NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - DESCRIPTION OF BUSINESS
General
Summit Hotel Properties, Inc. (the “Company”) is a self-managed hotel investment company that was organized on June 30, 2010 as a Maryland corporation. The Company holds both general and limited partnership interests in Summit Hotel OP, LP (the “Operating Partnership”), a Delaware limited partnership also organized on June 30, 2010. Unless the context otherwise requires, “we,” “us,” and “our” refer to the Company and its consolidated subsidiaries.
We focus on owning premium-branded hotel properties with efficient operating models primarily in the Upscale segment of the lodging industry. At March 31, 2022, our portfolio consisted of 101 hotel properties with a total of 15,228 guestrooms located in 24 states. As of March 31, 2022, we own 100% of the outstanding equity interests in 61 of our 101 hotel properties. We own a 51% controlling interest in 40 hotel properties through a joint venture. Our joint venture was formed in July 2019 with GIC (the “Joint Venture”), Singapore’s sovereign wealth fund, to acquire assets that align with our current investment strategy and criteria. We serve as general partner and asset manager of the Joint Venture and we generally invest 51% of the equity capitalization of the limited partnership, with GIC investing the remaining 49%. The Joint Venture typically finances assets with a 50% overall leverage target.
We have elected to be taxed as a real estate investment trust (“REIT”) for federal income tax purposes. To qualify as a REIT, we cannot operate or manage our hotel properties. Accordingly, all of our hotel properties are leased to our taxable REIT subsidiaries (“TRS Lessees”).
During the quarter ended March 31, 2022, the Operating Partnership and the Joint Venture closed on a transaction with NewcrestImage Holdings, LLC, a Delaware limited liability company, and NewcrestImage Holdings II, LLC, a Delaware limited liability company (together, “NewcrestImage”), to purchase from NewcrestImage a portfolio of 27 hotel properties, containing an aggregate of 3,709 guestrooms, and two parking structures, containing 1,002 spaces (such hotel properties and parking structures, the “Portfolio”), and various financial incentives for an aggregate purchase price of $822.0 million (the "NCI Transaction"). See "Note 3 - Investment in Hotel Properties, net - Acquisition of NewcrestImage Portfolio" for further information.
Risks and Uncertainties
The Company is subject to risks and uncertainties as a result of the effects of the novel coronavirus, designated as COVID-19 (“COVID-19”) and its variants, for at least the near future. The pandemic has had a significant negative effect on the U.S. and global economies, including a rapid and sharp decline in all forms of travel, both domestic and international, and a significant decline in hotel demand. These conditions resulted in a substantial decline in our revenues, profitability and cash flows from operations beginning in March, 2020.
Beginning in March 2020, the Company took several actions to reduce costs and increase liquidity to mitigate the effects of the COVID-19 pandemic on the Company. We continue to engage in certain steps to reduce costs while taking appropriate actions to maintain guest safety and satisfaction. For additional information concerning such actions taken in response to the effects of the COVID-19 pandemic on our business, please see our Annual Report on Form 10-K for the year ended December 31, 2021.
During the three months ended March 31, 2022, we continued to experience significant improvement in our business compared to earlier in the Pandemic, driven primarily by leisure travel and to a lesser extent modest improvement in other demand segments, including corporate and group. The improvement was the result of a significant increase in the availability and administration of vaccines globally as well as the easing of government restrictions and guidance in most jurisdictions. We anticipate that continued improvement in operating trends will be dependent on continued strength in leisure travel and a recovery of business travel. More broadly, a return to normalized levels of operations is dependent upon a continuation in the recovery of our business, further dissipation of concerns related to the Pandemic, geopolitical stability, moderating inflation and maintaining a high-quality portfolio aligned with evolving guest preferences.
NOTE 2 - BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
We prepare our Condensed Consolidated Financial Statements in conformity with U.S. Generally Accepted Accounting Principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the Consolidated Financial Statements and reported amounts of revenues and expenses in the reporting period. Actual results could differ from those estimates. As interim statements, the Condensed Consolidated Financial Statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation in accordance with GAAP have been included. Results for the three months ended March 31, 2022 may not be indicative of the results that may be expected for the full year of 2022. For further information, please read the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2021.
The accompanying Condensed Consolidated Financial Statements consolidate the accounts of all entities in which we have a controlling financial interest, as well as variable interest entities for which the Company is the primary beneficiary. All significant intercompany balances and transactions have been eliminated in the Condensed Consolidated Financial Statements.
We evaluate joint venture partnerships to determine if they should be consolidated based on whether the partners exercise joint control. For a joint venture where we exercise primary control and we also own a majority of the equity interests, we consolidate the joint venture partnership. We have consolidated the accounts of our Joint Venture partnership with GIC in our accompanying Condensed Consolidated Financial Statements. See "Note 9 - Non-controlling Interests and Redeemable Non-controlling Interests" for further information.
Investment in Hotel Properties
The Company allocates the purchase price of acquired hotel properties based on the fair value of the acquired land, land improvements, building, furniture, fixtures and equipment, identifiable intangible assets or liabilities, other assets and assumed liabilities. Intangible assets may include certain value associated with the on-going operations of the hotel business being acquired as part of the hotel property acquisition. Acquired intangible assets that derive their values from real property or an interest in real property, are inseparable from that real property or interest in real property, and do not produce or contribute to the production of income other than consideration for the use or occupancy of space, are recorded as a component of the related real estate asset in our Condensed Consolidated Financial Statements. We allocate the purchase price of acquired hotel properties to land, building and furniture, fixtures and equipment based on independent third-party determinations of fair value.
If substantially all of the fair value of the gross assets acquired are concentrated in a single identifiable asset or group of similar identifiable assets, the asset or asset group is not considered a business. When we conclude that an acquisition meets this threshold, acquisition costs will be capitalized as part of our allocation of the purchase price of the acquired hotel properties.
Our hotel properties and related assets are recorded at cost, less accumulated depreciation. We capitalize hotel property development costs and the costs of significant additions and improvements that materially upgrade, increase the value or extend the useful life of the property. These costs may include hotel property development, refurbishment, renovation, and remodeling expenditures, as well as certain indirect internal costs related to construction projects. If an asset requires a period of time in which to carry out the activities necessary to bring it to the condition necessary for its intended use, the interest cost incurred during that period as a result of expenditures for the asset is capitalized as part of the cost of the asset. We expense the cost of repairs and maintenance as incurred.
On a limited basis, we provide financing to developers of hotel properties for development projects. We evaluate these arrangements to determine if we participate in residual profits of the hotel property through the loan provisions or other agreements. Where we conclude that these arrangements are more appropriately treated as an investment in the hotel property, we reflect the loan as Investment in hotel properties, net in our Condensed Consolidated Balance Sheets.
We monitor events and changes in circumstances for indicators that the carrying value of a hotel property or undeveloped land may be impaired. Additionally, we perform at least annual reviews to monitor the factors that could trigger an impairment. Factors that we consider for an impairment analysis include, among others: i) significant underperformance relative to historical or anticipated operating results, ii) significant changes in the manner of use of a property or the strategy of our overall business, including changes in the estimated holding periods for hotel properties and land parcels, iii) a significant increase in competition, iv) a significant adverse change in legal factors or regulations, v) changes in values of comparable land or hotel property sales, and vi) significant negative industry or economic trends. When such factors are identified, we prepare an estimate of the undiscounted future cash flows of the specific property and determine if the carrying amount of the asset is recoverable. If an impairment is identified, we estimate the fair value of the property based on discounted cash flows or sales price if the property is under contract and an adjustment is made to reduce the carrying value of the property to its estimated fair value.
Intangible Assets
We amortize intangible assets with determined finite useful lives using the straight-line method. We do not amortize intangible assets with indefinite useful lives, but we evaluate these assets for impairment annually or at interim periods if events or circumstances indicate that the asset may be impaired.
Trade Receivables and Credit Policies
We grant credit to qualified customers, generally without collateral, in the form of trade accounts receivable. Trade receivables result from the rental of hotel guestrooms and the sales of food, beverage, and banquet services and are payable under normal trade terms. Trade receivables also include credit and debit card transactions that are in the process of being settled. Trade receivables are stated at the amount billed to the customer and do not accrue interest. We regularly review the collectability of our trade receivables. A provision for losses is determined on the basis of previous loss experience and current economic conditions. Our allowance for doubtful accounts was $0.1 million at March 31, 2022 and $0.2 million at December 31, 2021. Bad debt expense was $0.0 million and $0.1 million for the three months ended March 31, 2022 and 2021, respectively.
Leases
In accordance with ASU No. 2016-02, Leases (Topic 842), we record the financial liability and right-of-use assets that are inherent to leasing an asset on the balance sheet for all leases with a term of greater than 12 months regardless of their classification.
Several of our hotel properties lease retail or restaurant space to third-party tenants. The majority of our third-party tenants requested rent deferrals in prior years to ease the negative financial effects of the COVID-19 pandemic on their businesses. We primarily negotiated rent deferrals with these tenants that defer rent for a specified number of months and require repayment of the deferred rent over a negotiated period of time. We have adopted a policy that the deferrals are not a change in the provisions of the lease. As such, we are accounting for the concessions using the rights and obligations of the existing lease and recognizing a short-term lease receivable in the period that the cash payment is owed.
Notes Receivables
We selectively provide mezzanine financing to developers where we also have the opportunity to acquire the hotel property at or after the completion of the development project, and we also may provide seller financing under limited circumstances. We classify notes receivable as held-to-maturity and carry the notes receivable at cost less the unamortized discount, if any. In accordance with ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326), we measure financial assets (or a group of financial assets) at amortized cost and present them at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. We routinely evaluate our notes receivable and interest receivables for collectability. Probable losses on notes receivable are recognized in a valuation account that is deducted from the amortized cost basis of the notes receivable and recorded as Provision for credit losses in our Condensed Consolidated Statements of Operations. When we place notes receivable on non-accrual status, we suspend the recognition of interest income until cash interest payments are received. Generally, we return notes receivable to accrual status when all delinquent interest becomes current and collectability of interest is reasonably assured. We do not measure an allowance for credit losses for accrued interest receivable. Accrued interest receivable is written-off to bad debt expense when collection is not reasonably assured.
Cash and Cash Equivalents
We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. At times, cash on deposit may exceed the federally insured limit. We maintain our cash with high credit quality financial institutions.
Restricted Cash
Restricted cash consists of certain funds maintained in escrow for property taxes, insurance, and certain capital expenditures. Funds may be disbursed from the account upon proof of expenditures and approval from the lender or other party requiring the restricted cash reserves.
