Item 1A. Risk Factors
In addition to the other information in this Annual Report on Form 10-K, the following risk factors should be considered carefully in evaluating our Company and our business. Any of the following risks could materially and adversely affect our business, financial condition and results of operations.
Risks Related to the Ongoing Covid-19 Pandemic
The ongoing COVID-19 pandemic has caused severe disruptions in the U.S. and global economy and to our business and is expected to continue to adversely impact our business at least for the near term. The overall impact on our business, operating results, cash flows and/or financial condition has been and may continue to be material.
In December 2019, a novel coronavirus disease was reported and in January 2020, the World Health Organization (“WHO”) declared COVID-19 a Public Health Emergency of International Concern. The WHO has characterized COVID-19 as a pandemic. The COVID-19 pandemic has spread to over 200 countries and territories, including the U. S., and has spread to every state in the U.S. and has adversely affected global economies, financial markets and the overall environment for our business. Until vaccines are successfully deployed to a sufficient percentage of the population, the COVID-19 pandemic could continue to have an adverse impact on economic and market conditions and has triggered a period of global economic slowdown. The extent to which it may impact our future results of operations and overall financial performance remains uncertain; however, we expect such impact to be material.
The scale and scope of the COVID-19 pandemic has heightened the potential adverse effects on our business, operating results, cash flows and/or financial condition described in the other risk factors contained herein, including the impact of:
• contraction in the U.S. economy or low levels of economic growth, which could adversely affect our revenues and profitability as well as limit or slow our future growth;
• many of the expenses associated with owning hotels, such as debt-service payments, property taxes, insurance, utilities and employee wages and benefits, as well as expenses related to being an independent public company, being inflexible and not necessarily decreasing in tandem with a reduction in revenue at the hotels;
• increases in operating costs, including for cleaning, adjusting and rehiring staff, marketing and customer acquisition and retention;
• higher health standards, disinfection, tracing requirements, reporting of infections;
• temporary suspensions of guest reservations, decreasing our revenues;
• decreased demand and reduced availability of buyer financing in executing our non-core disposition strategy;
• the capital intensity of our business;
• the imposition of lender cash traps and minimum liquidity requirements by lenders affecting our access to operating liquidity;
• reductions in our ability to maintain or improve our portfolio or act in accordance with applicable brand standards;
• reduction in the availability of financing and other liquidity sources; and
• changes to estimates or projections used to assess the fair value of our assets, or operating results that are lower than our current estimates at certain properties, which has caused, and may continue to cause, us to incur additional impairment charges that could adversely affect our results of operations.
In addition, the COVID-19 pandemic has adversely impacted our business and financial condition in other areas, including: the ability of potential hotel purchasers to (i) review assets that we are seeking to dispose pursuant to our non-core disposition strategy, in affected areas as a result of quarantines, restrictions on travel, shelter in place rules, restrictions on types of businesses that may continue to operate and/or restrictions on types of construction projects that may continue or (ii) obtain financing for the purchase of such assets, either of which could result in discounts to our sales prices, less favorable terms and delays in completing our non-core disposition program, our ability to make payments on our indebtedness, our ability to fund planned capital expenditures and our ability to make distributions to our stockholders.
If, due to the impact of the COVID-19 pandemic, we are unable to generate sufficient cash flow to service our debt and meet our other commitments, we may need to restructure or refinance all or a portion of our debt, sell material assets or operations or raise additional debt or equity capital (to the extent permitted under the agreements governing our indebtedness and other contractual or other obligations).
Beginning in late March 2020, up to 30 of our hotels were temporarily not accepting transient guests or most other reservations due to the impact of the COVID-19 pandemic. Each of these hotels resumed a ccepting transient guests and reservations by August 2020. Because our hotels are located in the U.S., the COVID-19 pandemic will impact our hotels to the extent that its spread within the U.S. continues to limit occupancy, increases the cost of operation or necessitates the closure of certain properties.
The duration and extent of the impact from the COVID-19 pandemic depends on future developments that cannot be accurately predicted at this time, such as the severity and transmission rate of COVID-19, the extent and effectiveness of containment actions, the effectiveness of vaccines and national, state, and local governments’ ability to effectively distribute such vaccines and the impact of these and other factors on our hotel operations. Currently, certain cities are experiencing increased COVID-19 infection rates, which may lead to new or expanded restrictions on businesses and travelers.
Risks Related to Our Business and Industry
We are subject to the business, financial and operating risks inherent to the lodging industry, any of which could reduce our profits, the value of our properties and our ability to make distributions and limit opportunities for growth.
Our business is subject to a number of business, financial and operating risks inherent to the lodging industry, including:
• significant competition from other lodging businesses and hospitality providers in the markets in which our properties are located;
• changes in operating costs, including energy, food, compensation, benefits, insurance and unanticipated costs resulting from force majeure events;
• increases in costs due to inflation or other factors that may not be fully offset by price or other revenue increases in our business;
• changes in taxes and governmental regulations that influence or set wages, prices, interest rates or construction and maintenance procedures and costs;
• the costs and administrative burdens associated with complying with applicable laws and regulations;
• the costs or desirability of complying with local practices and customs;
• significant increases in cost for health care coverage for employees, including employees of third-party hotel managers, and potential government regulation with respect to health coverage, such as costs associated with compliance with the requirements of the Patient Protection and Affordable Care Act;
• shortages of labor or labor disruptions;
• significant increases in insurance expenses, self-retained losses and loss mitigation capital expenditures;
• the availability and cost of capital necessary to fund investments, capital expenditures and service debt obligations;
• delays in, or cancellations of, planned or future development or renovation projects;
• the quality of services provided by LQM or any other future third-party hotel managers;
• the financial condition of LQM or any other future third-party hotel managers, developers and joint venture partners;
• relationships with LQM or any other future third-party hotel managers, developers and joint venture partners, including the risk that LQM, LQ Franchising or any other third-party hotel managers or franchisors may terminate our management or franchise agreements and joint venture partners may terminate joint venture agreements;
• changes in desirability of particular geographic locations;
• changes in lodging preferences and travel patterns of potential guests of our properties and geographic concentration of our portfolio;
• changes in the supply and demand for hotel services;
• decreases in business travel that may result from improvements to the alternatives to in-person meetings, including virtual meetings hosted online or over private teleconferencing networks or from pandemics or outbreaks of contagious disease;
• the ability of third-party internet and other travel intermediaries to attract and retain guests;
• the availability of debt and equity capital on satisfactory terms; and
• increased competition and changes in terms for the disposition and acquisition of hotel investments.
Any of these factors could limit or reduce our revenues or increase costs or affect our ability to develop new hotels or maintain our existing hotels. As a result, any of these factors can reduce our profits, the value of our properties and our ability to make distributions and limit opportunities for growth.
Macroeconomic and other factors beyond our control can adversely affect and reduce lodging demand.
Macroeconomic and other factors beyond our control can reduce demand for our lodging products and services, including demand for rooms at our hotels. These factors include, but are not limited to:
• changes in general economic conditions, including the severity and duration of any downturn in the U.S. or global economy and financial markets;
• war, political conditions or civil unrest, violence or terrorist activities or threats and heightened travel security measures instituted in response to these events;
• pandemics or outbreaks of contagious diseases, such as COVID-19, Zika virus, measles, Ebola, legionella bacteria, avian flu, severe acute respiratory syndrome (SARS) and H1N1 (swine flu);
• natural or man-made disasters, such as hurricanes, fires, earthquakes, tsunamis, tornadoes, typhoons, floods, oil spills and nuclear incidents;
• decreased corporate or government travel-related budgets and spending and cancellations, deferrals or renegotiations of group business;
• low consumer confidence, high levels of unemployment or depressed real estate prices;
• the financial condition and general business condition of the airline, automotive and other transportation-related industries and its impact on travel;
• decreased airline capacities and routes;
• travel-related accidents;
• oil prices and travel costs;
• statements, actions or interventions by governmental officials related to travel and corporate travel-related activities and the resulting negative public perception of such travel and activities;
• governmental action, regulations and legislation, as well as political debate, conflicts and compromises related to such actions, to the extent that they negatively impact our operating costs, the financial markets and consumer confidence and spending or adversely impact the U.S. economy or international travel;
• cyber-attacks;
• climate change and resource scarcity, such as water and energy scarcity;
• domestic and international political and geopolitical conditions including tariffs, sanctions and boycotts; and
• cyclical over-building in the hotel and lodging industries.
These factors, and the reputational repercussions of these factors, can adversely affect, and from time to time have adversely affected, individual hotels, particular regions and our business, financial condition and results of operations as a whole. Any one or more of these factors could limit or reduce the demand, or the rates that can be charged, for rooms. Declines in ADR and occupancy relating to declines in consumer demand will lower RevPAR and may adversely affect our business, financial condition and results of operations. In addition, these factors could increase our operating costs or affect our ability to purchase or develop new hotels or to maintain our existing hotels.
Contraction in the global economy or low levels of economic growth could adversely affect our revenues and profitability as well as limit or slow our future growth.
Consumer demand for products and services provided by the lodging industry is closely linked to the performance of the general economy and is sensitive to business and personal discretionary spending levels. Decreased demand can be especially pronounced during periods of economic contraction or low levels of economic growth, and the recovery period in our industry may lag overall economic improvement. Declines in consumer demand due to adverse general economic conditions could negatively impact our business by decreasing the revenues and profitability of our properties. In addition, many of the expenses associated with our business, including personnel costs, interest, rent, property taxes, insurance and utilities, are relatively fixed. During a period of overall economic weakness, if we are unable to meaningfully decrease these costs as demand for our hotels decreases, our financial performance may be adversely affected.
In addition to general economic conditions, new hotel room supply is an important factor that can affect the lodging industry’s performance, and overbuilding has the potential to further exacerbate the negative impact of an economic downturn. Room rates and occupancy, and thus RevPAR, tend to increase when demand growth exceeds supply growth. A reduction or slowdown in growth of lodging demand or increased growth in lodging supply could result in returns that are substantially below expectations or result in losses, which could materially and adversely affect our revenues and profitability as well as limit or slow our future growth.
A significant percentage of our hotels are concentrated in three states, which exposes our business to the effects of certain regional events and occurrences.
Although we have hotels located in 35 U.S. states as of December 31, 2020, a significant concentration of our hotels is located in three states. Specifically, as of December 31, 2020, approximately 49% of hotels in our portfolio were located in Texas, Florida and California. The concentration of hotels in one region or a limited number of markets may expose us to risks of adverse economic developments that are greater than if our portfolio were more geographically diverse. These economic developments include regional economic downturns, significant increases in the number of our competitors’ hotels in these markets and potentially higher local property, sales and income taxes in the geographic markets in which we are concentrated. For example, the downturn in the oil and gas industry significantly affected demand in certain markets in Texas, such as Houston and South and West Texas, materially adversely affecting our business in those markets, and a further decline could further adversely affect our business in those markets. In addition, our hotels are subject to the effects of adverse acts of nature, such as winter storms, hurricanes, hail storms, winds, fires, earthquakes and tornadoes, which have in the past caused such as flooding and other to our hotels in specific geographic locations, including in the Texas, Florida and California markets. Depending on the of these acts of nature, the to our hotels could require us to close all or substantially all of our hotels in one or more markets for a period of time while the necessary repairs and renovations, as applicable, are undertaken. State and local government imposed restrictions in response to pandemics or outbreaks of contagious disease could also affect our business in jurisdictions where such restrictions are in effect. Additionally, we cannot you that the amount of our hurricane, windstorm, earthquake, flood, business or other casualty insurance we maintain would entirely cover caused by any such event.
As a result of our geographic concentration of hotels, we will face a greater risk of a negative impact on our revenues in the event these areas are more severely impacted by adverse economic, social and competitive conditions and extreme weather than other areas in the U.S.
Our hotels operate and we compete for acquisitions in a highly competitive industry.
The lodging industry is highly competitive. Our principal competitors include hotel operating companies, ownership companies (including other lodging REITs) and national and international hotel brands. We face increased competition from providers of less expensive accommodations during periods of economic downturn as leisure and business travelers become more sensitive to room rates. Our hotels generally operate in chain scales that contain numerous competitors, including a wide range of lodging facilities offering full-service, select-service and all-suite lodging options. Hotels in other chain scales, such as full-service hotels, may lower their rates to a level comparable to those of select-service hotels such as ours that, in turn, may further increase competitive pressure in our segments. Our hotels generally compete for guests on the basis of several factors, including the attractiveness of the facility, location, room rates, quality of accommodations, public and meeting spaces, brand reputation and the ability to earn and redeem loyalty program points through a global system. We have also seen the emergence of a sharing economy with the increasing availability of online short-term rentals, including single family homes. Additionally, an increasing supply of hotel rooms in our hotels’ chain scales, and consolidations in the lodging industry generally, have resulted in the creation of several large, multi-branded hotel chains with diversified operations and greater marketing and financial resources than we or our hotels have, which has increased competition for guests in the segments in which our hotels operate. If we are to compete for hotel guests, our revenues or profits may .
We also compete for hotel acquisitions with entities that have similar investment objectives as we do. This competition could limit the number of investment opportunities that we find suitable for our business. It may also increase the bargaining power of property owners seeking to sell to us, making it more difficult for us to acquire new properties on attractive terms or on the terms contemplated in our business plan. Some of these entities may have substantially greater financial resources than we do and may be able and willing to accept more risk than we believe we can prudently manage. During the recovery phase of the lodging cycle, competition among potential buyers may increase the bargaining power of potential sellers, which may reduce the number of suitable investment opportunities available to us or increase pricing. Similarly, during times when we seek to sell hotels, competition from other sellers may increase the bargaining power of the potential property buyers.
We are subject to risks associated with the concentration of our portfolio in the La Quinta brand. Any deterioration in the quality or reputation of the La Quinta brand, including changes to loyalty programs, or our relationship with the La Quinta brand could have an adverse impact on our financial condition or results of operations.
All of our properties currently utilize the La Quinta brand, and we have entered into management and franchise agreements with LQM and LQ Franchising, respectively, to manage and franchise all of our owned properties. As a result, the success of our hotels and their ability to attract and retain guests depends on brand recognition and reputation, including the consistency of the La Quinta brand experience amongst our portfolio of hotels. We cannot assure you that the prior performance of our hotels will be indicative of future results or that competition from other brands will not adversely affect our market position or financial performance.
In addition, the brand recognition and support that provide much of the basis for the successful operation of our hotels can also mean that changes or problems with the La Quinta brand ( e.g. , integration challenges relating to the acquisition by Wyndham Worldwide Corporation (“Wyndham Worldwide”) of the La Quinta brand, changes in management practices, or acts or omissions that adversely affect our business) can have a substantial negative impact on the operations of our hotels and can cause a loss of consumer confidence in La Quinta hotels or otherwise result in reduced bookings at our hotels. For example, we have seen negative effects on our revenues following the systems migration to the Wyndham platform effected in the second quarter of 2019 which we believe are due to, among other things, modifications LQM mad e to our revenue management software and tools, call center customer interface technology and the administration of corporate and group bookings. If modifications or enhancements for such systems, software and tools and other processes, developed pursuant to the settlement we entered into with our hotel manager in October 2019 to our of several events of under the management agreements relating to all of our wholly owned properties (the “Wyndham Settlement”), do not prove to be or if we experience further integration , our financial condition and results of operations could be further impacted.
