Agreement.

(b) Purchase Price . The Purchase Price by wire transfer to an account specified by the Seller in writing delivered to Buyer at least three business days before the Closing Date.

(c) Executed Partnership Agreement . Signature pages of the Partnership Agreement (which Partnership Agreement shall be in substantially the form attached hereto as Exhibit A) duly executed by its general partner.

(d) Tax Indemnity . Buyer shall have executed a Tax Indemnity with the Partnership.

(e) Assignment . Assignment and assumption of the Operating Agreements.

(f) Third Party Consents . Any third party consents required in connection with the assignment and assumption of any Operating Agreements.

(g) Other Documents . Any other document or instrument reasonably requested by a Seller or required hereby.

2.4 Fees and Expenses; Closing Costs . The Buyer shall pay all fees, expenses and closing costs relating to the transactions contemplated by this Agreement, including transfer taxes, recordation expenses, all reasonable costs relating to the payoff of the mortgage held by Midland Loan Servicing, reasonable costs of Hilton Inns, Inc. consenting to the assignment and assumption of the Hilton license agreement, reasonable costs of third party and governmental consents, the costs of a survey of, and title insurance for, the Property, and all other reasonable

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search and documentary costs, but nothing herein shall require Sellers to pay any such costs if Buyer deems them to be unreasonable. Transfer taxes shall include the county and state transfer taxes and state stamp taxes; provided however, that each Seller shall pay its own attorneys’ and consultants’ fees and expenses. In the event the Closing does not occur as a result of a failure to conclude an IPO, the Partnership agrees to pay to Buyer 19.2% of the actual out-of-pocket costs incurred by Buyer and its affiliates in connection with the proposed IPO of the REIT, which the Partnership agrees represents the pro rata share of the expected transaction costs of the Sellers. Each Seller acknowledges and agrees, by executing this Agreement, that it will benefit from such an IPO and, as a consequence, the Partnership will bear a portion of its costs if such transaction is not completed for the foregoing reasons. In addition, if the Closing does not occur as a result of the failure to conclude an IPO, then Buyer shall reimburse Seller for Seller’s costs and expenses incurred in connection with the negotiating and entry of this Agreement and pursuing this transaction, including without limitation due diligence costs and counsel fees (it being understood that such costs and expenses shall be included in the Buyer’s costs for which Seller is obligated to reimburse Buyer for Seller’s pro-rata share, so that the net reimbursement to Seller shall be 80.8% of Seller’s costs).

2.5 Default Remedies . If the Closing fails to occur due to a default by the Buyer, the Sellers shall be entitled to receive as liquidated damages Seller’s costs and expenses incurred in connection with the negotiating and entry of this Agreement and pursuing this transaction, including without limitation due diligence costs and counsel fees, as Seller’s sole and exclusive remedy for such default, in addition to those remedies specified in Article IX, and the Seller hereby waives any right it may have to other damages (compensatory, consequential or otherwise) from the Buyer as a result of such default. If a Seller defaults in performing any of the Seller’s obligations under this Agreement, the Buyer’s sole and exclusive remedies in addition to those remedies specified in Article IX shall be to either (a) terminate this Agreement, or (b) enforce this Agreement by specific performance. The parties acknowledge and agree that the failure of a condition precedent to occur, notwithstanding the good faith and commercially reasonable efforts of the applicable party, shall not be a default hereunder. No such limitation on any party’s damages shall limit the effect of any indemnification provisions set forth herein.

2.6 Permitted Encumbrances . (a) Subject to the provisions of subsection (b), for purposes of this Agreement the term “Permitted Encumbrances” shall refer to the following:

(i) General real estate taxes for the year in which Closing occurs and subsequent tax years;

(ii) All easements, restrictions, covenant, rights-of-way, encroachments, reservations, agreements, conditions, and other matters of record affecting all or any portion of the Property, which do not prevent Buyer from operating a first-class hotel;

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(iii) All building restrictions and zoning regulations now or hereafter in effect, to the extent adopted by any municipal or other public authority and related to all or any portion of the Property; and

(iv) Any lien, mortgage, charge, restriction or encumbrance which Buyer agrees to assume or pay off pursuant to this Agreement.

(b) Buyer shall have the right within thirty (30) days after the date hereof, to deliver to Seller a copy of a title commitment with respect to the Property prepared by a title company selected by Buyer (the “ Title Insurance Commitment ”), (ii) copies of all recorded documents noted in Schedule B of the Title Insurance Commitment, (iii) a survey for the Property, and (iv) a statement specifying any objections to title or the survey which are not Permitted Encumbrances (“ Buyer’s Statement ”). Seller shall remove encumbrances which are voluntarily created by Seller after the date of this Agreement or which are judgment liens, tax liens, mechanics liens or other monetary liens other than those that Buyer is obligated to assume or pay off pursuant to this Agreement (“Seller Encumbrances”). If Seller does not, within five (5) business days after receipt of Buyer’s Statement, advise Buyer in writing that it will remove all of the defects listed in Buyer’s Statement (“Seller Defects), then Buyer’s sole right shall be to either (a) waive such remaining defects and close title without abatement, in which case such objections shall be deemed Permitted Encumbrances, or (b) terminate this Agreement, in either case upon notice to Seller given within five (5) business days following Seller’s response or failure to timely respond. If Buyer does not timely deliver to Seller Buyer’s Statement, or notify Seller of its election to terminate this Agreement, within the time period set forth in this Section 2.6(b) , Buyer shall conclusively be deemed to have waived its right of termination, and any damages or indemnity that Buyer may claim on account of any title defects other than Seller Encumbrances and Seller Defects. This covenant shall survive the Closing.

2.7 Environmental Matters . Buyer shall have the right within thirty (30) days after the date hereof, to conduct a Phase I environmental study and inspection of the Property and the Hotel for purposes of testing, among others, groundwater, land surface water and other aspects of the Property and the Hotel to determine the presence of any hazardous condition, substance or materials (a “Phase I Study”). Within 5 days of receipt, Buyer shall provide Seller with a copy of the Phase I Study and advise Buyer as to whether such report identifies an environmental condition relating to the Property or the Hotel which if uncured would cause Buyer to terminate this Agreement (a “Termination Election”) or that Buyer wishes to conduct further testing (a “Phase II Study”) to obtain additional data regarding the condition of the Property and Hotel (a “Phase II Election”). In the event Buyer makes a Termination Election, Seller shall have 5 days to notify Buyer that it will assume all responsibility for remediating such environmental condition to the satisfaction of Buyer and indemnify Buyer against any costs or liabilities arising from or relating to such condition or the remediation thereof. In the event Seller does not provide such notice within such 5 day period, this Agreement will

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terminate and neither Seller nor Buyer shall have any further obligation hereunder. In the event Buyer makes a Phase II Election, Buyer shall have 10 days to cause such a study to be conducted. Buyer shall provide Seller with a copy of such study within 5 days of receipt and advise Buyer as to whether such report identifies an environmental condition relating to the Property or Hotel which if uncured would cause Buyer to terminate this Agreement (“Phase II Termination Election”). In the event Buyer makes a Phase II Termination Election, Seller shall have 5 days to notify Buyer that it will assume all responsibility for remediating such environmental condition to the satisfaction of Buyer and indemnify Buyer against any costs or liabilities raising from or relating to such condition or the remediation thereof. In the event Seller does not provide such notice within such period this Agreement will terminate and neither Seller nor Buyer shall have any further obligation to the other. In the event Buyer fails to provide Seller a Termination Election or a Phase II Election within the specified period following Buyer’s receipt of the Phase I Study or fails to provide Seller a Phase II Termination Election with the specified period following receipt of the Phase II Report, Buyer shall be deemed to have waived any termination right it may have in respect of such report and to have accepted the environmental condition of the Property and Hotel and waived any right it may have to seek damages in respect of the environmental condition of the Property and Hotel. This covenant shall survive the Closing.

ARTICLE III

REPRESENTATIONS AND COVENANTS

3.1 Representations by Buyer . The Buyer hereby represents and warrants unto each Seller that the following statements are true, correct, and complete as of the date of this Agreement and will be true, correct, and complete as of the Closing Date:

(a) Organization and Power . The Buyer is duly organized, validly existing, and in good standing under the laws of the State of Delaware, and has full right, power, and authority to enter into this Agreement and to assume and perform all of its obligations under this Agreement; and, the execution and delivery of this Agreement and the performance by the Buyer of its obligations hereunder have been duly authorized by all requisite action of the Buyer and require no further action or approval of the Buyer’s partners or of any other individuals or entities in order to constitute this Agreement as a binding and enforceable obligation of the Buyer. This Agreement constitutes the legal, valid and binding obligation of Buyer and is enforceable in accordance with its terms.

(b) Noncontravention . Neither the entry into nor the performance of, or compliance with, this Agreement by the Buyer has resulted, or will result, in any violation of, or default under, or result in the acceleration of, any obligation under any existing certificate of limited partnership, partnership agreement, mortgage, indenture, lien agreement, note, contract, permit, judgment, decree, order, restrictive covenant, statute, rule, or regulation applicable to the Buyer or the REIT.

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(c) Litigation . There is no action, suit, or proceeding, pending or known to be threatened, against or affecting the Buyer or the REIT in any court or before any arbitrator or before any federal, state, municipal, or other governmental department, commission, board, bureau, agency or instrumentality which (i) in any manner raises any question affecting the validity or enforceability of this Agreement, (ii) could materially and adversely affect the business, financial position, or results of operations of the Buyer or the REIT, (iii) could materially and adversely affect the ability of the Buyer to perform its obligations hereunder, or under any document to be delivered pursuant hereto.

(d) Units Validly Issued . The Units, when issued, will have been duly and validly authorized and issued, free of any preemptive or similar rights, and will be fully paid and nonassessable, without any obligation to restore capital except as required by the Delaware Revised Uniform Limited Partnership Act (the “Limited Partnership Act”). Each Seller shall be admitted as a limited partner of the Buyer as of the Closing Date and shall be entitled to all of the rights and protections of a limited partner under the Limited Partnership Act and the provisions of the Partnership Agreement, with the same rights, preferences, and privileges as all other limited partners on a pari passu basis.

(e) Consents . Each consent, approval, authorization, order, license, certificate, permit, registration, designation, or filing by or with any governmental agency or body necessary for the execution, delivery, and performance of this Agreement or the transactions contemplated hereby by the Buyer which is Buyer’s responsibility hereunder has been obtained or will be obtained on or before the Closing Date.

(f) Brokerage Commission . The Buyer has not engaged the services of any real estate agent, broker, finder or any other person or entity for any brokerage or finder’s fee, commission or other amount with respect to the transactions described herein on account of any action by the Buyer. The Buyer hereby agrees to indemnify and hold the Sellers and each of their employees, directors, members, partners, affiliates and agents harmless against any claims, liabilities, damages or expenses arising out of a breach of the foregoing. This indemnification shall survive Closing or any termination of this Agreement.

(g) Buyer and REIT . Attached hereto as Exhibit A is a true and complete copy of the Partnership Agreement of the Buyer. Attached hereto as Exhibit C is a true and complete copy of the filed certificate of limited partnership of the Buyer. Attached hereto as Exhibit D is a true and complete copy of the filed Certificate of Incorporation and the By-Laws of the REIT. All such documents remain in full force and effect and have not been amended or modified. Buyer has no knowledge of any default or alleged default thereunder. The REIT is a corporation, validly existing and in good standing under the laws of its state of incorporation

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and in any other state where its qualification is required by applicable law. The REIT has or will have as of the Closing full power and authority to enter into the IPO and to issue any interests in the REIT to Buyer upon redemption of the Units, and no further authorizations or consents are required in connection therewith. Upon the Closing Date, the Buyer’s participation in the IPO shall have been conducted in compliance with all applicable laws, rules, regulations and ordinances. Sellers shall be entitled to rely upon any disclosures set forth in the prospectus issued in connection with the IPO (other than those disclosures or financial data relating to the Property or the Hotel) as if they were set forth herein at length.

(h) Non-Dilution . Schedule 1.3 sets forth the number of Units that will be issued by the Buyer to the initial partners of Buyer in exchange for the contribution of such partners’ properties to Buyer in connection with the IPO transaction. Except as otherwise provided herein, Buyer shall not alter the aggregate number of Units to be issued from that shown on Schedule 1.3 as part of the IPO transaction.

3.2 Representations by Sellers . Each Seller hereby represents and warrants unto the Buyer, jointly and severally, that each and every one of the following statements is true, correct, and complete as of the date of this Agreement and will be true, correct, and complete as of the Closing Date.

(a) Organization and Power . Such Seller is duly organized, validly existing, and in good standing under the laws of the state of its organization. Such Seller has full right, power, and authority to enter into this Agreement and to assume and perform all of its obligations under this Agreement; and the execution and delivery of this Agreement and the performance by such Seller of its obligations hereunder have been duly authorized by all requisite action of such Seller and require no further action or approval of such Seller’s members or managers or directors or shareholders or partners, as the case may be, or of any other individuals or entities in order to constitute this Agreement as a binding and enforceable obligation of such Seller. This Agreement has been duly executed by such Seller and constitutes the legal, valid and binding obligation of such Seller and is enforceable in accordance with its terms.

(b) Noncontravention . Neither the entry into nor the performance of, or compliance with, this Agreement by such Seller has resulted, or will result, in any violation of, or default under, or result in the acceleration of, any obligation under such Seller’s organizational documents, or any, mortgage, indenture, lien or security agreement, note, contract, permit, judgment, decree, order, restrictive covenant, statute, rule, or regulation applicable to such Seller or to the Assets.

(c) Litigation . There is no action, suit, or proceeding, pending or known to be threatened, against or affecting such Seller or the Hotel or the Property in any court or before any arbitrator or before any federal, state, municipal, or other governmental department,

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commission, board, bureau, agency or instrumentality which (A) in any manner raises any question affecting the validity or enforceability of this Agreement, (B) could materially and adversely affect the business, financial position, or results of operations of the Hotel, (C) could materially and adversely affect the ability of the Seller to perform its obligations hereunder, or under any document to be delivered pursuant hereto, (D) could create a lien on the Assets, any part thereof, or any interest therein, or (E) could materially adversely affect the Assets, any part thereof, or any interest therein.

(d) Good Title . (A) The Company is the sole owner beneficially and of record of the Property specified in Schedule 1.1(A) (B) the Partnership owns beneficially and of record the Hotel and all of the other Assets other than the Property, (C) except as set forth on Schedule 3.2(d) and the title search delivered by Buyer to Sellers, the Sellers have no knowledge of any liens, pledges, mortgages, deeds of trust, voting agreements, security interests, encumbrances, or other similar rights of any nature of any third party whatsoever encumbering the Assets, (D) neither Seller has granted any other person or entity an option to purchase or a right of first refusal upon any of the Assets nor are there any agreements or understandings between such Seller and any other person or entity with respect to the disposition of the Seller’s Assets other than this Agreement, (E) each Seller has full power and authority to convey the Assets it owns free and clear of any liens, claims and encumbrances except as set forth above, and (F) upon delivery of the deed and bill of sale to Buyer, Buyer will acquire good and marketable title in record and in fact thereto, free and clear of any liens, claims and encumbrances except as set forth above.

(e) No Consents . Except for those which are Buyer’s responsibility under this Agreement, to the knowledge of each Seller, such Seller has obtained or filed or will obtain or file before the Closing Date each consent, approval, authorization, order, license, certificate, permit, registration, designation, or filing by or with any governmental agency or body necessary for the execution, delivery, and performance of this Agreement by such Seller or the transactions contemplated hereby. Except for those which are Buyer’s responsibility under this Agreement to obtain, to Seller’s knowledge, no person has any right or approval to consent to the execution, delivery or performance of this Agreement by such Seller, or the transactions contemplated hereby which has not been obtained or which will not be obtained prior to the Closing.

(f) Securities Law Matters . (A) In acquiring the Units and engaging in this transaction, except as otherwise set forth in Section 3.1 of this Agreement, neither Seller nor any shareholder of the Company or partner of the Partnership is relying upon any representations, written or oral, made to it by the Buyer, or any of its partners, officers, employees, or agents that are not contained herein. Sellers are aware of the risks involved in investing in the Units and in the shares of common stock (“Common Stock”) of the REIT, issuable upon redemption of such Units. Sellers have had an opportunity to ask questions of, and to receive answers from, the Buyer or a person or persons authorized to act on its behalf,

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concerning the terms and conditions of this investment and the financial condition, affairs, and business of the Buyer and the REIT. Sellers confirm that all documents, records, and information pertaining to its investment in the Buyer and the REIT that have been requested by them, including a complete copy of the form of the Partnership Agreement, have been made available or delivered to them prior to the date hereof. Sellers have reviewed and approved the form of the Partnership Agreement attached hereto as Exhibit A.

(B) Each Seller and each shareholder of the Company and each partner of the Partnership thereof understands that neither the Units nor the shares of Common Stock issuable upon redemption of the Units have been registered under the Securities Act or any state securities acts and are instead being offered and sold in reliance on an exemption from such registration requirements. The Units issuable to Sellers are being acquired solely by them for their own respective accounts, for investment, and are not being acquired with a view to, or for resale in connection with, any distribution, subdivision, or fractionalization thereof, in violation of any securities laws, and neither Seller has any present intention to enter into any contract, undertaking, agreement, or arrangement with respect to any such resale or distribution in violation of any securities laws; provided, however, that, at or following Closing, Seller may distribute the Units to its shareholders or partners, as applicable, that (1) have represented and warranted to the Buyer in writing that, as of the time of such distribution, such shareholder is an accredited investor as that term is defined in Rule 501 of Regulation D under the Securities Act, and (2) have executed the Partnership Agreement as limited partners. Seller understands that any certificates evidencing the Units will contain appropriate legends reflecting the requirement that the Units not be resold by Seller without registration under all applicable securities laws or the availability of an exemption from such registration and that the Partnership Agreement will restrict transfer of the Units.

(g) Accredited Investor . Each Seller is an accredited investor as that term is defined in Rule 501 of Regulation D under the Securities Act.

(h) Tax Matters . Each Seller represents and warrants that it has obtained from its own counsel advice regarding the tax consequences of (i) the transfer of such Seller’s Assets to the Buyer and the receipt of Units as consideration therefor, (ii) such Seller’s admission as a limited partner of the Buyer, and (iii) any other transaction contemplated by this Agreement. Each Seller further represents and warrants that it has not relied on the Buyer or the Buyer’s representatives or counsel for such tax advice.

(i) Bankruptcy with respect to Seller . No Act of Bankruptcy has occurred with respect to the Sellers. As used herein, “Act of Bankruptcy” shall mean if a party hereto or any shareholder or director thereof shall (A) apply for or consent to the appointment of, or the taking of possession by, a receiver, custodian, trustee or liquidator of itself or of all or a substantial part of its property, (B) admit in writing its inability to pay its debts as they become due, (C) make a general assignment for the benefit of its creditors, (D) file a voluntary petition

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or commence a voluntary case or proceeding under the Federal Bankruptcy Code (as now or hereafter in effect), (E) be adjudicated bankrupt or insolvent, (F) file a petition seeking to take advantage of any other law relating to bankruptcy, insolvency, reorganization, receivership, dissolution, winding-up or composition or adjustment of debts, (G) fail to controvert in a timely and appropriate manner, or acquiesce in writing to, any petition filed against it in an involuntary case or proceeding under the Federal Bankruptcy Code (as now or hereafter in effect), or (H) take any entity action for the purpose of effecting any of the foregoing.

(j) Brokers . The Seller has not engaged the services of, any real estate agent, broker, finder or any other person or entity for any brokerage or finder’s fee, commission or other amount with respect to the transactions described herein on account of any action by the Seller. The Seller hereby agrees to indemnify and hold the Buyer and its employees, directors, members, partners, affiliates and agents harmless against any claims, liabilities, damages or expenses arising out of a breach of the foregoing. This indemnification shall survive Closing or any termination of this Agreement.

(k) Leases . Schedule 3.2(k) attached hereto is a true, correct and complete schedule of all ground leases, restaurant leases, telecommunications leases, subleases and other leases and other rights of occupancy in effect with respect to the Hotel and the Property of which either Seller is a party (collectively, the “Leases”) except hotel guest room licenses. Except as set forth on Schedule 3.2(k), there are no other leases, subleases, tenancies or other rights of occupancy in effect with respect to the Hotel or the Property of which either Seller is a party.

(l) Insurance . The Sellers currently maintain or cause to be maintained all of the public liability, casualty and other insurance coverage with respect to the Hotel and the Property as is currently in effect. All such insurance coverage shall be maintained in full force and effect through the IPO Closing and all premiums due and payable thereunder have been, and shall be, fully paid when due.

(m) Personal Property . The Personal Property consists of all equipment, fixtures and personal property located at the Hotel all of which is owned by the Sellers free and clear of liens, claims and encumbrances, except as otherwise set forth herein.

(n) [Intentionally Omitted.]

(o) Compliance With Laws . To the knowledge of the Seller, Sellers possess such certificates, approvals, licenses, authorities or permits issued by the appropriate local, state or federal agencies or bodies necessary to conduct the business to be conducted by it, and Sellers have not received any written notice of proceedings relating to the revocation or modification of any such certificate, approval, license, authority or permit which, singly or in the aggregate, if the subject of an unfavorable decision, ruling, or finding, would materially and

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adversely affect the condition, financial or otherwise, or the earnings, business affairs or business prospects of the Property or the Hotel. The Sellers have not received any written or other notice of any violation of any applicable zoning, building, fire, health or safety code, rule, regulation or ordinance, or of any employment, or other regulatory law, order, regulation or other requirement, including without limitation the Americans With Disabilities Act (“ADA”) or any restrictive covenants or other easements, encumbrances or agreements, relating to the Property or the Hotel, which remains uncured.

(p) Condemnation . Sellers have received no notice of a pending or to the Seller’s knowledge threatened condemnation or eminent domain proceedings, or negotiations for purchase in lieu of condemnation, which affect or would affect any portion of or all of the Property or any improvements thereon.

(q) No Contracts . No agreements, undertakings or contracts affecting the Hotel or the Property, written or oral, of which Seller is a party, will be in existence as of the Closing, except as set forth on Schedule 3.2(q) attached hereto, and true and correct copies of such contracts have been delivered or made available to Buyer. With respect to any such contracts set forth on Schedule 3.2(q), each such contract is valid and binding on the Sellers, and is in full force and effect in all material respects. To the knowledge of Seller, no party to any such contract has breached or defaulted under the terms of such contract, except for such breaches or defaults that would not, individually or in the aggregate, have a material adverse effect on the business or operations of the Hotel or the Property.