Redeemable Non-controlling Interests
Redeemable non-controlling interests represent redeemable preferred units issued by our Operating Partnership ("Redeemable Preferred Units") in connection with the NCI Transaction. Redeemable non-controlling interests are recorded as temporary equity in a mezzanine presentation outside of Equity on our Condensed Consolidated Balance Sheets. We record Redeemable non-controlling interests at fair value on the issuance date of the securities. When the carrying value (the acquisition date fair value adjusted for the non-controlling interest’s share of net income (loss) and dividends) is less than the redemption value, we adjust the redeemable non-controlling interest to equal the redemption value with changes recognized as an adjustment to Accumulated deficit and distributions in excess of retained earnings. Any such adjustment, when necessary, is recorded as of the applicable balance sheet date.
Non-controlling Interests
Non-controlling interests represent the portion of equity in a consolidated entity held by owners other than the consolidating parent. Non-controlling interests are reported in the Condensed Consolidated Balance Sheets within equity, separately from stockholders’ equity. Revenue, expenses and net income attributable to both the Company and the non-controlling interests are reported in the Condensed Consolidated Statements of Operations.
Our Condensed Consolidated Financial Statements include non-controlling interests related to common units of limited partnership interests (“Common Units”) in the Operating Partnership held by unaffiliated third parties and third-party ownership of a 49% interest in the Joint Venture. Also, our Condensed Consolidated Financial Statements include Redeemable Preferred Units in the Operating Partnership issued to complete the NCI Transaction and held by unaffiliated third parties. These Redeemable Preferred Units are presented as temporary equity related to our Operating Partnership in a mezzanine position between liabilities and stockholders' equity on our Condensed Consolidated Balance Sheet as Redeemable Non-controlling Interests. See "Note 9 - Non-controlling Interests and Redeemable Non-controlling Interests" for further information.
Revenue Recognition
In accordance with ASU No. 2014-09, revenues from the operation of our hotel properties are recognized when guestrooms are occupied, services have been rendered or fees have been earned. Revenues are recorded net of any discounts and sales and other taxes collected from customers. Revenues consist of room sales, food and beverage sales, and other hotel property revenues and are presented on a disaggregated basis on our Condensed Consolidated Statements of Operations.
Room revenue is generated through short-term contracts with customers whereby customers agree to pay a daily rate for the right to occupy hotel rooms for one or more nights. Our performance obligations are fulfilled at the end of each night that the customers have the right to occupy the rooms. Room revenues are recognized daily at the contracted room rate in effect for each room night.
Food and beverage revenues are generated when customers purchase food and beverage at a hotel property's restaurant, bar or other facilities. Our performance obligations are fulfilled at the time that food and beverage is purchased and provided to our customers.
Other revenues such as fees for parking, meeting space or communication services are recognized at the point in time or over the time period that the associated good or service is provided. Ancillary services such as parking at certain hotel properties are provided by third parties and we assess whether we are the principal or agent in such arrangements. If we are determined to be the agent, revenue is recognized based upon the commission paid to us by the third party for the services rendered to our customers. If we are determined to be the principal, revenues are recognized based upon the gross contract price of the service provided. Certain of our hotel properties have retail spaces, restaurants or other spaces that we lease to third parties. Lease revenues are recognized on a straight-line basis over the respective lease terms and are included in Other income on our Condensed Consolidated Statements of Operations.
Cash received prior to customer arrival is recorded as an advance deposit from the customer and is recognized as revenue at the time of occupancy.
Equity-Based Compensation
Our 2011 Equity Incentive Plan, which was amended and restated effective May 13, 2021 (as amended, the “Equity Plan”), provides for the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, dividend equivalent rights, and other stock-based awards. We account for time-based and performance-based stock awards using the grant date fair value of those equity awards. Restricted stock awards with performance-based vesting conditions are market-based awards tied to total stockholder return and are valued using a Monte Carlo simulation model in accordance with ASC Topic 718, Compensation — Stock Compensation. We expense the fair value of awards under the Equity Plan ratably over the vesting period and market-based awards are not adjusted for performance. The amount of stock-based compensation expense may be subject to adjustment in future periods due to a change in forfeiture assumptions or modification of previously granted awards.
Derivative Financial Instruments and Hedging
We use interest rate derivatives to hedge our risks on variable-rate debt. Interest rate derivatives could include swaps, caps, collars, and floors. We assess the effectiveness of each hedging relationship by comparing changes in fair value or cash flows of the derivative financial instrument with the changes in fair value or cash flows of the designated hedged item or transaction. All derivative financial instruments are recorded at fair value as a net asset or liability in our Condensed Consolidated Balance Sheets.
The change in the fair value of the hedging instruments is recorded in Other comprehensive income. Amounts deferred in Other comprehensive income will be reclassified to Interest expense in our Condensed Consolidated Statements of Operations in the period in which the hedged item affects earnings.
Income Taxes
We have elected to be taxed as a REIT under certain provisions of the Internal Revenue Code. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute annually to our stockholders at least 90% of our REIT taxable income, subject to certain adjustments and excluding any capital gain. As a REIT, we generally will not be subject to federal income tax (other than taxes paid by our TRSs at regular corporate income tax rates) to the extent we distribute 100% of our REIT taxable income to our stockholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate income tax rates and generally will be unable to re-elect REIT status until the fifth calendar year after the year in which we failed to qualify as a REIT, unless we satisfy certain relief provisions.
Substantially all of our assets are held by and all of our operations are conducted through our Operating Partnership or our subsidiary REITs. Partnerships are not subject to U.S. federal income taxes as revenues and expenses pass through to and are taxed on the owners. Generally, the states and cities where our partnerships operate follow the U.S. federal income tax treatment. However, there are a limited number of local and state jurisdictions that tax the taxable income of the Operating Partnership. Accordingly, we provide for income taxes in these jurisdictions for the Operating Partnership.
Taxable income related to our TRSs are subject to federal, state and local income taxes at applicable tax rates. Our consolidated income tax provision includes the income tax provision related to the operations of the TRSs as well as state and local income taxes related to the Operating Partnership.
Where required, we account for federal and state income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for: i) the future tax consequences attributable to differences between carrying amounts of existing assets and liabilities based on GAAP and the respective carrying amounts for tax purposes, and ii) operating losses and tax-credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date of the change in tax rates. However, deferred tax assets are recognized only to the extent that it is more likely than not they will be realized based on consideration of available evidence. Valuation allowances are provided if, based upon the weight of the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
We consider all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance for deferred tax assets is needed. Due to the effects of the COVID-19 pandemic, certain of our TRSs have incurred operating losses in the past and are expected to be in a cumulative loss for the foreseeable future. As such, the realizability of our deferred tax assets at March 31, 2022 is not reasonably assured. Therefore, we have recorded a valuation allowance against substantially all of our deferred tax assets at March 31, 2022.
We perform a quarterly review for any uncertain tax positions. The Company had no accruals for uncertain tax positions as of March 31, 2022 and December 31, 2021.
Fair Value Measurement
Fair value measures are classified into a three-tiered fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
| | | | | | | | |
| Level 1: | | Observable inputs such as quoted prices in active markets. |
| Level 2: | | Directly or indirectly observable inputs, other than quoted prices in active markets. |
| Level 3: | | Unobservable inputs in which there is little or no market information, which require a reporting entity to develop its own assumptions. |
Assets and liabilities measured at fair value are based on one or more of the following valuation techniques:
| | | | | | | | |
| Market approach: | | Prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. |
| Cost approach: | | Amount required to replace the service capacity of an asset (replacement cost). |
| Income approach: | | Techniques used to convert future amounts to a single amount based on market expectations (including present-value, option-pricing, and excess-earnings models). |
Our estimates of fair value were determined using available market information and appropriate valuation methods. Considerable judgment is necessary to interpret market data and develop estimated fair value. The use of different market assumptions or estimation methods may have a material effect on the estimated fair value amounts. We classify assets and liabilities in the fair value hierarchy based on the lowest level of input that is significant to the fair value measurement.
We have elected a measurement alternative for equity investments, such as our purchase option, that do not have readily determinable fair values. Under the alternative, our purchase option is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer, if any.
Use of Estimates
Our Condensed Consolidated Financial Statements are prepared in conformity with GAAP, which requires us to make estimates based on assumptions about current and, for some estimates, future economic and market conditions that affect reported amounts and related disclosures in our Condensed Consolidated Financial Statements. Although our current estimates contemplate current and expected future conditions, as applicable, it is reasonably possible that actual conditions could materially differ from our expectations, which could materially affect our expectations for our consolidated financial position and results of operations. In particular, a number of estimates have been and will continue to be affected by the ongoing COVID-19 pandemic.
Reclassifications
Certain amounts related to intangible assets totaling approximately $3.5 million and accumulated amortization of approximately $1.0 million have been reclassified within Investments in Hotel Properties, net to conform to the current period presentation.
New Accounting Standards
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848). ASU No. 2020-04 contains practical expedients for reference rate reform related activities that affect debt, leases, derivatives and other contracts. The guidance in ASU No. 2020-04 is optional and may be elected over time as reference rate reform activities occur. During the year ended December 31, 2020, the Company elected to apply the hedge accounting expedients related to probability and the assessments of effectiveness for future LIBOR-indexed cash flows to assume that the index upon which future hedged transactions will be based matches the index on the corresponding derivatives. Application of these expedients preserves the presentation of derivatives consistent with past presentation. The Company continues to evaluate the effect of the guidance and may apply other elections as applicable as additional changes in the market occur.
In August 2020, the FASB issued ASU No. 2020-06, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40) – Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The objective of ASU No. 2020-06 is to address issues identified as a result of the complexity associated with applying generally accepted accounting principles for certain financial instruments with characteristics of liabilities and equity.
The amendments in ASU No. 2020-06 reduce the number of accounting models for convertible debt instruments and convertible preferred stock. For convertible instruments with conversion features that are not required to be accounted for as derivatives under Topic 815, Derivatives and Hedging, or that do not result in substantial premiums accounted for as paid-in capital, the embedded conversion features no longer are separated from the host contract. The amendments in ASU No. 2020-06 remove certain conditions that otherwise should be considered in the derivatives scope exception evaluation under Subtopic 815-40, Derivatives and Hedging—Contracts in Entity’s Own Equity, and clarify the scope and certain requirements under Subtopic 815-40. The amendments also improve the guidance related to the disclosures and earnings-per-share (EPS) for convertible instruments and contracts in an entity’s own equity.
