Sunstone Hotel Investors, Inc. (SHO) FY 2021 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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The following discussion should be read together with the consolidated financial statements and related notes included elsewhere in this report. This discussion focuses on our financial condition and results of operations for the year ended December 31, 2021 as compared to the year ended December 31, 2020. A discussion and analysis of the year ended December 31, 2020 as compared to the year ended December 31, 2019 is included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on February 12, 2021, under the caption “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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Overview

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Sunstone Hotel Investors, Inc. is a Maryland corporation. We operate as a self-managed and self-administered real estate investment trust. A REIT is a corporation that directly or indirectly owns real estate assets and has elected to be taxable as a real estate investment trust for federal income tax purposes. To qualify for taxation as a REIT, the REIT must meet certain requirements, including regarding the composition of its assets and the sources of its income. REITs generally are not subject to federal income taxes at the corporate level as long as they pay stockholder dividends equivalent to 100% of their taxable income. REITs are required to distribute to stockholders at least 90% of their REIT taxable income. We own, directly or indirectly, 100% of the interests of Sunstone Hotel Partnership, LLC, which is the entity that directly or indirectly owns our hotel properties. We also own 100% of the interests of our taxable REIT subsidiary, Sunstone Hotel TRS Lessee, Inc., which, directly or indirectly, leases all of our hotels from the Operating Partnership, and engages independent third-parties to manage our hotels.

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We own hotels that we consider to be LTRR® in the United States, specifically hotels in urban and resort destination locations that benefit from significant barriers to entry by competitors and diverse economic drivers. As part of our ongoing portfolio management strategy, on an opportunistic basis, we may also selectively sell hotel properties that we believe do not meet our criteria of LTRR®. As of December 31, 2021, we had interests in 17 hotels (the “17 Hotels”), one of which was considered held for sale (Hyatt Centric Chicago Magnificent Mile), leaving 16 hotels currently held for investment. All but two (the Boston Park Plaza and the Oceans Edge Resort & Marina) of our hotels are operated under nationally recognized brands. Our two unbranded hotels are located in top urban and resort destination markets that have enabled them to establish awareness with both group and transient customers.

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The following tables summarize our total portfolio and room data from January 1, 2020 through December 31, 2021:

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COVID-19 Impact and Response

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In March 2020, the COVID-19 pandemic was declared a National Public Health Emergency, which led to significant cancellations, corporate and government travel restrictions and an unprecedented decline in hotel demand. As a result of these cancellations, restrictions and the health concerns related to COVID-19, we determined that it was in the best interest of our hotel employees and the communities in which our hotels operate to temporarily suspend operations at 14 of our hotels. As of December 31, 2021, all of our hotels were open and operating.

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Our asset management team has worked closely with each hotel’s third-party manager to create detailed operating plans, including adherence to safety precautions developed by the Center for Disease Control and Prevention and other public health experts. We continue to closely monitor the safety measures at our hotels, including frequent and enhanced cleaning and sanitation, contactless check-in, the use of personal protective equipment by hotel employees and guests and increased physical distancing throughout each hotel in accordance with federal and local guidelines and mandates.

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During 2021, leisure demand was the dominant source of business at many of our hotels, while business transient and group demand both improved as compared to 2020, but remained well below pre-pandemic levels. We believe that the return of traditional business transient and group business will ultimately depend on the speed of vaccine distribution, the management and control of COVID-19 and its variants and the degree and speed to which business returns. The effects of the COVID-19 pandemic on the hotel industry have been significant and unprecedented, and we have limited visibility to predict future operations.

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Following widespread layoffs and furloughs, our hotels are hiring again; however, some of our hotels have experienced challenges recalling workers. To attract and retain talented workers, many of our hotels are holding hiring events and offering sign-on or retention bonuses. In select competitive areas, our hotels are offering increased wages in line with the market. In addition, some of our hotels have increased flexibility and benefits to help attract and retain leadership talent. While hiring improved slightly in the second half of 2021, the COVID-19 Omicron variant negatively impacted the availability of employees, and we expect the labor challenges will continue in 2022.

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2021 Summary

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Demand. Occupancy during 2021 and 2020 at the 15 hotels we owned during both years (the “Existing Portfolio”) was as follows:

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Since our Existing Portfolio’s COVID-19-related occupancy low point of 1.1% in April 2020, we have experienced steady improvements in hotel demand. Following strong demand over most of the summer, leisure travel moderated in August and September 2021 due to concerns regarding the Delta variant, extreme weather conditions across the country and the beginning of the school year. During the fourth quarter of 2021, leisure demand again accelerated, particularly around the holidays. We began to see improvements in business transient demand and group demand during the second half of 2021, as events at our hotels increased across our portfolio and started to become a more meaningful contributor to occupancy. We also began to see events with more guests and events that took place over longer periods of time. We expect the demand recovery to extend past 2021; although, the introduction of the Omicron variant impacted business during the fourth quarter of 2021 and is expected to impact 2022 business transient and group demand. We continue to be encouraged by future group bookings, which leads us to believe that our portfolio will continue to improve in 2022 and 2023.