Moreover, changes or problems at our hotel properties ( e.g. , crime, pandemics, scandal, litigation, negative publicity, catastrophic fires or similar events or accidents and injuries or other harm to guests or employees at our hotels) can have a substantial negative impact on the operations of otherwise successful individual locations and can cause a loss of consumer confidence in La Quinta hotels and other hotels in our segment. Adverse incidents have occurred in the past and may occur in the future. The considerable expansion in the use of social media over recent years has compounded the potential scope of the negative publicity that could be generated by such incidents. We could also face legal and publicity from a variety of events or conditions, many of which are beyond our control (such as drug use, gambling, or prostitution by guests). If the reputation or perceived quality of the La Quinta brand , our financial condition or results of operations could be affected.
During the second quarter of 2019, the La Quinta Returns loyalty program was combined with the Wyndham Rewards loyalty program. La Quinta Returns allowed, and Wyndham Rewards allows, program members to accumulate points based on eligible stays and hotel charges and redeem the points for a range of benefits including free rooms and other items of value. Rewards programs are an important aspect of our business and of the affiliation value of our hotels. As part of the Wyndham Rewards program, prior La Quinta Returns members may use their points for other hotels in the Wyndham family of brands (not just La Quinta), which may in certain cases directly compete with our hotels, negatively impacting our business. If the Wyndham Rewards program deteriorates or materially changes in a manner adverse to us, our business, financial condition or results of operations could be materially adversely affected.
We are dependent on the performance of LQM and other future third-party hotel managers and could be materially and adversely affected if LQM or such other future third-party hotel managers do not properly manage our hotels or otherwise act in our best interests.
In order for us to continue to qualify as a REIT, with limited exceptions, third parties must operate our hotels. We lease all but one of our hotels to our TRS lessees. Our TRS lessees, in turn, have entered into management agreements with LQM to operate our hotels. We could be materially and adversely affected if LQM or any other future third-party hotel manager fails to provide quality services and amenities, fails to maintain a quality brand name or otherwise fails to manage our hotels in our best interests, and can be financially responsible for the actions and inactions of our third-party hotel managers pursuant to our management agreements. For example, in connection with the systems migration to the Wyndham platform effected in the second quarter of 2019, key proprietary revenue management software and tools and other processes were modified. We believe these modifications and other problems relating to implementation of the transition of our hotels in LQM’s platform had a negative effect on our business and if further modifications or enhancements for such software and tools, and other processes developed by LQM are , or LQM otherwise to manage our hotels effectively, our results of operations will be further impacted.
We also rely on the management company to engage general managers at each of our hotels to manage daily operations and oversee the efforts of their employees. We require the third-party hotel manager to hire general managers who are trained professionals in the hospitality industry and have extensive experience in many markets worldwide. The failure of the management company to recruit, retain, train or successfully manage general managers for our hotels could negatively affect our operations. LQM is a wholly owned subsidiary of Wyndham, which manages and franchises other brands and hotels that compete with our hotels, which could result in conflicts of interest. As a result, LQM may make decisions regarding competing lodging facilities that are not in our best interests. Other third-party hotel managers that we engage in the future may also have similar conflicts of interest.
From time to time, disputes may arise between us, LQM and/or any other future third-party hotel manager regarding their performance or compliance with the terms of the hotel management agreements, which in turn could adversely affect our results of operations or could make us liable to them or result in significant litigation costs or other expenses. For example, on July 30, 2019 and August 14, 2019, we gave notice to LQM of several events of default under the management agreements relating to all of our wholly owned properties, and on October 18, 2019, we entered into the Wyndham Settlement in order to resolve all such claims. If we are
unable to reach a satisfactory resolution of any future dispute with LQM and/or any other future third-party hotel manager through discussions and negotiations, we or the relevant third-party hotel manager may choose to pursue legal resolution, the outcome of which may be unfavorable to us. Any such dispute could be very expensive for us, even if the outcome is ultimately in our favor. Pursuant to the hotel management agreements we entered into with LQM, we do not have the option of exploring other potentially more favorable judicial procedures to litigate any such dispute. Furthermore, the management agreements have initial terms of 20 years with two additional five-year renewal periods at manager’s option and we may terminate the management agreements only upon an event of default by the applicable third-party hotel manager, a sale of the property or the relevant manager’s failure of certain performance tests which, if , are subject to legal action.
In the event that we terminate any of our management agreements, whether due to events of default or otherwise, we can provide no assurances that we could find a replacement hotel manager or that any replacement hotel manager will be successful in operating our hotels. If any of the foregoing were to occur, it could materially and adversely affect us.
Furthermore, if our relationship with LQM and/or LQ Franchising were to deteriorate or terminate as a result of disputes regarding the management of our hotels or for other reasons, LQM and/or LQ Franchising could, under certain circumstances, terminate our management agreements or franchise agreements for our current hotels or hotels that we may acquire in the future. If any of the foregoing were to occur, it could materially and adversely affect our results of operations and profitability as well as limit or slow our future growth and impair our ability to compete effectively.
Certain of our hotel franchise agreements contain provisions limiting or restricting the sale of our hotels, which could materially and adversely affect our profitability.
Certain of our hotel franchise agreements with LQ Franchising contain provisions that limit or restrict our ability to sell a hotel. Although in connection with the Wyndham Settlement, our franchise agreements were amended to limit the criteria for LQ Franchising’s approval of asset sales, generally, we may not agree to sell, lease or otherwise transfer a particular hotel unless agreed criteria are met or LQ Franchising otherwise approves the transfer pursuant to the applicable franchise agreement. In addition, we could be liable for significant liquidated damages in connection with the termination of such franchise agreement or continue to be obligated under any guarantee contained in the applicable franchise agreement in connection with any approved transfer. As a result, selling or transferring certain of our hotels may be less advantageous than it otherwise may have been, or we may be prohibited from taking actions that would otherwise be in our and our stockholders’ best interests. In addition, LQ Franchising may have a conflict that results in LQ Franchising’s declining to approve a transfer that would be in our and our stockholders’ best interests.
If we are unable to maintain good relationships with LQM, LQ Franchising and other third-party hotel managers and franchisors that we may engage in the future, profitability could decrease, and our growth potential may be adversely affected.
The success of our properties largely depends on our ability to establish and maintain good relationships with LQM, LQ Franchising and other third-party hotel managers and franchisors that we may engage in the future. If we are unable to maintain good relationships with LQM, LQ Franchising and such other third-party hotel managers and franchisors, we may be unable to renew existing management or franchise agreements or expand relationships with them. Additionally, opportunities for developing new relationships with additional third-party managers or franchisors may be adversely affected. This, in turn, could have an adverse effect on our results of operations and our ability to execute our growth strategy.
On July 30, 2019 and August 14, 2019, we gave notice to LQM of several events of default under the management agreements relating to all of our wholly owned properties, and on October 18, 2019 we entered into the Wyndham Settlement in order to resolve all such claims. If we are unable to amicably resolve any future disputes relating to LQM’s performance under the management agreements, it may have an adverse effect on our relationship with LQM which could, in turn, have an adverse effect on our results of operations and financial condition and could result in additional costs for us to report our financial information on a timely basis.
Our efforts to reposition, renovate, redevelop or develop our hotels could be delayed or become more expensive, which could reduce profits or impair our ability to compete effectively.
We must maintain and renovate our hotels to remain competitive, maintain the value and brand standards of these hotels and comply with applicable laws and regulations. From time to time, we evaluate our hotels to determine whether additional capital expenditures are required and will provide an acceptable return on investment.
Our strategy includes maintenance and renovation of our hotels and may include redevelopment, development and conversion of hotels, which is subject to a number of risks, including:
• the inability to obtain financing upon favorable terms or at all;
• construction delays or cost overruns (including labor and materials) that may increase project costs;
• lack of availability of rooms for revenue-generating activities during construction, modernization or renovation projects;
• changes in economic conditions that may result in weakened or lack of demand for improvements that we make or negative project returns for improvements that we make;
• obtaining zoning, occupancy, and other required permits or authorizations;
• governmental restrictions on the size or kind of development;
• volatility in the debt and capital markets that may limit our ability to raise capital for projects or improvements;
• force majeure events, including earthquakes, tornadoes, hurricanes, floods or tsunamis, or acts of terrorism; and
• design defects that could increase costs.
Furthermore, we generally rely heavily on local contractors, who may be inadequately capitalized or understaffed. The inability or failure of one or more local contractors to perform its obligations may result in construction or remodeling delays, increased costs and loss of revenues. As a result, we may not increase our revenues or generate expected profits and cash flows from the renovation, redevelopment or development of hotels.
If hotels under renovation or development cannot begin operating as scheduled, or if renovation investments adversely affect or fail to improve performance, our ability to compete effectively could be diminished and revenues could be reduced. Further, due to the lengthy development cycle, adverse economic conditions may alter or impede our development plans, thereby resulting in incremental costs to us or potential impairment charges. If the cost of funding these renovations or developments exceeds budgeted amounts, profits could be reduced. Moreover, during the early stages of operations of our hotel properties, charges related to interest expense and depreciation may substantially detract from, or even outweigh, the profitability of certain new hotel investments.
The lodging industry is subject to seasonal and cyclical volatility, which may contribute to fluctuations in our financial condition and results of operations.
The lodging industry is seasonal in nature. The periods during which our properties experience higher revenues vary from hotel to hotel, depending principally upon location and customer base served. Generally, our revenues are greater in the second and third calendar quarters than in the first and fourth quarters. The timing of holidays, local special events and weekends can also impact our quarterly results and comparability to prior periods. This seasonality can be expected to cause quarterly fluctuations in revenue, profit margins and net earnings. In addition, the opening of hotels and the timing of any hotel acquisitions or dispositions may cause a variation of revenue from quarter to quarter. We can provide no assurances that our cash flows will be sufficient to offset any shortfalls that occur as a result of these fluctuations. As a result, we may have to enter into short-term borrowings in certain quarters to make distributions to our stockholders in accordance with our distribution policy as a REIT, and we can provide no assurances that such borrowings will be available to us on favorable terms, if at all. In addition, the lodging industry is cyclical and demand generally follows the broader economy on a lagged basis. The seasonality and cyclicality of our industry may contribute to fluctuations in our financial condition and results of operations.
Our expenses may not decrease even if our revenue decreases.
Many of the expenses associated with owning hotels, such as debt-service payments, property taxes, insurance, utilities and corporate employee wages and benefits, as well as expenses related to being an independent public company, are relatively inflexible. They do not necessarily decrease in tandem with a reduction in revenue at the hotels, or in the case of our expenses as a public company, decrease in tandem with the number of hotels we own, and may be subject to increases that are not tied to the performance of our hotels or the increase in the rate of inflation generally. In addition, some of our third-party ground leases require periodic increases in ground rent payments. Our ability to pay these rents could be affected adversely if our hotel revenues do not increase at the same or a greater rate than the increases in rental payments under the ground leases.
In the event of a significant decrease in demand, LQM or other third-party hotel managers that we may engage in the future may not be able to adjust the labor model to offset the decrease in demand. Our hotel managers also may be unable to offset any fixed or increased expenses with higher room rates. Any of our efforts to reduce operating costs also could adversely affect the future growth of our business and the value of our hotel properties.
Our business is capital intensive and our failure to make necessary investments could adversely affect the profitability of our properties.
As of December 31, 2020, our hotels had an average a ge of 30 years. Fo r these hotels to remain attractive and competitive, to mitigate repairs and to optimize operating performance, we have to make periodic investments to keep these hotels well maintained, modernized and refurbished. This creates an ongoing need for capital. We may be unable to access capital or unwilling to spend available capital when necessary. For example, in 2020, in response to the revenue decline we experienced due to the COVID-19 pandemic, we deferred all non-essential capital expenditures. In addition, we are required to make distributions to our stockholders in accordance with our distribution policy as a REIT which may limit the capital available for us to invest in our hotels. To the extent that we cannot fund expenditures from cash generated by the operation of our properties, funds must be borrowed or otherwise obtained, which may be difficult to obtain. Failure to make the investments necessary to maintain or improve our portfolio or act in accordance with applicable brand standards could adversely affect the and market value of our properties.
We are exposed to the inherent risks resulting from our investments in real estate, including the relative illiquidity of such investments, which could increase our costs, reduce our profits and limit our ability to respond to market conditions.
Real estate investments are relatively illiquid and, therefore, cannot be purchased or sold rapidly in response to changes in economic or other conditions. Buyers may not be identified quickly or be able to secure suitable financing to consummate a transaction or we may not be able to sell hotels on terms favorable to us. Furthermore, sales of certain appreciated hotels could generate material adverse tax consequences, which may affect our ability to sell hotels in response to market conditions and adversely affect our ability to generate cash flows.
Moreover, the Code imposes restrictions on a REIT’s ability to dispose of properties that are not applicable to other types of real estate companies. In particular, the tax laws applicable to REITs require that we hold our hotels for use in a trade or business or for investment, rather than primarily for sale in the ordinary course of business, which may cause us to forgo or defer sales of hotels that otherwise would be in our best interests or to incur significant liabilities in connection with these sales. Therefore, we may not be able to adjust the composition of our portfolio promptly in response to changing economic, financial and investment conditions or dispose of assets at opportune times or on favorable after-tax economic terms, which may adversely affect our cash flows and our ability to make distributions to stockholders.
Additionally, real estate ownership is subject to other risks, including:
• governmental regulations relating to real estate ownership or operations, including tax, environmental, zoning and eminent domain laws;
• loss in value or functionality, or unanticipated liabilities, due to environmental conditions, local market or neighborhood conditions, governmental takings, uninsured casualties or restrictive changes in zoning and similar land use laws and regulations or in health, safety and environmental laws, rules and regulations and other governmental and regulatory action;
• changes in tax laws and property taxes, even if the hotel level cash flows remain the same or decrease;
• increased potential civil liability for accidents or other occurrences in hotels;
• the ongoing need for owner funded capital improvements and expenditures to maintain or upgrade hotels;
• periodic total or partial closures due to renovations and hotel improvements;
• risks associated with mortgage debt, including the possibility of default, fluctuating interest rate levels and uncertainties in the availability of replacement financing;
• risks associated with the possibility that cost increases will outpace revenue increases and that in the event of an economic slowdown, the high proportion of fixed costs will make it difficult to reduce costs to the extent required to offset declining revenues;
• changes in customer demand due to local or national economic conditions, travel needs and alternatives, and social dislocations, including pandemics;
• acts of God, including hurricanes, fires, earthquakes, floods, winter storms and other natural disasters, or pandemics or outbreaks of contagious diseases that may result in uninsured losses, including property value losses caused by nearby events even if our hotels are completely undamaged;
• changes in terms of property insurance, including deductions, loss exclusions, regulatory and lender requirements and increased premium costs;
• fluctuations in real estate values or potential impairments in the value of our assets;
• maintaining tenants for leased properties; and
• contingent liabilities that exist after we have exited a property.