ASU No. 2020-06 is effective for fiscal years beginning after December 15, 2021. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020. We elected to adopt ASU No. 2020-06 effective January 1, 2021 in connection with our Convertible Notes Offering closed on January 12, 2021 as described in "Note 5 – Debt." In accordance with the provisions of ASU No. 2020-06, we will account for the convertible notes issued in 2021 entirely as a liability and we will use the if-converted method for diluted share calculations.
NOTE 3 - INVESTMENT IN HOTEL PROPERTIES, NET
Investment in Hotel Properties, net
Investment in hotel properties, net is as follows (in thousands):
| | | | | | | | | | | | | | |
| | March 31, 2022 | | December 31, 2021 |
| Hotel buildings and improvements | | $ | 2,762,269 | | | $ | 2,127,782 | |
| Land | | 363,727 | | | 323,276 | |
| Furniture, fixtures and equipment | | 242,165 | | | 167,245 | |
| Construction in progress | | 26,669 | | | 18,321 | |
| Intangible assets | | 37,981 | | | 10,834 | |
| Real estate development loan | | 29,632 | | | 27,595 | |
| | | 3,462,443 | | | 2,675,053 | |
| Less - accumulated depreciation and amortization | | (614,042) | | | (583,080) | |
| | | $ | 2,848,401 | | | $ | 2,091,973 | |
We provided a mezzanine loan to fund up to $28.9 million for a mixed-use development project that includes a hotel property, retail space, and parking. The hotel property is a 264 guestroom dual-branded AC Hotel by Marriott and Element Miami Brickell Hotel in Miami, FL. In December 2021, we modified the loan agreement to increase our funding commitment by $1.0 million. As of March 31, 2022, we funded $29.6 million of our total $29.9 million commitment under the mezzanine loan. The mezzanine loan was classified as Investment in hotel properties, net in our Condensed Consolidated Balance Sheets at March 31, 2022 and December 31, 2021. See "Note 4 - Investment in Real Estate Loans" for further information.
Acquisition of NewcrestImage Portfolio
On November 2, 2021, the Operating Partnership and the Joint Venture entered into a Contribution and Purchase Agreement (the “Contribution and Purchase Agreement”) with NewcrestImage Holdings, LLC, a Delaware limited liability company, and
NewcrestImage Holdings II, LLC, a Delaware limited liability company (together, “NewcrestImage”), to purchase from
NewcrestImage a 100% interest in a portfolio of 27 hotel properties, containing an aggregate of 3,709 guestrooms, and two parking structures, containing 1,002 spaces (such hotel properties and parking structures, the “Portfolio”), and various financial and tax incentives for certain of the acquired properties, for an aggregate purchase price of $822.0 million.
On January 13, 2022, the Joint Venture completed the acquisition of the Portfolio except for one hotel property, the 176 guestroom Canopy New Orleans which was still under construction, for an aggregate purchase price of $766.0 million, paid in the form of 15,314,494 Common Units (deemed value of $10.0853 per unit), 1,958,429 preferred units of limited partnership of the Operating Partnership newly designated as 5.25% Series Z Cumulative Perpetual Preferred Units (Liquidation Preference $25 Per Unit) (the “Series Z Preferred Units”), $382.0 million cash draw from a term loan entered into by subsidiaries of the Joint Venture, the assumption by a subsidiary of the Joint Venture of approximately $6.5 million in PACE loan debt and $5.9 million of cash contributed to escrow in the prior year by GIC, as a limited partner in the Joint Venture, and approximately $171.4 million cash contributed by GIC at closing. GIC also contributed to the Joint Venture an additional $18.5 million in cash for estimated pre-acquisition costs related to the NCI Transaction, a portion of which will be distributed to the Operating Partnership as reimbursement for transaction costs paid by the Operating Partnership.
The Joint Venture acquired the Canopy New Orleans on March 23, 2022 upon completion of its construction, for a purchase price of $56.0 million, which was paid in the form of 550,180 Common Units, 41,571 Series Z Preferred Units, $13.8 million cash contributed by GIC, as a limited partner in the Joint Venture, and $28.0 million cash proceeds from a draw on the term loan entered into by subsidiaries of the Joint Venture.
We valued the Common Units and Series Z Preferred Units at fair market value on the closing dates of the NCI Transaction, which resulted in us recording the issued Common Units and Series Z Preferred Units at $157.5 million and $50.0 million, respectively. The Common Units were recorded at the closing prices of our Common Stock on the closing dates since the Common Units are redeemable for shares of our Common Stock on a 1:1 basis. We estimated the fair value of the Series Z Preferred Units based on the features and stated dividend coupon of the Series Z Preferred Units relative to similar securities with more readily determinable market values. We recorded the Series Z Preferred Units at their redemption value of $50.0 million which approximates fair value on the closing dates.
Our Joint Venture assumed $335.2 million of debt in connection with the NCI Transaction and immediately repaid $328.7 million of the assumed debt on the closing date using proceeds from borrowings on the Joint Venture Term Loan (as defined below). We recorded debt assumed in connection with the NCI Transaction at its face amount, which approximated fair market value on the closing date.
Our Joint Venture recorded the NCI Transaction as an asset acquisition and allocated the aggregate purchase price paid for the NCI Transaction to the net assets acquired based on their relative estimated fair values. The allocation of the aggregate purchase price to the fair value of the assets and liabilities acquired for the NCI Transaction is as follows (in thousands):
| | | | | | | | | | | | | | |
| Assets and Liabilities Acquired | | | Net Cash Disbursed | |
| Land | $ | 52,797 | | | Purchase price (1) | $ | 823,056 | |
| Hotel buildings and improvements | 676,607 | | | Acquisition costs | 3,027 | |
| Furniture, fixtures and equipment | 76,729 | | | Deferred financing fees | 4,625 | |
| Incentives and other intangibles | 23,670 | | | | $ | 830,708 | |
| Other assets (2) | 5,318 | | | | |
| Total assets acquired | 835,121 | | | Cash | $ | 208,819 | |
| Debt assumed | (335,205) | | | Preferred Operating Partnership Units | 50,000 | |
| Other liabilities (3) | (9,361) | | | Common Units (1) | 157,513 | |
| Net assets acquired | $ | 490,555 | | | Debt | 414,376 | |
| | | | $ | 830,708 | |
| | | | |
| | | | |
(1) The contractual purchase price for the NCI Transaction was $822.0 million based on the issuance of Common OP Units totaling $160.0 million on the contract date. However, the fair value of the Common OP Units on the closing dates totaled $157.5 million based on the closing prices of our Common Stock on January 13, 2022 and March 23, 2022 of $9.94 and $9.61 per share, respectively. As such, the purchase price has been adjusted to reflect the fair value of the Common Units issued on the closing dates of the NCI Transaction plus additional costs incurred to close the transaction.
(2) Amount includes right-of-use assets related to assumed leases totaling approximately $5.3 million.
(3) Amount includes assumed key money liabilities of approximately $3.9 million, lease liabilities of approximately $5.1 million, and other liabilities of approximately $0.4 million.
Incentives and other intangibles include tax incentives totaling approximately $19.8 million associated with certain of the acquired hotel properties in the NCI Transaction and are being amortized over a weighted average amortization period of approximately 9.1 years, which is the period in which we expect to meet the requirements to receive payment of the tax incentives. Other intangible assets totaling approximately $3.9 million are related to key money associated with certain of the hotel properties acquired in the NCI Transaction and are being amortized over a weighted average amortization period of approximately 19.7 years, which is the remaining the key money contract period with the franchisor.
Intangible assets, net is as follows (in thousands):
| | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
| Indefinite-lived intangible assets: | | | |
| Air rights | $ | 10,754 | | | $ | 10,754 | |
| Other | 80 | | | 80 | |
| 10,834 | | | 10,834 | |
| Finite-lived intangible assets: | | | |
| Tax incentives | 19,750 | | | — | |
| Key money | 7,397 | | | — | |
| 27,147 | | | — | |
| 37,981 | | | 10,834 | |
| Less - accumulated amortization | (2,015) | | | — | |
| Intangible assets, net | $ | 35,966 | | | $ | 10,834 | |
We recorded amortization expense related to intangible assets of approximately $1.0 million and $0.05 million for the three months ended March 31, 2022 and 2021, respectively. Future amortization expense related to intangible assets is as follows (in thousands):
| | | | | |
| 2022 | $ | 4,290 | |
| 2023 | 4,252 | |
| 2024 | 3,541 | |
| 2025 | 1,546 | |
| 2025 | 1,546 | |
| Thereafter | 9,957 | |
| $ | 25,132 | |
| |
We also acquired in the NCI Transaction a limited liability corporation with an historical tax credit (the "HTC Entity"). The third-party member in the HTC Entity (the "HTC Partner") that owns the majority interest in the HTC Entity is entitled to the value of the historical tax credit. The recapture period related to the historical tax credit expires in October 2022. We have a call option to purchase the HTC Partner's entire interest in the HTC Entity (the "HTC Call Option") commencing on the last day of the recapture period and continuing for 180 days thereafter for $2.6 million plus certain additional costs, estimated to be approximately $0.1 million. If we do not exercise the HTC Call Option, the HTC Partner has a put option to require us to purchase its interest in the HTC Entity upon expiration of the HTC Call Option and continuing for six months thereafter for the same amount as the Call Option exercise price. We have a note receivable from NewcrestImage for $2.7 million that is payable upon our exercise of the HTC Call Option. We have entered into an agreement with NewcrestImage to timely exercise the HTC Call Option. As a result, we have recorded a note receivable of $2.7 million from NewcrestImage and a liability at March 31, 2022 of $2.7 million related to our obligation to exercise the HTC Call Option.
Assets Held for Sale
Assets held for sale at March 31, 2022 include a land parcel in Flagstaff, AZ and the 169 guestroom Hilton Garden Inn San Francisco Airport North in San Francisco, CA which is expected to close in the second quarter of 2022 for a gross selling price of $75.0 million. Assets Held for Sale at December 31, 2021 include a land parcel in Flagstaff, AZ.
Assets held for sale were as follows (in thousands):
| | | | | | | | | | | |
| March 31, | | December 31, |
| 2022 | | 2021 |
| Hotel buildings and improvements | $ | 43,078 | | | $ | — | |
| Land | 12,771 | | | 425 | |
| Furniture, fixtures and equipment | 3,199 | | | — | |
| | | |
| | | |
| 59,048 | | | 425 | |
| Less - accumulated depreciation and amortization | (6,247) | | | — | |
| $ | 52,801 | | | $ | 425 | |
| | | |
NOTE 4 — INVESTMENT IN REAL ESTATE LOANS
Investment in real estate loans, net is as follows (in thousands):
| | | | | | | | | | | | | | |
| | | March 31, 2022 | | December 31, 2021 |
| Real estate loans | | $ | 2,350 | | | $ | 2,350 | |
| | | | |
| Allowance for credit losses | | (2,350) | | | (2,350) | |
| Investment in real estate loans, net | | $ | — | | | $ | — | |
The amortized cost bases of our Investment in real estate loans, net approximate their fair values.