3.3 Limitations on Representations . (a) If before the Closing either party acquires knowledge of any condition which constitutes a material change in any of the representations and warranties set forth in Section 3.2 (c), (e), (k), (l), (m), (o), (p) and (q) (the “Operational Representations”), such party shall promptly notify the other party of such condition. If Seller is not able to cure any such condition prior to the Closing Date, then, provided that such condition was not the result of Seller’s willful misrepresentation or willful act, Buyer’s exclusive remedy shall be the termination of this Agreement, by delivering written notice of such termination to Seller within ten (10) days after the date that Seller notifies Buyer that Seller is unable to cure such condition. Upon such termination, except as expressly provided herein, this Agreement and all rights and obligations of the respective parties hereunder shall be null and void. If Buyer fails to terminate this Agreement within such ten (10) day period, Buyer shall be deemed to waive its right of termination with respect to any such condition, and such condition shall be incorporated and become part of the applicable representation or warranty as of the Closing Date so as to make same a true statement.

(b) Neither Buyer nor any party claiming through Buyer, including its officers, directors, shareholders, members, employees, agents, lenders or consultants, shall have any recourse, claim, remedy or right against Seller or any members or partners of Seller and their respective officers, directors, employees and agents (collectively, the “ Seller’s

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Related Parties ”), at law or in equity, to assert or maintain any action for damages, direct, consequential or otherwise, or any other remedy available at law or in equity, as a result of any of the Operational Representations of Seller being untrue, inaccurate or misleading if Buyer had actual knowledge or is deemed to know under the circumstances set forth in the next succeeding sentence that such representation or warranty was untrue, inaccurate or misleading at the time of the Closing, and Buyer closed title to the Assets notwithstanding same provided, however, that Buyer’s actual or deemed knowledge relating to an Operational Representation shall not limit or preclude Buyer’s right to terminate this Agreement or to decline to proceed with Closing in the event that Seller’s representations and warranties contained herein are not accurate as of the Closing Date. Buyer shall conclusively be deemed to have known that such representation or warranty was untrue, inaccurate or misleading if Buyer or its directors, officers or employees had actual knowledge of information, or had in their possession documents, reports, studies or other materials which contain information reasonably discernible by a review thereof that makes such representation or warranty untrue, inaccurate or misleading at the time the representation and warranty was made. The provisions of this Section 3.3(b) shall survive the Closing.

(c) BUYER ACKNOWLEDGES AND AGREES THAT, EXCEPT AS EXPRESSLY SET FORTH IN THIS AGREEMENT, NEITHER SELLER, NOR ANY AGENT OR REPRESENTATIVE OF SELLER HAS MADE, AND SELLER IS NOT LIABLE OR RESPONSIBLE FOR OR BOUND IN ANY MANNER BY, ANY REPRESENTATIONS, WARRANTIES, COVENANTS, AGREEMENTS, OBLIGATIONS, GUARANTEES, STATEMENTS, INFORMATION OR INDUCEMENTS PERTAINING TO THE ASSETS OR ANY PART THEREOF, TITLE TO THE ASSETS, THE PHYSICAL CONDITION THEREOF, THE FITNESS AND QUALITY THEREOF, THE VALUE AND PROFITABILITY THEREOF, OR ANY OTHER MATTER OR THING WHATSOEVER WITH RESPECT THERETO. WITHOUT LIMITING THE FOREGOING, BUYER ACKNOWLEDGES AND AGREES THAT, EXCEPT AS EXPRESSLY SET FORTH IN THIS AGREEMENT, NEITHER SELLER NOR ANY MEMBER, OFFICER, EMPLOYEE, AGENT OR REPRESENTATIVE OF SELLER IS LIABLE OR RESPONSIBLE FOR OR BOUND IN ANY MANNER BY (AND BUYER HAS NOT RELIED UPON) ANY VERBAL OR WRITTEN REPRESENTATIONS, WARRANTIES, COVENANTS, AGREEMENTS, OBLIGATIONS, GUARANTEES, STATEMENTS, INFORMATION OR INDUCEMENTS PERTAINING TO THE ASSETS OR ANY PART THEREOF, AND ANY OTHER INFORMATION RESPECTING SAME FURNISHED BY OR OBTAINED FROM SELLER OR ANY AGENT OR REPRESENTATIVE OF SELLER.

(d) Buyer acknowledges that no facts or circumstances known by the current property manager of the Assets shall be deemed to be known by Seller in making any representation or warranty hereunder unless Seller also has actual knowledge of such facts or circumstances.

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ARTICLE IV

COVENANTS OF SELLERS

4.1 Access and Investigation . Between the date of this Agreement and the Closing Date and upon reasonable advance notice from Buyer, Sellers will (a) afford Buyer and its representatives and prospective lenders and their representatives full and free access to the personnel, properties (including subsurface testing), contracts, books and records, and other documents and data of Sellers relating to the Assets, (b) furnish such persons with copies of all such contracts, books and records, and other documents and data relating to the business as Buyer may reasonably request, and (c) furnish such persons with such additional financial, operating and other data and information relating to the business as Buyer may reasonably request. Buyer shall hold and save Seller harmless from and against any and all direct loss, cost, damage, injury or expense arising out of or in any way related to the exercise of this right of entry and caused by Buyer, its agents, employees and consultants. Prior to any entry by Buyer’s consultants, or any entry by Buyer for the purpose of conducting tests or studies, Buyer shall furnish to Seller evidence that Buyer or the consultant entering the Property has procured comprehensive liability insurance from an insurer authorized to do business in the Commonwealth of Pennsylvania which is reasonably acceptable to Seller protecting Seller from claims for bodily injury or death resulting from Buyer’s exercise of its right of entry in single limit amount of not less than $1,000,000. Such insurance shall name Sellers as an additional insured and shall provide that at least thirty (30) days’ notice of termination, cancellation, or lapse of coverage shall be given to Seller. The indemnification provision contained in this Section 4.1 shall survive the termination of this Agreement and/or the Closing.

4.2 Operation of the Business . Between the date of this Agreement and the Closing Date, Sellers will (a) conduct the business of the Hotel only in the ordinary course of business, (b) confer with Buyer or cause its asset manager to confer with Buyer concerning operational matters of a material nature, (c) otherwise report or cause the asset manager to report periodically to Buyer concerning the status, operations and finances of the business and (d) not enter into any agreement affecting the Property without Buyer’s prior written consent.

4.3 Negative Covenant . Except as otherwise expressly permitted by this Agreement, between the date of this Agreement and the Closing Date, the Sellers will not (a) make any modifications to any material contract, (b) enter into any compromise or settlement of any pending or threatened proceeding relating to the business of the Hotel or for which the Sellers have any liability or (c) remove any equipment, except for equipment that becomes obsolete or unusable which may be disposed of or replaced in the ordinary course of business.

4.4 Required Approvals . As promptly as practicable after the date of this Agreement, the Sellers will make all filings that are required by law from Sellers to

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consummate the transactions contemplated by this Agreement, other than those the Buyer has agreed to obtain hereunder. Between the date of this Agreement and the Closing Date, the Sellers will cooperate with Buyer with respect to all filings, consents, approvals, licenses and permits that Buyer makes or seeks to obtain in connection with the contemplated transactions.

4.5 Notification . Between the date of this Agreement and the Closing Date, the Sellers will promptly notify Buyer in writing if any Seller becomes aware of (a) any fact or condition that causes or constitutes a breach of any of Sellers’ representations and warranties as of the date of this Agreement, (b) any material development known to Seller affecting the Hotel or Property and the operations and results of operations related to the Hotel or Property; or (c) any material development known to Seller affecting the ability of such party to consummate the transactions contemplated by this Agreement. No disclosure by any party pursuant to this Section, however, shall be deemed to amend or supplement any Schedule or to prevent or cure any misrepresentation, breach of warranty or breach of covenant, except as otherwise set forth herein.

4.6 No Negotiation . The Sellers will, and will cause each of their representatives to, immediately discontinue any negotiations or discussions with any person (other than Buyer) relating to any business combination transaction involving the Hotel and the Property, including the sale of any of the shares or partnership interests of, any merger or consolidation, or the sale of any of the assets of the Hotel (other than inventory in the ordinary course of business). Until such time, if any, as this Agreement is terminated pursuant to Article VIII, Sellers will not, and will cause each of their representatives not to, directly or indirectly, solicit, initiate, encourage or entertain any inquiries or proposals from, discuss or negotiate with, provide any non-public information to, or consider the merits of any inquiries or proposals from, any person (other than Buyer) relating to any such transaction involving the Hotel or Property. The Sellers will immediately notify Buyer regarding any contact between the Sellers or their respective representatives and any other person regarding any such transaction or any related inquiry.

4.7 [Intentionally Omitted.]

4.8 Damage or Destruction of Assets . Between the Date of this Agreement and the Closing Date, Sellers shall maintain all insurance coverage presently in effect with regard to the Property and any improvements thereon, including, but not limited to, the Hotel. In the event of destruction or material damage, at or before the moment of Closing, of any of the assets of the Hotel or Property, then at Buyer’s election, Buyer will be entitled to receive the insurance proceeds, if any, payable in respect of such damaged or destroyed property, in lieu of or together with such properties, in which event the Purchase Price shall remain the same, or Buyer may terminate this Agreement. The Closing may be delayed by such time as is reasonably necessary to determine whether such assets, properties and rights are destroyed, materially damaged, or substantially impaired.

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4.9 PIP. Subject to Section 4.9 hereof, Sellers shall use good faith efforts to implement the Product Improvement Plan agreed to with the Hotel’s licensor, but Sellers shall not be obligated to incur any costs and expenses in connection therewith unless such costs and expenses are required for Sellers to maintain the license agreement with Hilton. All costs and expenses incurred by Sellers in connection therewith shall be paid by Buyer to Sellers on the Closing Date, together with any bank fees (if such loan is from a third party bank) and interest thereon from the date that such expenses are incurred until the Closing Date at a rate equal to (i) actual interest rate paid by Sellers in connection with any such sums that are borrowed from third party lenders, or (ii) the rate, not to exceed, in any event LIBOR plus 7% per annum in connection with any sums that are borrowed from affiliates of the Seller.

4.10 Hilton License . The Sellers shall maintain the effectiveness of the Hilton License Agreement (and, upon request of Buyer, execute an extension or new ten year license agreement with Hilton Inns prior to the expiration of the existing Hilton license agreement) and refrain from taking action which could, with the passage of time or otherwise, materially and adversely affect Sellers’ rights under said license agreement and their ability to assign same to Buyer. Notwithstanding the foregoing, Sellers shall have the right to negotiate a license agreement with another hotel chain to replace the license from Hilton, provided that Sellers shall not enter into a license with another chain without the prior written consent of Buyer, which shall not be unreasonably withheld.

ARTICLE V

COVENANTS OF BUYER

5.1 Required Approvals . As promptly as practicable after the date of this Agreement, Buyer will make all filings and pursue all consents, approvals, permits and licenses required by law or from third parties or governmental authorities to make to consummate the contemplated transactions. Between the date of this Agreement and the Closing Date, Buyer will cooperate with Sellers with respect to all filings, licenses, consents, approvals and permits that Sellers make in connection with the contemplated transactions.

5.2 Best Efforts . Buyer will use its best efforts to cause the conditions in Article VII to be satisfied; provided, however, that Buyer will not be required to make any material change to its business, dispose of any material asset, expend material funds (except as otherwise set forth in this Agreement), incur any material burden or take actions that would result in a material adverse change in the benefits to Buyer of this Agreement and the contemplated transactions.

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5.3 Notification . Between the date of this Agreement and the Closing Date, the Buyer will promptly notify Seller in writing if Buyer becomes aware of any fact or condition that causes or constitutes a breach of any of Buyer’s representations and warranties as of the date of this Agreement. No disclosure by any party pursuant to this Section, however, shall be deemed to amend or supplement any Schedule or to prevent or cure any misrepresentation, breach of warranty or breach of covenant.

5.4. Sponsorship . Buyer agrees that Sellers shall not be named a “sponsor” on any document, whether internal or external, issued by Buyer in connection with the issuance of the Units or any shares in the REIT, and Buyer shall revise any documents that currently exist to remove any reference to Sellers as “sponsor” thereunder. The provisions of this Paragraph 5.4 shall survive the Closing.

5.5 Covenant Not to Sue Seller . Buyer, by paying the Purchase Price on the Closing Date, agrees that it will not commence any proceeding against Seller or the Seller’s Related Parties for any claims of liability against Seller or any of the Seller’s Related Parties attributable to the condition of the Property, including, without limitation, claims or causes of action under any federal, state, county or local law, statute, judgment, order, regulation or requirement, or any common law, relating to environmental contamination of the Property, it being understood that Buyer is relying on its own knowledge and investigations with respect to the Property. The foregoing limitation on Buyer’s remedies shall not be applicable to any action brought by Buyer (a) with respect to a Seller Encumbrance or a Seller Defect; (b) to enforce any obligation by Seller to indemnify Buyer pursuant to Section 2.7; or (c) to enforce a misrepresentation by Seller pursuant to Section 3.2 brought during the period that such representation survives the Closing, subject to Section 3.3. The provisions of this Section 5.5 shall survive the Closing.

ARTICLE VI

CONDITIONS PRECEDENT TO BUYER’S OBLIGATION TO CLOSE

Buyer’s obligation to purchase the Assets and to take the other actions required to be taken by Buyer at the Closing is subject to the satisfaction, on or before the Closing Date, of each of the following conditions (any of which may be waived by Buyer, in whole or in part):

6.1 Accuracy of Representations . (a) All the Sellers’ representations and warranties in this Agreement (considered both collectively and individually) must have been accurate as of the date of this Agreement, and must be accurate as of the Closing Date as if then made.

6.2 Performance . (a) All of the covenants and obligations that any Seller is required to perform or to comply with under this Agreement on or before the Closing Date (considered both collectively and individually) must have been duly performed and complied with in all material respects.

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6.3 Consents . Each of the governmental authorizations, licenses, certificates and consents that is required to be obtained as a condition to the Closing must have been obtained and must be in full force and effect.

6.4 Additional Documents . Seller shall have caused the documents and instruments required by Section 2.2 and the following documents to be delivered to Buyer:

(a) if requested by Buyer, any Consents or other instruments that may be required to permit Buyer’s qualification under the Hotel’s name in each jurisdiction in which such entity is licensed or qualified to do business as a foreign corporation; and

6.5 No Proceedings . Since the date of this Agreement, there must not have been commenced or threatened against Buyer, or against any related person of Buyer, any proceeding (a) involving any challenge to, or seeking damages or other relief in connection with, any of the contemplated transactions, or (b) that may have the effect of preventing, delaying, making illegal or otherwise interfering with any of the contemplated transactions.

6.6 No Prohibition . Neither the consummation nor the performance of any of the contemplated transactions will, directly or indirectly (with or without notice or lapse of time), contravene, or cause Buyer or any related person of Buyer to suffer any Adverse Consequence (as defined below) under (a) any applicable law, order or governmental authorization, or (b) any law or order that has been published, introduced or otherwise proposed by or before any governmental body.

6.7. Material Adverse Change . There shall have been no material adverse change (or changes which in the aggregate are materially adverse) since the date hereof in the financial position, results of operations, properties, business, or prospects of the Hotel, taken as a whole, whether by reason of change in government regulation or action or otherwise including, but not limited to any change in law, ordinance, zoning, or regulation or any decision of any governmental authority which would materially and adversely affect Buyer’s operation or development of the Hotel.

6.8 Bankruptcy . The Sellers shall have not been the subject of a petition for reorganization or liquidation under the Federal bankruptcy laws, or under state or foreign insolvency laws, nor shall an assignment for the benefit of any of the Seller’s creditors or any similar protective proceeding or act or event of bankruptcy have occurred.

6.9 Third Party Consents . All third party consents required to consummate the transaction have been obtained.

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6.10 Completion of IPO . The IPO shall have been completed.

6.11 Consent of Franchisor . Buyer shall have obtained from the Franchisor of the Hotel consent to the transaction contemplated herein and the assignment and assumption of the Hilton License Agreement on terms and conditions that are acceptable to Buyer in its sole discretion.

6.12 Survey . Provided that Buyer has used all reasonable diligence to obtain such survey, Buyer shall have obtained, at its own cost and expense, a current survey of the Property to be certified to Buyer and its title insurer and which shall be acceptable to both, completed in accordance with ALTA standards and which shall set forth at least:

(a) the legal description of the parcels comprising the Property, covenants, restrictions of record, all recorded easements and rights of way by endorsement on the Survey by the recording date of the instruments creating same and the dimensions and total area of the Property;

(b) interior lot lines, if any, dimensions and locations of the improvements, access to public roads and the location of adjoining streets; and

6.13 Affidavit . Sellers shall have completed, executed and delivered a non-foreign status affidavit under §1445 of the Individual Revenue Code.

ARTICLE VII

CONDITIONS PRECEDENT TO SELLERS’ OBLIGATION TO CLOSE

The Sellers’ obligation to sell the Assets and to take the other actions required to be taken by them at the Closing is subject to the satisfaction, on or before the Closing Date, of each of the following conditions (any of which may be waived by any Seller), in whole or in part):

7.1 Accuracy Of Representations . All of Buyer’s representations and warranties in this Agreement (considered both collectively and individually) must have been accurate in all material respects as of the date of this Agreement and must be accurate in all material respects as of the Closing Date as if then made.

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7.2. Buyer’s Performance . All of the covenants and obligations that Buyer is required to perform or to comply with under this Agreement on or before the Closing Date (considered both collectively and individually) must have been performed and complied with in all material respects.

7.3. Consents . Each of the governmental authorizations and consents that is required to be obtained as a condition to the Closing must have been obtained and must be in full force and effect.

7.4. No Prohibition . There must not be in effect any law or order that prohibits the consummation of the contemplated transactions.

7.5 Completion of IPO . The IPO shall have been completed.

7.6 Loan Repayment . Buyer shall have further paid off the mortgage loan in favor of Midland Loan Services and shall have assumed any equipment leases.

7.7 Consent of Franchisor . Buyer shall have obtained from the Franchisor of the Hotel consent to the transaction contemplated herein, the assignment and assumption of the Hilton License Agreement and the release of Sellers from any obligations thereunder on terms and conditions that are acceptable to Seller in their sole discretion.

7.8 Third Party Consents . All third party consents required to consummate the transaction have been obtained.

7.9 REIT . Buyer shall have delivered to Seller an opinion of counsel reasonably acceptable to Seller which confirms that upon completion of the IPO and the transactions contemplated by this Agreement and based on certain assumptions, the REIT shall qualify for treatment as a real estate investment trust for Federal income tax purposes.

ARTICLE VIII

TERMINATION

8.1 Termination Events . Subject to Section 8.2, this Agreement may, by notice given before or at the Closing, be terminated:

(a) by Buyer at any time if the REIT does not go forward with the IPO;

(b) by the Sellers if Buyer has committed a material breach of any provision of this Agreement and Sellers have not waived such breach;

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(c) by the Buyer if any Seller has committed a material breach of any provision of this Agreement and Buyer has not waived such breach;

(d) by the Sellers if the satisfaction of any condition to Seller’s obligation to close title in Article VII is or becomes impossible (other than through the failure of any Seller to comply with its obligations under this Agreement) and the Seller has not waived such condition;

(e) by the Buyer if the satisfaction of any condition to Buyer’s obligation to close title in Article VII is or becomes impossible (other than through the failure of Buyer to comply with its obligations under this Agreement) and the Buyer has not waived such condition; and

(f) by Sellers if the Closing has not occurred (other than through the default by Seller under this Agreement) on or before March 31, 2005.

8.2. Effect Of Termination . Each Party’s right of termination under Section 8.1 is in addition to any other rights it may have under this Agreement or otherwise, and the exercise of such right of termination will not be an election of remedies. If this Agreement is terminated by any party because of the breach of the Agreement by the other party, such party’s right to pursue its remedies under this Agreement will survive such termination unimpaired.

ARTICLE IX

POST CLOSING REMEDIES

9.1 Survival; Knowledge; Waiver . All representations and warranties and those covenants and obligations in this Agreement that expressly survive the Closing pursuant to their terms will survive the Closing and the consummation of the contemplated transactions for a period of five years, subject to the limitations set forth in this Article.

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9.2 Indemnification By Sellers . The Sellers, jointly and severally, hereby indemnify and agree to hold harmless Buyer and its representatives, equity owners, controlling persons and affiliates (collectively, the “Buyer Indemnitees”) against, and will pay to the Buyer Indemnitees the monetary value of, any liability, loss, damage (including incidental and consequential damages), claim, cost, deficiency, diminution of value, or expense (including costs of investigation and defense, penalties and reasonable legal fees and costs), whether or not involving a third-party claim (“Adverse Consequences”), arising, directly or indirectly, from or in connection with:

(a) subject to Section 3.3, any breach of any representation or warranty made by any Seller in this Agreement; and

(b) any liabilities of Seller relating to the Operating Agreements that accrued prior to the Closing Date other than those expressly assumed by Buyer.

(d) any Seller Encumbrances or Seller Defects pursuant to Section 2.6;

(e) any indemnification obligation on the part of Seller arising under Section 2.7; and

(f) any breach by Seller of a covenant or obligation that survives the Closing.

For purposes of this Section, any Seller, as the case may be, will be deemed to have breached its representations and warranties in this Agreement if any third party alleges facts that, if true, would mean such Seller has breached any such representation or warranty.

9.3 Indemnification By Buyer . Buyer will indemnify and hold harmless the Sellers, and will pay to the Sellers the monetary value of any Adverse Consequences arising, directly or indirectly, from or in connection with:

(a) any breach of any representation or warranty made by Buyer in this Agreement; and

(b) any liability or obligation arising from or in connection with the operation of the Hotel or the Property after the Closing or otherwise assumed by Buyer hereunder;

(d) any breach by Buyer of a covenant or obligation that survives the Closing.

For purposes of this Section, Buyer will be deemed to have breached its representations and warranties in this Agreement if any third party alleges facts that, if true, would mean Buyer has breached any such representation or warranty.

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9.4 Time Limitations . (a) If the Closing occurs, the Sellers will have no liability (for indemnification or otherwise) for breach of (i) a covenant or obligation to be performed or complied with before the Closing Date or (ii) an Operational Representation unless on or before the first anniversary of the Closing Date, Buyer notifies the Seller of a claim specifying the factual basis of that claim in reasonable detail if then known by Buyer. A claim based upon any covenant that survives the Closing Date or any representation or warranty other than an Operational Representation may be made at any time.