Any of the foregoing risks could increase our costs, reduce our profits and the value of our properties and limit our ability to respond to market conditions.
We face various risks posed by our disposition activities as well as our acquisition, redevelopment, repositioning, renovation and re-branding activities.
We have recently disposed of a number of hotels that we did not believe met our long-term investment criteria and we have identified non-core hotels for future disposition. There can be no assurances that we will be able to recover the current carrying amount of our investments, and in some circumstances, sales of hotels or other assets may result in additional impairment expenses or other losses. Upon sales of hotels or assets, we may become subject to contractual indemnity or termination obligations, incur unusual or extraordinary distribution requirements or material tax liabilities or, as a result of required debt repayment, face a shortage of liquidity. Current disruptions in the global markets resulting from the COVID-19 pandemic has limited and may continue to limit the availability of liquidity for us and for prospective purchasers of our hotels and has and could continue to result in prospective purchasers terminating contracts to purchase hotels prior to closing. There can be no assurance as to the timing of any future sales, whether any approvals required under applicable franchise agreements will be obtained or upon what terms, whether such sales will be completed at all, or, if completed, their effect on our future results.
In the future, we may also invest in identifying and consummating acquisitions of additional hotels and portfolios. We can provide no assurances that we will be successful in identifying attractive hotels or that, once identified, we will be successful in consummating an acquisition. We face significant competition for attractive investment opportunities from other well-capitalized investors, some of which have greater financial resources and a greater access to debt and equity capital to acquire hotels than we do. This competition increases as investments in real estate become increasingly attractive relative to other forms of investment. As a result of such competition, we may be unable to acquire certain hotels or portfolios that we deem attractive or the purchase price may be significantly elevated or other terms may be substantially more onerous. In addition, we expect to finance future acquisitions through a combination of retained cash flows, borrowings and offerings of equity and debt securities, which may not be available on terms, or at all. Any or on our part to identify, negotiate, finance on terms, consummate and integrate such acquisitions could materially our growth.
In addition, under the Code, we will be required to contract with an independent third-party for on-site management services for any acquired hotels. Such management services may be on different terms than our current management agreements, including cost, length of service and scope of services, and may require different Company oversight and administration, which could result in higher operating expenses for us.
We are also obligated to re-flag certain hotels currently operating under the La Quinta brand due to the completion of nearby hotels in La Quinta’s franchisee pipeline. Such rebranding, which may affect three of our hotels, may mean that our hotels are rebranded as a less profitable brand.
In addition, newly acquired, redeveloped, renovated, repositioned or re-branded hotels may fail to perform as expected and the costs necessary to bring such hotels up to applicable brand standards may exceed our expectations, which may result in the hotels’ failure to achieve projected returns.
These activities could pose the following risks to our ongoing operations:
• we may abandon such activities and may be unable to recover expenses already incurred in connection with exploring such opportunities;
• management attention may be diverted by our disposition, acquisition, redevelopment, repositioning or re-branding activities, which in some cases may turn out to be less compatible with our strategy than originally anticipated;
• acquired, redeveloped, renovated or re-branded hotels may not initially be accretive to our results, and we and the third-party hotel managers may not successfully manage newly acquired, renovated, redeveloped, repositioned or re-branded hotels to meet our expectations;
• we may be unable to quickly, effectively and efficiently integrate new acquisitions, particularly acquisitions of portfolios of hotels, into our existing portfolio;
• our redevelopment, repositioning, renovation or re-branding activities may not be completed on schedule, which could result in increased debt service and other costs and lower revenues, and defects in design or construction may result in delays and additional costs to remedy the defect or require a portion of a property to be closed during the period required to rectify the defect;
• we may not be able to meet the loan covenants in any financing obtained to fund the new development, creating default risks;
• we may issue shares of stock or other equity interests in connection with such acquisitions that could dilute the interests of our existing stockholders;
• we may assume various contingent liabilities in connection with such transactions;
• we may divest hotels which will impact our revenue and EBITDA and may yield lower than expected returns or otherwise fail to achieve the benefits we expect;
• we may incur losses on sales or impairment on anticipated sales of properties; and
• the IRS may take the position that we are acting in the capacity of a “dealer” in hotel property which would subject us to a 100% tax on any resultant gain on the disposition of any such hotel properties.
The occurrence of any of the foregoing events, among others, could materially and adversely affect our results of operations and profitability as well as limit or slow our future growth.
Required capital expenditures and costs associated with, or failure to maintain, brand operating standards may materially and adversely affect our results of operations and profitability.
The terms of our franchise agreements and management agreements generally require us to meet specified operating standards and other terms and conditions and compliance with such standards may be costly. We expect that LQ Franchising and any other future third-party franchisors will periodically inspect our hotels to ensure that we and any third-party hotel managers follow brand standards. Additionally, under the terms of the franchise agreements, we are required to make specified per-room capital expenditures at each property, which requirement could cause us to make greater investments in properties than we might otherwise. See “Item 1. Business—Our Principal Operating Agreements—Franchise Agreements.”
Failure by us, or any hotel management company that we engage, to maintain the operating standards, make required capital expenditures or comply with other terms and conditions could result in a franchise agreement being canceled or the franchisor requiring us to undertake a costly property improvement program. If a franchise agreement is terminated due to our failure to make required improvements or to otherwise comply with its terms, we also may be liable to the franchisor for a termination payment, which varies by franchisor and by hotel. If the funds required to maintain brand operating standards are significant, or if a franchise agreement is terminated, it could materially and adversely affect our results of operations and profitability.
If we were to lose a brand license at one or more of our hotels, the value of the affected hotels could decline significantly and we could incur significant costs to obtain new franchise agreements, which could materially and adversely affect our results of operations and profitability as well as limit or slow any future growth.
As of December 31, 2020, all of our properties utilize the La Quinta brand. We lease all but one of our hotels to our TRS lessees. Our TRS lessees, in turn, entered into management agreements with LQM to operate our hotels. We may, in the future, rebrand existing properties, acquire properties that operate under other brands and/or engage other third-party hotel managers and franchisors. If we were to lose a brand license, the underlying value of a particular hotel could decline significantly from the loss of associated name recognition, marketing support, participation in guest loyalty programs and the centralized reservation system provided by the franchisor or brand manager, which could require us to recognize an impairment on the hotel. Furthermore, the loss of a franchise agreement for a particular hotel could harm our relationship with the franchisor or brand manager, which could impede our ability to operate other hotels under the same brand, limit our ability to obtain new franchise agreements or brand management agreements from the franchisor or brand in the future on favorable terms, or at all, and cause us to incur significant costs to obtain a new franchise agreement or brand management agreement for the particular hotel. Accordingly, if we one or more franchise
agreements or brand management agreements, it could materially and adversely affect our results of operations and profitability as well as limit or slow any future growth.
Cyber threats and the risk of data breaches or disruptions of our hotel manager or our own information technology systems could materially adversely affect our business.
LQM and the La Quinta brand are dependent on information technology networks and systems, including the internet, to access, process, transmit and store proprietary and customer information, and we expect that other hotel managers or brands that we may contract with in the future also will be dependent on such networks. These complex networks include reservation systems, hotel management systems, customer databases, call centers, administrative systems and third-party vendor systems. These systems require the collection, retention and transfer of large volumes of personally identifiable information of hotel guests, including credit card numbers.
These information networks and systems can be vulnerable to threats such as: system, network or internet failures; computer hacking or business disruption; cyber-terrorism; viruses, worms or other malicious software programs; and employee error, negligence or fraud. The risk of a security breach or disruption, particularly through cyber-attack or cyber intrusion, including by computer hackers, nation-state affiliated actors and cyber terrorists has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. The La Quinta brand has been subject to cyber-attacks in the past and we expect it will be subject to cyber-attacks in the future and may experience data breaches. We rely on LQM, and other hotel managers that we may contract with in the future, to protect proprietary and customer information from these . Any compromise of our hotel managers’ networks could result in a to operations, such as in fulfilling guest reservations, bookings or guest reservations. Any of these events could, in turn, result in of the operations of our hotels, in increased costs (e.g., related to response, and notification) or in potential and liability. In addition, public disclosure, or of customer or proprietary information could result in to LQM’s or another applicable property manager’s reputation, a of confidence among hotel guests, reputational for our hotels and potential , which may have a material effect on our business, financial condition and results of operations.
In addition to the information technologies and systems our hotel managers use to operate our hotels, we have our own corporate technologies and systems that are used to access, store, transmit, and manage or support a variety of business processes. We may be required to expend significant attention and financial resources to protect these technologies and systems against physical or cybersecurity incidents. There can be no assurance that the security measures we have taken to protect the contents of these systems will prevent failures, inadequacies or interruptions in system services or that system security will not be breached through physical or electronic break-ins, computer viruses, and attacks by hackers. Disruptions in service, system shutdowns and security breaches in the information technologies and systems we use, including unauthorized disclosure of confidential information, could have a material adverse effect on our business, our financial reporting and compliance, and could subject us to liability or result in , monetary or regulatory which could be significant.
The growth of internet reservation channels could adversely affect our business and profitability.
A significant percentage of hotel rooms for individual guests is booked through internet travel intermediaries. Search engines and peer-to-peer inventory sources also provide online travel sources that compete with our hotels. If bookings continue to shift to higher cost distribution channels, including internet and traditional travel intermediaries and meeting procurement firms, it could materially impact our profits. Bookings through these intermediaries have been increasing. For the year ended December 31, 2020, such bookings represented approximately 33% of the booking channel mix for our Comparable Hotels. As such bookings increase, these intermediaries may be able to obtain higher commissions, reduced room rates or other significant contract concessions from the La Quinta brand, other brands our properties may utilize in the future and management companies. These hospitality intermediaries also may reduce these bookings by de-ranking our hotels in search results on their platforms, and other online providers may divert business away from our hotels. Moreover, hospitality intermediaries generally employ aggressive marketing strategies, including expending significant resources for online and television advertising campaigns to drive consumers to their websites. Further, some of these internet travel intermediaries are attempting to commoditize hotel rooms by increasing the importance of price and general indicators of quality at the expense of brand identification.
As of December 31, 2020, all of our properties utilize the La Quinta brand. Consumers may develop brand loyalties to the intermediaries’ websites and reservations systems rather than to the La Quinta brand. If this happens, our business and profitability may be significantly harmed. Consolidation of internet travel intermediaries, and the entry of major internet companies into the internet travel bookings business, also could divert bookings away from La Quinta’s website and increase our hotels’ cost of sales.
In addition, class action litigation against several online travel intermediaries and lodging companies have challenged the legality under antitrust law of certain provisions in contracts with third-party intermediaries. In one such action, several online travel intermediaries and lodging companies were sued for deceptive advertising and allegedly conspiring to fix prices. The court dismissed
the action after finding the plaintiffs’ claims implausible and not linked to any harm. Although La Quinta was not named in that action, and the case sets favorable precedent, there is no guarantee that another similar action will not be filed in the future.
A disruption to the functioning of the reservation system for our hotels, or decrease in the efficiency of the rate management tools to which our property manager has access, has in the past had and could in the future have an adverse effect on our business.
Wyndham manages a reservation system that communicates reservations to our hotels that have been made by individuals directly, either online or by telephone to call centers or through devices via mobile applications, or through intermediaries like travel agents, internet travel web sites and other distribution channels. We expect that any other future third-party franchisor would similarly manage a reservation system. The cost, speed, efficacy and efficiency of these reservation systems, as well as protection of personal or confidential information of its users, are important aspects of any brand. Any degradation of, failure of adequate development relative to, or security breach of, such reservation systems may adversely affect our affiliated hotels. These reservation systems generally rely on data communications networks operated by unaffiliated third parties. Any significant interruption of the function of these reservation systems (or significant parts of thereof) may adversely affect our business as well as our ability to generate revenues.
The migration of reservation, property management and booking services for our hotels from La Quinta’s reservation property management and booking systems to systems hosted by Wyndham took place in the second quarter of 2019. In connection with the migration, key proprietary revenue management software was modified. We have experienced a negative impact to our revenues as a result of the modification of such software and other problems relating to implementation and transition of our hotels to LQM’s platform. If the modifications or enhancements LQM developed for such software and systems pursuant to the Wyndham Settlement are ineffective, our ability to generate revenues may continue to be negatively impacted.
The cessation, reduction or taxation of program benefits of loyalty programs or our access to them could adversely affect the La Quinta brand and guest loyalty.
All of our properties currently participate in the Wyndham Rewards loyalty program. Our hotels contribute a percentage of the guest’s room rate per night to the program for each hotel stay of a program member. LQM arranges with service providers such as airlines to exchange monetary value represented by points for program awards and may charge a license fee to such service providers for use of the La Quinta brand trademarks. Program members accumulate points based on eligible stays and hotel charges and redeem the points for a range of benefits, including free rooms, airline miles and other items of value.
Currently, the program benefits are not taxed as income to members. We are not the owner of the Wyndham Rewards program and changes to the program, or our access to it could negatively impact our business. If the program awards and benefits are materially altered, curtailed or taxed, or if customers choose other brands within the Wyndham Rewards program, and, as a result, a material number of our customers choose to stay at non-La Quinta-branded hotels, our business could be adversely affected.
A number of our hotels are subject to ground leases; if we are found to be in breach of a ground lease or are unable to renew a ground lease, we could be adversely affected.
As of December 31, 2020, 14 of our hotels were either completely or partially on land subject to ground leases. If we are found to be in breach of a ground lease or ground sublease, such ground lease or sublease could be terminated. Assuming that we exercise all available options to extend the terms of our ground leases and ground subleases, all of our ground leases and ground subleases will expire between 2022 and 2096. However, in certain cases, our ability to exercise such options is subject to the condition that we are not in default under the terms of the ground lease or ground sublease, as applicable, at the time that we exercise such options and/or the time such extension occurs, and we can provide no assurances that we will be able to exercise our options at such time. Furthermore, we can provide no assurances that we will be able to renew our ground leases and ground subleases upon expiration or at satisfactory economic terms. If a ground lease or ground sublease expires or is terminated, we would be unable to derive income from such hotel, which could affect us. We may also be subject to franchise and management early fees if the ground lease is not renewed and the affected hotel is no longer operating.
We will not recognize any increase in the value of the land or improvements subject to our ground leases and may only receive a portion of compensation paid in any eminent domain proceeding with respect to the hotel.
Unless we purchase a fee interest in the land and improvements subject to our ground leases, we will not have any economic interest in the land or improvements at the expiration of our ground leases and therefore we generally will not share in any increase in value of the land or improvements beyond the term of a ground lease, notwithstanding our capital outlay to purchase our interest in the hotel or fund improvements thereon and will lose our right to use the hotel. Furthermore, if a governmental authority seizes a hotel subject to a ground lease under its eminent domain power, we may only be entitled to a portion of any compensation awarded for the seizure. We may also be subject to franchise and management early termination fees if the ground lease is not renewed and the affected hotel is no longer operating.
We may be subject to unknown or contingent liabilities related to our hotels and the hotels that we may acquire in the future, which could materially and adversely affect our revenues and profitability growth.