Real Estate Development Loans
During the year ended December 31, 2019, we provided a mezzanine loan to fund up to $28.9 million for a mixed-use
development project that includes the AC Hotel by Marriott and Element Miami Brickell Hotel in Miami, FL, retail space, and parking. The loan closed in the third quarter of 2019 and has a stated interest rate of 9%. In November 2020, we extended the maturity date of the loan from February 15, 2022 to May 15, 2022. In December 2021, we modified the loan agreement to increase the Company's funding commitment by $1.0 million. The loan is secured by a second mortgage on the development project and a pledge of the equity in the project owner. As of March 31, 2022, we funded $29.6 million of our total $29.9 million commitment.
We have an option to purchase a 90% interest in the AC Hotel by Marriott and Element Miami Brickell Hotel in Miami, FL (the “Initial Purchase Option”). We also have the right to purchase the remaining interest in the hotel property five years after the completion of construction. In December 2021, construction of the hotel property was completed. We have issued a $10.0 million letter of credit under our senior revolving credit facility to secure the exercise of the Initial Purchase Option. As such, we have classified the loan as Investment in hotel properties, net on our Consolidated Balance Sheets at March 31, 2022 and December 31, 2021. Interest income on the mezzanine loan is recorded in our Consolidated Statement of Operations as it is earned. We have recorded the aggregate estimated fair value of the Initial Purchase Option totaling $2.8 million in Other assets and as a contra-asset to Investment in hotel properties, net. The contra-asset will be amortized as a component of non-cash interest income over the term of the real estate development loan using the straight-line method, which approximates the interest method. During each of the three months ended March 31, 2022 and 2021, we amortized $0.1 million and $0.3 million, respectively, as non-cash interest income. Including the amortization of the contra-asset, the current effective interest rate on this loan is approximately 11.4%.
In April 2022, we exercised the Initial Purchase Option to acquire a 90% equity interest in the AC Hotel by Marriott and Element Miami Brickell Hotel in Miami, FL containing an aggregate 264 guestrooms. The option price was based on a gross hotel valuation of $89.0 million determined prior to commencement of the development project. We expect to fund our estimated equity requirement with the proceeds from the payment in full of our outstanding mezzanine loan to the developer of the project, which is expected to be $29.9 million at closing, the assumption of senior debt on the development project of approximately $47.0 million, and $7.9 million in cash. We expect to close the transaction in June 2022.
For additional information regarding our real estate development loans, please see our Annual Report on Form 10-K filed on February 23, 2022.
Seller-Financing Loans
On June 29, 2018, we sold the Holiday Inn in Duluth, GA and the Hilton Garden Inn in Duluth, GA for an aggregate selling
price of $24.9 million. We provided seller financing totaling $3.6 million on the sale of these properties under two, 3.5 year
second mortgage notes with a blended interest rate of 7.38% that are further collateralized by a personal guarantee from the
principal of the borrower. As of March 31, 2022, there was $2.4 million outstanding on the seller-financing loans. During
the year ended December 31, 2020, we recorded an allowance for credit losses in an amount equal to the outstanding balance of
the loans due to a borrower default caused by the negative effects of the pandemic.
On June 1, 2021, we amended the terms of the seller-financing loans and extended the maturity date of each loan to December
31, 2022. Interest is accruing at a rate of 9.00% monthly, including 5.00% payable in cash and 4.00% paid-in-kind. Semiannual
principal payments of $0.3 million began on April 15, 2022.
NOTE 5 - DEBT
At March 31, 2022, our indebtedness was comprised of borrowings under our 2018 Senior Credit Facility (as defined below), the 2018 Term Loan (as defined below), the 2017 Term Loan (as defined below), the Joint Venture Credit Facility (as defined below), the Joint Venture Term Loan (as defined below), the PACE Loan (as defined below), the Convertible Notes (as defined below), and indebtedness secured by first priority mortgage liens on various hotel properties. The weighted average interest rate, after giving effect to our interest rate derivatives, for all borrowings was 3.34% at March 31, 2022 and 3.35% at December 31, 2021.
Debt, net of debt issuance costs, is as follows (in thousands):
| | | | | | | | | | | | | | |
| | | March 31, 2022 | | December 31, 2021 |
| Revolving debt | | $ | 68,500 | | | $ | 68,500 | |
| Term loans | | 972,000 | | | 562,000 | |
| Convertible notes | | 287,500 | | | 287,500 | |
| Mortgage loans | | 168,640 | | | 163,315 | |
| | | 1,496,640 | | | 1,081,315 | |
| Unamortized debt issuance costs | | (14,745) | | | (11,518) | |
| Debt, net of debt issuance costs | | $ | 1,481,895 | | | $ | 1,069,797 | |
We have entered into interest rate swaps to partially fix the interest rates on a portion of our variable interest rate indebtedness. See "Note 7 - Derivative Financial Instruments and Hedging" to the Condensed Consolidated Financial Statements for additional information. Our total fixed-rate and variable-rate debt, after considering our interest rate derivative agreements that are currently effective, is as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | March 31, 2022 | | Percentage | | December 31, 2021 | | Percentage |
| Fixed-rate debt | | $ | 848,249 | | | 57% | | $ | 842,858 | | | 78% |
| Variable-rate debt | | 648,391 | | | 43% | | 238,457 | | | 22% |
| | $ | 1,496,640 | | | | | $ | 1,081,315 | | | |
Information about the fair value of our fixed-rate debt that is not recorded at fair value is as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | March 31, 2022 | | December 31, 2021 | | |
| | | Carrying
Value | | Fair Value | | Carrying
Value | | Fair Value | | Valuation Technique |
| Convertible notes | | $ | 287,500 | | | $ | 303,003 | | | $ | 287,500 | | | $ | 300,384 | | | Level 1 - Market approach |
| Fixed-rate mortgage loans | | 160,749 | | | 154,852 | | | 155,358 | | | 155,765 | | | Level 2 - Market approach |
| | $ | 448,249 | | | $ | 457,855 | | | $ | 442,858 | | | $ | 456,149 | | | |
At March 31, 2022 and December 31, 2021, we had $400.0 million of debt with variable interest rates that had been converted to fixed interest rates through derivative financial instruments which are carried at fair value. Differences between carrying value and fair value of our fixed-rate debt are primarily due to changes in interest rates. Inherently, fixed-rate debt is subject to fluctuations in fair value as a result of changes in the current market rate of interest on the valuation date. For additional information on our use of derivatives as interest rate hedges, refer to "Note 7 - Derivative Financial Instruments and Hedging."
$600 Million Senior Credit and Term Loan Facility
On December 6, 2018, the Operating Partnership, as borrower, the Company, as parent guarantor, and each party executing the loan documentation as a subsidiary guarantor, entered into a $600.0 million senior credit facility (the “2018 Senior Credit Facility”) with Deutsche Bank AG New York Branch, as administrative agent, and a syndicate of lenders. The 2018 Senior Credit Facility is comprised of a $400.0 million revolver (the "$400 Million Revolver") and a $200.0 million term loan facility (the “$200 Million Term Loan”). At March 31, 2022, we had $200.0 million borrowed, an outstanding letter of credit of $10.0 million securing the exercise of the Initial Purchase Option, and $340.0 million available to borrow plus an additional $50.0 million available to borrow subject to certain security requirements to be provided to the lender. At March 31, 2022, we had no borrowings outstanding on the $400 Million Revolver.
Amendments to $600.0 Million Senior Credit Facility
Between May 2020 and November 2021, the Company entered into several amendments to the Credit Agreement of the 2018 Senior Credit Facility (the “Credit Facility Amendments”).
As of March 31, 2022, the cumulative effect of the Credit Facility Amendments resulted in the waiver or adjustment of certain financial and other covenants under the 2018 Senior Credit Facility, for the periods described below:
•Waivers of key financial and certain other covenants in the 2018 Senior Credit Facility for the period April 1, 2020 through March 31, 2022; and
•Beginning on April 1, 2022, adjustments to certain of the key financial covenants have gone into effect as follows:
◦Reduction of the Minimum Consolidated Fixed Charge Coverage Ratio;
◦Increase of the Maximum Unsecured Leverage Ratio;
◦Reduction of the Minimum Unsecured Interest Coverage Ratio; and
◦Increases to the Maximum Leverage Ratio, that adjusts down through calendar year 2023.
The interest rate on the 2018 Senior Credit Facility is based on a pricing grid ranging from 140 basis points to 240 basis points plus the the London Interbank Offered Rate ("LIBOR") for the $400 Million Revolver and 135 basis points to 235 basis points plus LIBOR for the $200 Million Term Loan, depending upon the Company's leverage ratio. The pricing grid was modified under the Credit Facility Amendments such that during the period ending December 31, 2021, or earlier at the Company's election subject to certain requirements (the "Amendment Period"), the applicable margin was at Pricing Level VII, as defined in the 2018 Senior Credit Facility documents. The applicable margin is currently set at Pricing Level VIII. The interest rate at March 31, 2022 for the $200 Million Term Loan was 2.80%. The 2018 Senior Credit Facility has been amended to accommodate the transition from LIBOR to the Secured Overnight Financing Rate ("SOFR"), when LIBOR is no longer available.
The Credit Facility Amendments require the borrower and certain subsidiaries to pledge to the secured parties all of the equity interests in the entities that own all properties included in the unencumbered asset pool supporting the facility (“Unencumbered Properties”), as well as the equity interests in the TRS lessees related to such Unencumbered Properties until the borrower meets certain conditions for their release. The Credit Facility Amendments also permitted the Company to complete the Convertible Notes Offering (defined below), the Series F preferred shares offering (defined below), and close on the NCI Transaction and enter into equity transactions and indebtedness related thereto.
The Credit Facility Amendments allow the borrower to advance up to $350 million on the $400 Million Revolver. Furthermore, the Credit Facility Amendments permit the borrower to advance an additional $50 million, in addition to the $350 million advance described in the preceding sentence, upon filing mortgages and related security agreements on all Unencumbered Properties, with such security documents to be released upon the borrower meeting certain conditions for their release.