(b) If the Closing occurs, Buyer will have no liability (for indemnification or otherwise) for breach of a covenant or obligation to be performed or complied with before the Closing Date unless on or before the first anniversary of the Closing Date, the Seller notifies Buyer of a claim specifying the factual basis of that claim in reasonable detail if then known by them. A claim based upon any covenant that survives the Closing Date or a any representation or warranty may be made at any time.

9.5 Limitations On Amount – The Company And Sellers . The Sellers will have no liability (for indemnification or otherwise) with respect to the matters governed by Section 9.2(a), or, to the extent relating to any failure to perform or comply before the Closing Date, Section 9.2(f), until the total monetary value of all Adverse Consequences with respect to such matters exceeds Fifty Thousand Dollars ($50,000.00) in which event Buyer may assert its right to indemnification hereunder for the full amount of Adverse Consequences. Notwithstanding the foregoing, this Section will not apply to (a) material breach of any of the Sellers’ representations and warranties of which breach any Seller had knowledge before the date on which such representation and warranty was made, or (b) any intentional breach by any Seller of any covenant or obligation; Sellers will be jointly and severally liable for all Adverse Consequences with respect to such breaches.

9.6 Limitations On Amount—Buyer . Buyer will have no liability (for indemnification or otherwise) with respect to the matters governed by Section 9.3(a), or to the extent relating to any failure to perform or comply before the Closing Date, Section 9.3(b) until the total monetary value of all Adverse Consequences with respect to such matters exceeds Fifty Thousand Dollars ($50,000.00) in which event the Sellers may assert their right to indemnification hereunder for the full amount of Adverse Consequences. Notwithstanding the foregoing, this Section will not apply to (a) Buyer’s material breach of any of its representations and warranties of which breach Buyer had knowledge before the date on which it made such representation and warranty, or (b) Buyer’s intentional breach of any covenant or obligation; Buyer will be liable for all Adverse Consequences with respect to such breaches.

9.7 Procedure For Indemnification—Defense Of Third-Party Claims . (a) Promptly after receipt by a person entitled to indemnity under Section 9.2 or 9.3 (an “Indemnified Person”) of notice of the assertion of a third-party claim against it, the Indemnified Person will, if a claim is to be made against a Person obligated to indemnify under such Section (an

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“Indemnifying Person”), give notice to the Indemnifying Person of the assertion of such claim. An Indemnified Person’s failure to notify an Indemnifying Person will not relieve the Indemnifying Person of any liability that it may have to the Indemnified Person, except to the extent that the Indemnifying Person demonstrates that the resolution of such claim is prejudiced by the Indemnified Person’s failure to give such notice.

(b) If any claim referred to in Section 9.7(a) is brought against an Indemnified Person by means of a proceeding and the Indemnified Person gives notice to the Indemnifying Person of the commencement of such proceeding, the Indemnifying Person will be entitled to participate in such proceeding and, to the extent that it wishes, to assume the defense of such proceeding with counsel satisfactory to the Indemnified Person (unless (i) the Indemnifying Person is also a party to such proceeding and the Indemnified Person determines in good faith that joint representation would be inappropriate or (ii) the Indemnifying Person fails to provide reasonable assurance to the Indemnified Person of its financial capacity to defend such proceeding and provide indemnification with respect to such proceeding). After notice from the Indemnifying Person to the Indemnified Person of its election to assume the defense of such proceeding, the Indemnifying Person will not, as long as it diligently conducts such defense, be liable to the Indemnified Person under this Article for any fees of other counsel or any other expenses with respect to the defense of such proceeding, in each case subsequently incurred by the Indemnified Person in connection with the defense of such proceeding, other than reasonable costs of investigation. If the Indemnifying Person assumes the defense of a proceeding, (i) it will be conclusively established for purposes of this Agreement that the claims made in that proceeding are within the scope of and subject to indemnification, (ii) no compromise or settlement of such claims may be effected by the Indemnifying Person without the Indemnified Person’s consent unless (A) there is no finding or admission of any violation of laws or any violation of the rights of any person and no effect on any other claims that may be made against the Indemnified Person, and (B) the sole relief provided is monetary damages that are paid in full by the Indemnifying Person, and (iii) the Indemnified Person will have no liability with respect to any compromise or settlement of such claims effected without its consent.

(c) If notice is given to an Indemnifying Person of the commencement of any proceeding and the Indemnifying Person does not, within ten days after the Indemnified Person’s notice is given, give notice to the Indemnified Person of its election to assume the defense of such proceeding, the Indemnified Person will be entitled to assume the defense of such proceeding and the Indemnifying Person will be bound by any determination made in such proceeding or any compromise or settlement effected by the Indemnified Person.

(d) Notwithstanding the foregoing, if an Indemnified Person determines in good faith that there is a reasonable probability that a proceeding may adversely affect it or its affiliates other than as a result of monetary damages for which it would be entitled to indemnification under this Agreement, the Indemnified Person may, by notice to the

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Indemnifying Person, assume the exclusive right to defend, compromise or settle such proceeding, but the Indemnifying Person will not be bound by any determination of a proceeding so defended or any compromise or settlement effected without its consent (which may not be unreasonably withheld).

(e) The Sellers and Buyer consent to the non-exclusive jurisdiction of any court in which a proceeding is brought against any Buyer Indemnitee or Seller Indemnitee for purposes of any claim that a Buyer Indemnitee or Seller Indemnitee may have under this Agreement with respect to such proceeding or the matters alleged therein. The Sellers and Buyers agree that process may be served on the Sellers or Buyer with respect to such a claim anywhere in the world.

9.8 Procedure For Indemnification—Other Claims . A claim for indemnification for any matter not involving a third-party claim may be asserted by notice to the party obligated to indemnify and will be paid promptly after such notice.

9.9 Treatment Of Indemnification Payments . Any indemnification payment made pursuant to this Article will be treated by the parties to the extent permitted under applicable law as an adjustment to the Purchase Price for tax, accounting and all other purposes.

ARTICLE X

MISCELLANEOUS

10.1 Notices . Any notice provided for by this Agreement and any other notice, demand, or communication required hereunder shall be in writing and either delivered in person (including by confirmed facsimile transmission) or sent by hand delivered against receipt or sent by recognized overnight delivery service or by certified or registered mail, postage prepaid, with return receipt requested. All notices shall be addressed as follows:


If to Buyer:		Mr. Andrew M. Sims
		MHI Hotel Services, L.L.C.
		814 Capitol Landing Road
		Williamsburg, VA 23185

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With a copy to:		Thomas J. Egan, Jr., Esquire
		Baker & McKenzie LLP
		815 Connecticut Avenue, NW
		Washington, DC 20006

Notices to Sellers shall be sent to the addresses specified on Schedule 1.3, with a copy to

		Stephen A. Urban, Esq.
		Duane Morris LLP
		744 Broad Street
		Suite 1200
		Newark, NJ 07102

10.2 Entire Agreement; Modifications and Waivers; Cumulative Remedies . This Agreement supersedes any existing letter of intent between the parties hereto, constitutes the entire agreement among the parties hereto and may not be modified or amended except by instrument in writing signed by the parties hereto, and no provisions or conditions may be waived other than by a writing signed by the party waiving such provisions or conditions. No delay or omission in the exercise of any right or remedy accruing to the Seller or the Buyer upon any breach under this Agreement shall impair such right or remedy or be construed as a waiver of any such breach theretofore or thereafter occurring. The waiver by the Seller or the Buyer of any breach of any term, covenant, or condition herein stated shall not be deemed to be a waiver of any other breach, or of a subsequent breach of the same or any other term, covenant, or condition herein contained. All rights, powers, options, or remedies afforded to Seller or the Buyer either hereunder or by law shall be cumulative and not alternative, and the exercise of one right, power, option, or remedy shall not bar other rights, powers, options, or remedies allowed herein or by law, unless expressly provided to the contrary herein.

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be formed in connection with the proposed public offering of an entity that intends to qualify as a real estate investment trust without approval of the Sellers, provided, however, that such assignment does not affect the status of this transaction as a contribution pursuant to Section 721 of the Code and Section 1.9 hereof. This Agreement shall be binding upon, and inure to the benefit of the parties and their respective legal representatives, successors, and permitted assigns.

10.4 Article Headings . Article headings and article and section numbers are inserted herein only as a matter of convenience and in no way define, limit, or prescribe the scope or intent of this Agreement or any part hereof and shall not be considered in interpreting or construing this Agreement.

10.5 Time of Essence . With regard to all dates and time periods set forth or referred to in this Agreement, time is of the essence.

10.6 Governing Law . This Agreement shall be construed and interpreted in accordance with the laws of the Commonwealth of Pennsylvania, without regard to conflicts of laws principles.

10.7 Counterparts . This Agreement may be executed in any number of counterparts and by any party hereto on a separate counterpart, each of which when so executed and delivered shall be deemed an original and all of which taken together shall constitute but one and the same instrument.

10.8 Survival . All representations and warranties contained in this Agreement, and all covenants and agreements contained in the Agreement which contemplate performance after the Closing Date (including, without limitation, those covenants and agreements contained in Section 1.2 hereof) shall survive the Closing.

10.9 Further Acts . In addition to the acts, instruments and agreements recited herein and contemplated to be performed, executed and delivered by the Buyer and the Sellers, each of the Buyer and each Seller shall perform, execute, and deliver or cause to be performed, executed, and delivered at the Closing or after the Closing, any and all further acts, instruments, and agreements and provide such further assurances as the other party hereto may reasonably require to consummate the transaction contemplated hereunder.

10.10 Severability . In case any one or more of the provisions contained in this Agreement shall for any reason be held to be invalid, illegal, or unenforceable in any respect, such invalidity, illegality, or unenforceability shall not affect any other provision hereof, and this Agreement shall be construed as if such invalid, illegal, or unenforceable provision had never been contained herein.

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10.11 Expenses . Except as otherwise expressly provided in this Agreement, each party to this Agreement will bear its respective expenses incurred in connection with the preparation, execution and performance of this Agreement and the contemplated transactions, including all fees and expenses of its representatives. Should a party hereto employ an attorney or attorneys to enforce any of the provisions hereof or to protect its interest in any manner arising under this Agreement, or to recover damages for breach of this Agreement, any non-prevailing party in any action pursued in a court of competent jurisdiction (the finality of which is not legally contested) shall pay to the prevailing party all reasonable costs, damages, and expenses, including reasonable attorneys’ fees, expended or incurred in connection therewith.

10.12 Confidentiality . The Seller acknowledges that the matters relating to the REIT, the initial underwritten public offering of the REIT, this Agreement, and the other documents, terms, conditions and information related thereto (collectively, the “Information”) are confidential in nature. Therefore, each Seller covenants and agrees to keep the Information confidential and will not (except as required by applicable law, regulation or legal process, and only after compliance with the provisions of this Section 10.12), without the Buyer’s prior written consent, disclose any Information in any manner whatsoever; provided, however, that the Information may be revealed only to a Seller’s key employees, legal counsel and financial advisors, each of whom shall be informed of the confidential nature of the Information and shall agree to act in accordance with the terms of this Section 10.12. In the event that a Seller or its key employees, legal counsel or financial advisors (collectively, the “Information Group”) are requested pursuant to, or required by, applicable law, regulation or legal process to disclose any of the Information, the applicable member of the Information Group will notify the Buyer promptly so that it may seek a protective order or other appropriate remedy or, in its sole discretion, waive compliance with the terms of this Section 10.12. In the event that no such protective order or other remedy is obtained before such member of the Information Group is obligated to disclose such information, or that the Buyer waives compliance with the terms of this Section 10.12, the applicable member of the Information Group may furnish only that portion of the Information which it is advised by counsel is legally required and will exercise reasonable efforts to obtain reliable assurance that confidential treatment will be accorded the Information. Each Seller acknowledges that remedies at law may be inadequate to protect the Buyer or the REIT against any actual or threatened breach of this Section 10.12, and, without prejudice to any other rights and remedies otherwise available, each Seller agrees to the granting of injunctive relief in favor of the REIT and/or the Buyer without proof of actual damages. Notwithstanding any other express or implied agreement to the contrary, the parties hereto agree and acknowledge that each of them and each of their employees, representatives, and other agents may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the transaction and all materials of any kind (including opinions or other tax analyses) that are provided to any of them relating to such tax treatment and tax structure, except to the extent that confidentiality is reasonably necessary to comply with U.S. federal or state securities laws. For purposes of this paragraph, the terms “tax treatment” and “tax structure” have the meanings specified in Treasury Regulation section

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1.6011-4(c). Receipt of confidential information of Buyer or any of its affiliates by Sellers constitutes each of Seller’s acknowledgement that it is aware that applicable securities laws may impose restrictions on each of them from purchasing or selling securities of the REIT, and each Seller agrees not to purchase or sell securities of the REIT, or any affiliate of the REIT, in violation of applicable securities laws.

10.13 No Personal Liability . No member, principal, officer, director, employee, attorney, accountant or other agent of Seller or Buyer, including, without limitation, any person who signs this Agreement or any Closing document, shall have any personal liability hereunder. The provisions of this Section 10.13 shall survive the Closing hereunder.

10.14 Venue . Any suit, action, or proceeding between Buyer and Sellers relating to this Agreement, to any document, instrument, or agreement delivered pursuant hereto, referred to herein, or contemplated hereby, or in any other manner arising out of the transaction of which it is a part, shall be commenced and maintained exclusively in a state or federal court of competent subject-matter jurisdiction sitting in the Commonwealth of Pennsylvania. Buyer and Sellers hereby submit themselves unconditionally and irrevocably to the jurisdiction of such courts. Sellers and Buyer further agree that venue shall be in Pennsylvania. Sellers and Buyer irrevocably waive any objection to such jurisdiction or venue including, but not limited to, the objection that any suit, action, or proceeding brought in Pennsylvania has been brought in an inconvenient forum.

[Signatures follow on next page]

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The parties hereto have executed and delivered this Agreement as of the date indicated in the first sentence of this Agreement.


SELLERS:

Elpizo Limited Partnership

By:		/s/ Cheong Kee Soon
Name:		CHEONG KEE SOON
Its:		DIRECTOR

Phileo Land Corporation

By:		/s/ Cheong Kee Soon
Name:		CHEONG KEE SOON
Its:		DIRECTOR

BUYER:

MHI Hospitality LP

By:		/s/ Andrew M Sims
Name:		Andrew M Sims
Its:		CEO and President of the G.P.

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Exhibit 10.10

Laurel

ASSET PURCHASE AGREEMENT

THIS ASSET PURCHASE AGREEMENT (this “Agreement”) is made as of the 19th day of August, 2004 (the “Effective Date”) by and among Accord LLC, a Maryland limited liability company (“Accord”), West Laurel Corporation, a Maryland corporation (“West Laurel” with Accord, the “Sellers” and individually a “Seller”), and MHI Hotels Services, L.L.C., a Delaware limited liability company (the “Buyer”).

RECITALS

A. Accord LLC, a Maryland limited liability company (“Accord”) is the owner of (i) a fee simple interest in certain real property consisting of approximately 338,916 square feet of land located in Laurel, Maryland (the “Property”) and (ii) certain improvements located thereon consisting of a 205 room hotel trading as the Best Western Maryland and other improvements together with all personal property, furniture, fixtures, equipment, durable goods and inventory therein or relating thereto (the “Hotel”); and

B. West Laurel Corporation, a Maryland corporation (“West Laurel”) is the lessee of certain restaurant facilities located in the Hotel (the “Restaurant”) pursuant to the terms of a lease agreement (the “Restaurant Lease”).

AGREEMENT

NOW, THEREFORE, for and in consideration of the mutual covenants herein contained, the parties hereto agree as follows:

ARTICLE I

THE PURCHASE AND SALE

1.1 Agreement to Purchase and Sell . The Sellers agree to sell and transfer to the Buyer, and the Buyer agrees to purchase and accept from Sellers pursuant to the terms and conditions set forth in this Agreement the following assets (the “Purchased Assets”) of Sellers:

A. The Property as further described in Schedule 1.1A and the Hotel and Restaurant improvements located thereon;

B. To the extent assignable, all of Sellers’ rights, title and interest in the Best Western license agreement relating to the Hotel;

C. All of the personal property and equipment owned by Sellers and located in or at the Hotel and the Restaurant and used in connection therewith, including

but not limited to, cleaning equipment, furniture, fixtures, carpets, rugs, draperies, mechanical and electrical equipment, office equipment, china, glassware, silver, cooking utensils, flatware, linens, and uniforms (collectively, the “Personal Property”);

D. To the extent owned by Sellers and relating to or located on or in the Hotel and the Restaurant and transferable by Sellers, the telephone number for the Hotel and the Restaurant, the Hotel and the Restaurant directory listings, surveys, plans and specifications, licenses and permits, contractor and maintenance files, service manuals, notices of compliance with state and federal and all governmental agencies and regulations, estoppel certificates or affidavits, and guaranties and warranties as to Personal Property which pertain to the Hotel and the Restaurant or are used in connection therewith;

E. Inventory at Closing, including without limitation merchandise held for sale and reserve stocks of operating supplies on hand at Closing (“the Inventory”); and

F. To the extent assignable by Sellers, all leases, lease-purchase agreements, warranties, contracts and purchase agreements (the “Operating Agreements”) relating to the maintenance, use or occupancy of the Hotel or the Restaurant.

The assets and property described in paragraphs A through F (the “Assets”) shall be transferred by Sellers to the Buyer free and clear of all liens, claims and encumbrances.

Notwithstanding the foregoing, the transfer of the Assets pursuant to this Agreement shall not include the assumption of any liability related to the Assets or any other liabilities of Sellers except for liabilities relating to the performance of the Operating Agreements following the Closing Date.

1.2 Consideration . In exchange for the sale and transfer by the Sellers of the Purchased Assets to the Buyer, the Buyer agrees, subject to the terms of this Agreement, to pay to the Sellers Eleven Million Nine Hundred Fifty Thousand Dollars ($11,950,000) (the “Purchase Price”). The Purchase Price shall be allocated as follows:


Furniture Fixtures – West Laurel Corp.	$	50,000.00
Leasehold Improvements - West Laurel Corp.		500,000.00
Other Assets sold by West Laurel. Corp (Including Goodwill, inventories etc. and liquor licenses)		1,600,000.00
Furniture, Fixtures and Equipment Sold by Accord LLC		500,000.00
Real Property		9,300,000.00

TOTAL	$	11,950,000.00

The sale of the Purchased Assets shall be contingent upon the purchase of the Purchased Assets from both entities.

A. Upon the execution of the Agreement, the sum of Fifty Thousand Dollars ($50,000.00) (the “Deposit”) will be paid by Buyer to Sellers as a good faith deposit, which Deposit shall be applied to the Purchase Price at Closing (as hereinafter defined). The Deposit shall be held in escrow by Chicago Title Insurance Company as a good faith deposit.

B. Subject to the adjustments specified in Section 1.3 below, the balance of Eleven Million Nine Hundred Thousand Dollars ($11,900,000) shall be paid by Buyer to Sellers at Closing in cash or by wire transfer of funds immediately available to Seller. The amount of cash to be paid to each Seller is set forth in Schedule 1 attached hereto for their respective interests.

1.3 Adjustments, Assumptions and Payments .

A. The sale proceeds shall be subject to adjustment as follows:

(i) Real estate taxes, regular and special assessments, personal property taxes, utilities, water and sewer, rents, and other governmental assessments on the Hotel and the Property shall be prorated between Buyer and Seller on a calendar or fiscal year basis, using the fiscal year of the applicable taxing authority or the billing period for any utility service as the basis for accrual thereof, as of the date of the Closing and be assumed thereafter by Purchaser. The sale proceeds shall be increased or decreased, as the case may be, based on the net adjustments for such prorated amounts.

(ii) The sale proceeds will be increased by an amount equal to all monies in house banks and cash registers. Such house banks and cash drawers will be counted jointly by representatives of Seller and Buyer at 6:00 a.m. on the date of Closing.

(iii) The sale proceeds will be increased by an amount equal to the transient guest ledger balance for all occupied rooms as of 6:00 a.m. on the date of Closing.

(iv) The sale proceeds shall be increased by an amount equal to such prepaid expenses that inure to the benefit of Buyer as Seller and Buyer may reasonably agree.

B. Travel agent commission liabilities incurred prior to the date of the Closing shall be paid by Sellers in cash.

C. All amounts relating to prepaid unapplied room rentals, and all deposits for advance reservations for banquets, or future services shall be delivered to Buyer or credited to Buyer at Closing. Copies of all agreements relating to banquets or future service shall be jointly compiled by representatives of Buyer and Sellers prior to Closing. Buyer will be responsible for performing such agreements (which shall constitute Operating Agreements for purposes of this Agreement) following the Closing.

D. Sellers shall be entitled to all accounts receivable balances originating prior to the date of Closing and due from tenants, guests, and patrons of the Hotel for rents and other customary hotel direct bill charges. Buyer agrees that if any such accounts receivable payments are received by Buyer, they shall be received in trust for Sellers and shall be promptly remitted to Sellers.

E. Accord and West Laurel shall pay all outstanding trade payables as of the date of Closing. In the event any trade payables are unpaid as of the Closing Date because of delays receiving said invoices, Buyer shall forward and Sellers shall immediately pay such invoices.

F. Buyer agrees to pay in cash at Closing the cost of recording all documents including a deed of trust, if any, assignments, financing statements and other collateral documents, all sales taxes on the sale and all of the transfer taxes. Transfer taxes shall include the county and state transfer taxes and state stamp taxes.

1.4 Closing Deliveries . At the Closing:

(a) Accord and West Laurel as applicable will deliver to Buyer:

(i) a special warranty deed conveying good marketable fee simple title to the Property free and clear of any and all deeds of trust, mortgages or other liens or indebtedness, encumbrances, conditions, easements, rights of way, assessments and restrictions except Permitted Encumbrances (as hereinafter defined). Accord shall pay any prepayment fee due its lender at settlement;

(ii) a bill of sale conveying to Buyer the Personal Property and Inventory free and clear of all liens, claims and encumbrances;

(iii) an assignment of each Operating Agreement and assignments by each of the Sellers of the Restaurant Lease to Buyer in form and substance satisfactory to Buyer and its legal counsel and executed by Accord and West Laurel as the case may be;

(iv) such other assignments, certificates of title, transfer tax declarations or certificates, releases by governmental bodies from holdback requirements under any law relating to taxes, documents and other instruments of transfer and conveyance as may reasonably be requested by Buyer, each in form and substance satisfactory to Buyer and its legal counsel and executed by Accord, West Laurel and the Sellers, as the case may be;

(v) [Intentionally Omitted]; and

(vi) evidence of the transfer to Buyer of the license to serve alcoholic beverages at the Hotel and Restaurant; provided that in the event such transfer has not been approved by the governmental authority, Seller agrees to enter into a lease agreement or customary terms and conditions to enable Buyer or its designee to effect continuous uninterrupted alcoholic beverage service at the Hotel and Restaurant until said license transfer is issued and effective.