Our current hotels, and the hotels that we may acquire in the future, may be subject to unknown or contingent liabilities for which we may have no recourse, or only limited recourse, against the sellers. In general, the representations and warranties provided under the transaction agreements related to the purchase of the hotels we acquire may not survive the completion of the transactions. Furthermore, indemnification under such agreements may be limited and subject to various materiality thresholds, a significant deductible or an aggregate cap on losses. As a result, there is no guarantee that we will recover any amounts with respect to losses due to breaches by the sellers of their representations and warranties. In addition, the total amount of costs and expenses that may be incurred with respect to liabilities associated with these hotels may exceed our expectations, and we may experience other unanticipated adverse effects, all of which could materially and adversely affect our revenues and profitability.
We depend on external sources of capital for future growth; therefore, any disruption to our ability to access capital at times and on terms reasonably acceptable to us may affect adversely our business and results of operations.
Ownership of hotels is a capital-intensive business that requires significant capital expenditures to acquire, operate, maintain and renovate properties. To continue to qualify as a REIT, we are required to distribute to our stockholders at least 90% of our REIT taxable income (determined without regard to the deduction for dividends paid and excluding any net capital gain), including taxable income recognized for U.S. federal income tax purposes but with regard to which we do not receive cash. As a result, we must finance our growth, fund debt repayments and fund these significant capital expenditures largely with external sources of capital. Our ability to access external capital could be hampered by a number of factors, many of which are outside of our control, including:
• price volatility, dislocations and liquidity disruptions in the U.S. and global equity and credit markets;
• changes in market perception of our growth potential, including pandemics or downgrades by rating agencies;
• decreases in our current and estimated future earnings;
• decreases or fluctuations in the market price of our common stock;
• increases in interest rates; and
• the terms of our existing indebtedness.
Any of these factors, individually or in combination, could prevent us from being able to obtain the external capital we require on terms that are acceptable to us, or at all, which could have a material adverse effect on our ability to finance our future growth and our financial condition and results of operations. Potential consequences of disruptions in U.S. and global equity and credit markets and, as a result, an inability for us to access external capital at times, and on terms, reasonably acceptable to us could include:
• a need to seek alternative sources of capital with less attractive terms, such as more restrictive covenants and shorter maturity;
• adverse effects on our financial condition and liquidity, and our ability to meet our anticipated requirements for working capital, debt service and capital expenditures;
• higher costs of capital;
• an inability to enter into derivative contracts to hedge risks associated with changes in interest rates and foreign currency exchange rates; or
• an inability to execute on acquisitions.
Governmental regulation may adversely affect the operation of our hotels.
Our hotels are subject to extensive local, regional and national regulations and, on a periodic basis, must obtain various licenses and permits. The laws and regulations of states, counties, cities, provinces and other political subdivisions may also require certain registration, disclosure statements and other practices with respect to the franchising of hotels. Any failure to identify, obtain or maintain required licenses and permits could result in adverse consequences.
The lodging industry is subject to extensive federal, state and local governmental regulations in the U.S., including those relating to building and zoning requirements and those relating to the preparation and sale of food. We and our hotel managers are also subject to licensing and regulation by state and local departments relating to health, sanitation, fire and safety standards, and to laws governing their relationships with employees, including minimum wage requirements, overtime, working conditions and citizenship requirements. In connection with the continued operation or remodeling of certain of our hotels, we may be required to expend funds to meet federal, state and local regulations. For example, we have incurred and may incur additional significant costs complying with the Americans with Disabilities Act (“ADA”), which requires that all public accommodations meet certain federal requirements related to access and use by disabled persons. The regulations also mandate certain operational requirements that hotel operators must observe. If, pursuant to the ADA, we are required to make substantial alterations to, and capital expenditures for, our hotels, including removal of access barriers, it could increase our expenditures and, in turn, could reduce our earnings. Any failure to obtain or maintain any such licenses or any publicity resulting from actual or alleged violations of any such laws and regulations could result in injunctive relief, , awards or capital expenditures and could have an effect on our results of operations. Moreover, new or revised laws and regulations or new interpretations of existing laws and regulations could affect the operation of our hotels or result in significant additional expense and operating restrictions on us.
U.S. environmental laws and regulations may cause us to incur substantial costs or subject us to potential liabilities.
We are subject to certain compliance costs and potential liabilities under various U.S. federal, state and local environmental, health and safety laws and regulations. These laws and regulations govern actions including air emissions, the use, storage and disposal of hazardous and toxic substances and wastewater disposal. Our failure to comply with such laws, including any required permits or licenses, could result in substantial fines or possible revocation of our authority to conduct some of our operations. We could also be liable under such laws for the costs of investigation, removal or remediation of hazardous or toxic substances at our currently or formerly owned or operated hotels or at third-party locations in connection with our waste disposal operations, regardless of whether or not we knew of, or caused, the presence or release of such substances. In some cases, we may be entitled to indemnification from the party that caused the contamination, but there can be no assurance that we would be able to recover all or any costs we incur in addressing such problems. From time to time, we may be required to remediate such substances or remove, abate or manage asbestos, mold, radon gas, lead or other conditions at our hotels. The presence or release of such toxic or substances could result in third-party for personal , property or natural resource , business or other . Such and the need to , remediate, or otherwise address , toxic or conditions could affect our operations, the value of any affected hotel, or our ability to sell, lease or assign our rights in any such hotel, or could otherwise our business. Environmental, health and safety requirements have also become increasingly , and our costs may increase as a result. For example, Congress, the U.S. Environmental Protection Agency (“EPA”), and some states are considering or have undertaken actions to regulate and reduce greenhouse gas emissions. New or revised laws and regulations or new interpretations of existing laws and regulations, such as those related to climate change, could affect the operation of our hotels or result in significant additional expense and operating restrictions on us.
Asbestos, lead-based paint, mold and other hotel related issues could expose us to substantial liability.
Certain U.S. laws impose liability for the release of asbestos containing materials into the air or require the removal or containment of asbestos containing materials, and third parties may seek recovery from owners or operators of real properties for personal injury associated with exposure to toxic or hazardous substances. Some of our hotels have asbestos containing materials, and with respect to such hotels, we are required to take action as and when required by applicable law. Such laws require that, as owners of buildings containing asbestos, we must (i) properly manage and maintain the asbestos, (ii) notify and train certain personnel regarding the presence of asbestos and the related hazards and (iii) undertake special precautions, including removal or other abatement, if asbestos would be disturbed during renovation or demolition of a building. Such laws may impose fines and penalties on us if we fail to comply with these requirements and may allow third parties to seek recovery for personal injury associated with exposure to asbestos fibers, which could significantly increase our operating costs and reduce our earnings.
In addition, certain laws impose liability for lead based paint, and third parties may seek recovery from owners of real properties for personal injury associated with lead-based paint. Limits are placed on the amount of lead that may be present in public drinking water supplies, and third parties may seek recovery from owners of real properties for injuries arising from exposure to high lead concentration. We indemnify LQM, and we will indemnify other third-party hotel managers that we may engage in the future, for certain legal costs resulting from management of our hotels.
Other materials used in the construction of our hotels that are currently thought to be safe may in the future be determined to be hazardous, and could expose us to substantial liability for damages, injuries, adverse health effects or removal and disposal costs. In addition, other building supplies thought to be appropriate for their use, while not toxic, have been discovered to be defective (such as fire-retardant plywood or polybutylene piping). Defects in such supplies have resulted in substantial costs on the part of the owners of affected hotels to remove and replace the defective materials. Materials currently thought to be appropriate or safe may in the future prove to be defective and could result in substantial costs or losses.
Problems associated with mold may pose risks to our hotels and also may be the basis for personal injury claims against us. There is no generally accepted standard for the assessment of mold. If left unchecked or inadequately addressed, the growth of mold could result in litigation and remediation expenses, or in a closure of some or all of a hotel, that could adversely affect revenues from an individual hotel. We have discovered that some of our hotels have problems with mold. The presence of mold at some of our hotels has required us to undertake a remediation program to remove the mold from the affected hotels. The cost of remediation to date has not been material. However, remediation costs may substantially increase if there is mold in our other hotels or if costs related to mold such as legal and insurance expense continue to increase rapidly, which could significantly increase our operating costs and reduce our earnings.
Additionally, the EPA has identified certain health risks associated with elevated radon gas in buildings and has recommended that certain mitigating measures be considered. It is possible that other environmental conditions not currently known, or known but not currently thought to be dangerous, may in the future be determined to present a risk to health or safety, such as with respect to possible exposure to waterborne pathogens.
For all of these reasons, the presence of, or potential for contamination by, such hazardous or toxic substances, or exposure to pathogens, at, on, under, adjacent to, emanating from, or in any of our hotels could materially adversely affect the operations, the value of such hotel or the ability to attract guests to such hotel, or could otherwise harm our business.
The loss of senior executives could significantly harm our business.
Our ability to maintain our competitive position depends to a large degree on the efforts and abilities of our senior executives. Finding suitable replacements for senior executives could be difficult. We currently do not have a life insurance policy or key person insurance policy with respect to any of our senior executives. In addition, while we have long-term compensation plans designed to retain our senior executives, if our retention and succession plans do not operate effectively, our business could be adversely affected. Any failure of our management to work together to effectively manage our operations, any additional departures of senior executives, our inability to hire other key management, and any failure to effectively integrate new management into our controls, systems and procedures may adversely affect our business, results of operations and financial condition.
We are subject to risks associated with the employment of hotel personnel, particularly with hotels that employ unionized labor, which could increase our operating costs, reduce the flexibility of our hotel managers to adjust the size of the workforce at our hotels and could materially and adversely affect our revenues and profitability.
We entered into management agreements with LQM to operate each of our hotels. LQM is generally responsible for hiring and maintaining the labor force at each of the hotels they manage. Although we generally do not directly employ or manage personnel at our hotels, we are subject to many of the costs and risks generally associated with the hotel labor force. Increased labor costs due to factors like additional taxes or requirements to incur additional employee benefits costs, including the requirements of the Affordable Care Act or any similar health care regulations enacted in the future, may adversely impact our operating costs. LQM employees at two of our hotels are currently represented by labor unions. Labor costs at hotels where the workforce is unionized may be particularly challenging and unionization may also hinder the ability of LQM and any other hotel management company that we engage to resolve employment matters and disputes directly with their employees.
From time to time, strikes, lockouts, public demonstrations or other negative actions and publicity may disrupt hotel operations at any of our hotels, negatively impact our reputation or the reputation of our brands, or harm relationships with the labor forces at our hotels. We also may incur increased legal costs and indirect labor costs as a result of contract disputes or other events. Additionally, hotels where our hotel managers have collective bargaining agreements with their employees are more highly affected by labor force activities than others. Property values associated with these hotels may also decrease. The resolution of labor disputes or new or re-negotiated labor contracts could lead to increased labor costs, either by increases in wages or benefits or by changes in work rules that raise hotel operating costs. Furthermore, labor agreements may limit the ability of our hotel managers to reduce the size of hotel workforces during an economic downturn because collective bargaining agreements are negotiated between the hotel managers and labor unions. We do not have the ability to control the outcome of these negotiations.
If the insurance that we carry does not sufficiently cover damage or other potential losses or liabilities to third parties involving our hotels, our profits could be reduced.
We and our hotel manager carry insurance from insurance carriers that we believe is adequate for foreseeable first and third-party losses and with terms and conditions that we believe are reasonable and customary. Nevertheless, market forces could limit the scope of the insurance coverage that we can obtain or may otherwise restrict our ability to buy insurance coverage at reasonable rates. In the event of a substantial loss, the insurance coverage that we carry may not be sufficient to reimburse us in full for our losses or pay the full value of financial obligations, liabilities or the replacement cost of any lost investment or property loss, which could
adversely affect our profits. In addition, risks that may fall outside the general coverage terms and limits of the policies and certain types of losses that are significantly uncertain, or generally of a catastrophic nature, such as hurricanes, fires, earthquakes and floods or terrorist acts, may be uninsurable or not economically insurable. If such losses or events occur, they could cause substantial damage to our hotels or the surrounding area, without any insurance coverage. Further, we may not be able to obtain or renew insurance policies or, if we are able to obtain or renew our coverage, it may be at a significantly higher cost than the historic cost.
In addition, insurance coverage for our hotels and for casualty losses does not customarily cover damages that are characterized as punitive or similar damages. As a result, any claims or legal proceedings, or settlement of any such claims or legal proceedings that result in damages that are characterized as punitive or similar damages may not be covered by our insurance. If these types of damages are substantial, our financial condition and results of operation may be adversely affected.
In some cases, these factors could result in certain losses being completely uninsured. As a result, we could lose some or all of the capital invested in a hotel, as well as the anticipated future revenues and profits from the hotel. We could suffer an uninsured or underinsured loss, and we may not have sufficient insurance to cover awards of damages resulting from claims made against us.
We have experienced increased premiums and retention requirements from insurance carriers and further historical losses paid by insurance carriers could result in further increases in premiums and deductions.
Due to the combination of the COVID-19 pandemic and storm related claims generally experienced by the lodging industry coupled with the older age of our hotels and tightened insurance markets, we have experienced increased premiums and retention requirements from insurance carriers. We expect this to result in increases in operating expenses, self-insurance loss claims and loss mitigation capital expenditures. To obtain insurance coverage, carriers could require us to incur capital expenditures to mitigate future losses. Such requirements could reduce our ability to make other investments and reduce future profits.
Terrorism insurance may not be available at commercially reasonable rates or at all.
Following the September 11, 2001 terrorist attacks in New York City and the Washington, D.C. area, Congress passed the Terrorism Risk Insurance Act of 2002, which established the Terrorism Risk Insurance Program (the “Program”) to provide insurance capacity for terrorist acts. The Program was scheduled to expire at the end of 2020 but was reauthorized, with some adjustments to its provisions, in December 2019 for seven years through December 31, 2027. We carry insurance from insurance carriers to respond to both first-party and third-party liability losses related to terrorism. We purchase our first-party property damage and business interruption insurance as a stand-alone policy in place of and to supplement insurance from government run pools. If the Program is not extended or renewed upon its expiration in 2027, or if there are changes to the Program that would negatively affect insurance carriers, premiums for terrorism insurance coverage will likely increase and/or the terms of such insurance may be materially amended to increase stated exclusions or to otherwise effectively decrease the scope of coverage available, perhaps to the point where it is effectively unavailable.
Terrorist attacks and military conflicts may adversely affect the lodging industry.
The September 11, 2001 terrorist attacks in New York City and the Washington, D.C. area and more recent terrorist attacks in other areas of the world underscore the possibility that large public facilities or economically important assets could become the target of terrorist attacks in the future. The occurrence or the possibility of terrorist attacks or military conflicts could, among other things, generally reduce travel to affected areas for tourism and business or adversely affect the willingness of guests to stay in or avail themselves of hotel services and result in higher costs for security and insurance premiums or diminish the availability of insurance coverage for losses related to terrorist attacks, all of which could adversely affect our financial condition and results of operations.
Changes to estimates or projections used to assess the fair value of our assets, or operating results that are lower than our current estimates at certain properties, may cause us to incur impairment charges that could adversely affect our results of operations.