The Credit Facility Amendments revise the restrictions that were previously placed on certain investments in assets, equity offerings and securing of permitted indebtedness to permit the borrower and Company to take such actions, provided that (i) portions of the proceeds from such events will be used to pay down the balance of the 2018 Senior Credit Facility, the 2018 Term Loan (defined below) and 2017 Term Loan (defined below) in accordance with the terms of the Credit Facility Amendments, and (ii) the borrower and Company comply with the other conditions to taking such actions, including maintaining a minimum of $150 million in liquidity.
Certain other typical limitations and conditions for credit facilities of this nature include, among other provisions, limitations on the use of revolving facility advances, certain restrictions on payments of dividends and establishment of a minimum liquidity requirement as indicated above. At March 31, 2022, we were in compliance with all financial covenants.
The 2018 Senior Credit Facility has an accordion feature which will allow the Company to increase the total commitments by an aggregate of up to $300.0 million. The $400 Million Revolver will mature on March 31, 2023 and can be extended to March 31, 2024 at the Company’s option, subject to certain conditions. The $200 Million Term Loan will mature on April 1, 2024.
Term Loans
2018 Term Loan
On February 15, 2018, our Operating Partnership, as borrower, the Company, as parent guarantor, and each party executing the term loan documentation as a subsidiary guarantor, entered into a new $225.0 million term loan (the “2018 Term Loan”) with KeyBank National Association, as administrative agent, and a syndicate of lenders listed in the loan documentation, which is fully drawn as of March 31, 2022. The 2018 Term Loan has an accordion feature that allows us to increase the total commitments by $150.0 million prior to the maturity date of February 14, 2025, subject to certain conditions.
Amendments to $225.0 Million 2018 Term Loan
Between May 2020 and November 2021, the Company entered into several amendments to the First Amended and Restated Credit Agreement (the “2018 Term Loan Amendments”). As of March 31, 2022, the cumulative effect of the changes to the 2018 Term Loan effected by the 2018 Term Loan Amendments are substantially similar to the changes described above effected by the Credit Facility Amendments.
We pay interest on advances at varying rates, based upon, at our option, either (i) 1-, 2-, 3-, or 6-month LIBOR, plus a LIBOR margin between 1.35% and 1.95%, depending upon our leverage ratio (as defined in the loan documents). The pricing grid was modified under the 2018 Term Loan Amendments such that during the Amendment Period the applicable margin was set at Pricing Level VII, as defined in the 2018 Term Loan documents. We are required to pay other fees, including customary arrangement and administrative fees. The interest rate at March 31, 2022 was 2.60%. The 2018 Term Loan has been
amended to accommodate the transition from LIBOR to SOFR, when LIBOR is no longer available.
Financial and Other Covenants. We are required to comply with various financial and other covenants to draw and maintain borrowings under the 2018 Term Loan. The 2018 Term Loan Amendments provide that certain financial and other covenants under the 2018 Term Loan were waived or adjusted, which waivers and adjustments are the same as under the amendments to the Company’s 2018 Senior Credit Facility. At March 31, 2022, we were in compliance with all financial covenants.
Unencumbered Assets. The 2018 Term Loan Amendments require the borrower and certain subsidiaries to pledge to the secured parties all of the equity interests in the entities that own the Unencumbered Properties, as well as the equity interests in the TRS lessees related to such Unencumbered Properties until the borrower meets certain conditions for the release of such pledges. During the period that the pledges are in place, as well as at all other times during the term of the facility, borrowings under the 2018 Term Loan are limited by the value of the Unencumbered Assets.
2017 Term Loan
On September 26, 2017, our Operating Partnership, as borrower, the Company, as parent guarantor, and each party executing the term loan documentation as a subsidiary guarantor, entered into a $225.0 million term loan (the "2017 Term Loan") with KeyBank National Association, as administrative agent, and a syndicate of lenders listed in the loan documentation, which 2017 Term Loan has a principal balance of $62.0 million as of March 31, 2022.
Amendments to $225.0 Million 2017 Term Loan
Between May 2020 and November 2021, the Company entered into various amendments to the 2017 Term Loan (the “2017 Term Loan Amendments”). As of March 31, 2022, the cumulative effect of the changes to the 2017 Term Loan effected by the 2017 Term Loan Amendments are substantially similar to the changes described above effected by the Credit Facility Amendments.
The 2017 Term Loan has an accordion feature which allows us to increase the total commitments by an aggregate of $175.0 million prior to the maturity date, subject to certain conditions. The 2017 Term Loan matures on November 25, 2022.
We pay interest on advances at varying rates, based upon, at our option, either (i) 1-, 2-, 3-, or 6-month LIBOR, plus a LIBOR margin between 1.45% and 2.25%, depending upon our leverage ratio (as defined in the loan documents). The pricing grid was modified under the 2017 Term Loan Amendments such that during the Amendment Period the applicable margin was set at Pricing Level VI, as defined in the 2017 Term Loan documents. We are required to pay other fees, including customary arrangement and administrative fees. The interest rate at March 31, 2022 was 2.90%. The 2017 Term Loan has been
amended to accommodate the transition from LIBOR to SOFR, when LIBOR is no longer available.
Financial and Other Covenants. We are required to comply with a series of financial and other covenants to draw and maintain borrowings under the 2017 Term Loan. The 2017 Term Loan Amendments provide that certain financial and other covenants under the 2017 Term Loan were waived or adjusted, which waivers and adjustments are the same as under the Credit Facility Amendments. At March 31, 2022, we were in compliance with all financial covenants.
Unencumbered Assets. The 2017 Term Loan Amendments require the borrower and certain subsidiaries to pledge to the secured parties all of the equity interests in the entities that own the Unencumbered Properties, as well as the equity interests in the TRS lessees related to such Unencumbered Properties until the borrower meets certain conditions for the release of such pledges. During the period that the pledges are in place, as well as at all other times during the term of the facility, borrowings under the 2017 Term Loan are limited by the value of the Unencumbered Assets.
Convertible Senior Notes and Capped Call Options
On January 7, 2021, we entered into an underwriting agreement (the “Convertible Notes Offering”) pursuant to which the Company agreed to offer and sell $287.5 million aggregate principal amount of the Company’s 1.50% convertible senior notes due 2026 (the “Convertible Notes"). The net proceeds from the Convertible Notes Offering, after deducting underwriting discounts and commissions and offering expenses payable by the Company (including net proceeds from the full exercise by the underwriters of their over-allotment option to purchase additional Convertible Notes), were approximately $280.0 million before consideration of the Capped Call Transactions (as defined below). These proceeds were used to pay the cost of the Capped Call Transactions and to partially repay outstanding obligations under the 2018 Senior Credit Facility and 2017 Term Loan.
The Convertible Notes bear interest at a rate of 1.50% per year, payable semi-annually in arrears on February 15 and August 15 of each year, beginning on August 15, 2021. The Convertible Notes will mature on February 15, 2026 (the “Maturity Date”), unless earlier converted, purchased or redeemed. Prior to August 15, 2025, the Convertible Notes will be convertible only upon certain circumstances and during certain periods. On or after August 15, 2025 and through the Maturity Date, holders may convert any of their Convertible Notes into shares of the Company’s common stock, at the applicable conversion rate at any time prior to the close of business on the second scheduled trading day prior to the Maturity Date, unless the Convertible Notes have been previously purchased or redeemed by the Company. During the three months ended March 31, 2022 and 2021, the Company recorded coupon interest expense of $1.0 million and $0.9 million, respectively, and amortized $0.4 million and $0.4 million, respectively, of the $7.6 million debt issuance costs related to the Convertible Notes Offering. Including the amortization of the debt issuance costs, the current effective interest rate on the Convertible Notes is approximately 2.00%.
The initial conversion rate of the Convertible Notes is 83.4028 shares of common stock per $1,000 principal amount of Convertible Notes, which is equivalent to an initial conversion price of $11.99 per share of common stock based on the 37.5% base conversion premium on the reference price of $8.72 per share. In no event will the conversion rate exceed 114.6788 shares of common stock per $1,000 principal amount of Convertible Notes, subject to certain adjustments defined in the Convertible Notes Offering.
On January 7, 2021, in connection with the pricing of the Convertible Notes, and on January 8, 2021, in connection with the full exercise by the Underwriters of their option to purchase additional Convertible Notes pursuant to the Underwriting Agreement, the Company entered into privately negotiated capped call transactions (the “Capped Call Transactions”) with certain of the underwriters or their respective affiliates and another financial institution (the “Capped Call Counterparties”). The Capped Call Transactions initially cover, subject to anti-dilution adjustments substantially similar to those applicable to the Convertible Notes, the number of shares of common stock underlying the Convertible Notes. The Capped Call Transactions are generally expected to reduce the potential dilution to holders of shares of common stock upon conversion of the Convertible Notes or offset the potential cash payments that the Company could be required to make in excess of the principal amount of any converted Convertible Notes upon conversion thereof, with such reduction or offset subject to a cap.
The effective strike price of the Capped Call Transactions is initially $15.26, which represents a premium of 75.0% over the last reported sale price of the common stock on the New York Stock Exchange on January 7, 2021, and is subject to certain adjustments under the terms of the Capped Call transactions.
MetaBank Loan
On June 30, 2017, we entered into a $47.6 million secured, non-recourse loan with MetaBank (the "MetaBank Loan"). The MetaBank Loan provides for a fixed interest rate of 4.44%, amortizes over 25 years, and matures on July 1, 2027. The MetaBank Loan is secured by three hotel properties and is subject to a prepayment penalty if prepaid prior to April 1, 2027. On May 1, 2020, MetaBank waived the annual minimum debt service covenant ratio for the year ended December 31, 2020, and on April 12, 2021, MetaBank extended such waiver for the year ended December 31, 2021. The next covenant measurement date is December 31, 2022.
Mortgage Loans
At March 31, 2022 and December 31, 2021, we had mortgage loans totaling $162.2 million and $163.3 million, respectively, that are secured primarily by first mortgage liens on 17 and 16 hotel properties, respectively.
Joint Venture Credit Facility
On October 8, 2019, Summit JV MR 1, LLC (the “Borrower”), as borrower, Summit Hospitality JV, LP (the “Parent”), as parent, and each party executing the credit facility documentation as a subsidiary guarantor, entered into a $200.0 million credit facility (the “Joint Venture Credit Facility”) with Bank of America, N.A., as administrative agent and sole initial lender, and BofA Securities, Inc., as sole lead arranger and sole bookrunner.