(b) Buyer will deliver to Seller:

(i) the Purchase Price by wire transfer to an account specified by the Seller in a writing delivered to Buyer at least three business days before the Closing Date.

1.5 Permitted Encumbrances . For purposes of this Agreement the term “Permitted Encumbrances” shall refer to the following:

(i) General real estate taxes consisting of regular and any special assessments for the year in which Closing occurs and subsequent tax years;

(ii) All easements, restrictions, covenant, rights-of-way, encroachments, reservations, agreements, conditions, and other matters affecting all or any portion of the Property, which do not prevent Buyer from operating a first-class hotel;

(iii) All building restrictions and zoning regulations now or hereafter in effect, to the extent adopted by any municipal or other public authority and related to all or any portion of the Property.

ARTICLE II

REPRESENTATIONS AND WARRANTIES

2.1 Representations by Buyer . The Buyer hereby represents and warrants unto the Sellers that the following statements are true, correct, and complete as of the date of this Agreement and will be true, correct, and complete as of the Closing Date:

(a) Organization and Power . The Buyer is duly organized, validly existing, and in good standing under the laws of the State of Delaware, and has full right, power, and authority to enter into this Agreement and to assume and perform all of its obligations under this Agreement; and, the execution and delivery of this Agreement and the performance by the Buyer of its obligations hereunder have been duly authorized by all requisite action of the Buyer and require no further action or approval of the Buyer’s members or of any other individuals or entities is necessary in order to constitute this Agreement as a binding and enforceable obligation of the Buyer. This Agreement constitutes the legal, valid and binding obligation of the Buyer, enforceable against such entity in accordance with its terms. Buyer shall qualify to do business in Maryland prior to Closing.

(b) Noncontravention . Neither the entry into nor the performance of, or compliance with, this Agreement by the Buyer has resulted, or will result, in any

violation of, or default under, or result in the acceleration of, any obligation under the Buyer’s organizational documents, mortgage, indenture, lien agreement, note, contract, permit, judgment, decree, order, restrictive covenant, statute, rule, or regulation applicable to the Buyer.

(c) Litigation . There is no action, suit, or proceeding, pending or known to be threatened, against or affecting the Buyer in any court or before any arbitrator or before any federal, state, municipal, or other governmental department, commission, board, bureau, agency or instrumentality which (i) in any manner raises any question affecting the validity or enforceability of this Agreement, or (ii) could materially and adversely affect the ability of the Buyer to perform its obligations hereunder, or under any document to be delivered pursuant hereto.

(d) Consents . Except as may otherwise be set forth in Schedule 2.1(d) hereof, each consent, approval, authorization, order, license, certificate, permit, registration, designation, or filing by or with any governmental agency or body necessary for the execution, delivery, and performance of this Agreement or the transactions contemplated hereby by the Buyer has been obtained or will be obtained on or before the Closing Date. Buyer shall be responsible for obtaining the consent of the Prince George’s County Liquor Board for the transfer of West Laurel’s license to serve alcoholic beverages.

(e) Brokerage Commission . The Buyer has not engaged the services of any real estate agent, broker, finder or any other person or entity for any brokerage or finder’s fee, commission or other amount with respect to the transactions described herein on account of any action by the Buyer.

2.2 Representations by Sellers . Each Seller, jointly and severally, hereby represents and warrants unto the Buyer that each and every one of the following statements is true, correct and complete as of the date of this Agreement and will be true, correct and complete as of the Closing Date:

(a) Organization and Power . Each of Accord and West Laurel is duly organized, validly existing, and in good standing under the laws of the state of its organization. Each Seller has full right, power, and authority to enter into this Agreement and to assume and perform all of its obligations under this Agreement; and the execution and delivery of this Agreement and the performance by the Sellers of their obligations hereunder have been duly authorized by all requisite action of Sellers and require no further action or approval of Seller’s members or managers or directors or shareholders, as the case may be, or of any other individuals or entities in order to constitute this Agreement as a binding and enforceable obligation of the Seller, except the sale of assets by West Laurel Corporation requires approval of 75% vote of its shareholders which will be provided at settlement. This Agreement constitutes the legal, valid and binding obligation of each Seller, enforceable against such entity in accordance with its terms.

(b) Noncontravention . Neither the entry into nor the performance of, or compliance with, this Agreement by Accord or West Laurel has resulted, or will result, in any violation of, or default under, or result in the acceleration of, any obligation under the their organizational documents, or any regulations, mortgage, indenture, lien agreement, note, contract, permit, judgment, decree, order, restrictive covenant, statute, rule, or regulation applicable to them except a first trust loan on the Property shall be due in full upon such closing of this Agreement.

(c) Litigation . There is no action, suit, or proceeding, pending or known to be threatened, against or affecting Accord or West Laurel in any court or before any arbitrator or before any federal, state, municipal, or other governmental department, commission, board, bureau, agency or instrumentality which (A) in any manner raises any question affecting the validity or enforceability of this Agreement, (B) could materially adversely affect the business, financial position, or results of operations of the Hotel, the Property, Accord or West Laurel, (C) could affect the ability of the Seller to perform its obligations hereunder, or under any document to be delivered pursuant hereto, or (D) could create a lien on the Property or the Hotel.

(d) [Intentionally Omitted.]

(e) Operation of the Hotel . The buildings, plants, structures, and equipment of the Hotel are sold in “as is” condition and after the Closing shall be in substantially the same manner as conducted prior to the Closing.

(f) [Intentionally Omitted.]

(g) [Intentionally Omitted.]

(h) [Intentionally Omitted.]

(i) Financial Statements . (A) Accord and West Laurel each have delivered to Buyer (i) unaudited balance sheets (the “ Balance Sheets ”) of each entity as at December 31, 2003 for each of the years 2001, 2002 and 2003, and the related consolidated statement of income (ii) unaudited balance sheets of each entity as at July 31, 2004 (the “ Interim Balance Sheet ”), and the related unaudited consolidated statement of income. Such financial statements and notes fairly present the consolidated financial conditions of Accord and West Laurel as at the respective dates of and for the periods referred to in such financial statements, subject in the case of interim financial statements to normal recurring year-end adjustments (the effect of which will not, individually or in the aggregate, be materially adverse) and the absence of notes (that, if presented, would not differ materially from those included in the financial statements). The financial statements referred to in this Section reflect the consistent application of accounting principles throughout the periods involved.

(j) Leases . Schedule 2.2(j) attached hereto is a true, correct and complete schedule of all ground leases, restaurant leases, subleases and other rights of

occupancy in effect with respect to the Hotel and the Property (collectively, the “Leases”). Except as set forth on Schedule 2.2(j), there are no other leases, subleases, tenancies or other rights of occupancy in effect with respect to the Hotel or the Property.

(k) Management Agreements . All management, services and similar agreements relating to the Hotel, Restaurant or Property are described on Schedule 2.2(k) attached hereto (collectively, the “Management Agreements”), and all such Management Agreements shall be terminated as of Closing and thereafter shall be void and of no further force and effect and no further amounts will be due any party under such Management Agreements.

(l) Insurance . Accord and West Laurel currently maintain or cause to be maintained all of the public liability, casualty and other insurance coverage with respect to the Hotel as set forth on Schedule 2.2(l) attached hereto. All such insurance coverage shall be maintained in full force and effect through the Closing and all premiums due and payable thereunder have been, and shall be, fully paid when due. Accord and West Laurel maintain in full force and effect insurance policies covering its insurable business risks and liabilities in adequate amounts to provide reasonable protection for the Hotel to operate. No event has occurred that may enable an insurer to rescind any insurance policy. Underwriters have not raised any question concerning the insurability of any aspect of the Hotel, nor has insurance ever been denied for any aspect of the Hotel.

(m) Personal Property . The Personal Property consists of all equipment, fixtures and personal property located at the Hotel and the Restaurant all of which is owned by Accord or West Laurel free and clear of liens, claims and encumbrances. Each item of personal property used in or held for use in connection with, necessary for or related to its business, is in good operating condition and repair, ordinary wear and tear excepted, is free from latent and patent defects and is suitable for immediate use in the ordinary course of business. The Personal Property constitutes all assets necessary for the continued operation of the Hotel after the Closing in the same manner as before the Closing.

(n) No Contracts . Schedule 2.2(n) sets forth all of the agreements, undertakings or contracts (other than leases identified in Schedule 2.2(j)) affecting Accord, West Laurel, the Hotel, the Property and the Restaurant, written or oral, as of the date hereof and the Closing and identifies the Operating Agreements which are those agreements which will be assigned to and assumed by Buyer at the Closing. With respect to any such contracts set forth on Schedule 2.2(n), each such contract is valid and binding on Accord or West Laurel, as the case may be, and is in full force and effect in all material respects. To the best knowledge of Seller, no party to any such contract has breached or defaulted under the terms of such contract, except for such breaches or defaults that would not have a material adverse effect on the business or operations of the Hotel.

(o) Environmental Matters . To the best of Sellers’ knowledge: (A) Each of Accord and West Laurel is, and at all times has been, in full compliance with, and has not been and is not in violation of or liable under, any environmental law. There is no basis for and no pending or threatened order, notice, or communication from (i) any governmental body or private citizen acting in the public interest, or (ii) the current or prior owner or operator of any facilities, of any actual or potential violation or failure to comply with any environmental law, or any actual or threatened obligation to undertake or bear the cost of any environmental, health, and safety liabilities with respect to any of the facilities or any other properties or assets (whether real, personal, or mixed) in which Accord or West Laurel has had an interest, or with respect to any property or facility at or to which hazardous materials were generated, manufactured, refined, transferred, imported, used, or processed by Accord, West Laurel or any other person for whose conduct they are or may be held responsible, or from which hazardous materials have been transported, treated, stored, handled, transferred, disposed, recycled, or received.

(B) There are no pending or, to the knowledge of Accord and West Laurel, threatened claims, encumbrances, or other restrictions of any nature, resulting from any environmental, health and safety liabilities or arising under or pursuant to any environment law, with respect to or affecting the Hotel or Property or any other properties and assets (whether real, personal, or mixed) in which Accord, West Laurel or the Sellers has or had an interest.

(C) There is no basis for any other person for whose conduct they are or may be held responsible, received, any citation, directive, inquiry, notice, order, summons, warning, or other communication that relates to hazardous activity, hazardous materials, or any alleged, actual, or potential violation or failure to comply with any environmental law, or of any alleged, actual, or potential obligation to undertake or bear the cost of any environmental, health, or safety liability with respect to the Property, Hotel, the Restaurant or any other properties or assets (whether real, personal, or mixed) in which Accord or West Laurel had an interest, or with respect to any property or facility to which hazardous materials generated, manufactured, refined, transferred, imported, used, or processed by Accord, West Laurel, or any other person for whose conduct they are or may be held responsible, have been transported, treated, stored, handled, transferred, disposed, recycled, or received.

(D) Neither Accord nor West Laurel, has any environmental, health, or safety liability with respect to the Hotel, the Restaurant, Property or with respect to any other properties and assets (whether real, personal, or mixed) in which Accord, West Laurel or Sellers (or any predecessor) has or had an interested, or at any property geologically or hydrologically adjoining the Hotel, Property or any such other property or assets.

(E) There are no hazardous materials present on or in the environment at the Hotel, Restaurant, Property or at any geologically or hydrologically adjoining property, including any hazardous materials contained in barrels, above or underground storage tanks, landfills, land deposits, dumps, equipment (whether moveable

or fixed) or other containers, either temporary or permanent, and deposited or located in land, water, sumps, or any other part of the Hotel, Property or such adjoining property, or incorporated into any structure therein or thereon. Accord, West Laurel, Sellers, and any other person for whose conduct they are or may b e held responsible, or any persons, has permitted or conducted, or is aware of any hazardous activity conducted with respect to the Hotel, Property or any other properties or assets (whether real, personal, or mixed) in which Accord, West Laurel, or Sellers has or had an interest.

(F) There has been no release or , to the knowledge of Accord, West Laurel and the Sellers, threat of release, of any hazardous materials at or from the Hotel, Property or at any other locations where any hazardous materials were generated, manufactured, refined, transferred, produced, imported, used, or processed from or by the Hotel, Property, or from or by any other properties and assets (whether real, personal, or mixed) in which Accord, West Laurel or any Sellers has or had interest, or any geologically or hydrologically adjoining property, whether by Accord, West Laurel, Sellers or any other person.

(G) Sellers have delivered to Buyer true and complete copies and results of any reports, studies, analyses, tests, or monitoring possessed or initiated by Sellers, Accord or West Laurel pertaining to hazardous materials or hazardous activities in, on, or under the Hotel and Property, or concerning compliance by Sellers, Accord, West Laurel, or any other person for whose conduct they are or may be held responsible, with environmental laws.

(p) Assets . Except as disclosed in Schedule 2.2(p), Accord and West Laurel own and have good marketable title to the Assets, in each case free and clear of any and all liens, claims and encumbrances except, with respect to the Property, Permitted Encumbrances. Accord has delivered true, complete and accurate copies of all deeds, title insurance policies, surveys and abstracts relating to the Property.

(q) Books and Records . The books of account and other records of Accord and West Laurel, all of which have been made available to Buyer, are accurate and complete in all material respects and have been maintained in accordance with sound business practices. Each transaction of Accord and West Laurel are properly and accurately recorded on the books and records of the entity, and each document (including any contract, invoice or receipt) on which entries in the entities’ books and records are based is accurate and complete in all material respects.

(r) Compliance with Laws; Governmental Authorizations . (A) Without limiting the scope of any other representation in this Agreement, and at all times since January 1, 2002, Accord and West Laurel have been in compliance in all material respects with each law that is or was applicable to them or to the conduct of the business. No event has occurred or circumstance exists that (with or without notice or lapse of time) may cause Accord or West Laurel to contravene any law or may give rise to any obligation on the part of any of them to undertake, or to bear all or any portion of the cost of, any remedial action of any nature. Neither Accord nor West Laurel has received at

any time since January 1, 2002 any notice or other communication (whether oral or written) from any governmental body or any other person regarding any actual, alleged or potential contravention of any law or any actual, alleged or potential obligation on the part of Accord or West Laurel to undertake, or to bear all or any portion of the cost of, any remedial action of any nature.

(B) Each of Accord and West Laurel possess such certificates, approvals, licenses, authorities or permits issued by the appropriate local, state or federal agencies or bodies necessary to conduct the business to be conducted by it, and, to the knowledge of Seller, each of Accord and West Laurel has not received any written notice of proceedings relating to the revocation or modification of any such certificate, approval, license, authority or permit which, singly or in the aggregate, if the subject of an unfavorable decision, ruling, or finding, would materially and adversely affect the condition, financial or otherwise, or the earnings, business affairs or business prospects of the Hotel, Restaurant or Property. To the knowledge of Seller, neither Accord nor West Laurel has received any written or other notice of any violation of any applicable zoning, building or safety code, rule, regulation or ordinance, or of any employment, environmental, wetlands or other regulatory law, order, regulation or other requirement, including without limitation the Americas With Disabilities Act (“ADA”) or any restrictive covenants or other easements, encumbrances or agreements, relating to the Hotel, Restaurant or Property, which remains incurred. The Hotel, Restaurant or Property has been constructed and is operated in accordance with all applicable laws, ordinances, rules and regulations. All approvals regarding zoning, land use, subdivision, environmental and building and construction laws, ordinances, rules and regulations have been obtained, and such approvals will not be invalidated by the consummation of the transactions contemplated by this Agreement; provided, however, the Hotel, Restaurant or Property (including all improvements) is substantially in compliance with the ADA.

(C) The governmental authorizations listed in Schedule 2.2(r) collectively constitute all of the governmental authorizations necessary to permit Accord and West Laurel to conduct their respective business lawfully in the manner in which they currently conduct such business and to permit Accord and West Laurel to own and use the assets of the business in the manner in which they currently own and use the same.

(s) Condemnation and Moratoria . Except as set forth on Schedule 2.2(s), there are (i) no pending or threatened condemnation or eminent domain proceedings, or negotiations for purchase in lieu of condemnation, which affect or would affect any portion of the Hotel, Restaurant or Property; (ii) no pending or, to the knowledge of Seller, threatened moratoria on utility or public sewer hook-ups or the issuance of permits, licenses or other inspections or approvals necessary in connection with the construction or reconstruction of improvements, including without limitation tenant improvements, which affect or would affect any portion of the Hotel, Restaurant or Property; and (iii) no pending or, to the knowledge of Seller, threatened proceeding to change adversely the existing zoning classification as to any portion of the Hotel, Restaurant or Property. No portion of the Hotel, Restaurant or Property is a designated historic property or located within a designated historic area or district and there are no graveyards or burial grounds located within the Hotel, Restaurant or Property.

(t) Brokerage Commission . The Seller has not engaged the services of, any real estate agent, broker, finder or any other person or entity for any brokerage or finder’s fee, commission or other amount with respect to the transactions described herein on account of any action by the Seller. The Seller hereby agrees to indemnify and hold the Buyer and its employees, directors, members, partners, affiliates and agents harmless against any claims, liabilities, damages or expenses arising out of a breach of the foregoing paragraph 2.2(t). This indemnification shall survive Closing or any termination of this Agreement.

ARTICLE III

COVENANTS OF SELLERS

BEFORE CLOSING

3.1. Access and Investigation . Between the date of this Agreement and the Closing Date and upon reasonable advance notice from Buyer, Accord and West Laurel will (a) afford Buyer and its representatives and prospective lenders and their representatives full and free access to the personnel, properties (including subsurface testing), contracts, books and records, and other documents and data of Accord and West Laurel, (b) furnish such persons with copies of all such contracts, books and records, and other documents and data relating to the business as Buyer may reasonably request, and (c) furnish such persons with such additional financial, operating and other data and information relating to the business as Buyer may reasonably request.

3.2. Operation of the Business . Between the date of this Agreement and the Closing Date, Accord and West Laurel will (a) conduct the business only in the ordinary course of business, (b) use its best efforts to preserve intact the current business organization, keep available the services of its current employees and agents, and maintain relations and goodwill with its suppliers, customers, landlords, creditors, employees, agents and others having business relationships with Accord and West Laurel, (c) confer with Buyer concerning operational matters of a material nature and (d) otherwise report periodically to Buyer concerning the status, operations and finances of the business.

3.3 Negative Covenant . Except as otherwise expressly permitted by this Agreement, between the date of this Agreement and the Closing Date, Accord and West Laurel will not (a) make any modifications to any material contract or any governmental authorization or (b) remove any Equipment, except for Equipment that becomes obsolete or unusable which may be disposed of or replaced in the ordinary course of business.

3.4 Required Approvals . As promptly as practicable after the date of this Agreement, Buyer will make all filings that are required by law to make to consummate

the contemplated transactions. Between the date of this Agreement and the Closing Date, Accord and West Laurel will (a) cooperate with Buyer with respect to all filings that Buyer elects to make or that Buyer is required by law to make in connection with the contemplated transactions, and (b) cooperate with Buyer in obtaining any governmental authorizations and consents identified in Schedule 2.2(r), including a transfer of any license necessary for the Restaurant to serve alcoholic beverages.

3.5 Notification . Between the date of this Agreement and the Closing Date, the Sellers will promptly notify Buyer in writing if Accord or West Laurel becomes aware of (a) any fact or condition that causes or constitutes a breach of any of Sellers’ representations and warranties as of the date of this Agreement, (b) the occurrence after the date of this Agreement of any fact or condition that would cause or constitute a breach of any such representation or warranty had that representation or warranty been made as of the time of the occurrence or discovery of such fact or condition, (c) any material development affecting the Hotel, the Restaurant or Property and the operations and results of operations related to the Hotel, the Restaurant or Property; or (d) any material development affecting the ability of such party to consummate the transactions contemplated by this Agreement.

3.6 No Negotiation . Each of Accord and West Laurel will, and will cause each of their representatives to, immediately discontinue any negotiations or discussions with any person (other than Buyer) relating to any business combination transaction involving the Hotel, the Restaurant and the Property, any merger or consolidation, or the sale of any of the assets of the Hotel or the Restaurant (other than inventory in the ordinary course of business). Until such time, if any, as this Agreement is terminated pursuant to Article VII, Accord, West Laurel and Sellers will not, and will cause each of their Representatives not to, directly or indirectly, solicit, initiate, encourage or entertain any inquiries or proposals from, discuss or negotiate with, provide any non-public information to, or consider the merits of any inquiries or proposals from, any person (other than Buyer) relating to any such transaction involving the Hotel, Restaurant or Property. Accord and West Laurel will immediately notify Buyer regarding any contact between Accord, West Laurel, the Sellers or their respective representatives and any other person regarding any such transaction or any related inquiry.

3.7 Covenant to Remedy Breaches . Without limiting the obligations of Seller set forth in this Agreement, each Seller covenants to use all reasonable efforts within its control (i) to prevent the breach of any representation or warranty of such Seller hereunder and (ii) to satisfy all covenants of such Seller hereunder.

3.8 Damage or Destruction of Assets . In the event of destruction or material damage, at or before the moment of Closing, of any of the assets of the Hotel, Restaurant or Property, then either Buyer of Seller shall have the right to terminate this Agreement.

ARTICLE IV

COVENANTS OF BUYER PRIOR TO CLOSING

4.1 Required Approvals . As promptly as practicable after the date of this Agreement, Buyer will make all filings that it is required by law to make to consummate the contemplated transactions. Between the date of this Agreement and the Closing Date, Buyer will (a) cooperate with Accord and West Laurel with respect to all filings that Accord and West Laurel elect to make or that it is required by law to make in connection with the contemplated transactions, and (b) cooperate with Accord, West Laurel and the Sellers in obtaining any governmental authorizations and consents listed in Schedule 2.2(r); provided, however, that this Section will not require Buyer to dispose of or make any change in any portion of its business or to incur any other unreasonable burden.

4.2 Best Efforts . Buyer will use its best efforts to cause the conditions in Article VI to be satisfied; provided, however, that Buyer will not be required to make any material change to its business, dispose of any material asset, expend material funds (except as set forth in Section 10.11), incur any material burden or take actions that would result in a material adverse change in the benefits to Buyer of this Agreement and the contemplated transactions.