Our total assets include a substantial amount of long-lived assets, principally hotel related land, property and equipment. We analyze our assets for impairment if events or changes in circumstances indicate that an asset might be impaired. Our evaluation of impairment requires us to make certain estimates and assumptions including projections of our holding period, future results and fair value assessments of our assets. After performing our evaluation for impairment, including an analysis to determine the recoverability of long-lived assets, we will record an impairment loss when the carrying value of the underlying asset, asset group or reporting unit exceeds its fair value. Decisions to divest hotels could result in the requirement to record an impairment charge due to, among other factors, a decrease in the assumed holding period or fair value for the hotel. For example, during 2020 and 2019 we recognized non-cash impairment charges of $54 million and $141 million, respectively, primarily due to lower valuation of certain of our properties related to the ongoing impact of the COVID-19 pandemic on the lodging industry in 2020 and, a reduction in our estimated holding periods and potential sales of hotels in 2019. Future changes in holding periods or other assumptions or of our hotel investments could result in additional charges. During times of economic , demand and
earnings often result in declining asset values. If any impairment losses we recognize are significant, our financial condition and results of operations would be adversely affected.
Political, social and economic uncertainty could impact our financial results and growth.
Potential disruptions in the U.S. economy as a result of governmental action or inaction on the federal deficit, budget, interest rates, responses to events such as COVID-19, tariffs and related issues, including, for example any governmental shutdown, and the uncertainty over how long any of these conditions will continue, have had in the past and could have in the future a negative impact on the lodging industry. U.S. federal spending cuts and any further limitations that may result from congressional action or inaction, could cause us to experience weakened demand for our hotel rooms.
Entities in existence prior to the Spin-Off are currently under audit by the Internal Revenue Service and may be required to pay additional taxes for which we would be responsible.
We are subject to regular audits by federal and state tax authorities, which may result in additional tax liabilities related to prior periods. In 2018, La Quinta Holdings Inc. completed the distribution to its stockholders of all the then-outstanding shares of common stock of CorePoint Lodging Inc. following which we became an independent, self-administered, publicly traded company (the “Spin-Off”). Subsequently, La Quinta Holdings Inc. merged with Wyndham Worldwide. Entities in existence prior to the Spin-Off and transferred to Wyndham Worldwide as a part of the Spin-Off are currently under audit by the IRS for tax years ended December 31, 2010 to 2013. As a part of the Spin-Off, we agreed to indemnify Wyndham for any obligations and expenses arising from these IRS audits, including the legal and accounting defense expenses. In 2014, the IRS commenced a tax audit, primarily related to transfer pricing for internal rents charged by our prior REIT. Subsequently, we have supplied information to the IRS supporting our position. In November of 2019, the IRS issued notices of proposed adjustments (“NOPA,” also known as a 30-Day Letter) proposing a redetermined rent adjustment totaling $138 million attributable to tax years 2010 and 2011, exclusive of penalties and interest. Additionally, the November 2019 NOPA proposed an adjustment resulting in the loss of tax operating loss carryforwards generated in tax years 2006 through 2009. The adjustment to the tax operating carryforwards, measured at the tax rates enacted during the year of utilization and of and interest, is $31million.
We have responded to the IRS in disagreement with their NOPA and the matter was transferred to the IRS Appeals office in 2020. We believe the IRS transfer pricing methodologies applied in the audits contain flaws and that the IRS proposed tax and adjustments are inconsistent with the U.S. federal tax laws. We have concluded that the positions reported on our tax returns under audit by the IRS are, based on their technical merits, more-likely-than-not to be sustained upon conclusion of the examination. Accordingly, as of December 31, 2020, we have not established any reserves related to this proposed adjustment or any other issues reflected on the returns under examination. If, however, we are unsuccessful in challenging the IRS, an excise tax and/or additional taxes would be imposed on the REIT or its taxable REIT subsidiary related to the excess rent and we would be responsible for additional income taxes, interest and penalties, which could adversely affect our financial condition, results of operations and cash flow and the trading price of our common stock. Such adjustments could also give rise to additional state income taxes.
Risks Related to Our Indebtedness
Our substantial indebtedness could adversely affect our financial condition, our ability to raise additional capital to fund our operations, our ability to operate our business, our ability to react to changes in the economy or our industry and our ability to pay our debts and could expose us to interest rate risk to the extent of our variable debt and divert our cash flow from operations to make debt payments.
We have a significant amount of indebtedness. As of December 31, 2020, our total loan indebtedness was approximately $810 million, and the aggregate liquidation preference of our preferred stock was $15 million. Our substantial debt has had and could continue to have important consequences, including:
• requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, thereby reducing our ability to use our cash flow to fund our operations, capital expenditures and distributions to stockholders and to pursue future business opportunities;
• requiring compliance with leverage and interest coverage financial covenants which may affect our availability under our line of credit, access to cash on hand and cash proceeds from the sale of hotels;
• increasing our vulnerability to adverse economic, industry or competitive developments;
• exposing us to increased interest expense, as our degree of leverage may cause the interest rates of any future indebtedness (whether fixed or floating rate interest) to be higher than they would be otherwise;
• exposing us to the risk of increased interest rates because certain of our indebtedness is at variable rates of interest;
• making it more difficult for us to satisfy our obligations with respect to our indebtedness, and any failure to comply with the obligations of any of our debt instruments, including restrictive covenants, could result in an event of default that accelerates our obligation to repay indebtedness;
• restricting us from making strategic acquisitions or causing us to make non-strategic divestitures;
• limiting our ability to obtain additional financing for working capital, capital expenditures, hotel development, satisfaction of debt service requirements, acquisitions and general corporate or other purposes; and
• limiting our flexibility in planning for, or reacting to, changes in our business or market conditions and placing us at a competitive disadvantage compared to our competitors who may be better positioned to take advantage of opportunities that our leverage prevents us from exploiting.
Due to our failure to satisfy certain financial metrics under our credit facilities, our lenders have rights to control the disbursement of our hotel operating cash receipts (referred to as a “cash trap”). During a cash trap, certain disbursements from these hotel operating cash receipts, primarily other corporate general and administrative expenditures, dividends to common stockholders and repurchases of our common stock, would require consent of our lenders. As of December 31, 2020, approximately $21 million of our cash and cash equivalents were subject to these cash traps. While we do expect the cash trapped amounts will be available to fund hotel operations, we expect we will not be able to increase our cash not subject to the cash trap. In the event hotel operations are insufficient to fund hotel liquidity requirements, then we expect we would fund this deficit by moving cash from our non-cash trapped cash to the cash trap. Any funds contributed to the cash traps would then not be available for other corporate purposes without approval from our lenders. As of December 31, 2020, we had approximately $122 million of cash and cash equivalents not subject to the cash traps .
In addition, we are a holding company and substantially all of our consolidated assets are owned by, and most of our business is conducted through, our subsidiaries. Revenues from these subsidiaries are our primary source of funds for debt payments and operating expenses. If our subsidiaries are restricted from making distributions to us, that may impair our ability to meet our debt service obligations or otherwise fund our operations. Moreover, there may be restrictions on payments by subsidiaries to their parent companies under applicable laws, including laws that require companies to maintain minimum amounts of capital and to make payments to stockholders only from profits. As a result, although a subsidiary of ours may have cash, we may not be able to obtain that cash to satisfy our obligation to service our outstanding debt or fund our operations.
Servicing our indebtedness requires a significant amount of cash. Our ability to continue generating sufficient cash depends on many factors, some of which are not within our control.
Our ability to make payments on our indebtedness, to fund planned capital expenditures and to make distributions to our stockholders will depend on our ability to generate cash in the future. To a certain extent, this is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. If we are unable to generate sufficient cash flow to service our debt and meet our other commitments, we may need to restructure or refinance all or a portion of our debt, sell material assets or operations or raise additional debt or equity capital. We may not be able to affect any of these actions on a timely basis, on commercially reasonable terms or at all, and these actions may not be sufficient to meet our capital requirements. In addition, the terms of our existing or future debt arrangements may restrict us from affecting any of these alternatives. Our failure to make the required interest and principal payments on our indebtedness would result in an event of default under the agreement governing such indebtedness, which may result in the acceleration of some or all of our outstanding indebtedness.
We may be able to incur substantially more debt in the future and enter into other transactions, which could further exacerbate the risks to our financial condition described above.
We may be able to incur significant additional indebtedness in the future. Although our debt agreements contain restrictions on the incurrence of additional indebtedness and entering into certain types of other transactions, these restrictions are often subject to a number of qualifications and exceptions. Additional indebtedness incurred in compliance with these restrictions could be substantial. These restrictions also do not prevent us from incurring obligations, such as trade payables, that do not constitute indebtedness as defined under our debt instruments. In addition, our organizational documents contain no limitation on the amount of debt we may incur, and our board of directors may change our financing policy at any time without stockholder notice or approval. To the extent new debt is added to our current debt levels, the substantial leverage risks described in the preceding two risk factors would increase.
Our debt agreements contain, and future debt agreements may contain, restrictions that may limit our flexibility in operating our business.
Our debt agreements contain operating covenants that limit the discretion of management with respect to certain business matters. These covenants place restrictions on our ability to incur additional indebtedness and make guarantees, create liens on assets, enter into sale and leaseback transactions, engage in mergers and consolidations, sell assets, make fundamental changes, pay dividends and distributions or repurchase our capital stock, make investments, loans and advances, including acquisitions, engage in certain transactions with affiliates, make changes in the nature of our business and make prepayments of junior debt and may require us to maintain certain levels of indebtedness and/or interest expense.
Additionally, the agreements governing our future indebtedness may place additional restrictions on us and may require us to meet certain financial ratios and tests. Our ability to comply with these and other provisions of our new debt agreements and future debt agreements is dependent on our future performance, which will be subject to many factors, some of which are beyond our control. The breach of any of these covenants or non-compliance with any of these financial ratios and tests could result in an event of default under the debt agreements, which, if not cured or waived, could result in acceleration of the related debt and the acceleration of debt under other instruments evidencing indebtedness that may contain cross-acceleration or cross-default provisions.
The use of debt to finance future acquisitions could restrict operations, inhibit our ability to grow our business and revenues, and negatively affect our business and financial results.
We may incur additional debt in connection with future hotel acquisitions. We may, in some instances, borrow under our secured mortgage and, in certain circumstances mezzanine credit facility or secured revolving credit facility or borrow new funds to acquire hotels. In addition, we may incur mortgage debt by obtaining loans secured by a portfolio of some or all of the hotels that we own or acquire. If necessary or advisable, we also may borrow funds to make distributions to our stockholders to maintain our qualification as a REIT for U.S. federal income tax purposes. To the extent that we incur debt in the future and do not have sufficient funds to repay such debt at maturity, it may be necessary to refinance the debt through debt or equity financings, which may not be available on acceptable terms or at all and which could be dilutive to our stockholders. If we are unable to refinance our debt on acceptable terms or at all, we may be forced to dispose of hotels at inopportune times or on disadvantageous terms, which could result in losses. To the extent we cannot meet our future debt service obligations, we will risk losing to foreclosure some or all of our hotels that may be pledged to secure our obligations.
For tax purposes, a foreclosure of any of our hotels would be treated as a sale of the hotel for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the hotel, we would recognize taxable income on foreclosure, but we would not receive any cash proceeds, which could hinder our ability to meet the REIT distribution requirements imposed by the Code. In addition, we may give full or partial guarantees to lenders of mortgage debt on behalf of the entities that own our hotels. When we give a guarantee on behalf of an entity that owns one of our hotels, we will be responsible to the lender for satisfaction of the debt if it is not paid by such entity. If any of our hotels are foreclosed on due to a default, our ability to pay cash distributions to our stockholders will be limited.
Changes in interest rates and changes in the method for determining LIBOR and the potential replacement of LIBOR may affect our cost of capital and net investment income.
General interest rate fluctuations and changes in credit spreads on floating rate loans may have a substantial negative impact on our investments and investment opportunities and, accordingly, may have a material adverse effect on our rate of return on invested capital, our net income, and the market price of our common stock. The majority of our debt has, and is expected to have, variable interest rates that reset periodically based on benchmarks such as LIBOR. An increase in interest rates may make it more difficult for us to service our debt obligations. Rising interest rates could also cause us to shift cash from other productive uses to the payment of interest, which may have a material adverse effect on our business and operations.
As a result of concerns about the accuracy of the calculation of LIBOR, a number of British Bankers’ Association (“BBA”) member banks entered into settlements with certain regulators and law enforcement agencies with respect to the alleged manipulation of LIBOR. Actions by the BBA, regulators or law enforcement agencies as a result of these or future events, may result in changes to the manner in which LIBOR is determined. In July 2017, the head of the United Kingdom Financial Conduct Authority, which has statutory powers to require panel banks to contribute to LIBOR where necessary, announced its intention to cease sustaining LIBOR by the end of 2021. Late in 2020, LIBOR’s administrator, ICE Benchmark Administration Limited, announced its intention to cease publication of the one week and two month U.S. dollar LIBOR rates immediately following the LIBOR publication on December 31, 2021, and the remaining U.S. dollar LIBOR rates following the LIBOR publication on June 30, 2023. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, has identified the Secured Overnight Financing Rate (“SOFR”), a new index calculated by short-term repurchase agreements, backed by Treasury securities, as its preferred alternative rate for U.S. dollar LIBOR. Although there have been a few issuances utilizing SOFR
or the Sterling Over Night Index Average, an alternative reference rate that is based on transactions, it is unknown whether these alternative reference rates will attain market acceptance as replacements for LIBOR.
As of December 31, 2020, we had $810 million of floating rate debt with maturities, including extension options, that extend past 2021 for which the interest rate was tied to LIBOR and which may require interest rate caps tied to LIBOR also with maturities extending past 2021. As a result of reference rate reform, the LIBOR index for new contracts will cease as of December 31, 2021 and the LIBOR index will no longer be published after June 30, 2023. Our CMBS and Revolving Facilities provide for alternate interest rate calculations. There is no assurance that such alternative interest rate calculations will not increase our cost of borrowing under the CMBS and Revolving Facilities or any refinancing or replacements of such debt, which could impact our results of operations. We are assessing the impact of a potential transition from LIBOR; however, potential effect of any such event on our cost of capital and net income cannot yet be determined.
Covenants applicable to our current debt do and covenants applicable to future debt could restrict our ability to make distributions to our stockholders, and as a result, we may be unable to make distributions necessary to qualify as a REIT, which could materially and adversely affect us and the market price of our shares of common stock.
We are organized and we intend to continue to operate in a manner that will enable us to qualify as a REIT for U.S. federal income tax purposes. To continue to qualify as a REIT, we generally are required to distribute at least 90% of our REIT taxable income, determined without regard to the dividends paid deduction and excluding net capital gains, each year to our stockholders. To the extent that we satisfy this distribution requirement but distribute less than 100% of our REIT taxable income, including capital gains, we will be subject to U.S. federal and state corporate income tax on our undistributed taxable income and gains. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we distribute to our stockholders in a calendar year is less than a minimum amount specified under the Code. The credit agreement governing our revolving credit facility restricts our ability to pay dividends to our common stockholders. If, as a result of covenants applicable to our current or future debt, we are unable to make distributions necessary for us to avoid U.S. federal corporate income and excise taxes and to maintain our qualification as a REIT, our business, results of operations and financial condition could be materially and affected.