The Parent is the joint venture between the Operating Partnership and an affiliate of GIC, Singapore's sovereign wealth fund. See "Note 9 – Non-controlling Interests and Redeemable Non-controlling interests" for additional information. The Operating Partnership and the Company are not borrowers or guarantors of the Joint Venture Credit Facility. The Joint Venture Credit Facility is guaranteed by all of the Borrower’s existing and future subsidiaries, subject to certain exceptions.
The Joint Venture Credit Facility is comprised of a $125.0 million revolving credit facility (the “$125 Million Revolver”) and a $75.0 million term loan (the “$75 Million Term Loan”). The Joint Venture Credit Facility has an accordion feature which will allow us to increase the total commitments by up to $300.0 million, for aggregate potential borrowings of up to $500.0 million on the Joint Venture Credit Facility. At March 31, 2022, we had $68.5 million outstanding under the $125 Million Revolver.
The $125 Million Revolver and the $75 Million Term Loan will mature on October 8, 2023. Each can be extended for a single consecutive twelve-month period at the Borrower's option, subject to certain conditions.
Interest is paid on revolving credit advances at varying rates based upon, at the Borrower's option, either (i) 1-, 2-, 3-, or 6-month LIBOR, plus a margin of 2.15% for Eurodollar rate advances, or (ii) LIBOR, plus a margin of 2.15% for LIBOR floating rate advances. The interest rate at March 31, 2022 was 2.75%. The applicable margin for a term loan advance shall be five basis points less than revolving credit advances referenced above. The Joint Venture Credit Facility has been amended to
accommodate the transition from LIBOR to SOFR, when LIBOR is no longer available. At March 31, 2022, we were in compliance with all financial covenants.
Amendments to $200 Million Joint Venture Credit Facility
On June 18, 2020, the Company entered into a Second Amendment to Credit Agreement concerning the Joint Venture Credit Facility (“Second Amendment”). The Second Amendment resulted in waivers or adjustments to certain financial and other covenants under the Joint Venture Credit Facility, which are described in the Current Report on Form 8-K filed by the Company on June 24, 2020.
On April 29, 2021, the Borrower, Parent, and each party executing the credit facility documentation as a subsidiary guarantor, entered into a Third Amendment to Credit Agreement concerning the Joint Venture Credit Facility (the “Joint Venture Amendment”).
Certain financial and other covenants under the Joint Venture Credit Facility were waived or adjusted as follows:
• Increase of the Maximum Leverage Ratio through the initial maturity date;
• Reduction of the Fixed Charge Coverage Ratio through March 31, 2022;
• Increase of the Borrowing Base Leverage through the initial maturity date;
• Reduction of the Minimum Borrowing Base Interest Coverage Ratio through March 1, 2022
During the covenant waiver period, the applicable margin was increased to 230 basis points and 225 basis points for the $125 million Revolver and $75 million Term Loan, respectively. After the covenant waiver period, the applicable margin will revert to 215 basis points and 210 basis points for the $125 million Revolver and $75 million Term Loan, respectively.
The Joint Venture Amendment provides that the Borrower may make additional advances on the $125 Million Revolver, subject to certain financial covenant limitations. Certain other typical limitations and conditions for credit facilities of this nature were included among the provisions in the amendments including, among other provisions, limitations on the use of revolving facility advances, certain restrictions on payments of dividends and limitations on investments and dispositions. We retain the right to opt out of certain additional restrictive covenants upon demonstration of compliance with the required financial covenants.
Borrowing Base Assets. The Joint Venture Credit Facility is secured primarily by a first priority pledge of the Borrower's equity interests in the subsidiaries that hold the initial five borrowing base assets financed by the facility, and the related TRS entities, which wholly own the TRS Lessees that lease each of the borrowing base assets. There are currently five hotel properties deemed borrowing base assets and an additional seven hotel properties that may be contributed to the borrowing base to increase borrowing availability.
Joint Venture Term Loan
In connection with the NCI Transaction, on January 13, 2022, Summit JV MR 2, LLC, Summit JV MR 3, LLC and Summit NCI NOLA BR 184, LLC (collectively, the “Borrowers”), the Joint Venture, as parent guarantor, and each party executing the credit facility documentation as a subsidiary guarantor, entered into a $410.0 million senior secured term loan facility (the “Joint Venture Term loan”) with Bank of America, N.A., as administrative agent and initial lender, Wells Fargo Bank, National Association, as syndication agent and an initial lender, and BofA Securities, Inc. and Wells Fargo Securities, LLC, as joint lead arrangers and joint bookrunners.
Neither the Operating Partnership nor the Company are borrowers or guarantors of the Joint Venture Term Loan. The Joint Venture Term Loan is guaranteed by the Joint Venture and all of the Borrowers’ existing and future subsidiaries, subject to certain exceptions.
The Joint Venture Term Loan provides for a $410.0 million term loan. The Joint Venture Term Loan has an accordion feature which will permit an increase in the total commitments by up to $190.0 million, for aggregate potential borrowings of up to $600.0 million. The Joint Venture Term Loan will mature on January 13, 2026 and can be extended for one 12-month period at the Company’s option, subject to certain conditions.
As of March 31, 2022, we had $410.0 million outstanding on the Joint Venture Term Loan bearing interest at a floating rate of SOFR plus 2.86%. The interest rate at March 31, 2022 was 3.15%.
Borrowing Base Assets
The Joint Venture Term Loan is secured primarily by a first priority pledge of the Borrowers’ equity interests in the subsidiaries that hold a direct or indirect interest in the 27 hotel properties and two parking facilities purchased in the NCI Transaction that constitute borrowing base assets. The Joint Venture Term Loan contains terms, conditions and covenants for typical for similar credit facilities.
For additional information concerning the Joint Venture Term Loan, please see our Current Report on Form 8-K filed on January 14, 2022.
PACE Loan
As part of the NCI Transaction, a subsidiary of the Joint Venture assumed a PACE loan of approximately $6.4 million. The loan bears fixed interest at 6.10%, has amortization period of 20 years, and matures on July 31, 2040. The PACE loan is secured by assessment lien imposed by the County of Tarrant, Texas for the benefit of the lender.
NOTE 6 - LEASES
The Company has operating leases related to the land under certain hotel properties, conference centers, parking spaces, automobiles, our corporate office and other miscellaneous office equipment. These leases have remaining terms of 1 year to 77 years, some of which include options to extend the leases for additional years. The exercise of lease renewal options is at our sole discretion. Certain leases also include options to purchase the leased property. Leases with an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.
Certain of our lease agreements include rental payments based on a percentage of revenue over contractual levels and others include rental payments adjusted periodically for inflation. Our lease agreements do not contain any material residual value guarantees or restrictive covenants that materially affect our business. In addition, we rent or sublease certain owned real estate to third parties. We recorded gross third-party tenant income of $2.3 million and $0.6 million during the three months ended March 31, 2022 and 2021, respectively, which were recorded in Other income in the Condensed Consolidated Statement of Operations.
On January 1, 2019, the Company adopted ASC No. 842, Leases, and recognized right-of-use lease assets and related liabilities. The right-of-use assets and related liabilities include renewal options reasonably certain to be exercised. We base our lease calculations on our estimated incremental borrowing rate. As of March 31, 2022, our weighted average incremental borrowing rate was 4.76%.
During the three months ended March 31, 2022 and 2021, the Company's total operating lease cost was $1.0 million and $0.8 million, respectively, and the operating cash outflows from operating leases was $0.9 million and $0.7 million, respectively. As of March 31, 2022, the weighted average operating lease term was 36.5 years.
Operating lease maturities as of March 31, 2022 are as follows (in thousands):
| | | | | |
| 2022 | $ | 1,574 | |
| 2023 | 1,264 | |
| 2024 | 1,205 | |
| 2025 | 1,209 | |
| 2026 | 1,222 | |
| Thereafter | 37,808 | |
Total lease payments (1) | 44,282 | |
| Less interest | (22,233) | |
| Total | $ | 22,049 | |
(1)Certain payments above include future increases to the minimum fixed rent based on the Consumer Price Index in effect at the initial measurement of the lease balances.
NOTE 7 - DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING
Information about our derivative financial instruments at March 31, 2022 and December 31, 2021 is as follows (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | Notional Amount | | Fair Value |
| Contract date | | Effective Date | | Expiration Date | | Average Annual Effective Fixed Rate | | March 31, 2022 | | December 31, 2021 | | March 31, 2022 | | December 31, 2021 |
| October 2, 2017 | | January 29, 2018 | | January 31, 2023 | | 1.98 | % | | $ | 100,000 | | | $ | 100,000 | | | $ | (310) | | | $ | (1,617) | |
| October 2, 2017 | | January 29, 2018 | | January 31, 2023 | | 1.98 | % | | 100,000 | | | 100,000 | | | (319) | | | (1,629) | |
| June 11, 2018 | | September 28, 2018 | | September 30, 2024 | | 2.87 | % | | 75,000 | | | 75,000 | | | (794) | | | (3,831) | |
| June 11, 2018 | | December 31, 2018 | | December 31, 2025 | | 2.93 | % | | 125,000 | | | 125,000 | | | (2,187) | | | (8,646) | |
| | | | | | | | $ | 400,000 | | | $ | 400,000 | | | $ | (3,610) | | | $ | (15,723) | |
Our interest rate swaps have been designated as cash flow hedges and are valued using a market approach, which is a Level 2 valuation technique. At March 31, 2022 and December 31, 2021, all of our interest rate swaps were in a liability position. The liability related to our interest rate swaps has decreased substantially during the first quarter of 2022 due to increases in interest rates. Our interest rate swaps are recorded in Accrued expenses and other in our Condensed Consolidated Balance Sheets. We are not required to post any collateral related to these agreements and are not in breach of any financial provisions of the agreements.
Changes in the fair value of the hedging instruments are deferred in Other comprehensive income and are reclassified to Interest expense in our Condensed Consolidated Statements of Operations in the period in which the hedged item affects earnings. In the next twelve months, we estimate that $2.3 million will be reclassified from Other comprehensive income and recorded as an increase to Interest expense.
The table below details the location in the financial statements of the gain or loss recognized on derivative financial instruments designated as cash flow hedges (in thousands):
| | | | | | | | | | | | | | | | | | |
| | | | | For the
Three Months Ended
March 31, |
| | | | | | | 2022 | | 2021 |
| Gain recognized in Other comprehensive income on derivative financial instruments | | | | | | $ | 9,813 | | | $ | 3,885 | |
| Loss reclassified from Other comprehensive income to Interest expense | | | | | | $ | (2,300) | | | $ | (2,318) | |
| Total Interest expense in which the effects of cash flow hedges are recorded | | | | | | $ | (13,439) | | | $ | (10,788) | |
| | | | | | | | |
NOTE 8 - EQUITY
Common Stock
The Company is authorized to issue up to 500,000,000 shares of common stock, $0.01 par value per share (the "Common Stock"). Each outstanding share of our 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 class or series of stock, the holders of such shares possess the exclusive voting power.