ARTICLE V

INSPECTION PERIOD

5.1 Inspection Period . Buyer shall have a due diligence period (the “Inspection Period”) beginning on the date this Agreement is executed by all parties and expiring one hundred twenty (120) days thereafter. In the event Buyer does not wish to close on the purchase of the Purchased Assets, Buyer will provide Seller with written notice before the expiration of the 120-day Inspection Period, in which event this Agreement shall automatically terminate and Sellers shall cause Chicago Title Insurance Company to refund the Deposit to the Buyer, and neither party shall have any further obligation to the other with respect to this Agreement. If Buyer elects to proceed forward to Closing, Buyer will give Seller written notice of its intent to proceed with the purchase of the Assets at any time prior to the end of such 120 day period and the Deposit will become non-refundable. Closing will occur on or before December 31, 2004. Time is of the essence. However, the Buyer shall have the right to extend the Closing for two additional forty-five (45) day periods by paying an additional option fee of Fifty Thousand Dollars ($50,000) per forty-five day extension period, which would not be credited to the Purchase Price. In the event Buyer elects to terminate this Agreement at any time after the 120 day study period (or any 45 day extension thereof), Sellers shall be entitled to retain the Deposit.

5.2 Inspection . (a) At any reasonable time and from time to time during the Inspection Period, Buyer shall have the right to fully inspect the Hotel and to satisfy itself

that the Hotel, as of the date of such inspection, is in good operating condition and repair, all guest rooms are fully equipped and suitable for rental in the ordinary course of business; there are no material defects in the improvements constituting part of the Hotel; the roof, all plumbing, heating, electrical and air conditioning and the water and sewer systems are in good working order and condition. Sellers shall use their best efforts to assure that Buyer has access to the Hotel and Restaurant during normal business hours, and Sellers shall provide all available information concerning the Hotel that Buyer may reasonably request to assist Buyer in making such determinations.

(b) At any reasonable time and from time to time during the Inspection Period, Buyer shall have the right to fully examine all accounting ledgers, audit materials, bonds, operating reports, files and other materials relating to the financial condition and the operation of the Hotel as are available to Seller. Buyer shall bear the cost of all inspections referred to in this Paragraph. Buyer shall indemnify and hold Seller harmless from any physical damage to the Hotel occurring by Buyer or Buyer’s agents during said inspections.

(c) Seller shall furnish to Buyer within ten (10) days of this Agreement being signed by both parties a copy of its title insurance policy, and all surveys, architectural plans and drawings, engineering reports, elevator reports, and any and all other reports relating to the roof, structure, mechanical, electrical, plumbing, heating or air-conditioning systems, and environmental reports.

ARTICLE VI

CONDITIONS PRECEDENT TO BUYER’S OBLIGATION TO CLOSE

Buyer’s obligation to purchase the Purchased Assets and to take the other actions required to be taken by Buyer at the Closing is subject to the satisfaction, on or before the Closing Date, of each of the following conditions (any of which may be waived by Buyer, in whole or in part):

(b) In addition, each of the Sellers’ covenants and each of the Seller’s representations and warranties in this Agreement that contain an express materiality qualification, must have been accurate in all respects as of the date of this Agreement, and must be accurate in all respects as of the Closing Date as if then made.

6.2 Performance . (a) All of the covenants and obligations that Accord and West Laurel is required to perform or to comply with under this Agreement on or before the Closing Date (considered both collectively and individually) must have been duly performed and complied with in all material respects.

6.3 Consents . Each of the governmental authorizations, licenses, certificates and consents identified in Schedule 2.2(r) that is required to be obtained as a condition to the Closing must have been obtained and must be in full force and effect except as otherwise provided in Section 1.4(a)(vi) regarding entering into a lease during the pendency of the approval process for transfer of the Restaurant’s license to serve alcoholic beverages.

6.4 No Proceedings . Since the date of this Agreement, there must not have been commenced or threatened against Buyer, or against any related person of Buyer, any proceeding (a) involving any challenge to, or seeking damages or other relief in connection with, any of the contemplated transactions, or (b) that may have the effect of preventing, delaying, making illegal or otherwise interfering with any of the contemplated transactions.

6.5 No Prohibition . Neither the consummation nor the performance of any of the contemplated transactions will, directly or indirectly (with or without notice or lapse of time), contravene, or cause Buyer or any related person of Buyer to suffer any Adverse Consequence under (a) any applicable law, order or governmental authorization, or (b) any law or order that has been published, introduced or otherwise proposed by or before any governmental body.

6.6. Material Adverse Change . There shall have been no material adverse change (or changes which in the aggregate are materially adverse) since the date hereof in the financial position, results of operations, properties, business, or prospects of the Hotel, taken as a whole, whether by reason of change in government regulation or action or otherwise.

6.7 Bankruptcy . None of Accord and West Laurel shall have been the subject of a petition for reorganization or liquidation under the Federal bankruptcy laws, or under state or foreign insolvency laws, nor shall an assignment for the benefit of Accord and West Laurel’s, or any of the Seller’s creditors or any similar protective proceeding or act or event of bankruptcy have occurred.

ARTICLE VII

CONDITIONS PRECEDENT TO SELLER’S OBLIGATION TO CLOSE

The Sellers’ obligation to sell the Purchased Assets and to take the other actions required to be taken by them at the Closing is subject to the satisfaction, on or before the Closing Date, of each of the following conditions (any of which may be waived by the Seller Agent, in whole or in part):

7.3. Consents . Each of the governmental authorizations and consents including those identified in Schedule 2.2(r) that is required to be obtained as a condition to the Closing must have been obtained and must be in full force and effect.

7.4. No Prohibition . There must not be in effect any law or order that (a) prohibits the consummation of the contemplated transactions and (b) has been adopted or issued, or has otherwise become effective, since the date of this Agreement.

ARTICLE VIII

TERMINATION

8.1 Termination Events . Subject to Section 8.2, this Agreement may, by notice given before or at the Closing, be terminated:

(a) by Buyer at any time and by Seller at any time after December 31, 2004;

(b) by the Sellers if Buyer has committed a material breach of any provision of this Agreement and Sellers have not waived such breach;

(c) by the Sellers if the satisfaction of any condition in Article VII is or becomes impossible (other than through the failure of any Seller to comply with its obligations under this Agreement) and Accord, West Laurel and the Seller Agent have not waived such condition; and

(d) by Sellers if the Closing has not occurred (other than through the failure of any party seeking to terminate this Agreement to comply with its obligations under this Agreement) on or before March 31, 2005, or such later date as Buyer, the Sellers may agree upon.

8.2. Effect Of Termination . Each Party’s right of termination under Section 8.1 is in addition to any other rights it may have under this Agreement or otherwise, and the exercise of such right of termination will not be an election of remedies. If this Agreement is terminated by Buyer because of the breach of the Agreement by Sellers or

because one or more of the conditions to Buyer’s obligations under this Agreement is not satisfied as a result of any other party’s failure to comply with its obligations under this Agreement, Buyer’s right to pursue specific performance under all provisions of this Agreement will survive such termination unimpaired. Buyer’s sole remedy shall be an action for specific performance for Sellers’ failure to comply with its obligations under this Agreement.

ARTICLE IX

[INTENTIONALLY OMITTED]

ARTICLE X

MISCELLANEOUS


If to Buyer:		Mr. Andrew M. Sims
		MHI Hotel Services, L.L.C.
		814 Capitol Landing Road
		Williamsburg, VA 23185
With a copy to:		Thomas J. Egan, Jr., Esquire
		Baker & McKenzie LLP
		815 Connecticut Avenue, NW
		Washington, DC 20006

Notices to Sellers shall be sent to the addresses specified on Schedule 1.

amended except by instrument in writing signed by the parties hereto, and no provisions or conditions may be waived other than by a writing signed by the party waiving such provisions or conditions. No delay or omission in the exercise of any right or remedy accruing to the Seller or the Buyer upon any breach under this Agreement shall impair such right or remedy or be construed as a waiver of any such breach theretofore or thereafter occurring. The waiver by the Seller or the Buyer of any breach of any term, covenant, or condition herein stated shall not be deemed to be a waiver of any other breach, or of a subsequent breach of the same or any other term, covenant, or condition herein contained.

10.3 Successors and Assigns . Except as set forth in this Article, this Agreement may not be assigned by the Buyer or the Sellers without the prior approval of the other party hereto; provided, however, that the Buyer may assign this entire agreement or a right to acquire all or any portion of the Purchased Assets to a direct or indirect subsidiary or affiliate of Buyer including, without limitation, a limited partnership or corporation formed or to be formed in connection with the proposed public offering of an entity that intends to qualify as a real estate investment trust (“REIT”) without approval of the Sellers. This Agreement shall be binding upon, and inure to the benefit of the parties and their respective legal representatives, successors, and permitted assigns.

10.5 Time of Essence . With regard to all dates and time periods set forth or referred to in this Agreement, time is of the essence.

10.6 Governing Law . This Agreement shall be construed and interpreted in accordance with the laws of the State of Maryland, without regard to conflicts of laws principles.

10.8 Survival . All covenants and agreements contained in the Agreement which contemplate performance after the Closing Date (including, without limitation, those covenants and agreements contained in Section 1.2 hereof) shall survive the Closing.

10.12 Confidentiality . The Seller acknowledges that the matters relating to the REIT, the initial underwritten public offering of the REIT, this Agreement, and the other documents, terms, conditions and information related thereto (collectively, the “Information”) are confidential in nature. Therefore, each Seller covenants and agrees to keep the Information confidential and will not (except as required by applicable law, regulation or legal process, and only after compliance with the provisions of this Section 10.12), without the Buyer’s prior written consent, disclose any Information in any manner whatsoever; provided, however, that the Information may be revealed only to Sellers’ owners, Seller’s key employees, legal counsel and financial advisors, each of whom shall be informed of the confidential nature of the Information and shall agree to act in accordance with the terms of this Section 10.12. In the event that a Seller or its key employees, legal counsel or financial advisors (collectively, the “Information Group”) are requested pursuant to, or required by, applicable law, regulation or legal process to disclose any of the Information, the applicable member of the Information Group will notify the Buyer promptly so that it may seek a protective order or other appropriate remedy or, in its sole discretion, waive compliance with the terms of this Section 10.12. In the event that no such protective order or other remedy is obtained, or that the Buyer waives compliance with the terms of this Section 10.12, the applicable member of the Information Group may furnish only that portion of the Information which it is advised by counsel is legally required and will exercise all reasonable efforts to obtain reliable assurance that confidential treatment will be accorded the Information. Each Seller acknowledges that remedies at law may be inadequate to protect the Buyer or the REIT against any actual or threatened breach of this Section 10.12, and, without prejudice to any other rights and remedies otherwise available, each Seller agrees to the granting of injunctive relief in favor of the REIT and/or the Buyer without proof of actual damages. Notwithstanding any other express or implied agreement to the contrary, the parties hereto agree and acknowledge that each of them and each of their employees, representatives, and other agents may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the transaction and all materials of any kind (including opinions or other tax analyses) that are provided to any of them relating to such tax treatment and tax structure, except to the extent that confidentiality is reasonably necessary to comply with U.S. federal or state securities laws. For purposes of

this paragraph, the terms “tax treatment” and “tax structure” have the meanings specified in Treasury Regulation section 1.6011-4(c).

[Signatures follow on next page]

The parties hereto have executed and delivered this Agreement as of the date indicated in the first sentence of this Agreement.


	SELLERS:

	ACCORD, LLC

August 19, 2004	By:	/ S / C ARLTON M. G REEN
	Name:	Carlton M. Green
	Its:	Manager

	West Laurel Corporation

August 19, 2004	By:	/ S / C ARLTON M. G REEN
	Name:	Carlton M. Green
	Its:	President

	BUYER:

	MHI Hotel Services, LLC

	By:	/ S / A NDREW M. S IMS
	Name:	Andrew M. Sims
	Its:	President

Exhibit 10.13

LEASE AGREEMENT

DATED AS OF , 2004

BETWEEN

[OWNER ENTITY]

AS LESSOR

AND

MHI HOSPITALITY TRS, LLC

AS LESSEE

TABLE OF CONTENTS


Article 1 LEASED PROPERTY; TERM		4
1.1	Leased Property	4
1.2	Term	5
Article 2 DEFINITIONS		5
2.1	Definitions	5
Article 3 BASE RENT; PERCENTAGE RENT; ADDITIONAL CHARGES		16
3.1	Rent	16
3.2	Confirmation of Percentage Rent	18
3.3	Additional Charges	19
3.4	Net Lease Provision	19
3.5	Conversion of Property	20
Article 4 IMPOSITIONS		20
4.1	Payment of Impositions	20
4.2	Notice of Impositions	21
4.3	Adjustment of Impositions	21
4.4	Utility Charges	21
Article 5 NO TERMINATION; ABATEMENT		21
5.1	No Termination, Abatement, etc.	21
5.2	Abatement Procedures	22
Article 6 PERSONAL PROPERTY; LANDLORD’S LIEN		22
6.1	Ownership of the Leased Property	22
6.2	Lessee’s Personal Property	22
6.3	Lessor’s Lien	23
Article 7 CONDITIONS; USE		23
7.1	Condition of the Leased Property	23
7.2	Use of the Leased Property	24
7.3	Lessor to Grant Easements, etc.	24
Article 8 COMPLIANCE WITH APPLICABLE LAWS		25
8.1	Compliance with Legal and Insurance Requirements, etc.	25
8.2	Legal Requirement Covenants	25
8.3	Environmental Covenants	26
Article 9 MAINTENANCE AND REPAIRS		28
9.1	Maintenance and Repair	28
9.2	Encroachments, Restrictions, etc.	29
Article 10 ALTERATIONS		29
10.1	Alterations	29
Article 11 PROHIBITED LIENS AND ENCUMBRANCES		29
11.1	Liens	29
Article 12 PERMITTED CONTESTS		30
12.1	Permitted Contests	30
Article 13 INSURANCE REQUIREMENTS		31
13.1	General Insurance Requirements	31
13.2	Replacement Cost	32
13.3	Waiver of Subrogation	33
13.4	Form Satisfactory, etc.	33
13.5	Increase in Limits	33
13.6	Blanket Policy	33
13.7	No Separate Insurance	33


Article 14 INSURANCE PROCEEDS		34
14.1	Insurance Proceeds	34
14.2	Reconstruction in the Event of Damage or Destruction Covered by Insurance	34
14.3	Reconstruction in the event of Damage or Destruction not covered by Insurance	35
14.4	Lessee’s Property	35
14.5	Abatement of Rent	35
14.6	Damage near end of Term	35
14.7	Waiver	35
Article 15 CONDEMNATION; TAKING		36
15.1	Definitions	36
15.2	Parties’ Rights and Obligations	36
15.3	Total Taking	36
15.4	Allocation of Award	36
15.5	Partial Taking	36
15.6	Temporary Taking	37
Article 16 EVENTS OF DEFAULT; REMEDIES; DAMAGES		38
16.1	Events of Default	38
16.2	Surrender	39
16.3	Damages	39
16.4	Waiver	40
16.5	Application of Funds	40
Article 17 LESSOR’S RIGHT TO CURE		41
17.1	Lessor’s Right to Cure Lessee’s Default	41
Article 18 RESERVED		41
Article 19 REIT REQUIREMENTS		41
19.1	REIT Requirements	41
19.2	Lessee Officer and Employee Limitation	42
19.3	Management Agreement	43
Article 20 HOLDING OVER		43
20.1	Holding Over	43
Article 21 RISK OF LOSS		44
21.1	Risk of Loss	44
Article 22 INDEMNIFICATION		44
22.1	Indemnification	44
Article 23 SUBLETTING AND ASSIGNMENT		45
23.1	Subletting and Assignment	45
23.2	Attornment	45
Article 24 REPORTING AND CERTIFICATION REQUIREMENTS		46
24.1	Officer’s Certificates; Financial Statements; Budgets; Lessor’s Estoppel Certificates and Covenants	46
24.2	Operating Budget	46
24.3	Capital Budget	47
Article 25 LESSOR’S DEFAULT; CURE RIGHTS		48
25.1	Lessee’s Right to Cure	48
25.2	Breach by Lessor	48
Article 26 NOTICES		48
26.1	Notices	48


Article 27 MISCELLANEOUS PROVISIONS		49
27.1	Transfer of Licenses	49
27.2	Early Termination Rights; Termination Fees	49
27.3	Substitution of Initial Hotel	49
27.4	Compliance with Franchise Agreement	49
27.5	Lessor’s Right to Inspect	50
27.6	Conveyance by Lessor	50
27.7	Lessor may Grant Liens	50
27.8	Non Disturbance Agreement	50
27.9	Waiver of Presentment, etc.	50
27.10	Memorandum of Lease	50
27.11	Usury	50
27.12	No Waiver	51
27.13	Remedies Cumulative	51
27.14	Acceptance of Surrender	51
27.15	No Merger of Title	51
27.16	Quiet Enjoyment	51
27.17	Binding Effect	51
27.18	Entire Agreement; No Offer	51
27.19	Severability	52
27.20	Counterparts	52
27.21	Governing Law	52
27.22	Recitals; Headings	52
27.23	Survival	52
27.24	Exhibits	53
Exhibit A Land		55
Exhibit B Base Rent and Percentage Rent		56
Exhibit C Management Agreement		57

LEASE AGREEMENT

THIS LEASE AGREEMENT (hereinafter called “Lease”), is made as of the day of , 2004, by and between [ Owner Entity ], a [ ] (hereinafter called “Lessor”), and MHI Hospitality TRS, LLC, a Delaware limited liability company (hereinafter called “Lessee”), and provides as follows:

WITNESSETH:

Lessor owns fee title to the Leased Property (as defined below); and

Lessor desires to lease to Lessee and Lessee desires to lease from Lessor, the Leased Property, pursuant to the terms and conditions of this Lease.

NOW, THEREFORE , intending to be legally bound, 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, as follows:

ARTICLE 1

LEASED PROPERTY; TERM

1.1 Leased Property . The Leased Property is comprised of all of Lessor’s right, title and interest in that certain [ ] hotel located at in County, and known as the “ ,”as follows (collectively, “Leased Property”):

(a) the land and/or ground leasehold interests 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, alleyways and connecting tunnels, sidewalks, utility pipes, conduits and lines (on-site and offsite), parking areas and roadways appurtenant to such buildings and structures presently situated upon the Land (collectively, the “Improvements”);

(c) all easements, rights and appurtenances relating to the Land and the Improvements;

(d) all equipment, machinery, fixtures, and other items of property required or incidental to the use of the Improvements as a hotel, including all components thereof, now and hereafter permanently affixed to or incorporated into the 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 (collectively, the “Fixtures”);

(e) all furniture and furnishings and all other items of personal property (excluding Inventory and personal property owned by Lessee) located on, and used in connection with, the operation of the Improvements as a hotel, together with all replacements, modifications, alterations and additions thereto; and

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

THE LEASED PROPERTY IS DEMISED IN ITS PRESENT CONDITION WITHOUT REPRESENTATION OR WARRANTY (EXPRESSED OR IMPLIED) BY LESSOR AND SUBJECT TO THE RIGHTS OF PARTIES IN POSSESSION, AND 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 the Lease (the “Term”) shall commence on , 2004 (the “Commencement Date”) and shall end on [ , 2009] (the “Expiration Date”), unless sooner terminated in accordance with the provisions hereof.

ARTICLE 2

DEFINITIONS

2.1 Definitions . For all purposes of this Lease, used in this Lease and not otherwise defined, shall except as otherwise expressly provided or unless the context otherwise requires, (a) the terms used in this Lease and not otherwise defined, shall have the meanings assigned to them in this Article II 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 subparagraphs are to the designated Articles, Sections and other subparagraphs 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 subparagraphs.

“ Additional Charges ” shall have the meaning as set forth in Section 3.3.

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

“ Award ” shall have the meaning as set forth in Section 15.1(c).

“ Base Rent ” shall have the meaning as set forth in Section 3.1(a).

“ Beverage Sales ” shall mean gross revenue from (i) the sale of wine, beer, liquor or other alcoholic beverages, whether sold in the bar or lounge, delivered to a guest room, sold at meetings or banquets or at any other location at the Leased Property, or (ii) non-alcoholic beverages sold in the bar or lounge. Such revenues shall not include the following:

(a) Any gratuity or service charge added to a customer’s bill or statement in lieu of a gratuity which is paid to an employee;

(b) Any revenues that are subsequently credited, rebated or refunded in the ordinary course of business; and

(c) Sales taxes or taxes of any other kind imposed on the sale of alcoholic or other beverages.

“ Business Day ” shall mean each Monday, Tuesday, Wednesday, Thursday and Friday that is not a day on which national banks in the Commonwealth of Virginia, or in the municipality wherein the Leased Property is located are closed.

“ Capital Budget ” shall have the meaning as set forth in Section 24.3.

“ Capital Expenditures ” shall mean amounts expended to pay the costs of replacement and renewals to the FF&E of the Leased Property and Capital Improvements.

“ Capital Improvements ” shall mean certain non-routine repairs and maintenance to the building(s) of the Leased Property which are normally capitalized under generally accepted accounting principles such as, but not limited to, exterior and interior repainting, resurfacing, building walls, floors, roofs and parking areas, and replacing folding walls and the like, and

major repairs, alterations, improvements, renewals or replacement to the building structure of the Leased Property or to its mechanical, electrical, heating, ventilating, air conditioning, plumbing or vertical transportation systems.

“ CERCLA ” means The Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended.

“ Claims ” shall have the meaning as set forth in Section 12.1.

“ Code ” shall mean the Internal Revenue Code of 1986, as amended.

“ Commencement Date ” shall mean the date set forth in Section 1.2 as the commencement date with respect to the Facility.

“ Condemnation ” shall have the meaning as set forth in Section 15.1(a).

“ Condemnor ” shall have the meaning as set forth in Section 15.1(d).

“ Consumer Price Index ” means Consumer Price Index, published for Urban Consumers for the U.S. City Average for all Items, 1982-84 = 100 issued by the Bureau of Labor Statistics of the United States Department of Labor, as published in The Wall Street Journal.

“ CPI Adjustment Year ” shall mean the calendar year next following the year in which the Commencement Date occurs, if the Commencement Date occurs between January 1 and June 30, or the second calendar year following the year in which the Commencement Date occurs, if the Commencement Date occurs between July 1 and December 31.

“ Date of Taking ” shall have the meaning as set forth in Section 15.1(b).

“ Encumbrance ” shall have the meaning as set forth in Section 27.7.

“ Eligible Independent Contractor ” shall mean a management company that meets the following requirements:

(a) The management company does not permit wagering activities to be conducted at or in connection with the Facility.

(b) The management company does not own, directly or indirectly (within the meaning of Section 856(d)(5) of the Code), more than 35% of the outstanding stock of MHI.

(c) No more than 35% of its interest in assets or net profits is owned, directly or indirectly (within the meaning of Section 856(d)(5) of the Code), by one or more Persons owning 35% (within the meaning of Section 856(d) of the Code) or more of the outstanding stock of MHI.