Risks Related to Our REIT Status and Certain Other Tax Items
If we do not maintain our qualification as a REIT, we will be subject to tax as a C corporation and could face a substantial tax liability.
For U.S. federal income tax purposes, we are taxed as a REIT. We believe that we are organized and operate in a REIT-qualified manner and we intend to continue to operate as such. However, we cannot assure you that we will remain qualified as a REIT.
Moreover, qualification as a REIT involves the interpretation and application of highly technical and complex Code provisions for which no or only a limited number of judicial or administrative interpretations may exist. Notwithstanding the availability of cure provisions in the Code, we could fail to meet various compliance requirements, which could jeopardize our REIT status. Furthermore, new tax legislation, administrative guidance or court decisions, in each instance potentially with retroactive effect, could make it more difficult or impossible for us to qualify as a REIT. If we fail to qualify as a REIT in any tax year, then, unless we were entitled to relief under applicable statutory provisions:
• we would be taxed as a C corporation, which under current laws, among other things, means being unable to deduct dividends paid to stockholders in computing taxable income and being subject to U.S. federal income tax on our taxable income at normal corporate income tax rates;
• we could be subject to increased state and local taxes;
• any resulting tax liability could be substantial and could have a material adverse effect on our book value and financial condition and reduce our cash available for distribution to stockholders; and
• we generally would not be eligible to requalify as a REIT for the subsequent four full taxable years.
In addition, if we fail to qualify as a REIT, we will not be required to make distributions to stockholders, and all distributions to stockholders will be subject to tax as dividend income to the extent of our current and accumulated earnings and profits. As a result of all these factors, our failure to qualify as a REIT could impair our ability to execute our business and growth strategies, as well as make it more difficult for us to raise capital and service our indebtedness.
Qualifying as a REIT involves highly technical and complex provisions of the Code and therefore, in certain circumstances, may be subject to uncertainty.
In order to continue to qualify as a REIT, we must satisfy a number of requirements, including requirements regarding the composition of our assets, the sources of our income, sales of our real estate investments, and the diversity of our stock ownership. Also, we must make distributions to stockholders aggregating annually at least 90% of our “REIT taxable income” (determined without regard to the dividends paid deduction and excluding net capital gain). Compliance with these requirements and all other requirements for qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. The complexity of these provisions and of the applicable Treasury regulations that have been promulgated under the Code is greater in the case of a REIT that, like us, conducts significant business operations through one or more TRSs. Even a technical or inadvertent action could jeopardize our REIT status. In addition, the determination of various factual matters and circumstances relevant to REIT qualification is not entirely within our control and may affect our ability to qualify as a REIT. Accordingly, we cannot be certain that our organization and operation will enable us to qualify as a REIT for U.S. federal income tax purposes.
If our TRS lessees are unable to generate sufficient revenue from operating the hotels leased from us then our TRS lessees may
not be able to make payments under the leases and we may not be able to make sufficient distributions to our stockholders.
Current disruptions in the global markets resulting from the COVID-19 pandemic has impacted the ability of our TRS lessees to generate revenue from the operation of the hotels leased from us which may adversely affect each TRS lessees’ ability to pay rent due to us under the leases. Our ability to make distributions to our stockholders depends on the revenues generated by the operation of our hotels leased by our TRS lessees. If we are unable to distribute at least 90% of our “REIT taxable income” to our stockholders then we may fail to qualify as a REIT.
Our ability to use our net operating losses to offset future income tax liabilities may be subject to limitations.
We have federal net operating losses. (See Note 12 “Income Taxes” to our consolidated financial statements for additional information.) In general, under Section 382 of the Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its pre-change net operating losses to offset future taxable income. Future changes in ownership of our stock (including as a result of a sale of our stock by Blackstone), many of which are outside of our control, could result in an ownership change under Section 382 of the Code. Accordingly, we may not be able to utilize a material portion of our net operating losses. Our ability to utilize our net operating losses is conditioned upon our attaining profitability and generating U.S. federal taxable income.
We may face other tax liabilities that reduce our cash flows.
Even if we continue to qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including taxes on any undistributed income, capital gains, tax on income from some activities conducted as a result of a foreclosure, and non-U.S., state or local income, property and transfer taxes. Moreover, if we have net income from “prohibited transactions,” that income will be subject to a 100% tax. In addition, the IRS may take the position that we are acting in the capacity of a “dealer” in hotel property which could subject us to a 100% tax on any resultant gain on the disposition of hotel properties. We could also, in certain circumstances, be required to pay an excise or penalty tax (which could be significant in amount) in order to utilize one or more relief provisions under the Code to maintain our qualification as a REIT. We are subject to U.S. federal and state income tax (and any applicable non-U.S. taxes) on the net income earned by our TRSs. In addition, our domestic TRS is subject to normal corporate federal, state and local taxation. Any of these taxes would decrease cash available for distributions to stockholders.
The ability of our board of directors to revoke our REIT election without stockholder approval may cause adverse consequences to our stockholders.
Our charter provides our board of directors with the power, under certain circumstances, to revoke or otherwise terminate our REIT election and cause us to be taxed as a regular corporation, without the approval of our stockholders. If we cease to qualify as a REIT, we would become subject to U.S. federal income tax on our net taxable income and we generally would no longer be required to distribute any of our net taxable income to our stockholders, which may have adverse consequences on our total return to our stockholders.
Liquidation of assets may jeopardize our REIT qualification and subject us to taxes.
To continue to qualify as a REIT, we must comply with requirements regarding our assets, our sources of income and our distributions. If we are compelled to liquidate our investments to repay obligations to our lenders, we may be unable to comply with
these requirements, ultimately jeopardizing our qualification as a REIT, or we may be subject to a corporate tax or a 100% tax on any resultant gain if we sell assets that are treated as dealer property or inventory.
We have limited operating history as a REIT, and our inexperience may impede our ability to successfully manage our business or implement effective internal controls.
While certain of our subsidiaries previously operated as REITs, we have limited operating history as a REIT. We cannot assure you that our past experience will be sufficient to successfully operate our company as a REIT. We are required to implement substantial control systems and procedures to qualify and maintain our qualification as a REIT. As a result, we have incurred and will incur significant legal, accounting and other expenses that we have not previously incurred, and our management and other personnel will need to devote a substantial amount of time to comply with these rules and regulations and establish the corporate infrastructure and controls demanded of a REIT. These costs and time commitments could be substantially more than we currently expect. Therefore, the historical consolidated financial statements contained herein may not be indicative of our future costs and performance as a REIT.
Complying with REIT requirements may cause us to forgo and/or liquidate otherwise attractive opportunities and limit our expansion opportunities.
To continue to qualify as a REIT for U.S. federal income tax purposes, we must continually satisfy tests concerning, among other things, our sources of income, the nature of our investments in real estate and related assets, the amounts we distribute to our stockholders and the ownership of our stock. We may also be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution. Thus, compliance with REIT requirements may hinder our ability to operate solely on the basis of maximizing profits.
To continue to qualify as a REIT, we must also ensure that at the end of each calendar quarter, at least 75% of the value of our gross assets consists of cash, cash items, government securities and qualified real estate assets. The remainder of our investments in securities cannot include more than 10% of the outstanding voting securities of any one issuer or 10% of the total value of the outstanding securities of any one issuer unless we and such issuer jointly elect for such issuer to be treated as a TRS under the Code. The total value of all of our investments in TRSs cannot exceed 20% of the value of our total assets. No more than 5% of the value of our assets (other than government securities and securities that are qualifying real estate assets) can consist of the securities of any one issuer other than a TRS. In addition, not more than 25% of our total assets may be represented by securities (other than those includable in the 75% asset test) or by debt instruments issued by publicly offered REITs that are “nonqualified” debt instruments. If we fail to comply with these requirements, we must dispose of a portion of our assets within 30 days after the end of the calendar quarter in which such discrepancy arises or qualify for certain statutory relief provisions to avoid losing our REIT status and suffering tax consequences. As a result, we may be required to from our portfolio, or contribute to a TRS, otherwise investments in order to maintain our qualification as a REIT. These actions could have the effect of reducing our income, increasing our income tax liability, and reducing amounts available for distribution to our stockholders. In addition, we may also be required to make distributions to stockholders at times or when we do not have funds readily available for distribution, and may be to pursue investments (or, in some cases, forgo the sale of such investments) that would be otherwise to us in order to the source-of-income or asset-diversification requirements for qualifying as a REIT. Thus, compliance with REIT requirements may our ability to operate solely on the basis of maximizing profits.
Complying with REIT requirements may limit our ability to hedge effectively and may cause us to incur tax liabilities.
The REIT provisions of the Code substantially limit our ability to utilize hedges, swaps, and other types of derivatives to hedge our liabilities. Any income from a hedging transaction we enter into to manage risk of interest rate changes with respect to borrowings made or to be made to acquire or carry real estate assets (each such hedge, a “Borrowings Hedge”), or to manage risk of foreign currency exchange rate fluctuations with respect to any item of qualifying income (each such hedge, a “Currency Hedge”), if clearly identified under applicable Treasury Regulations, does not constitute “gross income” for purposes of the 75% or 95% gross income tests that we must satisfy to maintain our qualification as a REIT. This exclusion from the 95% and 75% gross income tests also will apply if we previously entered into a Borrowings Hedge or a Currency Hedge, a portion of the hedged indebtedness or property is disposed of and in connection with such extinguishment or disposition, we enter into a new properly identified hedging transaction to offset the prior hedging position. To the extent that we enter into other types of hedging transactions, the income from those transactions is likely to be treated as non-qualifying income for purposes of both of the gross income tests. As a result of these rules, we intend to limit our use of advantageous hedging techniques or implement those hedges through one or more domestic TRSs. This could increase the cost of our hedging activities because our TRSs would be subject to tax on or us to risks associated with changes in interest rates than we would otherwise want to bear. In addition, in any TRS generally will not provide any tax , except for being carried forward future taxable income in such TRS.
Complying with REIT requirements may force us to borrow to make distributions to stockholders.
From time to time, our taxable income may be greater than our cash flow available for distribution to stockholders. If we do not have other funds available in these situations, we may be unable to distribute substantially all of our taxable income as required by the REIT provisions of the Code. Thus, we could be required to borrow funds, raise additional equity capital, sell a portion of our assets at disadvantageous prices or find another alternative to make distributions to stockholders. These options could increase our costs or reduce the value of our equity.
The ownership of our TRSs (including our TRS lessees) increases our overall tax liability.
Our domestic TRSs are subject to U.S. federal, state and local income tax on their taxable income, which in the case of our TRS lessees, consists of the revenues from the hotels leased by our TRS lessees, net of the operating expenses for such hotels and rent payments to us. Accordingly, although our ownership of our TRS lessees allows us to participate in the operating income from our hotels in addition to receiving rent, that operating income is fully subject to income tax. The after-tax net cash flow of each TRS lessee is available for distribution to us.
Our TRS lessee structure subjects us to the risk of increased hotel operating expenses that could adversely affect our operating results and our ability to make distributions to stockholders.
Our leases with our TRS lessees require such TRS lessees to pay us rent based in part on revenues from our hotels. Our operating risks include decreases in hotel revenues and increases in hotel operating expenses, including but not limited to the increases in wage and benefit costs, repair and maintenance expenses, energy costs, property taxes, insurance costs and other operating expenses, which would adversely affect each TRS lessees’ ability to pay us rent due under the leases.
Increases in these operating expenses can have a significant adverse impact on our financial condition, results of operations, the market price of our shares of common stock and our ability to make distributions to our stockholders.
Our ownership of our TRSs, and any other TRSs we form, are subject to limitations, and our transactions with our TRSs, and any other TRSs we form, may cause us to be subject to a 100% penalty tax on certain income or deductions if those transactions are not conducted on arm’s-length terms.
Overall, no more than 20% of the value of a REIT’s assets may consist of stock or securities of one or more TRSs. In addition, the Code limits the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation. The Code also imposes a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis. The 100% tax may apply, for example, to the extent that we were found to have charged our TRS lessees rent in excess of an arm’s-length rent. For example, LQH Parent’s predecessor, which was taxed as a REIT for U.S. federal income tax purposes prior to LQH Parent’s initial public offering, is currently undergoing an audit by the IRS in which the IRS has asserted this 100% excise tax on the grounds that the rent paid pursuant to the lease agreement between LQH Parent’s predecessor and its TRS was not arms’ length. See “—Risks Related to Our Business and Industry—Entities in existence prior to the Spin-Off are currently under audit by the Internal Revenue Service and may be required to pay additional taxes for which we would be responsible.” It is our policy to evaluate material intercompany transactions and to attempt to set the terms of such transactions so as to achieve substantially the same result as they believe would have been the case if they were unrelated parties. As a result, we believe that all material transactions between and among us and the entities in which we own a direct or indirect interest have been and will be negotiated and structured with the intention of an arm’s-length result and that the potential application of the 100% excise tax will not have a material effect on us. There can be no assurance, however, that we will be to comply with the TRS or to avoid application of the 100% excise tax.
If the leases of our hotels to our TRS lessees are not respected as true leases for U.S. federal income tax purposes, we will fail to qualify as a REIT.
To continue to qualify as a REIT, we must annually satisfy two gross income tests, under which specified percentages of our gross income must be derived from certain sources, such as “rents from real property.” Rents paid to us by our TRS lessees pursuant to the leases of our hotels constitute substantially all of our gross income. In order for such rent to qualify as “rents from real property” for purposes of the gross income tests, the leases must be respected as true leases for U.S. federal income tax purposes and not be treated as service contracts, financing arrangements, joint ventures or some other type of arrangement. If our leases are not respected as true leases for U.S. federal income tax purposes, we will fail to qualify as a REIT.
If LQM or any other future third-party hotel managers do not qualify as “eligible independent contractors,” or if our hotels are not “qualified lodging facilities,” we will fail to qualify as a REIT.
Rent paid by a lessee that is a “related party tenant” of ours will not be qualifying income for purposes of the two gross income tests applicable to REITs. An exception is provided, however, for leases of “qualified lodging facilities” (as defined below) to a TRS so long as the hotels are operated by an “eligible independent contractor” and certain other requirements are satisfied. We lease all but one of our hotels to our TRS lessees and we engage third-party hotel managers (including LQM, which manages all of our hotels) that we believe qualify as “eligible independent contractors.” Among other requirements, to qualify as an eligible independent contractor (i) the hotel manager cannot own, actually or constructively, more than 35% of our outstanding shares, and (ii) one or more actual or constructive owners of more than 35% of the hotel manager cannot own 35% or more of our outstanding shares (determined by taking into account only the shares held by persons owning, actually or constructively, more than 5% of our outstanding shares because our shares will be regularly traded on an established securities market and, if the stock of the hotel manager is regularly traded on an established securities market, determined by taking into account only shares held by persons owning, actually or constructively, more than 5% of the publicly traded stock of the hotel manager). The ownership attribution rules that apply for purposes of these 35% thresholds are complex and monitoring actual and ownership of our shares by our hotel managers and their owners may not be practical. Accordingly, there can be no assurance that these ownership levels will not be exceeded, including with respect to LQM.