On May 25, 2017, the Company and the Operating Partnership entered into separate sales agreements (collectively, the “Sales Agreements”) with several underwriters (the “Sales Agents”), pursuant to which the Company may sell our Common Stock (the “Shares”) from time to time through the Sales Agents, each acting as a sales agent and/or principal (the "2017 ATM Program"). The 2017 ATM Program was updated in 2019 to allow us to sell Shares having an aggregate offering price of up to $110.0 million. To date, we have not sold any shares of our Common Stock under the 2017 ATM Program.
Changes in Common Stock during the three months ended March 31, 2022 and 2021 were as follows:
| | | | | | | | | | | |
| For the
Three Months Ended
March 31, |
| 2022 | | 2021 |
| Beginning common shares outstanding | 106,337,724 | | | 105,708,787 | |
| | | |
| Grants under the Equity Plan | 626,312 | | | 626,355 | |
| | | |
| | | |
| | | |
| | | |
| Performance share and other forfeitures | (3,173) | | | (60,823) | |
| Shares retained for employee tax withholding requirements | — | | | (155,605) | |
| Ending common shares outstanding | 106,960,863 | | | 106,118,714 | |
Preferred Stock
The Company is authorized to issue up to 100,000,000 shares of preferred stock, $0.01 par value per share, of which 89,600,000 is currently undesignated, 6,400,000 shares have been designated as 6.25% Series E Cumulative Redeemable Preferred Stock (the "Series E preferred shares") and 4,000,000 shares have been designated as 5.875% Series F Cumulative Redeemable Preferred Stock (the "Series F preferred shares").
The Company's outstanding shares of preferred stock (collectively, “Preferred Shares”) rank senior to our common stock and on parity with each other with respect to the payment of dividends and distributions of assets in the event of a liquidation, dissolution, or winding up. The Preferred Shares do not have any maturity date and are not subject to mandatory redemption or sinking fund requirements. The Company may not redeem the Series E or Series F preferred shares prior to November 13, 2022 and August 12, 2026, respectively, except in limited circumstances relating to the Company’s continuing qualification as a REIT or in connection with certain changes in control. After those dates, the Company may, at its option, redeem the applicable Preferred Shares, in whole or from time to time in part, by payment of $25 per share, plus any accumulated, accrued and unpaid distributions up to, but not including, the date of redemption. If the Company does not exercise its rights to redeem the Preferred Shares upon certain changes in control, the holders of the Preferred Shares have the right to convert some or all of their shares into a number of the Company’s common shares based on a defined formula, subject to a share cap, or alternative consideration. The share cap on each Series E preferred share is 3.1686 shares of common stock and each Series F preferred share is 5.8275 shares of common stock, all subject to certain adjustments.
The Company pays dividends at an annual rate of $1.5625 for each Series E preferred share and $1.46875 for each Series F preferred share. Dividend payments are made quarterly in arrears on or about the last day of February, May, August and November of each year.
NOTE 9 - NON-CONTROLLING INTERESTS AND REDEEMABLE NON-CONTROLLING INTERESTS
Non-controlling Interests in Operating Partnership
Pursuant to the limited partnership agreement of our Operating Partnership, the unaffiliated third parties who hold Common Units in our Operating Partnership have the right to cause us to redeem their Common Units in exchange for cash based upon the fair value of an equivalent number of our shares of Common Stock at the time of redemption; however, the Company has the option to redeem Common Units with shares of our Common Stock on a one-for-one basis. The number of shares of our Common Stock issuable upon redemption of Common Units may be adjusted upon the occurrence of certain events such as share dividend payments, share subdivisions or combinations. On January 13, 2022 and March 23, 2022, in connection with the NCI Transaction, the Operating Partnership issued 15,864,674 Common Units as partial consideration for the purchase.
At March 31, 2022 and December 31, 2021, NewcrestImage and other unaffiliated third parties owned 15,989,471 and 124,797 of Common Units of the Operating Partnership, respectively, representing approximately 13% and less than 1% of the Common Units of the Operating Partnership for each period.
We classify outstanding Common Units held by unaffiliated third parties as Non-controlling interests in the Operating Partnership, a component of equity in the Company’s Condensed Consolidated Balance Sheets. The portion of net income allocated to these Common Units is reported on the Company’s Condensed Consolidated Statements of Operations as Net income attributable to non-controlling interests of the Operating Partnership.
Non-controlling Interests in Joint Venture
In July 2019, the Company entered into a joint venture agreement with GIC, Singapore’s sovereign wealth fund, to acquire assets that align with the Company’s current investment strategy and criteria. The Company serves as general partner and asset manager of the Joint Venture and intends to invest 51% of the equity capitalization of the limited partnership, with GIC investing the remaining 49%. The Company earns fees for providing services to the Joint Venture and will have the potential to earn incentive fees based on the Joint Venture achieving certain return thresholds. As of March 31, 2022, the Joint Venture owns the 40 hotel properties totaling 5,583 guestrooms in nine states.
The Joint Venture owns the hotel proeprties through master real estate investment trusts (“Master REIT”) and subsidiary REITs (“Subsidiary REIT”). All of the hotel properties owned by the Joint Venture are leased to taxable REIT subsidiaries of the Subsidiary REITs (“Subsidiary REIT TRSs”). To qualify as a REIT, the Master REIT and each Subsidiary REIT must meet all of the REIT requirements summarized under “Note 2 - Basis of Presentation and Significant Accounting Policies - Income Taxes.” Taxable income related to the Subsidiary REIT TRSs is subject to federal, state and local income taxes at applicable tax rates.
We classify the Non-controlling interests in the Joint Venture as a component of equity in the Company’s Condensed Consolidated Balance Sheets. The portion of net income (losses) allocated to these non-controlling interests is reported on the Company’s Condensed Consolidated Statements of Operations as Net income (losses) attributable to non-controlling interests of the Joint Venture.
Redeemable Non-controlling Interests
In connection with the NCI Transaction, Summit Hotel GP, LLC, a wholly-owned subsidiary of the Company and the sole general partner of the Operating Partnership, on its own behalf as general partner of the Operating Partnership and on behalf of the limited partners of the Operating Partnership, on January 13, 2022, entered into the Tenth Amendment (the “Tenth Amendment”) to the First Amended and Restated Agreement of Limited Partnership of the Operating Partnership, to provide for the issuance of up to 2,000,000 Series Z Preferred Units. The Series Z Preferred Units rank on a parity with the Operating Partnership’s Series E and Series F Preferred Units and holders will receive quarterly distributions at a rate of 5.25% per year. From issuance until the tenth anniversary of their issuance, the Series Z Preferred Units will be redeemable at the holder’s request at any time, or in connection with a change of control of the Company, for, at the Company’s election, cash or shares of the Company’s 5.25% Series Z Cumulative Perpetual Preferred Stock (which will be designated and authorized following notice of redemption by holder of the Series Z Preferred Units) on a one-for-one basis. After the fifth anniversary of their issuance, the Company may redeem the Series Z Preferred Units for cash at a redemption amount of $25 per unit. For a 90-day period immediately following both the tenth and the eleventh anniversaries of their issuance or in connection with a change of control of the Company, the Series Z Preferred Units will be redeemable at the holder’s request for cash at a redemption amount of $25 per unit. On January 13, 2022 and March 23, 2022, in connection with the NCI Transaction, the Operating Partnership issued 2,000,000 Series Z Preferred Units as partial consideration for the purchase. At March 31, 2022, the redeemable Series Z Preferred Units issued in connection with the NCI Transaction are recorded as temporary equity of the Operating Partnership and reflected as Redeemable non-controlling interests in a mezzanine position presentation outside of Equity in our Consolidated Condensed Balance Sheet as of March 31, 2022.
NOTE 10 - FAIR VALUE MEASUREMENT
The following table presents information about our financial instruments measured at fair value on a recurring basis at March 31, 2022 and December 31, 2021. In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, we classify assets and liabilities based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
Disclosures concerning financial instruments measured at fair value are as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Fair Value Measurements at March 31, 2022 using |
| | | Level 1 | | Level 2 | | Level 3 | | Total |
| Assets: | | | | | | | | |
| | | | | | | | |
| Purchase options related to real estate loans | | $ | — | | | $ | — | | | $ | 2,800 | | | $ | 2,800 | |
| | | | | | | | |
| Liabilities: | | | | | | | | |
| Interest rate swaps | | — | | | 3,610 | | | — | | | 3,610 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Fair Value Measurements at December 31, 2021 using |
| | | Level 1 | | Level 2 | | Level 3 | | Total |
| Assets: | | | | | | | | |
| | | | | | | | |
| Purchase options related to real estate loans | | $ | — | | | $ | — | | | $ | 2,800 | | | $ | 2,800 | |
| Liabilities: | | | | | | | | |
| Interest rate swaps | | — | | | 15,723 | | | — | | | 15,723 | |
Our Purchase Option relates to real estate loans and does not have a readily determinable fair values. The original fair value of the Purchase Option was estimated using the Black-Scholes model.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
Franchise Agreements
We expensed fees related to our franchise agreements of $10.1 million and $4.1 million for the three months ended March 31, 2022 and 2021, respectively.
Management Agreements
Our hotel properties operate pursuant to management agreements with various professional third-party management companies. The terms of our management agreements range from month-to-month to twenty-five years with various extension provisions. Each management company receives a base management fee, which is a percentage of total hotel property revenues. In some
cases there are also monthly fees for certain services, such as accounting, based on the number of guestrooms. Generally, there
are also incentive fees based on attaining certain financial thresholds. Management fee expenses were $3.8 million and $1.6 million for the three months ended March 31, 2022 and 2021, respectively.
Litigation
We are involved from time to time in litigation arising in the ordinary course of business. There are currently no pending legal actions that we believe would have a material effect on our financial position or results of operations.
NOTE 12 - EQUITY-BASED COMPENSATION
Our currently outstanding equity-based awards were issued under the Equity Plan which provides for the granting of stock options, stock appreciation rights, restricted stock, restricted stock units, dividend equivalent rights, and other equity-based awards or incentive awards.