(d) Neither MHI, the Lessor, nor the Lessee, derives or receives any income from the management company or any of its subsidiaries.

(e) 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 Person” 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 person” within the meaning of Section 856(d)(9)(F) of the Code with respect to MHI or the Lessee (an “Unrelated Person”). For purposes of determining whether the requirement of this paragraph (e) 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 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 provide 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.

A “ qualified lodging facility ” is defined in Section 856(d)(9)(D) of the Code and means a “Lodging Facility” (defined below), 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 fully authorized to engage in such business at or in connection with such facility. A “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, and includes customary amenities and facilities operated as party of, or associated with, the lodging facility so long as such amenities and facilities are customary for other properties of a comparable size and class owned by other owners unrelated to MHI.

“ Environmental Authority ” shall mean 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 ” shall mean any license, permit, order, approval, consent, notice, registration, filing or other form of permission or authorization required under any Environmental Law.

“ Environmental Laws ” shall mean all applicable federal, state, local and foreign 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, a Release or threatened Release of Hazardous Materials or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of Hazardous Materials. Environmental Laws include but are not limited to CERCLA, FIFRA, RCRA, SARA and TSCA.

“ Environmental Liabilities ” shall mean 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 or in any way affecting the Leased Property;

(c) A Release at any time of any Hazardous Materials on, in, at, under or in any way affecting 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 ” shall have the meaning as set forth in Section 16.1.

“ Expiration Date ” the date set forth in Section 1.2 as the expiration date with respect to the Facility.

“ Facility ” shall mean the hotel and/or other facility offering lodging and other services or amenities being operated or proposed to be operated on the Leased Property.

“ FF&E ” shall mean all Fixtures, furniture, furnishings and equipment.

“ FIFRA ” means The Federal Insecticide, Fungicide, and Rodenticide Act, as amended.

“ First Annual Room Revenues Break Point ” shall mean the amount of Room Revenues for the applicable Lease Year corresponding to such term as set forth on Exhibit B .

“ First Tier Room Revenue Recognition ” shall mean all Lease Year to date Room Revenues in excess of the First Tier Rent Floor up to but not exceeding the First Annual Room Revenues Break Point.

“ First Tier Rent Floor ” shall mean the amount of Room Revenues for the applicable Lease Year corresponding to such term as set forth on Exhibit B .

“ Fiscal Year ” shall mean the 12-month period from January 1 to December 31.

“ Fixtures ” shall have the meaning as set forth in Section 1.1(d).

“ Food Sales ” shall mean gross revenue from the sale, for on-site consumption, of food and non-alcohol beverages sold at the Leased Property, including in respect to guest rooms, banquet rooms, meeting rooms and other similar rooms. Such revenues shall not include the following:

(a) Vending machine sales;

(b) Any gratuities or service charges added to a customer’s bill or statement in lieu of a gratuity which is paid to an employee;

(c) Non-alcoholic beverages sold from the bar or lounge;

(d) Sales taxes or taxes of any other kind imposed on the sale of food or non-alcoholic beverages; and

(e) Any revenues that are subsequently credited, refunded or rebated in the ordinary course of business.

“ Franchise Agreement ” shall mean any franchise license agreement with a national franchisor under which the Facility is operated.

“ Full Replacement Cost ” shall have the meaning as set forth in Section 13.2.

“ GAAP ” shall mean, as of any date of determination, generally accepted accounting principles consistently applied as recognized by the accounting industry and standards within the United States.

“ Government ” shall mean 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 Revenues ” shall mean all revenues and receipts of every kind received from operating the Facility and all departments and parts thereof, including but not limited to, income from both cash and credit transactions, income from the rental of rooms, stores, offices, banquet rooms, conference rooms, exhibits or sale space of every kind, license, lease and concession fees and rentals (not including gross receipts of licensees, lessors and concessionaires), vending machines, health club membership fees, food and beverage sales, wholesale and retail sales of merchandise, service charges, and proceeds, if any, from business interruption or other loss of income insurance; provided, however, Gross Revenues shall not include (a) gratuities to the Facility’s employees, (b) federal, state or municipal excise, sales or use taxes or similar

impositions collected directly from customers, patrons or guests or included as part of the sales prices of any goods or services paid over to federal, state or municipal governments, (c) property insurance or condemnation proceeds (excluding proceeds from business interruption coverage), (d) proceeds from the sale or refinance of assets other than sales in the ordinary course of business, (e) funds furnished by the Lessor, (f) judgments and awards, (g) the amount of all credits, rebates or refunds (which shall be deductions from Gross Revenues) to customers, patrons or guests, (h) the value of complimentary rooms, food and beverages, (i) interest income, (j) lease security deposits, and (k) items constituting “allowances” under the Uniform System.

“ Hazardous Materials ” shall mean all chemicals, pollutants, contaminants, wastes and toxic substances, including without limitation:

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

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

(c) substances, as defined in TSCA 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.

“ Impositions ” shall mean 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 its business conducted upon the Leased Property), 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.

“ Improvements ” shall have the meaning as set forth in Section 1.1(b).

“ Indemnified Party ” shall mean either Lessee Indemnified Party or a Lessor Indemnified Party.

“ Indemnifying Party ” shall mean any party obligated to indemnify an Indemnified Party pursuant to Sections 8.3 or 22.1.

“ Insurance Requirements ” shall mean all terms of any insurance policy required by this Lease and all requirements of the issuer of any such policy.

“ Inventory ” shall mean all “Inventories of Merchandise” and “Inventories of Supplies” as defined in the Uniform System and including any property of the type described in Section 1221(1) of the Code.

“ Land ” shall have the meaning as set forth in Section 1.1(a).

“ Lease ” shall mean this Lease Agreement.

“ Lease Year ” shall mean any 12-month period from January 1 through December 31 during the Term, or any shorter period at the beginning or end of the Term.

“ Leased Property ” shall have the meaning as set forth in Section 1.1.

“ Legal Requirements ” shall mean 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.

“ Lessee ” shall mean the Lessee designated on this Lease and its respective permitted successors and assigns.

“ Lessee Indemnified Party ” shall mean the 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 ” shall have the meaning as set forth in Section 6.2.

“ Lessor ” shall mean the Lessor designated on this Lease and its respective successors and assigns.

“ Lessor Indemnified Party ” shall mean the Lessor, any Affiliate of Lessor, including MHI, any other Person against whom any claim for indemnification may be asserted hereunder as a result of a direct or indirect ownership interest in Lessor, the officers, trustees, directors, stockholders, partners, members, employees, agents and representatives of any of the foregoing Persons and of any stockholder, partner, member, agent, or representative of any of the foregoing Persons, and the respective heirs, personal representatives, successors and assigns of any such officer, trustee, director, partner, member, stockholder, employee, agent or representative.

“ Licenses ” shall have the meaning as set forth in Section 27.1.

“ Management Agreement ” shall have the meaning as set forth in Section 19.3.

“ Manager ” shall have the meaning as set forth in Section 19.3.

“ MHI ” shall mean MHI Hospitality Corporation, a Maryland corporation.

“ Notice ” shall mean a notice given pursuant to Article XXVI.

“ Officer’s Certificate ” shall mean a certificate of Lessee signed by the chief financial officer or another officer authorized so to sign by the board of directors or by-laws of Lessee, or any other person whose power and authority to act has been authorized by delegation in writing by any such officer.

“ Operating Budget ” shall have the meaning as set forth in Section 24.2.

“ Other Revenues ” shall mean all revenues, receipts, and income of any kind derived directly or indirectly from or in connection with the Facility and included in Gross Revenues, other than Room Revenues, Food Sales and Beverage Sales.

“ Overdue Rate ” shall mean on any date, a rate equal to the Prime Rate plus 3% per annum, but in no event greater than the maximum rate then permitted under applicable law.

“ Payment Date ” shall mean any due date for the payment of any installment of Base Rent.

“ Percentage Rent ” shall have the meaning as set forth in Section 3.1(b).

“ Period Revenues Computation ” shall have the meaning as set forth in Section 3.1(b).

“ Person ” shall mean any Government, natural person, corporation, partnership or other legal entity.

“ Predecessor ” shall mean 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 ” shall have the meaning as set forth in Section 7.2(b).

“ Prime Rate ” shall mean the “prime rate” as published in the “Money Rates” section of The Wall Street Journal; however, if such rate is, at any time during the Term of this Agreement, no longer so published, the term “Prime Rate” shall mean the average of the prime interest rates which are announced, from time to time, by the three (3) largest banks (by assets) headquartered in the United States which publish a “prime rate”.

“ Proceeding ” shall mean 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.

“ RCRA ” shall mean The Resource Conservation and Recovery Act, as amended.

“ Real Estate Taxes ” shall mean all real estate taxes, including general and special assessments, if any, which are imposed upon the Land, and any improvements thereon.

“ REIT Requirements ” shall have the meaning as set forth in Section 19.1(a).

“ Release ” shall mean 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.

“ Rent ” shall have the meaning as set forth in Section 3.1.

“ Room Revenues ” shall mean gross revenue from the rental of guest rooms, whether to individuals, groups or transients, but excluding the following:

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

(b) All sales taxes or any other taxes imposed on the rental of such guest rooms; and

(c) Any fees collected for amenities including, but not limited to: telephone, laundry, Internet, movies or concessions.

“ SARA ” shall mean the Superfund Amendments and Reauthorization Act of 1986, as amended.

“ Second Annual Room Revenues Break Point ” shall mean the amount of Room Revenues for the applicable Lease Year corresponding to such term as set forth on Exhibit B .

“ Second Tier Room Revenue Recognition ” shall mean all Lease Year to date Room Revenues in excess of the Second Annual Room Revenues Break Point.

“ State ” shall mean the State or Commonwealth of the United States in which the Leased Property is located.

“ Subsidiaries ” shall mean one or more corporations in which Lessee owns, directly or indirectly, more than 50% of the voting stock or control, as applicable.

“ Taking ” shall mean 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 ” shall have the meaning as set forth in Section 1.2.

“Termination Fee” shall have the meaning as set forth in Section 27.2.

“ TSCA ” shall mean the Toxic Substances Control Act, as amended.

“ Unavoidable Delay ” shall mean delays due to acts of God (including adverse weather conditions), acts of the state or federal government in its sovereign or contractual capacity, war, civil disturbance, riot or mob violence, terrorism, earthquake, flood, fire or other casualty, epidemic, quarantine restriction, labor strikes or lockout, freight embargo, or similar causes beyond the control of the parties hereto.

“ Uneconomic for its Primary Intended Use ” shall mean a state or condition of the 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, the 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 at the Leased Facility.

“ Uniform System ” shall mean the Uniform System of Accounts for the Lodging Industry, 9th Revised Edition, as may be modified from time to time by the International Association of Hospitality Accountants.

“Unsuitable for its Primary Intended Use ” shall mean a state or condition of the 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

BASE RENT; PERCENTAGE RENT; ADDITIONAL CHARGES

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, at Lessor’s address set forth in Article XXVI hereof or at such other place or to such other Person, as Lessor from time to time may designate in a Notice, rent (“Rent”), which shall be equal to the greater of the following:

(a) Base Rent : the annual amount of Base Rent set forth on Exhibit B (the “Base Rent”), which shall be payable one-twelfth (1/12th) monthly in arrears on or before the first Business Day of the subsequent calendar month beginning on the date as set forth on Exhibit B ; provided, however, that Base Rent shall be prorated as to any partial Lease Year; plus

(b) Percentage Rent : an amount of percentage rent (“Percentage Rent”), calculated for each calendar quarter, equal to the Period Revenues Computation through the end of such calendar quarter for the applicable Lease Year, which amount shall be payable on or before the fifteenth (15th) day of the following calendar quarter, beginning on the date as set forth on Exhibit B .

The term “Period Revenues Computation” as used herein shall equal the sum of, for the applicable Lease Year: (i) an amount equal to 0.35 times the First Tier Room Revenue Recognition and (ii) an amount equal 0.70 times the Second Tier Room Revenue Recognition.

If the Term begins or ends in the middle of a calendar year, then the number of calendar quarters falling within the Term during such calendar year shall constitute a separate Lease Year. In that event, the First Annual Room Revenues Break Point and the Second Annual Room Revenues Break Point shall be multiplied by a fraction equal to (x) the number of calendar quarters (including partial calendar quarters) in the Lease Year divided by (y) four.

(c) Officer’s Certificates . Additionally, an Officer’s Certificate in a form reasonably acceptable to Lessor shall be delivered to Lessor quarterly of each Lease Year during the Term with each Percentage Rent payment, setting forth the calculation of such rent payment for such quarter. Such quarterly payments shall be as set forth in Section 3.1(b).

In addition, on or before January 25 of each year, commencing with January 25 first following the end of the Fiscal Year in which the Commencement Date occurs, Lessee shall deliver to Lessor an Officer’s Certificate reasonably acceptable to Lessor setting forth the computation of Percentage Rent accrued and paid during the Fiscal Year that ended on the immediately preceding December 31. If the annual Percentage Rent due and payable for any Fiscal Year (as shown in the applicable Officer’s Certificate) exceeds the amount actually paid as Percentage Rent by Lessee for such year, Lessee shall pay such excess to Lessor at the time such certificate is delivered. If the Percentage Rent actually due and payable for such Fiscal Year is shown by such certificate to be less than the amount actually paid as Percentage Rent for the applicable Fiscal Year, Lessor, at its option, shall reimburse such amount to Lessee or credit such amount against the following months’ Rent payments.

Any difference between the annual Percentage Rent due and payable for any Fiscal Year (as shown in the applicable Officer’s Certificate or as adjusted pursuant to this Section 3.1(c)) and the total amount of quarterly payments for such Fiscal Year actually paid by Lessee as Percentage Rent, whether in favor of Lessor or Lessee, shall bear interest at the Overdue Rate, which interest shall accrue from the close of such Fiscal Year until the amount of such difference shall be paid or otherwise discharged. Any such interest payable to Lessor shall be deemed to be and shall be payable as Additional Charges.

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 Rent . For each Fiscal Year of the Term beginning on or after the CPI Adjustment Year, the Base Rent then in effect, the First Annual Room Revenues Break Point and the Second Annual Room Revenues Break Point shall be adjusted from time to time beginning in the CPI Adjustment Year as follows:

(i) The average Consumer Price Index for the most recently ended Fiscal Year shall be divided by the average Consumer Price Index for the immediately preceding Fiscal Year.

(1) 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 (d)(1) above.

(2) The new threshold dollar amount in the Period 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, if the CPI Adjustment Year were 2004, the amount of Base Rent and the threshold Room Revenues amounts in the Period Revenues Computations for the Fiscal Year commencing January 1, 2005 would be adjusted to reflect any change in the average Consumer Price Index from the Fiscal Year ended December 31, 2003 as compared to the Fiscal Year ended December 31, 2004. Base Rent and the threshold Room Revenues amounts in the Period Revenues Computations for the Fiscal Year commencing January 1, 2005 would be the Base Rent and threshold Room Revenues amounts applicable for the fiscal year ended December 31, 2004 as further adjusted to reflect any change in the average Consumer Price Index from December 31, 2004 as compared to December 31, 2003.

Lessor shall calculate the annual adjustments as soon as reasonably possible after the Consumer Price Index becomes available and shall notify Lessee in writing of the amount of the annual adjustment, together with a copy of the computation showing the adjustment amount. 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.

The “Average Consumer Price Index” for any period shall be the average of the Consumer Price Index for each month during the period.

(ii) If (i) a significant change is made in the number or nature (or both) of items used in determining the Consumer Price Index, or (ii) the Consumer Price Index shall be discontinued for any reason, the Bureau of Labor Statistics shall be requested to furnish a new index comparable to the Consumer Price Index, together with information which will make possible a conversion to the new index in computing the adjustments to Rent hereunder. If for any reason the Bureau of Labor Statistics does not furnish such an index and such information, the parties will instead mutually select, accept and use such other index or comparable statistics on the cost of living that is computed and published by an agency of the United States or a responsible financial periodical of recognized authority.

3.2 Confirmation of Percentage Rent . Lessee shall utilize, or cause to be utilized, an accounting system for the Leased Property in accordance with its usual and customary practices, and in accordance with GAAP and the Uniform System, that will accurately record all data necessary to compute Percentage Rent, and Lessee shall retain, for at least four (4) years after the expiration of each Fiscal Year (and in any event until the reconciliation described in Section 3.1(c) for such Fiscal Year has been made), reasonably adequate records conforming to such accounting system showing all data necessary to compute Percentage Rent for the applicable Fiscal Years. Lessor, at its expense (except as provided herein below), shall have the right from time to time to have its accountants or representatives audit the information that formed the basis for the data set forth in any Officer’s Certificate provided under Section 3.1(c) and, in connection with such audits, to examine all Lessee’s records (including supporting data, franchisor reports 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 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 Percentage Rent actually due from Lessee for any Fiscal Year exceed those reported and paid by Lessee by more than 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. 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 will 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, and (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 will promptly pay and discharge every fine, penalty, interest and cost that may be added for non-payment or late payment of such items (the items referred to in clauses (a) and (b) of this Section 3.3 being additional rent hereunder and being referred to herein collectively as the “Additional Charges”), and 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, including, but not limited to, the right, but not the obligation to pay such Additional Charges on behalf of the Lessee and to require reimbursement thereof by Lessee, together with interest thereon at the Overdue Rate. 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, as Additional Charges, a late charge (to the 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. To the extent that Lessee pays any Additional Charges to Lessor pursuant to any requirement of this Lease, Lessee shall be relieved of its 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 Net Lease Provision . The Rent shall be paid absolutely net to Lessor, 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 V, but subject to any other provisions of this Lease that expressly provide for adjustment or abatement of Rent or other charges or expressly provide that certain expenses or maintenance shall be paid or performed by Lessor.

3.5 Conversion of Property . If, during the Term, Lessee wishes to cease food and beverage operations or institute food and beverage operations at the Facility (all in accordance with the requirements of any applicable Franchise Agreement), Lessee shall give Notice of such desire to Lessor. If, during the Term, Lessor wishes (a) Lessee to cease food and beverage operations or to institute food and beverage operations at the Facility (all in accordance with the requirements of any applicable Franchise Agreement), or (b) to change the franchise affiliation of the Facility or to make substantial renovations to the Facility, Lessor shall give Notice thereof to Lessee. Following any such notice, Lessor and Lessee shall commence negotiations to adjust Rent to reflect the proposed renovation or change to the operation of the Facility, each acting reasonably and in good faith, and subject to Lessor’s reasonable satisfaction that any Rent adjustment will not adversely affect MHI’s status as a real estate investment trust under the Code. 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” the Facility and Lessor shall not change the franchise or commence substantial renovations and Lessee shall continue fulfilling its obligations under the existing terms of this Lease. If no agreement is reached after such 60-day period, Lessee or Lessor, as appropriate, shall withdraw such notice and this Lease shall continue in full force.

ARTICLE 4

IMPOSITIONS

4.1 Payment of Impositions . Subject to Article XII 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 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 hereof (subject to Lessee’s right of contest pursuant to the provisions of Article XII) as the same respectively become due and before any fine, penalty, premium, further interest or cost may be added thereto. Lessor, at its expense, shall, to the extent required or permitted by applicable law, prepare and file all tax returns 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 its capital stock, and Lessee, at its expense, shall, to the extent required or permitted by applicable laws and regulations, prepare and file all other tax returns and reports in respect of 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 retained by Lessor due to an Event of Default shall be applied as

provided in Article XVI. 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 reports. Lessee shall file all personal property tax returns 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 so classified as personal property. Where Lessor is legally required to file personal property tax returns, Lessor shall provide Lessee with copies of assessment notices in sufficient time for Lessee to file a protest. Lessee may, upon notice to Lessor, at Lessee’s option and at Lessee’s sole expense, protest, appeal, or institute such other proceedings (in its or Lessor’s name) as Lessee may deem appropriate to effect a reduction of real estate or personal property assessments for those Impositions to be paid by Lessee, and Lessor, at Lessee’s expense as aforesaid, shall fully cooperate with Lessee in such protest, appeal, or other action. 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. Billings for reimbursement of personal property taxes by Lessee to 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 Lessor’s expense, shall cooperate fully with such activities.

4.2 Notice of Impositions . To the extent Lessor is notified of any Impositions, Lessor shall give prompt Notice to Lessee of such Impositions payable by Lessee hereunder, 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 Lessee, whether or not such Imposition is imposed before or after such termination, and Lessee’s obligation to pay its prorated share thereof after termination shall survive such termination.

4.4 Utility Charges . Lessee will be solely responsible for obtaining and maintaining utility services to the Leased Property and will pay or cause to be paid all charges for electricity, gas, oil, water, sewer and other utilities used in the Leased Property during the Term.

ARTICLE 5

NO TERMINATION; ABATEMENT

5.1 No Termination, Abatement, etc . Except as otherwise specifically provided in this Lease, Lessee, to the 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, corporation, partnership or other entity, 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 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, the Lease shall not terminate, 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.

ARTICLE 6

PERSONAL PROPERTY; LANDLORD’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 . At all times during the Term, Lessee will maintain Inventory as is required to operate the Leased Property in the manner contemplated by this Lease. Lessee may (and shall as provided herein below), at its expense, install, affix or assemble or place on any parcels of the Land or in any of the Improvements, any items of personal property (including Inventory) owned by Lessee (the “Lessee’s Personal Property”). Lessee may, subject to the conditions set forth herein, remove any of Lessee’s Personal Property upon the

expiration or any prior termination of the Term. All of Lessee’s Personal Property, other than Inventory, not removed by Lessee within ten days following the expiration or earlier termination of the Term shall be considered abandoned by Lessee and may be appropriated, sold, destroyed or otherwise disposed of by Lessor without first giving Notice thereof to Lessee, without any payment to Lessee and without any obligation to account therefor. Lessee will, at its expense, restore the Leased Property to the condition required by Section 9.1(d), including repair of all damage to the Leased Property caused by the removal of Lessee’s Personal Property, whether effected by Lessee or Lessor.

6.3 Lessor’s Lien . To the fullest extent permitted by applicable law, Lessor is granted a lien and security interest on all of Lessee’s Personal Property now or hereinafter placed in or upon the Leased Property, and such lien and security interest shall remain attached to Lessee’s Personal Property until payment in full of all Rent and satisfaction of all of Lessee’s obligations hereunder; provided, however, Lessor shall subordinate its lien and security interest to that of any non-Affiliate of Lessee which finances such Lessee’s Personal Property or any non-Affiliate conditional seller of such Lessee’s Personal Property, the terms and conditions of such subordination to be satisfactory to Lessor in the exercise of reasonable discretion. Lessee shall, upon the request of Lessor, execute such financing statements or other documents or instruments reasonably requested by Lessor to perfect the lien and security interests herein granted.