In addition, for a hotel management company to qualify as an eligible independent contractor, such company or a related person must be actively engaged in the trade or business of operating “qualified lodging facilities” for one or more persons not related to the REIT or its TRSs at each time that such company enters into a hotel management contract with a TRS or its TRS lessee. We believe LQM (or a related person) operated qualified lodging facilities for certain persons who are not related to us or our TRSs as of the consummation of the merger. However, no assurances can be provided that any of our current and future hotel managers will in fact comply with this requirement. Failure to comply with this requirement would require us to find other hotel managers for future contracts, and, if we hired a manager who failed to comply with this requirement without our knowledge, it could jeopardize our status as a REIT.
Finally, each property with respect to which our TRS lessees pay rent must be a “qualified lodging facility.” A “qualified lodging facility” is a hotel, motel or other establishment more than one-half of the dwelling units in which are used on a transient basis, including customary amenities and facilities, provided that no wagering activities are conducted at or in connection with such facility by any person who is engaged in the business of accepting wagers and who is legally authorized to engage in such business at or in connection with such facility. As of the date hereof, we believe that the properties that are leased to our TRS lessees are qualified lodging facilities. Although we intend to monitor future acquisitions and improvements of properties, REIT provisions of the Code provide no or only limited guidance for making determinations under the requirements for qualified lodging facilities, and there can be no assurance that these requirements will be satisfied.
Our charter generally does not permit any person to own more than 9.8% of our outstanding common stock or of our outstanding stock, and attempts to acquire our common stock or our stock of all other classes or series in excess of these 9.8% limits would not be effective without an exemption from these limits by our board of directors.
For us to qualify as a REIT under the Code, not more than 50% of the value of our outstanding stock may be owned directly or indirectly, by five or fewer individuals (including certain entities treated as individuals for this purpose) during the last half of a taxable year. In addition, for the rental income we receive on the hotels leased to our TRS lessees and operated by LQM (or another hotel manager) to be qualifying REIT income, LQM (or the other hotel manager) must qualify as an “eligible independent contractor.” For LQM (or another hotel manager) to qualify as an “eligible independent contractor,” (i) LQM (or another hotel manager) cannot own more than 35% of our stock and (ii) there cannot be 35% or more overlapping ownership between our stock and LQH Parent stock (or the other hotel manager’s stock), counting, for this purpose, only persons owning more than 5% of our outstanding stock, provided our stock (or other hotel manager’s stock) is regularly traded on an established securities market. For the purpose of preserving our qualification as a REIT for U.S. federal income tax purposes, among other purposes, our charter generally prohibits beneficial or constructive ownership by any person (other than certain existing holders and certain transferees) of more than 9.8%, in value or by number of shares, whichever is more restrictive, of the outstanding shares of our common stock or more than 9.8%, in value of our outstanding shares of stock, which we refer to as the “ownership limit.” Our board of directors has granted an exemption from the ownership limit to Blackstone. The ownership rules under the Code and our charter are complex and may cause shares of the outstanding common stock or preferred stock owned by a group of related persons to be deemed to be owned by one person. As a result, the acquisition of less than 9.8% of our outstanding common stock or our stock by a person could cause a person to own in excess of 9.8% of our outstanding common stock or our stock, respectively, and thus the ownership limit. There can be no assurance that our board of directors, as permitted in the charter, will not increase or decrease the ownership limit in the future. Any attempt to own or transfer shares of our common stock or preferred stock in excess of the ownership limit without the consent of our board of directors will result either in the shares in excess of the limit being transferred by
operation of the charter to a charitable trust, and the person who attempted to acquire such excess shares will not have any rights in such excess shares, or in the transfer being void.
The ownership limit may have the effect of precluding a change in control of us by a third party, even if such change in control would be in the best interests of our stockholders or would result in receipt of a premium to the price of our common stock (and even if such change in control would not reasonably jeopardize our REIT status). The exemptions to the ownership limit granted to date may limit our board of directors’ power to increase the ownership limit or grant further exemptions in the future.
Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.
Under current law, the maximum U.S. federal income tax rate applicable to qualified dividend income payable to certain non-corporate U.S. stockholders is 23.8% (taking into account the 3.8% Medicare tax applicable to net investment income). Dividends payable by REITs, however, generally are not qualified dividends. This does not adversely affect the taxation of REITs; however, the more favorable rates applicable to regular corporate qualified dividends could cause certain non-corporate investors to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our common stock. However, commencing with taxable years beginning on or after January 1, 2018 and continuing through 2025, individual taxpayers may be entitled to claim a deduction in determining their taxable income of 20% of ordinary REIT dividends (dividends other than capital gain dividends and dividends attributable to certain qualified dividend income received by us), which temporarily reduces the effective tax rate on such dividends.
We may be subject to adverse legislative or regulatory tax changes that could increase our tax liability, reduce our operating flexibility and reduce the price of our common stock.
The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Department of the Treasury (the “Treasury”). In recent years, numerous legislative, judicial and administrative changes have been made to the provisions of U.S. federal income tax laws applicable to investments similar to an investment in shares of our common stock. Moreover, as a result of the recent presidential and congressional elections in the U.S., there could be significant changes in tax law and regulations. No specific tax legislation or regulations have yet been enacted and the likelihood and nature of any such legislation or regulations is uncertain. Although REITs generally receive certain tax advantages compared to entities taxed as C corporations, it is possible that future legislation would result in a REIT having fewer tax advantages, and it could become more advantageous for a company that invests in real estate to elect to be treated for U.S. federal income tax purposes as a corporation. As a result, our charter provides our board of directors with the power, under certain circumstances, to revoke or otherwise terminate our REIT election and cause us to be taxed as a C corporation, without the approval of our stockholders.
Risks Related to Ownership of Our Common Stock
The interests of certain of our stockholders may conflict with ours or yours in the future.
Blackstone beneficially owned approximately 30% of our common stock as of December 31, 2020 . Under the stockholders’ agreement we entered into with Blackstone, we agreed to nominate to our board individuals designated by Blackstone, whom we refer to as the “Blackstone Directors,” according to the following scale: (1) if Blackstone continues to beneficially own at least 30% of our common stock, the lowest whole number that is greater than 30% of the total number of directors comprising our board of directors; (2) if Blackstone continues to beneficially own at least 20% (but less than 30%) of our common stock, the lowest whole number that is greater than 20% of the total number of directors comprising our board of directors; and (3) if Blackstone continues to beneficially own at least 5% (but less than 20%) of our common stock, the lowest whole number that is greater than 10% of the total number of directors comprising our board of directors. For so long as the stockholders’ agreement remains in effect, Blackstone Directors may be removed only with the consent of Blackstone. In the case of a vacancy on our board created by the removal or resignation of a Blackstone Director, the stockholders’ agreement requires us to nominate an individual designated by Blackstone for election to fill the vacancy. Two members of our board of directors are Blackstone employees. Accordingly, for so long as Blackstone retains significant ownership of us, Blackstone will have significant influence with respect to our management, business plans and policies, including the appointment and removal of our officers. For example, for so long as Blackstone continues to own a significant percentage of our stock, Blackstone may be to influence whether or not a change of control of our company or a change in the composition of our board of directors occurs and could any unsolicited acquisition of our company. The concentration of ownership could you of an to receive a premium for your shares of common stock as part of a sale of our company and ultimately might affect the market price of our common stock . In addition, Blackstone may be engaged from time to time in discussions relating to dispositions of its holdings of our common stock, including sale of a significant percentage to a single buyer. If such significant sale were to occur, the buyer could have influence over the management of our company, including through board representation. The cost of registering Blackstone’s owned common stock is our expense. During 2019, we incurred $1 million in such costs.
Blackstone engages in a broad spectrum of activities, including investments in real estate generally and in the hospitality industry in particular. In the ordinary course of their business activities, Blackstone may engage in activities where their interests conflict with our interests or those of our stockholders. For example, Blackstone owns interests in G6 Hospitality, LLC and Blackstone owns certain other investments in the hotel and lodging industries and may pursue ventures that compete directly or indirectly with us. Moreover, Blackstone may directly and indirectly own interests in other third-party hotel management companies and franchisors with whom we may engage in the future, may compete with us for investment opportunities and may enter into other transactions with us, including hotel development projects, that could result in their having interests that could conflict with ours. Our charter also provides that, to the maximum extent permitted from time to time by Maryland law, in the event that Blackstone or any non-employee director or any of his or her affiliates, acquires knowledge of a potential transaction or other business opportunity, such person will have no duty to communicate or offer such transaction or business opportunity to us or any of our affiliates and may take any such opportunity for himself or herself or offer it to another person or entity unless the business is expressly offered to such person in his or her capacity as our director. Blackstone also may pursue acquisition that may be complementary to our business, and, as a result, those acquisition may be to us. In addition, Blackstone may have an interest in pursuing acquisitions, and other transactions that, in its judgment, could its investments in the Company, even though such transactions might involve risks to you.
Our charter contains a provision that expressly permits Blackstone, our non-employee directors and their affiliates, to compete with us.
Blackstone may compete with us for investments in properties and for customers. There is no assurance that any conflicts of interest created by such competition will be resolved in our favor. Moreover, Blackstone is in the business of making investments in companies and acquires and holds interests in businesses that compete directly or indirectly with us. Our charter provides that, to the maximum extent permitted from time to time by Maryland law, we renounce any interest or expectancy that we have in, or any right to be offered an opportunity to participate in, any business opportunities that are from time to time presented to or developed by our directors or their affiliates, other than to those directors who are employed by us or our subsidiaries, unless the business opportunity is expressly offered or made known to such person in his or her capacity as our director, and none of Blackstone, or any director who is not employed by us or any of his or her affiliates, will have any duty to refrain from engaging, directly or indirectly, in the same business activities or similar business activities or lines of business in which we or our affiliates engage or propose to engage or to refrain from otherwise competing with us or our affiliates. Blackstone also may pursue acquisition that may be complementary to our business, and, as a result, those acquisition may not be available to us. Our charter provides that, to the maximum extent permitted from time to time by Maryland law, Blackstone and each of our non-employee directors (including those designated by Blackstone), and any of their affiliates, may:
• acquire, hold and dispose of shares of our stock or other equity interests, including units of partnership interest in CorePoint Operating Partnership L.P. (“CorePoint OP”) a wholly owned subsidiary of CorePoint Lodging Inc., for his, her or its own account or for the account of others, and exercise all of the rights of a stockholder of us or a limited partner of CorePoint OP, to the same extent and in the same manner as if he, she or it were not our director or stockholder; and
• in his, her or its personal capacity or in his, her or its capacity, as applicable, as a director, officer, trustee, stockholder, partner, member, equity owner, manager, advisor or employee of any other person, have business interests and engage, directly or indirectly, in business activities that are similar to ours or compete with us, that involve a business opportunity that we could seize and develop or that include the acquisition, syndication, holding, management, development, operation or disposition of interests in mortgages, real property or persons engaged in the real estate business.
Our charter also provides that, to the maximum extent permitted from time to time by Maryland law, in the event that Blackstone, any non-employee director, or any of their respective affiliates, acquires knowledge of a potential transaction or other business opportunity, such person will have no duty to communicate or offer such transaction or business opportunity to us or any of our affiliates and may take any such opportunity for itself, himself or herself or offer it to another person or entity unless the business opportunity is expressly offered to such person in his or her capacity as our director.
These provisions may limit our ability to pursue business or investment opportunities that we might otherwise have had the opportunity to pursue, which could have an adverse effect on our financial condition, our results of operations, our cash flow, the per share trading price of our common stock and our ability to satisfy our debt service obligations and to pay dividends to our stockholders.
Our rights and the rights of our stockholders to take action against our directors and officers are limited.
Our charter eliminates the liability of our directors and officers to us and our stockholders for money damages to the maximum extent permitted under Maryland law. Under current Maryland law and our charter, our directors and officers will not have any liability to us or our stockholders for money damages other than liability resulting from:
• actual receipt of an improper benefit or profit in money, property or services; or
• active and deliberate dishonesty by the director or officer that was established by a final judgment and is material to the cause of action adjudicated.
Our charter authorizes us and our bylaws obligate us to indemnify each of our directors or officers who is or is threatened to be made a party to or witness in a proceeding by reason of his or her service in those or certain other capacities, to the maximum extent permitted by Maryland law, from and against any claim or liability to which such person may become subject or which such person may incur by reason of his or her status as a present or former director or officer of us or serving in such other capacities. In addition, we may be obligated to pay or reimburse the expenses incurred by our present and former directors and officers without requiring a preliminary determination of their ultimate entitlement to indemnification. As a result, we and our stockholders may have more limited rights to recover money damages from our directors and officers than might otherwise exist absent these provisions in our charter and bylaws or that might exist with other companies, which could limit your recourse in the event of actions that are not in our best interests.
Our bylaws designate the Circuit Court for Baltimore City, Maryland as the exclusive forum for certain actions and proceedings that may be initiated by our stockholders against us or any of our directors, officers or other employees.
Our bylaws provide that, unless we consent in writing to the selection of an alternative forum, the Circuit Court for Baltimore City, Maryland, or, if that court does not have jurisdiction, the U.S. District Court for the District of Maryland, Baltimore Division, is be the sole and exclusive forum for (a) any derivative action or proceeding brought on our behalf, (b) any action asserting a claim of breach of any duty owed by any of our directors, officers or other employees to us or to our stockholders, (c) any action asserting a claim against us or any of our directors, officers or other employees arising pursuant to any provision of the Maryland General Corporation Law (the “MGCL”) or our charter or bylaws or (d) any action asserting a claim against us or any of our directors, officers or other employees that is governed by the internal affairs doctrine. Any person or entity purchasing or otherwise acquiring any interest in shares of our stock will be deemed to have notice of and consented to the provisions of our charter and bylaws, including the exclusive forum provisions in our bylaws. This choice of forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that the stockholder believes is favorable for such and may lawsuits us and any of our directors, officers or other employees. We believe that requiring these to be filed in a single court in Maryland is advisable because (i) these in a single court avoids redundant, , and time-consuming in multiple forums and (ii) Maryland courts are authoritative on matters of Maryland law and Maryland judges have more experience in dealing with issues of Maryland corporate law than judges in any other state.
Certain provisions in our organizational documents might discourage or delay acquisition attempts for us that you might consider favorable.