Stock options granted may be either incentive stock options or non-qualified stock options. Vesting terms may vary with each grant, and stock option terms are generally five to ten years. We have outstanding equity-based awards in the form of restricted stock awards. All of our outstanding equity-based awards are classified as equity awards.
Time-Based Restricted Stock Awards Made Pursuant to Our Equity Plan
The following table summarizes time-based restricted stock award activity under our Equity Plan for the three months ended March 31, 2022:
| | | | | | | | | | | | | | | | | | | | |
| | | Number
of Shares | | Weighted Average
Grant Date
Fair Value | | Aggregate
Current Value |
| | | | | (per share) | | (in thousands) |
| Non-vested at December 31, 2021 | | 605,470 | | | $ | 9.98 | | | $ | 5,909 | |
| Granted | | 316,643 | | | 9.83 | | | |
| Vested | | (227,153) | | | (9.70) | | | |
| Forfeited | | (3,173) | | | (10.29) | | | |
| Non-vested at March 31, 2022 | | 691,787 | | | $ | 9.85 | | | $ | 6,890 | |
The awards granted to our non-executive employees prior to 2022 vest over a four-year period based on continuous service (20% on the first, second and third anniversary of the grant date and 40% on the fourth anniversary of the grant date). The awards granted to our non-executive employees in 2022 vest over a three-year period based on continuous service (25% on the first and second anniversary of the grant date and 50% on the third anniversary of the grant date).
The awards granted to our executive officers generally vest over a three-year period based on continuous service (25% on the first and second anniversary of the grant date and 50% on the third anniversary of the grant date) or in certain circumstances upon a change in control.
The holders of these awards have the right to vote the related shares of common stock and receive all dividends declared and paid whether or not vested. The fair value of time-based restricted stock awards granted is calculated based on the market value of our common stock on the date of grant.
Performance-Based Restricted Stock Awards Made Pursuant to Our Equity Plan
The following table summarizes performance-based restricted stock activity under the Equity Plan for the three months ended March 31, 2022:
| | | | | | | | | | | | | | | | | | | | |
| | | Number
of Shares | | Weighted Average
Grant Date
Fair Value (1) | | Aggregate
Current Value |
| | | | | (per share) | | (in thousands) |
| Non-vested at December 31, 2021 | | 1,002,866 | | | $ | 11.92 | | | $ | 9,788 | |
| Granted | | 306,435 | | | 9.83 | | | |
| Vested | | (302,327) | | | (12.81) | | | |
| Forfeited | | — | | | — | | | |
| Non-vested at March 31, 2022 | | 1,006,974 | | | $ | 11.76 | | | $ | 10,029 | |
(1) The amounts included in this column represent the expected future value of the performance-based restricted stock awards calculated using the Monte Carlo simulation valuation model.
Our performance-based restricted stock awards are market-based awards and are accounted for based on the fair value of our common stock on the grant date. The fair value of the performance-based restricted stock awards granted was estimated using a Monte Carlo simulation valuation model. These awards cliff vest on the third anniversary of the grants based on our percentile ranking within the SNL U.S. REIT Hotel Index at the end of the period or upon a change in control. The awards require continued service during the measurement period and are subject to the other conditions described in the Equity Plan or award document.
The number of shares the executive officers may earn under these awards range from zero shares to twice the number of shares granted based on our percentile ranking within the index at the end of the measurement period. In addition, a portion of the performance-based shares may be earned based on the Company's absolute total shareholder return calculated during the performance period.
The holders of these grants have the right to vote the granted shares of common stock and any dividends declared will be accumulated and will be subject to the same vesting conditions as the awards. Further, if additional shares are earned based on our percentile ranking within the index, dividend payments will be issued as if the additional shares had been held throughout the measurement period.
Equity-Based Compensation Expense
Equity-based compensation expense included in Corporate general and administrative expenses in the Condensed Consolidated Statements of Operations for the three and three months ended March 31, 2022 and 2021 was as follows (in thousands):
| | | | | | | | | | | | | | | | | | |
| | | For the
Three Months Ended
March 31, | | |
| | | 2022 | | 2021 | | | | |
| Time-based restricted stock | | $ | 992 | | | $ | 665 | | | | | |
| Performance-based restricted stock | | 2,674 | | | 904 | | | | | |
| | | | | | | | |
| Director stock | | 32 | | | — | | | | | |
| | | $ | 3,698 | | | $ | 1,569 | | | | | |
We recognize equity-based compensation expense ratably over the vesting periods. The amount of expense may be subject to adjustment in future periods due to a change in the forfeiture assumptions. In January 2022, we granted a new member of our Board of Directors 3,234 shares of fully vested shares of our Common Stock at $9.94 per share.
Unrecognized equity-based compensation expense for all non-vested awards pursuant to our Equity Plan was $12.3 million at March 31, 2022 and will be recorded as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Total | | 2022 | | 2023 | | 2024 | | 2025 | | |
| Time-based restricted stock | | $ | 5,877 | | | $ | 1,954 | | | $ | 2,334 | | | $ | 1,396 | | | $ | 193 | | | |
| Performance-based restricted stock | | 6,378 | | | 2,159 | | | 2,552 | | | 1,458 | | | 209 | | | |
| | | $ | 12,255 | | | $ | 4,113 | | | $ | 4,886 | | | $ | 2,854 | | | $ | 402 | | | |
The Company's former Executive Vice President and Chief Operating Officer retired in March 2022. The Company recorded $1.3 million of additional stock-based compensation expense during the three months ended March 31, 2022 related to the modification of certain stock award agreements. This amount was comprised of $0.4 million related to time-based restricted stock awards and $0.9 million related to performance-based restricted stock awards.
NOTE 13 - INCOME TAXES
As a REIT, we generally will not be subject to U.S. federal income tax on ordinary income and capital gains income generated by our REIT activities that we distribute to our stockholders. We are subject to federal and state income taxes on the earnings of our TRS Lessees. In addition, our Operating Partnership is subject to tax in a limited number of local and state jurisdictions.
The Company recorded an income tax benefit of $2.0 million and income tax expense of $0.1 million for the three months ended March 31, 2022 and 2021, respectively. Due to the effects of the Pandemic, certain of our TRS Lessees have incurred operating losses in the past and are expected to be in a cumulative loss for the foreseeable future. A cumulative loss is significant negative evidence that the realizability of our deferred tax assets at March 31, 2022 is not reasonably assured. Therefore, we have recorded a valuation allowance against substantially all our deferred tax assets at March 31, 2022.
We had no unrecognized tax benefits at March 31, 2022. We expect no significant changes in unrecognized tax benefits within the next year.
NOTE 14 - EARNINGS PER SHARE
We apply the two-class method of computing earnings per share, which requires the calculation of separate earnings per share amounts for our non-vested time-based restricted stock awards with non-forfeitable dividends and for our common stock. Our non-vested time-based restricted stock awards with non-forfeitable rights to dividends are considered securities which participate in undistributed earnings with common stock. Under the two-class computation method, net losses are not allocated to participating securities unless the holder of the security has a contractual obligation to share in the losses. Our non-vested time-based restricted stock awards with non-forfeitable dividends do not have such an obligation so they are not allocated losses.
Below is a summary of the components used to calculate basic and diluted earnings per share (in thousands, except per share):
| | | | | | | | | | | | | | | | | | |
| | | For the
Three Months Ended
March 31, | | |
| | | 2022 | | 2021 | | | | |
| Numerator: | | | | | | | | |
| Net loss | | $ | (8,973) | | | $ | (32,871) | | | | | |
| Less: Preferred dividends | | (3,970) | | | (3,709) | | | | | |
| | | | | | | | |
| | | | | | | | |
| Attributable to non-controlling interest in Operating Partnership | | 482 | | | 54 | | | | | |
| Attributable to non-controlling interests in Joint Venture | | 82 | | | 1,452 | | | | | |
| Net loss attributable to common stockholders, net of amount allocated to participating securities | | $ | (12,379) | | | $ | (35,074) | | | | | |
| Denominator: | | | | | | | | |
| Weighted average common shares outstanding - basic and diluted | | 104,896 | | | 104,278 | | | | | |
| | | | | | | | |
| | | | | | | | |
| Loss per share: | | | | | | | | |
| Basic and diluted | | $ | (0.12) | | | $ | (0.34) | | | | | |
| | | | | | | | |
The Common Units held by the non-controlling interest holders have been excluded from the denominator of the diluted earnings per share calculation as there would be no effect on the amounts since the limited partners' share of income would also be added to derive net income attributable to common stockholders. Our unvested performance-based restricted stock awards and outstanding convertible notes have been excluded from the denominator of the diluted earnings per share calculation as their inclusion would be antidilutive.
NOTE 15 - SUBSEQUENT EVENTS
Dividends
On April 29, 2022, our Board of Directors declared cash dividends of $0.390625 per share of 6.25% Series E Cumulative Redeemable Preferred Stock and $0.3671875 per share of 5.875% Series F Cumulative Redeemable Preferred Stock. The Board of Directors also declared on behalf of the Operating Partnership, a cash dividend of $0.328125 per share of the Operating Partnership's unregistered 5.25% Series Z Cumulative Perpetual Preferred Units that were issued on January 13, 2022 and $0.249660 per unit for the units issued on March 23, 2022 as part of the NCI Transaction.
These dividends are payable May 31, 2022 to stockholders of record on May 22, 2022.
Exercise of Purchase Option
In April 2022, we exercised the Initial Purchase Option to acquire a 90% equity interest in the AC Hotel by Marriott and Element Miami Brickell Hotel in Miami, FL. The option price was based on a gross hotel valuation of $89.0 million determined prior to commencement of the development project. We expect to fund our estimated equity requirement with the proceeds from the payment in full of our outstanding mezzanine loan to the developer of the project, which is expected to be $29.9 million at closing, the assumption of senior debt on the development project of approximately $47.0 million, and $7.9 million in cash. We expect to close the transaction in June 2022. Although we currently do not have an estimate of the fair value of the Initial Purchase Option, we expect to the adjust the Initial Purchase Option to its estimated fair value during the second quarter of 2022 based on the estimated fair value of the hotel property on the closing date.
Disposition of Hotel Property
On March 23, 2022, our Joint Venture entered into an agreement to sell the entity that holds our Hilton Garden Inn San Francisco Airport North in San Francisco, CA containing 169 guestrooms for a gross selling price of $75 million, which will result in an approximate gain on the sale of $20.5 million. We have received $7.5 million of nonrefundable earnest money from the buyer and we expect the transaction to close during the second quarter of 2022. As such, we have classified this property as Held for sale at March 31, 2022.
PART I - FINANCIAL INFORMATION