ARTICLE 7

CONDITIONS; 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 OR 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 IT. 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 for breaches of warranties or representations or for 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 proceed with all due diligence and will exercise its best efforts to obtain and to maintain all approvals needed to use and operate the Leased Property and the Facility under applicable local, state and federal law.

(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 or such other use as otherwise approved by Lessor (the “Primary Intended Use”). Lessee shall not use the Leased Property or any portion thereof or any other use without the prior written consent of Lessor, which consent may be granted, denied or conditioned in Lessor’s sole 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 its 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 XIV, XV, XXI and XXII, Lessee covenants and agrees that during the Term it will (1) operate or cause to operate continuously the Leased Property as a hotel facility, (2) keep in full force and effect and comply with all the provisions of the Franchise Agreement, (3) not terminate or amend the Franchise Agreement without the consent of Lessor, (4) maintain appropriate certifications and licenses for such use and (5) will seek to maximize the gross revenues generated therefrom consistent with sound business practices.

(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 amendments to 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 its 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 is not detrimental to the proper conduct of the business of Lessee on the Leased Property and does not materially reduce the value of the Leased Property.

ARTICLE 8

COMPLIANCE WITH APPLICABLE LAWS

8.1 Compliance with Legal and Insurance Requirements, etc . Subject to Section 8.3(b) below and Article XII relating to permitted contests, and subject further to the obligations of Lessor with respect to Capital Improvements as set forth in Section 9.1 (b), Lessee, at its 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(b) 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 such sub-tenants, invitees 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. If by the terms of any such Legal Requirement compliance therewith pending the prosecution of any such proceeding may legally be delayed without the incurrence of any lien, charge or liability of any kind against the Facility or Lessee’s leasehold interest therein and without subjecting Lessee or Lessor to any liability, civil or criminal, for failure so to comply therewith, Lessee may delay compliance therewith until the final determination of such proceeding. If any lien, charge or civil or criminal liability would be incurred by reason of any such delay, Lessee, on the prior written consent of Lessor, which consent shall not be unreasonably withheld, may nonetheless contest as aforesaid and delay as aforesaid provided that such delay would not subject Lessor to criminal liability and 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 such time as all liabilities, duties or obligations of Lessee to the Lessor under the Lease have been satisfied in full, Lessee shall fully comply with all Environmental Laws applicable to the Leased Property and the operations thereon unless caused by the acts or grossly negligent failures to act of Lessor. Lessee agrees to give Lessor written notice of the following, promptly after Lessee receives knowledge thereof: (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 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) Lessee hereby agrees to defend, indemnify and save harmless any and all Lessor Indemnified Parties from and against any and all Environmental Liabilities except to the extent caused by the willful misconduct or gross negligence of Lessor.

(c) Lessor hereby agrees to defend, indemnify and save harmless any and all Lessee Indemnified Parties from and against any and all Environmental Liabilities caused by the willful misconduct or gross negligence of Lessor.

(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 hereunder the Indemnifying Party, upon request, shall at its 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 its 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, test, 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 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 VIII 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 VIII 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 the Leased Property by virtue of the termination of the Lease or repossession of the Leased Property, then Lessor may assign its 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:

(i) 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;

(ii) Such indemnification rights shall be limited to Environmental Liabilities relating to or specifically affecting the Leased Property; and

(iii) 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.

ARTICLE 9

MAINTENANCE AND REPAIRS

9.1 Maintenance and Repair .

(a) Except as provided in Section 9.1(b) or Articles VIII or XIV, Lessee, at its sole expense, will keep the Leased Property 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, with reasonable promptness, make all necessary and appropriate repairs, replacements, and improvements 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. Lessee, however, shall be permitted to prosecute claims against Lessor’s predecessors in title for breach of any representation or warranty or for any latent defects in the Leased Property to be maintained by Lessee unless Lessor is already diligently pursuing such a claim. All repairs shall, to the extent reasonably achievable, be at least equivalent in quality to the original work. Lessee will not take or omit to take any action, the taking or omission of which might materially impair the value or the usefulness of the Leased Property or any part thereof for its Primary Intended Use.

(b) Except as set forth in Article XVIII of this Lease, Lessee shall be required to make (at the sole cost and expense of Lessor) all Capital Expenditures required in connection with (i) Emergency Situations, (ii) Legal Requirements, (iii) maintenance of the Franchise Agreement, (iv) the performance by Lessee of its obligations under this Lease, and (v) other additions to the Leased Property as it may reasonably deem appropriate and that are permitted hereunder during the Term.

(c) 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 good order and repair, as would a prudent owner, during the entire Term of the Lease, to the extent required in Section 9.1(a)), or damage by casualty or Condemnation (subject to the obligations of Lessee to restore or repair as set forth in the Lease.)

9.2 Encroachments, Restrictions, etc . If any of the 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, at its expense, subject to its 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 Improvements, and take such other actions, as Lessee in the good faith exercise of its judgment deems reasonably practicable to remove such encroachment, and to end such violation or impairment, including, if necessary, the alteration of any of the Improvements, and in any event take all such actions as may be necessary in order to be able to continue the operation of the Improvements for the Primary Intended Use substantially in the manner and to the extent the Improvements were operated prior to the assertion of such violation, impairment or encroachment. Any such alteration shall be made in conformity with the applicable requirements of Article X. Lessee’s obligations under this Section 9.2 shall be in addition to and shall in no way discharge or diminish any obligation of any insurer under any policy of title or other insurance held by Lessor.

ARTICLE 10

ALTERATIONS

10.1 Alterations . Lessor shall have the right to make additions, modifications or improvements to the Leased Property from time to time as Lessor, in its discretion, may deem to be desirable for the permitted uses and purposes of the Leased Property, provided that such action will not significantly alter the character or purposes or significantly detract from the value or operating efficiency thereof and will not significantly impair the revenue-producing capability of the Leased Property or adversely affect the ability of the Lessee to comply with the provisions of this Lease. The cost of such additions, modifications or improvements to the Leased Property shall be paid by Lessor, and all such additions, modifications and improvements shall, be included under the terms of this Lease and shall at all times be the property of Lessor.

ARTICLE 11

PROHIBITED LIENS AND ENCUMBRANCES

11.1 Liens . Subject to the provision of Article XII relating to permitted contests, Lessee will not directly or indirectly create or allow to remain and will promptly discharge at its 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 XXIII hereof, (f) liens for Impositions or for sums resulting from noncompliance with Legal Requirements so long as (1) the same are not yet payable or are payable without the addition of any fine or penalty or (2) such liens are in the process of being contested as permitted by Article XII, (g) liens of mechanics, laborers, material-men, 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 XII hereof, and (h) any liens which are the responsibility of Lessor pursuant to the provisions of Article IV of this Lease.

ARTICLE 12

PERMITTED CONTESTS

12.1 Permitted Contests . Lessee shall have the right to 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 XI, by appropriate legal proceedings in good faith and with due diligence (but this shall not be deemed or construed in any way to relieve, modify or extend Lessee’s covenants to pay or its covenants to cause to be paid any such charges at the time and in the manner as in this Article XII provided), on condition, however, that such legal proceedings shall not operate to relieve Lessee from its obligations hereunder and shall not cause the sale or risk the loss of the Leased Property, or any part thereof, or cause Lessor or Lessee to be in default under any mortgage, deed of trust or security deed encumbering the Leased Property or any interest therein. Upon the request of Lessor, Lessee shall either (a) provide a bond or other assurance reasonably satisfactory to Lessor that all Claims which may be assessed against the Leased Property together with interest and penalties, if any, thereon will be paid, or (b) deposit within the time otherwise required for payment with a bank or trust company as trustee upon terms reasonably satisfactory to Lessor, as security for the payment of such Claims, money in an amount sufficient to pay the same, together with interest and penalties in connection therewith, as to all Claims which may be assessed against or become a Claim on the Leased Property, or any part thereof, in said legal proceedings. Lessee shall furnish Lessor and any lender of Lessor with reasonable evidence of such deposit within five days of the same. Lessor agrees to join in any such proceedings if the same be required to legally prosecute such contest of the validity of such Claims; provided, however, that Lessor shall not thereby be subjected to any liability for the payment of any costs or expenses in connection with any proceedings brought by Lessee; and Lessee covenants to indemnify and save harmless Lessor from any such costs or expenses. 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. In the event

that Lessee fails to pay any Claims when due or to provide the security therefor as provided in this paragraph and to diligently prosecute any contest of the same, Lessor may, upon ten days advance Notice to Lessee, pay such charges together with any interest and penalties and the same shall be repayable by Lessee to Lessor as Additional Charges at the next Payment Date provided for in this Lease. Provided, however, that should Lessor reasonably determine that the giving of such Notice would risk loss to the Leased Property or cause damage to Lessor, then Lessor shall give such Notice as is practical under the circumstances. Lessor reserves the right to contest any of the Claims at its expense not pursued by Lessee. Lessor and Lessee agree to cooperate in coordinating the contest of any Claims.

ARTICLE 13

INSURANCE REQUIREMENTS

13.1 General Insurance Requirements . During the Term of this Lease, Lessee and/or Lessor, as applicable shall at all times keep the Leased Property insured (or cause the Leased Property to be insured) with the kinds and amounts of insurance described below. This insurance shall be written by companies authorized to issue insurance in the State. The policies must name Lessor and/or Lessee, as the insured or as an additional named insured, as the case may be. Losses shall be payable to Lessor or Lessee as provided in this Lease. Any loss adjustment shall require the written consent of Lessor and Lessee, each acting reasonably and in good faith. Evidence of insurance shall be deposited with Lessor (with a copy to Lessee). The policies on the Leased Property, including the Improvements, Fixtures and Lessee’s Personal Property, shall include:

(a) To be paid for by Lessor as primary insured, with Lessee (lender or ground lessor, as applicable) as additional insured:

(i) Building insurance on the “Special Form” (formerly “All Risk” form) (including earthquake and flood in reasonable amounts as determined by Lessor) in an amount not less than 100% of the then full replacement cost thereof (as defined in Section 13.2) or such other amount which is acceptable to Lessor, and personal property insurance on the “Special Form” in the full amount of the replacement cost thereof;

(ii) Insurance for loss or damage (direct and indirect) from steam boilers, pressure vessels or similar apparatus, now or hereafter installed in the Facility, in the minimum amount of $5,000,000 or in such greater amounts as are then customary or as may be reasonably requested by Lessor from time to time;

(b) To be paid for by Lessee as primary insured, with Lessor, franchisor and Manager, as required, as additional insured:

(i) Personal property insurance on the “Special Form” in the full amount of the replacement cost thereof for any personal property owned by Lessee;

(ii) Loss of income insurance on the “Special Form”, in the amount of one year of the sum of Base Rent plus Percentage Rent (based on the most recently completed Lease Year of operation or, to the extent the Leased Property has not been operated for an entire 12-month Lease Year, based on prorated Percentage Rent) for the benefit of Lessor, and business interruption insurance on the “Special Form” in the amount of one year of gross operating profit, for the benefit of Lessee;

(iii) Commercial general liability insurance, with amounts not less than $1,000,000 combined single limit for each occurrence and $2,000,000 for the aggregate of all occurrences within each policy year, as well as excess liability (umbrella) insurance with limited of at least $35,000,000 per occurrence, covering each of the following: bodily injury, death, or property damage liability per occurrence, personal and advertising injury, general aggregate, products and completed operations, with respect to Lessor, and “all risk legal liability” including liquor law or “dram shop” liability if liquor or alcoholic beverages are served on the Leased Property) with respect to Lessor and Lessee;

(c) To be paid for by Lessee for the benefit of Manager as primary insured, with Lessor and Lessee as additional insured:

(i) Automobile insurance on vehicles operating in conjunction with the Facility with limits of liability of at least $1,000,000 combined, single limit coverage;

(ii) Workers’ compensation and employer’s liability insurance as may be required under applicable laws to the extent necessary to protect Lessor, Lessee, and the Leased Property against workers’ compensation claims covering all employees at the Facility, with such deductible limits or self insured retentions as may be established from time to time by Lessee and/or it’s Manager;

(iii) Fidelity bonds, or dishonest employee insurance with limits and deductibles as may be reasonably requested by Lessor, covering Manager’s employees in job classifications normally bonded under prudent hotel management practices in the United States or otherwise required by law; and

(d) Such other insurance covering such other hazards and in such amounts as may be customary for comparable properties in the area of the Leased Property to be paid for and carried by Lessor or Lessee, as customary, and which is available from insurance companies, insurance pools or other appropriate companies authorized to do business in the State at rates which are economically practicable in relation to the risks covered as may be reasonably requested by Lessor.

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 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, the 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.

13.4 Form Satisfactory, etc . All of the policies of insurance referred to in this Article XIII shall be written in a form, with deductibles and by insurance companies satisfactory to Lessor and shall satisfy the requirements of the Franchise Agreement, if any. Lessee shall pay or cause the payment of all of the premiums required for any insurance required to be carried by Lessee hereunder, and shall deliver such policies or certificates thereof to Lessor prior to 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 by Lessee either to effect 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, after ten (10) days’ Notice to Lessee, to effect such insurance and pay the premiums therefor, and to be reimbursed for any premium or premiums upon written demand therefore. Each insurer mentioned in this Article XIII shall agree, by endorsement to the policy or policies issued by it, or by independent instrument furnished to Lessee, that it will give to Lessor thirty (30) days’ written notice before the policy or policies in question shall be materially altered, allowed to expire or canceled.

13.5 Increase in Limits . If either Lessor or Lessee at any time deems the limits of the personal injury or property damage under the comprehensive commercial general liability insurance then carried to be either excessive or insufficient, Lessor or Lessee shall endeavor in good faith to agree on the proper and reasonable limits for such insurance to be carried and such insurance shall thereafter be carried with the limits thus agreed on until further change pursuant to the provisions of this Section.

13.6 Blanket Policy . Notwithstanding anything to the contrary contained in this Article XIII, Lessee 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 by manager at Lessee’s direction; 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 XIII are otherwise satisfied.

13.7 No Separate Insurance . Lessee shall not on Lessee’s own initiative 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 XIII 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 notify Lessor that Lessee has obtained any such separate insurance or of the increasing of any of the amounts of the then existing insurance.

ARTICLE 14

INSURANCE PROCEEDS

14.1 Insurance Proceeds . Subject to the provisions of Section 14.6 and the terms of any lender mortgage, 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 XIII of this Lease shall be paid to Lessor and held by Lessor in an interest-bearing account, shall be made available, if applicable, 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 Lessor from time to time for the reasonable costs of such reconstruction or repair upon satisfaction of reasonable terms and conditions specified by Lessor. Any excess proceeds of insurance remaining after the completion of the restoration or reconstruction of the Leased Property shall be paid to Lessor. If neither Lessor nor Lessee is required or elects to repair and restore, all insurance proceeds shall be retained by Lessor. All salvage resulting from any risk covered by insurance shall belong to Lessor.

14.2 Reconstruction in the Event of Damage or Destruction Covered by Insurance .

(a) Except as provided in Section 14.6, if during the Term the Leased Property is totally or partially destroyed by a risk covered by the insurance described in Article XIII, whether or not such damage or destruction renders the Facility Unsuitable for its Primary Intended Use, Lessee shall be obligated, but only to the extent of any insurance proceeds made available to Lessee and any other sums advanced by Lessor pursuant to the next sentence, to restore the Facility to substantially the same condition as existed immediately before the damage or destruction and otherwise in accordance with the terms of the Lease. If the insurance proceeds are not adequate to restore the Facility to that condition, each of Lessor and Lessee shall have the right to terminate this Lease, without in any way affecting any other leases in effect between Lessor and Lessee, by giving Notice to the other and all insurance proceeds shall be retained by Lessor; provided, however, that, if such termination is by Lessee, Lessor shall have the right, in its sole discretion, to nullify the termination and keep this Lease in full force by providing, within thirty (30) days after Lessee’s Notice of termination, a Notice to Lessee of Lessor’s unconditional, legally binding obligation to be responsible for all restoration costs in excess of the insurance proceeds. If this Lease is not terminated and Lessee restores the Facility, the insurance proceeds, and any other sums made available by Lessor as aforesaid, shall be paid out by Lessor from time to time for the reasonable costs of such restoration upon satisfaction of reasonable terms and conditions, and any excess proceeds remaining after such restoration shall be retained by Lessor.

(b) Notwithstanding the provisions of Section 14.2(a) above, if Lessee cannot within a reasonable time obtain all necessary government approvals, including building permits, licenses and conditional use permits, after diligent efforts to do so, to perform all required repair and restoration work and to operate the Facility for its Primary Intended Use in substantially the same manner as that existing immediately prior to such damage or destruction and otherwise in accordance with the terms of the Lease, either Lessor or Lessee may terminate this Lease by providing Notice to the other party, without in any way affecting any other Leases then in effect between Lessor and Lessee.

14.3 Reconstruction in the event of Damage or Destruction not covered by Insurance . Except as provided in Section 14.6, if during the Term the Facility is totally or materially destroyed by a risk not covered by the insurance described in Article XIII, whether or not such damage or destruction renders the Facility Unsuitable for its Primary Intended Use, the provisions of Section 14.2 applicable to casualties for which insurance proceeds are inadequate shall govern.

14.4 Lessee’s Property . All insurance proceeds payable by reason of any loss of or damage to any of Lessee’s Personal Property shall be paid to Lessee; provided, however, that no such payments shall diminish or reduce the insurance payments otherwise payable to or for the benefit of Lessor hereunder.

14.5 Abatement of Rent . Any damage or destruction due to casualty notwithstanding, this Lease shall remain in full force and effect (unless otherwise terminated as set forth hereinabove) and Lessee’s obligation to make rental payments and to pay Rent required by this Lease shall remain unabated by any damage or destruction which does not result in a reduction of Gross Revenues. If and to the extent that any damage or destruction results in a reduction of Gross Revenues which would otherwise be realizable from the operation of the Facility, then Lessor shall receive all loss of income insurance and Lessee shall have no obligation to pay Rent in excess of the amount of Percentage Rent, if any, realizable from Gross Revenues generated by the operation of the Leased Property during the existence of such damage or destruction.

14.6 Damage near end of Term . Notwithstanding any provisions of Section 14.2 or 14.3 to the contrary, if damage to or destruction of the Facility unsuitable for its Primary Intended Use occurs during the last twenty-four (24) months of the Term, then Lessee shall have the right to terminate this Lease by giving written notice to Lessor within thirty (30) days after the date of damage or destruction, whereupon all accrued Rent shall be paid immediately, and this Lease shall automatically terminate five days after the date of such notice.

14.7 Waiver . Lessee hereby waives any statutory rights of termination that may arise by reason of any damage or destruction of the Facility that Lessor is obligated to restore or may restore under any of the provisions of this Lease.

ARTICLE 15

CONDEMNATION; TAKING

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 awarded, 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 any Condemnation of all or any part of the Leased Property or any interest in this Lease, the rights and obligations of Lessor and Lessee shall be determined by this Article XV.

15.3 Total Taking . If title to the fee of the whole of the Leased Property 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 Allocation of Award . The total Award made with respect to the Leased Property in connection with a Total Taking shall be equitably apportioned between Lessor and Lessee in proportion to the then fair market values of the respective estates and interests of Lessor and Lessee in and to the Leased Property and under this Lease.

15.5 Partial Taking . If less than the whole of the Leased Property is condemned, and the 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 elects not to terminate this Lease as provided in Section 15.3, Lessee at its cost shall with all reasonable dispatch, but only to the extent of any condemnation awards made available to Lessee and any other sums advanced by Lessor pursuant to the next sentence, restore the untaken portion of any Improvements so that such Improvements constitute a complete architectural unit of the same general character and condition (as nearly as may be possible under the circumstances) as the Improvements existing immediately prior to the Condemnation. If the condemnation awards are

not adequate to restore the Facility to that condition, each of Lessor and Lessee shall have the right to terminate this Lease, without in any way affecting any other leases in effect between Lessor and Lessee, by giving Notice to the other; provided, however, that if such termination is by Lessee, Lessor shall have the right, in its sole discretion, to nullify the termination and keep this Lease in full force by providing, within thirty (30) days after Lessee’s Notice of termination, a Notice to Lessee of Lessor’s unconditional, legally binding obligation to be responsible for all restoration costs in excess of the condemnation awards. If this Lease is not terminated and Lessee restores the Facility, the condemnation awards, and any other sums made available by Lessor as aforesaid, subject to the terms of any lender mortgage, shall be held in trust by Lessor and paid out by Lessor from time to time for the reasonable costs of such restoration upon satisfaction of reasonable terms and conditions, and any excess awards remaining after such restoration shall be retained by Lessor unless the partial condemnation materially impairs the operations or financial performance of the Facility, in which latter event the award shall be equitably apportioned between Lessor and Lessee in proportion to the then fair market values of the respective estates and interests of Lessor and Lessee in and to the Leased Property and under this Lease.

15.6 Temporary Taking . If the whole or any part of the Leased Property 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, and Lessee shall continue to pay, in the manner and at the terms herein specified, the full amounts of the Base Rent, Percentage Rent and Additional Charges. In addition, 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 Lessee and, except for any portion thereof utilized for restoration, shall be deemed to be Room Revenues for the purpose of calculating the Percentage Rent payable hereunder during such temporary taking. 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. Lessee covenants that upon the termination of any such period of temporary use or occupancy it will, at its sole cost and expense (subject to Lessor’s contribution as set forth below), restore the Leased Property as nearly as may be reasonably possible to the condition in which the same was immediately prior to such Condemnation, unless (a) 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, or (b) the condemnation award is inadequate to cover the costs of such restoration, in which case the provisions of Section 15.5 applicable to inadequate awards shall govern. If restoration is required in connection with such temporary taking and the condemnation award (together with any other sums Lessor elects, in its sole discretion, to advance) is adequate to pay the costs thereof, the provisions of Section 15.5 shall govern the disbursement of the awards (and other sums, if applicable) and the disposition of any awards in excess of restoration costs. If restoration is required hereunder, Lessor shall contribute to the cost of such restoration that portion of its entire Award that is specifically allocated to such restoration in the judgment or order of the court, if any, and Lessee shall fund the balance of such costs in advance of restoration in a manner reasonably satisfactory to Lessor.