Our charter and bylaws contain provisions that may make a merger or acquisition of our company more difficult without the approval of our board of directors. Among other things:
• the restrictions on ownership and transfer of our stock in our charter generally prevent any person from acquiring more than 9.8% (in value or by number of shares, whichever is more restrictive) of our outstanding common stock or more than 9.8% in value of our outstanding stock without the approval of our board of directors;
• although we do not have a stockholder rights plan, and would either submit any such plan to stockholders for ratification or cause such plan to expire within a year, these provisions would allow us to authorize the issuance, or increase the number of authorized shares, of common or preferred stock in connection with a stockholder rights plan or otherwise, the terms of which may be established and the shares of which may be issued without stockholder approval, and which may include super voting, special approval, dividend, or other rights or preferences superior to the rights of the holders of common stock;
• these provisions provide that our board of directors is expressly authorized to make, alter or repeal our bylaws (except for provisions related to the “business combination” and “control share” provisions of the MGCL, which, in each case, require the approval of the affirmative vote of a majority of the votes cast on the matter by stockholders entitled to vote generally in the election of directors) and that our stockholders may only amend our bylaws with the approval of 80% or more of all of the outstanding shares of our stock entitled to vote; and
• these provisions establish advance notice requirements for nominations for elections to our board or for proposing matters that can be acted upon by stockholders at stockholder meetings.
These takeover defense provisions could discourage, delay or prevent a transaction involving a change in control of our company, including actions that our stockholders may deem advantageous, or negatively affect the trading price of our common stock.
These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and to cause us to take other corporate actions you desire.
The per share trading price and trading volume of our common stock has been and may in the future be volatile.
The per share trading price of our common stock has been and may be volatile. During 2020, the per share trading price of our common stock fluctuated from a low of $2.18 to a high of $10.74. In a ddition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. If the per share trading price of our common stock declines significantly, you may be unable to resell your shares at or above the purchase price. We cannot assure you that the per share trading price of our common stock will not fluctuate or decline significantly in the future. The market price of our common stock may fluctuate significantly, depending upon many factors, some of which may be beyond our control, including, but not limited to:
• a shift in our investor base;
• our quarterly or annual earnings, or those of comparable companies;
• actual or anticipated fluctuations in our operating results;
• our ability to obtain financing as needed;
• changes in laws and regulations affecting our business;
• changes in accounting standards, policies, guidance, interpretations or principles;
• announcements by us or our competitors of significant investments, acquisitions or dispositions;
• the failure of securities analysts to cover our common stock;
• changes in earnings estimates by securities analysts or our ability to meet those estimates;
• the operating performance and stock price of comparable companies;
• overall market fluctuations;
• a decline in the real estate markets; and
• general economic conditions and other external factors.
Moreover, securities markets worldwide are currently experiencing significant price and volume fluctuations. This market volatility, as well as general economic, market or political conditions, could reduce the market price of shares without regard to our operating performance. For example, the trading prices of equity securities issued by REITs historically have been affected by changes in market interest rates. One of the factors that may influence the market price of our common stock is the annual yield from distributions on our common stock as compared to yields on other financial instruments. An increase in market interest rates, or a decrease in our distributions to stockholders, may lead prospective purchasers of shares of our common stock to demand a higher distribution rate or seek alternative investments. As a result, if interest rates rise, it is likely that the market price of our common stock will decrease as market rates on interest-bearing securities increase. In addition, our operating results could be below the expectations of public market analysts and investors, and in response the market price of our shares could decrease significantly. The market value of the equity securities of a REIT is also based upon the market’s perception of the REIT’s growth potential and its current and potential future cash distributions, whether from operations, sales or refinancings, and is secondarily based upon the real estate market value of the underlying assets. For that reason, our common stock may trade at prices that are higher or lower than our net asset value per share. To the extent we retain operating cash flow for investment purposes, working capital reserves or other purposes, these retained funds, while increasing the value of our underlying assets, may not correspondingly increase the market price of our common stock. Our to meet the market’s expectations with regard to future earnings and cash distributions likely would affect the market price of our common stock and, in such instances, you may be to resell your shares for a profit. Other factors may also influence the price of our stock so long as we are qualified as a REIT.
In the past few years, stock markets have experienced extreme price and volume fluctuations. In the past, following periods of volatility in the overall market price of a company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.
We are an “emerging growth company” and a “smaller reporting company” and we cannot be certain if the reduced reporting requirements applicable to emerging growth companies and smaller reporting companies will make our common stock less attractive to investors.
We are an emerging growth company, and, for as long as we continue to be an emerging growth company, we may take advantage of exemptions from various reporting requirements applicable to other public companies but not to emerging growth companies, including, but not limited to, not being required to have our independent registered public accounting firm audit our internal controls over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002, reduced disclosure obligations regarding executive compensation in our registration statements, periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We could be an emerging growth company until December 31, 2023. We will cease to be an emerging growth company upon the earliest of: (i) the end of the fiscal year following the fifth anniversary of the Spin-Off, (ii) the first fiscal year after our annual gross revenues are $1.07 billion or more; (iii) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt securities; or (iv) the date on which we are deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Even after we no longer qualify as an emerging growth company, we may still qualify as a “smaller reporting company.” For as long as we continue to be a smaller reporting company, we will be allowed to take of many of the same exemptions from disclosure requirements as we do as an emerging growth company, including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act and reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements. As a smaller reporting company, we are also permitted to provide only two years of audited financial statements in our annual reports on Form 10-K. We will remain a smaller reporting company until (a) the aggregate market value of our outstanding common stock held by non-affiliates as of the last business day our most recently completed second fiscal quarter exceeds $250 million or (b) (1) we have $100 million or more in annual revenues and (2) the aggregate market value of our outstanding common stock held by non-affiliates as of the last business day our most recently completed second fiscal quarter equals or exceeds $700 million. We cannot predict if investors will find our common stock less because we may rely on these exemptions. If some investors find our common stock less as a result of any choices to reduce future disclosure, there may be a less active trading market for our common stock and our per share trading price of our common stock may be affected and more .
Under the Jumpstart Our Business Startups Act of 2012, or JOBS Act, emerging growth companies can also delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this accommodation allowing for delayed adoption of new or revised accounting standards, and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.
Future issuances of common stock or preferred stock by us, and the availability for resale of shares held by Blackstone, may cause the market price of our common stock to decline.
Sales of a substantial number of shares of our common stock in the public market, or the perception that these sales could occur, could substantially decrease the market price of our common stock. Substantially all of the outstanding shares of our common stock are available for resale in the public market. The market price of our common stock could drop significantly if the holders of these shares sell them or are perceived by the market as intending to sell them.
In addition, our charter provides that we may issue up to 1 billion shares of common stock and 50 million shares of preferred stock, $0.01 par value per share. Moreover, under Maryland law and as provided in our charter, our board of directors has the power to amend our charter to increase the aggregate number of shares of stock or the number of shares of stock of any class or series that we are authorized to issue without stockholder approval. Future issuances of shares of our common stock or securities convertible or exchangeable into common stock may dilute the ownership interest of our common stockholders. Because our decision to issue additional equity or convertible or exchangeable securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future issuances. In addition, we are not required to offer any such securities to existing stockholders on a preemptive basis. Therefore, it may not be possible for existing stockholders to participate in such future issuances, which may dilute the existing stockholders’ interests in us.
Pursuant to a registration rights agreement that we entered into with Blackstone, we granted Blackstone an unlimited number of “demand” registrations and customary “piggyback” registration rights. In addition, none of the shares outstanding, including those held by Blackstone, are “restricted securities” within the meaning of Rule 144 under the Securities Act, and are freely tradable subject to certain restrictions in the case of shares held by persons deemed to be our affiliates. Accordingly, the market price of our stock could decline if Blackstone exercises its registration rights, sells its shares in the open market or otherwise or is perceived by the market as intending to sell them.
In addition, as of December 31, 2020 we had an aggregate of approximately three million shares of common stock issuable upon vesting or exercise of outstanding awards and an aggregate of five million shares of common stock available for future issuance under our 2018 Omnibus Incentive Plan, subject to adjustments as set forth therein. We filed a registration statement on Form S-8
under the Securities Act to register shares of our common stock or securities convertible into or exchangeable for shares of our common stock issued pursuant to our 2018 Omnibus Incentive Plan. Accordingly, shares registered under such registration statement are generally available for sale in the open market.
The cash available for distribution to stockholders may not be sufficient to pay dividends at expected levels, nor can we assure you of our ability to make distributions in the future. We may use borrowed funds to make distributions.
We have elected to be taxed as a REIT. The Code generally requires that a REIT annually distribute at least 90% of its REIT taxable income, determined without regard to the deduction for dividends paid and excluding any net capital gain, and imposes tax on any taxable income retained by a REIT, including capital gains. While in the past we have made quarterly distributions to our stockholders, beginning in the second quarter of 2020 we suspended our cash dividend due to the adverse impact of the COVID-19 pandemic on our results of operations. Our ability to make distributions to our stockholders depends upon the performance of our asset portfolio. If our operations do not generate sufficient cash flow to allow us to satisfy the REIT distribution requirements, we may be required to fund distributions from working capital, borrow funds, raise additional equity capital, sell assets or reduce such distributions. Our inability to make expected distributions did in 2020 and could in the future result in a decrease in the market price of our common stock. In addition, our charter allows us to issue preferred stock that could have a preference over our common stock as to distributions All distributions will be made at the sole discretion of our board of directors and will depend on our earnings, our financial condition, maintenance of our REIT qualification and other factors as our board of directors may deem relevant from time to time. We may not be to make distributions in the future. In addition, some of our distributions may include a return of capital. To the extent that we decide to make distributions in excess of our current and accumulated earnings and profits, such distributions would generally be considered a return of capital for U.S. federal income tax purposes to the extent of the stockholder’s adjusted tax basis in their shares. A return of capital is not taxable, but it has the effect of reducing the stockholder’s adjusted tax basis in its investment. To the extent that distributions exceed the adjusted tax basis of a stockholder’s shares, they will be treated as from the sale or exchange of such stock. If we borrow to fund distributions, our future interest costs would increase, thereby reducing our earnings and cash available for distribution from what they otherwise would have been.
The stock ownership limits imposed by the Code for REITs and our charter may restrict stock transfers and/or business combination opportunities, particularly if our management and board of directors do not favor a combination proposal.
In order for us to maintain our qualification as a REIT under the Code, not more than 50% in value of our outstanding stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities) at any time during the last half of each taxable year following our first year. Our charter, with certain exceptions, authorizes our board of directors to take the actions that are necessary and desirable to preserve our qualification as a REIT. Unless exempted by our board of directors, no person or entity (other than a person or entity who has been granted an exception) may directly or indirectly, beneficially own, or be deemed to own by virtue of the applicable constructive ownership provisions of the Code, more than 9.8%, in value or by number of shares, whichever is more restrictive, of our outstanding common stock, or more than 9.8% in value of our outstanding stock.
Our board may, in its sole discretion, grant an exemption to the ownership limits, subject to certain conditions and the receipt by our board of certain representations and undertakings. In addition, our board of directors may change the stock ownership limits. Our charter also prohibits any person from: (1) beneficially or constructively owning shares of our stock that would result in our being “closely held” under Section 856(h) of the Code or otherwise cause us to fail to qualify as a REIT (including, but not limited to, as a result of any “eligible independent contractor” that operates a “qualified lodging facility” (as such terms are defined in Section 856(d)(9)(A) and 856(d)(9)(D) of the Code, respectively) on behalf of our TRS lessees failing to qualify as such); (2) transferring stock if such transfer would result in our stock being owned by fewer than 100 persons; (3) beneficially owning shares of our stock to the extent such ownership would result in our failing to qualify as a “domestically controlled qualified investment entity” within the meaning of Section 897(h) of the Code; and (4) beneficially or constructively owning shares of our stock to the extent that such ownership could result in us owning a 10% or interest in a tenant (as described in Section 856(d)(2)(B) of the Code), if the income so derived by us from such tenant for our taxable year during which such determination is being made could reasonably be expected to equal or exceed 1% of our gross income. The stock ownership limits contained in our charter key off the ownership at any time by any “person,” which term includes entities, and take into account direct and indirect ownership as determined under various ownership attribution rules in the Code. The stock ownership limits also might or prevent a transaction or a change in our control that might involve a premium price for our common stock or otherwise be in the interests of our stockholders.
Our authorized but unissued shares of common stock and shares of preferred stock may prevent a change in our control that might involve a premium price for our common stock or otherwise be in the best interests of our stockholders.
Our charter authorizes us to issue additional authorized but unissued shares of common or preferred stock. In addition, our board of directors may, without stockholder approval, amend our charter to increase the aggregate number of our shares of common stock or the number of shares of any class or series of preferred stock that we have authority to issue and classify or reclassify any unissued shares of common stock or preferred stock and set the preferences, rights and other terms of the classified or reclassified
stock. As a result, our board of directors may establish a series of common stock or preferred stock that could delay or prevent a transaction or a change in our control that might involve a premium price for our common stock or otherwise be in the best interests of our stockholders.
General Risk Factors
Adverse judgments or settlements resulting from legal proceedings in which we may be involved in the normal course of our business could reduce our profits or limit our ability to operate our business.
In the normal course of our business, we are involved in various legal proceedings. LQM and other third-party hotel managers that we may engage in the future, whom we indemnify for legal costs resulting from management of our hotels, may also be involved in various legal proceedings relating to the management of our hotels. The outcome of these proceedings cannot be predicted. If any of these proceedings were to be determined adversely to us or our third-party hotel managers or a settlement involving a payment of a material sum of money were to occur, it could materially and adversely affect our profits or ability to operate our business. In recent years, a number of hospitality companies have been subject to lawsuits, including class action lawsuits, alleging violations of federal laws and regulations regarding workplace and employment matters, consumer protection claims, human trafficking, and other commercial or other matters. A number of these lawsuits have resulted in the payment of substantial damages by the defendants through adverse judgments or settlement agreements. Additionally, we could become the subject of future by third parties, including current or former third-party property owners, guests who use our properties, our employees, our investors or regulators. Any significant judgments or settlements would reduce our profits and could limit our ability to operate our business. Further, we may incur costs related to for which we have appropriate third-party indemnity, but such third parties to fulfill their contractual obligations.
Changes in federal, state or local tax law or interpretations of existing tax law, or adverse determinations by tax authorities, could increase our tax burden or otherwise adversely affect our financial condition, results of operations or cash flows.
We are currently subject to taxation at the federal, state and local levels in the U.S. Our future effective tax rate could be affected by changes in the composition of earnings in jurisdictions with differing tax rates, changes in statutory rates and other legislative changes, changes in the valuation of our deferred tax assets and liabilities, or changes in determinations regarding the jurisdictions in which we are subject to tax. From time to time, the U.S. federal, state and local governments make substantive changes to tax rules and their application, which could result in materially higher taxes than would be incurred under existing tax law or interpretation and could adversely affect our profitability, financial condition, results of operations or cash flows. Moreover, as a result of the recent presidential and congressional elections in the U.S., there could be significant changes in tax law and regulations. No specific tax legislation or regulations have yet been enacted and the likelihood and nature of any such legislation or regulations is uncertain. State and local tax authorities have also increased their efforts to increase revenues through changes in tax law and audits. Such changes and proposals, if enacted, could increase our future effective income tax rates. We are subject to ongoing and periodic tax audits and disputes in various jurisdictions. An outcome from any tax audit could result in higher tax costs, and interest, thereby impacting our financial condition, results of operations or cash flows. Furthermore, we have elected to be taxed as a REIT. See “—Risks Related to Our REIT Status and Certain Other Tax Items.”