ARTICLE 16

EVENTS OF DEFAULT; REMEDIES; DAMAGES

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 or Percentage Rentor Additional Charges when the same become due and payable for a period of ten (10) days after receipt by the Lessee of Notice from the Lessor thereof;

(b) if Lessee fails to observe or perform any term, covenant or condition of this Lease, other than the payment of Rent or Additional Rent, 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, that in no event shall such cure period extend beyond one hundred and twenty (120) days after such Notice; or

(c) 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 its inability to pay its debts generally as they become due, or if a petition or answer proposing the adjudication of the Lessee as a bankrupt or its reorganization pursuant to any federal or state bankruptcy law or any similar federal or state law shall be filed in any court and the Lessee shall be adjudicated a bankrupt and such adjudication shall not be vacated or set aside or stayed within 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 sixty (60) days after such appointment; or

(d) 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 its assets; or

(e) 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 XII hereof); or

(f) if, except as a result of and to the extent required by damage, destruction, partial or complete Condemnation or Unavoidable Delay, Lessee voluntarily ceases operations on the Leased Property for a period in excess of thirty (30) days; or

(g) if: (A) an Event of Default has been declared by the franchisor under the Franchise Agreement with respect to the Facility on the Leased Premises as a result of any action or failure to act by Lessee or any Person with whom Lessee contracts for management services at the Facility, and (B) Lessee has failed, within thirty (30) days thereafter, to cure such default by either (1) curing the underlying default under the Franchise Agreement and paying all costs and expenses associated therewith, or (2) obtaining at Lessee’s sole cost and expense a substitute franchise license agreement with a substitute franchisor acceptable to Lessor, on terms and conditions acceptable to Lessor; provided, however, that if Lessee is in good faith disputing an assertion of default by the franchisor or is proceeding diligently to cure such default, the 30-day period shall be extended for such period of time as Lessee continues to dispute such default in good faith or diligently proceeds to cure such default, so long as there is no period during which the Facility is not operated pursuant to a Franchise Agreement approved by Lessor; 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, its right to terminate this Lease by giving Lessee not less than ten (10) days’ Notice of such termination.

If litigation is commenced with respect to any alleged default under this Lease, the prevailing party in such litigation shall receive, in addition to its damages incurred, such sum as the court shall determine as its reasonable attorneys’ fees, and all costs and expenses incurred in connection therewith.

No Event of Default (other than a failure to make a payment of money) shall be deemed to exist under clause (c) above during any time the curing thereof is prevented by an 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 to Lessor 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. Lessor shall be under no obligation to, but may if it so chooses, re-let the Leased Property or otherwise mitigate Lessor’s damages, except unless otherwise required by applicable law.

16.3 Damages . Neither (a) the termination of this Lease, (b) the repossession of the Leased Property, (c) the failure of Lessor to re-let the Leased Property, nor (d) the re-letting of all or any portion thereof, shall relieve Lessee of its liability and obligations hereunder, all of which shall survive any such termination, repossession or re-letting. 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.

Lessee shall forthwith pay to Lessor, at Lessor’s option, as and for liquidated and agreed current damages for Lessee’s default, either:

(a) Without termination of Lessee’s right to possession of the Leased Property, each installment of Rent and other sums payable by Lessee to Lessor under the Lease as the same becomes due and payable, which Rent and other sums shall bear interest at the Overdue Rate, and Lessor may enforce, by action or otherwise, any other term or covenant of this Lease; or

(b) the sum of:

(i) the unpaid Rent which had been earned at the time of termination, repossession or reletting, and

(ii) the amount 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

(iii) any other amount necessary to compensate Lessor for all the detriment proximately caused by Lessee’s failure to perform its obligations under this Lease or which in the ordinary course of things, would be likely to result therefrom. The amount at the time of termination, repossession or reletting referred to in subparagraph (B) is computed by discounting such amount at the discount rate of the Federal Reserve Bank of New York at the time of award plus 1%.

Rent for the purposes of this Section 16.3 shall be a sum equal to (i) the average of the annual amounts of the greater of the Base Rent or 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 greater of the Base Rent or Percentage Rent during the preceding Fiscal Years during which the Lease was in effect, or (iii) if one Fiscal Year has not elapsed, the amount derived by annualizing the greater of the Base Rent or 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 XVI, and (b) the benefit of any laws now or hereafter in force exempting property from liability for rent or for debt and Lessor waives any right to “pierce the corporate veil” of Lessee other than to the extent funds shall have been inappropriately paid to any Affiliate of Lessee following a default resulting in an Event of Default.

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

17.1 Lessor’s Right to Cure Lessee’s Default . 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, 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 XVII shall survive the expiration or earlier termination of this Lease.

ARTICLE 18

RESERVED

ARTICLE 19

REIT REQUIREMENTS

19.1 REIT Requirements .

(a) Lessee understands that, in order for MHI to qualify as a REIT, the following requirements (the “REIT Requirements”) must be satisfied:

(i) The average of the fair market values of Lessor’s personal property that is leased to Lessee under a lease at the beginning and end of a calendar year cannot exceed 15% of the average of the aggregate fair market values of all of Lessor’s property that is leased to Lessee under such lease at the beginning and end of such calendar year.

(ii) Lessee cannot sublet the property that is leased to it by Lessor, or enter into any similar arrangement, on any basis such that the rental or other amounts

paid by the sublessee thereunder would be based, in whole or in part, on either (i) the net income or profits derived by the business activities of the sublessee or (ii) any other formula such that any portion of the rent paid by Lessee to Lessor would fail to qualify as “rents from real property” within the meaning of Section 856(d) of the Code.

(iii) Lessee cannot sublease the property leased to it by Lessor to, or enter into any similar arrangement with, any person in which MHI owns, directly or indirectly, a 10% or more interest, within the meaning of Section 856(d)(2)(B) of the Code.

(iv) Lessee agrees to make an election to be, and to operate as a “Taxable REIT Subsidiary” of MHI within the meaning of Section 856(l) of the Code.

(v) No person can own, directly or directly, capital stock of MHI that exceeds the “LIMIT” (as defined in MHI’s certificate of incorporation, as amended and restated).

(vi) 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 its Affiliates.

(b) Lessee agrees, and agrees to use reasonable efforts to cause its Affiliates, to use its best efforts to permit the REIT Requirements to be satisfied. Lessee agrees, and agrees to use reasonable efforts to cause its Affiliates, to cooperate in good faith with MHI and Lessor to ensure that the REIT Requirements are satisfied, including but not limited to, providing MHI with information about the ownership of Lessee, and its Affiliates to the extent that such information is reasonably available. Lessee agrees, and agrees to use reasonable efforts to cause its Affiliates, upon request by MHI, and, where appropriate, at MHI’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 its Affiliates to notify, MHI of such noncompliance.

19.2 Lessee Officer and Employee Limitation . Anything contained in this Lease to the contrary notwithstanding, none of the officers or employees of the Lessee or any subsidiary of Lessee shall be officers or employees of Manager (or any Person who operates or manages the Leased Property). In addition, if a Person serves as both (a) a director of the Lessee or any subsidiary of Lessee and (b) a director and officer (or employee) of Manager (or any Person who operates or manages the Leased Property), that Person shall not receive any compensation for serving as a director of the Lessee or any subsidiary of Lessee. If a person serves as both (a) a director of Manager or any subsidiary of Manager (or any Person who operates or manages the Leased Property) and (b) a director and officer (or employee) of Lessee, that Person shall not receive any compensation for serving as a director of Manager.

19.3 Management Agreement . Lessee agrees that, in order to comply with certain of the REIT Requirements, it will, at all times during the Term, cause the Leased Property to be operated and managed by a management company (“Manager”) that is an Eligible Independent Contractor. Effective as of the Commencement Date, the Lessee shall enter into an initial management agreement in the form of Exhibit C attached hereto (the “Management Agreement”) and Lessee shall provide Lessor with an executed copy thereof. The Management Agreement is a hotel master management agreement which covers the Leased Property and all of the other hotel properties currently (or to be in the future) leased by Lessee from Affiliates of Lessor. Lessee may not amend, modify or terminate the Management Agreement in any material respect or change the Manager without the prior written consent of Lessor, which consent shall not be unreasonably withheld; provided that a majority of the independent directors of MHI as determined under the AMEX rules and regulations approves such amendment, modification or termination of the Management Agreement. Lessee shall also provide Lessor with copies of any amendments or modifications to the Management Agreement which are entered into from time to time or any other management agreement. Lessor shall have the right to approve in advance any Manager.

ARTICLE 20

HOLDING OVER

20.1 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 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 its 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

21.1 Risk of Loss . During the Term, the risk of loss or of 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 except as specifically provided in this Lease, and, 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 Indemnification . Notwithstanding the existence of any insurance, and without regard to the policy limits of any such insurance or self-insurance, but subject to Articles VIII, XIV and XV, 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 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, “dramshop” or similar laws, (b) any past, present or future use, misuse, non-use, condition, management, maintenance or repair by Lessee or any of its agents, employees or invitees of the Leased Property or Lessee’s Personal Property or any litigation, proceeding or claim by governmental entities 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 its agents, employees or invitees, including any failure of Lessee or any of its agents, employees or invitees 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.

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 (a) the gross negligence or willful misconduct of Lessor arising in connection with this Lease or (b) any failure on the part of Lessor to perform or comply with any of its obligations under this Lease.

Any amounts that become payable by an Indemnifying Party under this Section shall be paid within ten 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 its expense, shall contest, resist and defend any such claim, action or proceeding asserted or instituted against the Indemnified Party. The Indemnified Party, at its 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 against its own grossly negligent acts or omissions or willful misconduct.

Lessee’s or Lessor’s liability for a breach of the provisions of this Article XXII shall survive any termination of this Lease.

ARTICLE 23

SUBLETTING AND ASSIGNMENT

23.1 Subletting and Assignment . Subject to the provisions of Article XIX and Section 23.2 and any other express conditions or limitations set forth herein, Lessee may, but only with the prior written consent of Lessor which consent shall not be unreasonably withheld, (a) assign this Lease or sublet all or any part of the Leased Property to an Affiliate of Lessee, or (b) sublet any retail or restaurant portion of the Improvements in the normal course of the Primary Intended Use; provided that any subletting to any party other than an Affiliate of Lessee shall not individually as to any one such subletting, or in the aggregate, materially diminish the actual or potential Percentage Rent payable under this Lease. 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 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. 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

REPORTING AND CERTIFICATION REQUIREMENTS

24.1 Officer’s Certificates; Financial Statements; Budgets; Lessor’s Estoppel Certificates and Covenants .

(a) At any time and from time to time upon not less than twenty (20) days Notice by Lessor, Lessee will furnish to 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 to the knowledge of Lessee there is any existing default or Event of Default exists thereunder by Lessor or Lessee, 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, any lender and any prospective purchaser of the Leased Property.

(b) Throughout the Term, Lessee will furnish to Lessor such historical financial information of Lessee and the Facility as Lessor may reasonably request and shall provide Lessor access to Lessee’s books and records with respect thereto.

(c) Within five (5) days of Lessee’s receipt thereof, any inspection reports received from the franchisor under the Franchise Agreement.

(d) At any time and from time to time upon not less than twenty (20) days notice by Lessee, Lessor will furnish to Lessee or to 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 to the knowledge of Lessor there is any existing default or Event of Default on Lessee’s part hereunder, and such other information as may be reasonably requested by Lessee.

24.2 Operating Budget . Not later than forty-five (45) days prior to the commencement of each Lease Year, Lessee, in consultation with the Manager, shall prepare and submit to Lessor an operating budget for the Lease Year (the “Operating Budget”) in form and substance reasonably satisfactory to Lessor, prepared in accordance with the requirements of this Section 24.2. The Operating Budget shall be prepared in accordance with the Uniform System to the extent applicable and show by month and quarter and for the Lease Year as a whole in the degree of detail specified by the Uniform System for monthly statements, and in accordance with the detail level of monthly financial statements, the following:

(a) Lessee’s reasonable estimate of Gross Revenues, Room Revenues, Food Sales and Beverage Sales (including room rates) for the Facility for the forthcoming Lease Year itemized on schedules on a monthly and quarterly basis as approved by Lessor and Lessee, together with the assumptions, in narrative form, forming the basis of such schedules;

(b) A cash flow projection for the Lease Year; and

(c) Lessee’s reasonable estimate for each quarter of the Lease Year of Percentage Rent.

24.3 Capital Budget . Not later than forty-five (45) days prior to the commencement of each Lease Year, Lessee shall prepare and submit to Lessor a capital improvement budget for the Lease Year (the “Capital Budget”) prepared in accordance with the Uniform System to the extent applicable, and shall set forth the proposed Capital Expenditures for the ensuing Lease Year.

ARTICLE 25

LESSOR’S DEFAULT; CURE RIGHTS

25.1 Lessee’s Right to Cure . Subject to the provisions of Section 25.2, 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 25.1 shall survive the termination of this Lease with respect to the Leased Property.

25.2 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 its 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 30-day period, proceeds promptly and with due diligence to cure the failure and diligently completes the curing thereof. 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.

ARTICLE 26

NOTICES

26.1 Notices . All notices, demands, requests, consents approvals and other communications (“Notice” or “Notices”) hereunder shall be in writing and personally served, mailed (by registered or certified mail, return receipt requested and postage prepaid) or sent by facsimile, addressed to Lessor at , Facsimile , Attention: , and addressed to Lessee at , Attention: , Facsimile , or to such other address or addresses as either party may hereafter designate. 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 days.

ARTICLE 27

MISCELLANEOUS PROVISIONS

27.1 Transfer of Licenses . Upon the expiration or earlier termination of the Term, Lessee shall use its best efforts (i) to transfer to Lessor or Lessor’s nominee or designee all Franchise Agreements, 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 the Facility (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, all 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.

27.2 Early Termination Rights; Termination Fees . Lessor may terminate the Lease as to any Leased Property prior to the Expiration Date by reason of a sale of the Facility, (pursuant to the notice requirements contained herein), provided Lessor pays to Lessee a termination fee (the “Termination Fee”) equal to the fair market value of the leasehold estate.

27.3 Substitution of Initial Hotel . Notwithstanding the foregoing Section 27.2, in the event of a termination of this Lease, Lessor may (in its sole and absolute discretion) avoid payment of the Termination Fee by offering to substitute for the Leased Property within 120 days of such termination, another hotel facility reasonably comparable in size, number of rooms, quality of franchise operation, market and geographical location, and gross revenues, to be governed by the terms and conditions of this Lease from and after the date of such substitution, and, in the event Lessee desires to lease such substitute hotel, this Lease shall be amended accordingly. In the event of a substitution, any Rent and other charges payable under this Lease shall be suspended until the substitution is fully consummated.

27.4 Compliance with Franchise Agreement . To the extent any of the provisions of the Franchise Agreement impose a greater obligation on Lessee than the corresponding provisions of this Lease, then Lessee shall be obligated to comply with the provisions of the Franchise Agreement except in regard to those obligations which are the responsibility of Lessor as provided herein. It is the intent of the parties hereto that Lessee shall comply in every respect with the provisions of the Franchise Agreement so as to avoid any default thereunder during the term of this Lease. Lessee shall not terminate, extend or enter into any modification of the Franchise Agreement without in each instance first obtaining Lessor’s prior written consent. Lessor and Lessee agree to cooperate with each other in the event it becomes necessary to obtain a franchise extension or modification or a new franchise for the Leased Property, and in any transfer of the Franchise Agreement to Lessor (if applicable) or any designee of or any successor to Lessee (as applicable) upon the termination of this Lease. In the event of expiration or termination of a Franchise Agreement, for whatever reason, the Lessor will have the right, in its sole discretion, to approve any new Franchise Agreement for the Facility. If, upon any expiration or earlier termination of this Lease (other than upon an Event of Default by Lessee), a Franchise Agreement remains in effect, or would but for such expiration or termination remain in effect,

Lessor shall indemnify, defend and hold Lessee harmless with respect to the obligations and liabilities arising thereunder after the date of expiration or termination of this Lease.

27.5 Lessor’s Right to Inspect . Lessee shall permit Lessor and its authorized representatives as frequently as reasonably requested by Lessor to inspect the Leased Property and Lessee’s accounts and records pertaining thereto and make copies thereof, during usual business hours upon reasonable advance notice, subject only to any business confidentiality requirements reasonably requested by Lessee, provided that Lessor shall not cause any interference with the operation of the Leased Property.

27.6 Conveyance by Lessor . If Lessor or any successor owner of the Leased Property conveys the Leased Property to a Person other than a wholly owned Affiliate of Lessor in accordance with the terms hereof 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.

27.7 Lessor may Grant Liens . Without the consent of Lessee, Lessor may, subject to the terms and conditions set forth below in this Section 27.7, 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. Upon the request of Lessor, Lessee shall subordinate this Lease to the lien of a new mortgage on the Leased Property.

27.8 Non Disturbance Agreement . Lessor agrees, subject to any restrictions or limitations imposed by any lender of Lessor, to execute in favor of Manager a non disturbance and attornment agreement in form and substance reasonably acceptable to Lessor and Manager.

27.9 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.

27.10 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.

27.11 Usury . 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.

27.12 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 then existing or subsequent breach.

27.13 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.

27.14 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.

27.15 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.

27.16 Quiet Enjoyment . So long as Lessee pays all Rent as the same becomes due and complies with all of the terms of this Lease and performs its 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.

27.17 Binding Effect . The covenants, terms, conditions, provisions and undertakings in this Lease shall extend to and be binding upon the heirs, personal representatives, executors, administrators and permitted successors and assigns of the respective parties hereto.

27.18 Entire Agreement; No Offer . This Lease contains the entire agreement of Lessor and Lessee with respect to the subject matter hereof, and no representations, warranties, inducements, promises or agreements, oral or otherwise, between the parties not embodied in this Lease shall be of any force or effect. This Lease may be modified only by a written agreement executed by both parties with the same formalities as this Lease. All prior agreements or communications are and shall be merged into this Lease and shall have no force or effect.

Neither any submission of this Lease by one party to the other, nor any correspondence or other communications between the parties in connection therewith, is intended or shall be deemed to constitute an offer of any kind or to create any obligations between the parties unless and until one or more duplicates of this Lease has been fully executed and delivered between the parties. Accordingly, any such submission or communications or correspondence between the parties or their respective agents or attorneys is intended only as non-binding discussions, and either party shall have the absolute right to withdraw from such discussions without any liability whatsoever to the other party.

27.19 Severability . If any clause or provision of this Lease is illegal, invalid or unenforceable under applicable present or future Laws effective during the Term, the remainder of this Lease shall not be affected. In lieu of each clause or provision of this Lease which is illegal, invalid or unenforceable, there shall be added as a part of this Lease a clause or provision as nearly identical as may be possible and as may be legal, valid and enforceable. Notwithstanding the foregoing, in the event any clause or provision of this Lease is illegal, invalid or unenforceable as aforesaid and the effect of such illegality, invalidity or unenforceability is that Lessor no longer has the substantial benefit of its bargain under this Lease, then, in such event, Lessor may in its discretion cancel and terminate this Lease upon providing at least ninety (90) days advance notice thereof to Lessee.

27.20 Counterparts . This Lease may be executed in several counterparts, each of which shall be deemed an original, and all of such counterparts together shall constitute one and the same instrument.

27.21 Governing Law . This lease and its interpretation, validity and performance shall be governed by the laws of the state in which the Land is situate. In the event any court of law of appropriate judicial authority shall hold or declare that the law of another jurisdiction is applicable, this lease shall remain enforceable under the laws of the appropriate jurisdiction. The parties hereto agree that venue for any action in connection herewith shall be proper in the state or federal courts in or having jurisdiction over the county where the Land is situated. Each party hereto consents to the jurisdiction of any local, state or federal court situated in any of such locations and waives any objection which it may have pertaining to improper venue or forum non conveniens to the conduct of any proceeding in any such court.

27.22 Recitals; Headings . The recitals set forth in this Lease are true and correct, and are incorporated herein by this reference. The use of headings, captions and numbers in this Lease is solely for the convenience of identifying and indexing the various paragraphs and shall in no event be considered in construing or interpreting any provision in this Lease.

27.23 Survival . Notwithstanding anything to the contrary contained in this Lease, the provisions (including, without limitation, covenants, agreements, representations, warranties, obligations and liabilities described therein) of this Lease which from their sense and context are intended to survive the expiration or sooner termination of this Lease shall survive such expiration or sooner termination of this Lease and continue to be binding upon the applicable party.

27.24 Exhibits . The exhibits referred to in, and attached to, this Lease are hereby incorporated in full by reference. Unless otherwise expressly provided in the exhibit or the body of this Lease, in the event of any conflict or inconsistency with the provisions contained in the body of this Lease and the exhibits, the provisions contained in the body of this Lease shall control.

[Signatures follow on next page]

IN WITNESS WHEREOF, the parties have executed this Lease by their duly authorized officers as of the date first above written.


“LESSOR”

[OWNER ENTITY],
a [ ]

By:
[ ]
[ ]


“LESSEE”

MHI Hospitality TRS, LLC
A Delaware limited liability company

By:
[ ]
[ ]

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

MHI Hospitality Corporation

Williamsburg, Virginia

We consent to the use of our report dated August 25, 2004 on the balance sheet of MHI Hospitality Corporation as of August 25, 2004, included herein and to the reference of our firm under the headings “Experts” and “Selected Financial Data” in the prospectus.

We consent to the use of our report dated August 24, 2004 on the combined balance sheets of MHI Hotels Services Group as of December 31, 2003 and 2002 and the related combined statements of operations and partners’/members’ equity and cash flows for each of the years in the three-year period ended December 31, 2003, included herein and to the reference of our firm under the headings “Experts” and “Selected Financial Data” in the prospectus.

We also consent to the use of our report dated August 24, 2004 on the combined balance sheets of Elpizo Limited Partnership as of December 31, 2003 and 2002 and the related combined statements of operations’ and partners’ equity and cash flows for the years then ended, included herein and to the reference of our firm under the headings “Experts” and “ Selected Financial Data” in the prospectus.

We also consent to the use of our report dated August 24, 2004 on the balance sheets of Accord, LLC as of December 31, 2003 and 2002 and the related statements of operations’ and members’ equity and cash flows for the years then ended, included herein and to the reference of our firm under the headings “Experts” and “Selected Financial Data” in the prospectus.

/s/ Witt, Mares & Company, PLC

Williamsburg, Virginia

October 19, 2004

Exhibit 99.6

CONSENT OF PERSON ABOUT TO BE NAMED DIRECTOR

MHI Hospitality Corporation intends to file a Registration Statement on Form S-11 (together with any amendments, the “Registration Statement”) registering shares of common stock for issuance in its initial public offering. As required by Rule 438 under the Securities Act of 1933, as amended, the undersigned hereby consents to being named in the Registration Statement as a person who is serving as a director or has agreed to serve as a director beginning immediately after the closing of the offering.


Signature:		/s/ Anthony C. Zinni

Print Name:		Anthony C. Zinni

Date:		October 14, 2004