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Significant Renovations. During 2021, we took advantage of the COVID-19 pandemic-induced low demand to accelerate several capital projects that would have otherwise been highly disruptive to hotel operations. At the Boston Park Plaza, we completed the addition of a new 7,000 square foot meeting space that will give the hotel incremental capacity to host in-house group business and reduce the hotel’s reliance on citywide events. At the Wailea Beach Resort, we installed solar panels on the main roof and tower roof, allowing the hotel to offset energy usage. At the Hilton San Diego Bayfront, we reinvented the ground floor food and beverage offerings, including the addition of a market concept that we anticipate will provide a better guest experience at a higher profit margin. In addition, we converted unused space into 6,800 square feet of new waterfront meeting space. At the Renaissance Washington DC, we remodeled the ballroom and meeting space in connection with the hotel’s transformation to the soon-to-be-rebranded Westin Washington DC. In the first quarter of 2022, we will begin the next step in the hotel’s transformation, the renovation of all guestrooms and an enhancement of the lobby layout and design.

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Acquisitions. In April 2021, we purchased the fee-simple interest in the Montage Healdsburg, located in California, for $265.0 million, excluding closing costs. We funded this acquisition through the issuance of 2,650,000 shares of Series G Cumulative Redeemable Preferred Stock (the “Series G preferred stock”) with an aggregate liquidation preference of $66.3 million, as well as $198.8 million of cash on hand.

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In December 2021, we purchased the fee-simple interest in the Four Seasons Resort Napa Valley, located in California, for $177.5 million, excluding closing costs. We funded this acquisition through a combination of cash on hand and $110.0 million borrowed under our credit facility.

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Dispositions. During 2021, we sold two hotels. In October 2021, we sold the Renaissance Westchester for gross proceeds of $18.8 million, excluding closing costs, and recorded a net gain of $3.7 million on the sale. In December 2021, we sold the Embassy Suites La Jolla for gross proceeds of $226.7 million, excluding closing costs, and recorded a net gain of $148.8 million on the sale.

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Debt Transactions. In July and December 2020, we completed amendments to our unsecured debt, consisting of the credit facility, term loans and senior notes (the “Unsecured Debt Amendments”). Among other provisions, the Unsecured Debt Amendments

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included a waiver of required financial covenants through the end of the first quarter of 2022, with quarterly testing resuming for the period ending March 31, 2022. In July 2021, we amended the Unsecured Debt Amendments, which removed certain restrictions in place during the covenant waiver period ending March 31, 2022. The restrictions removed include the limitation on the aggregate value of unencumbered hotel acquisitions we can complete and, provided that an event of default has not occurred, the requirement to prepay our unsecured debt using net proceeds received from asset sales or equity issuances. In November 2021, we further amended the Unsecured Debt Agreements, providing financial covenant relief through the end of the third quarter of 2022, with quarterly testing resuming for the period ending September 30, 2022, subject to the satisfaction of certain conditions.

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In November and December 2021, we drew a total of $110.0 million under the credit facility to fund a portion of our purchase of the Four Seasons Resort Napa Valley. We repaid the outstanding balance of $110.0 million in December 2021, resulting in zero outstanding under the credit facility and $500.0 million of capacity available for additional borrowing under the facility as of December 31, 2021.

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In December 2021, we paid $65.6 million on our Term Loan 1 and $11.1 million on our Term Loan 2, resulting in a Term Loan 1 balance of $19.4 million and a Term Loan 2 balance of $88.9 million as of December 31, 2021.

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In December 2021, we entered into an agreement with the lender to extend the maturity of the $220.0 million loan secured by the Hilton San Diego Bayfront from December 2021 to December 2022. In addition, we purchased an interest rate cap derivative for $0.1 million that will continue to cap the floating rate interest on the loan at 6.0% until December 2022.

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In December 2021, we assigned the note secured by the Embassy Suites La Jolla, which had an outstanding balance of $56.6 million, to the hotel’s buyer in conjunction with the sale of the hotel.

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For more details on our 2021 debt transactions, see “Liquidity and Capital Resources” below.

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Capital Transactions. As noted above, in April 2021, we issued 2,650,000 shares of our Series G preferred stock, which is callable at a redemption price of $25.00 per share plus accrued and unpaid dividends by us at any time. The Series G preferred stock accrues dividends at an initial rate equal to the Montage Healdsburg’s annual net operating income yield on our investment in the hotel. The Series G preferred stock is not convertible into any other security.

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In May 2021, we issued 4,600,000 shares of our 6.125% Series H Cumulative Redeemable Preferred Stock (the “Series H preferred stock”) for gross proceeds of $115.0 million. The Series H preferred stock has a redemption price of $25.00 per share, and can be redeemed by us on or after May 24, 2026. We used the proceeds received from this issuance to redeem all 4,600,000 shares of our 6.95% Series E Cumulative Redeemable Preferred Stock (the “Series E preferred stock”). Because the redemption of the Series E preferred stock was a redemption in full, trading of the Series E preferred stock on the New York Stock Exchange ceased on the June 11, 2021 redemption date.

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In June 2021, we utilized our February 2017 At The Market (“ATM”) Program to issue 2,913,682 shares of our common stock for gross proceeds of $38.4 million, leaving $137.0 million available for sale under the February 2017 ATM Program.

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In July 2021, we issued 4,000,000 shares of our 5.70% Series I Cumulative Redeemable Preferred Stock (“the Series I preferred stock”) for gross proceeds of $100.0 million. The Series I preferred stock has a redemption price of $25.00 per share, and can be redeemed by us on or after July 16, 2026. We used the proceeds received from this issuance to redeem all 3,000,000 shares of our 6.45% Series F Cumulative Redeemable Preferred Stock (the “Series F preferred stock”). Because the redemption of the Series F preferred stock was a redemption in full, trading of the Series F preferred stock on the New York Stock Exchange ceased on the August 12, 2021 redemption date.

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Operating Activities

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

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Expenses. Our expenses consist of the following:

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Other Revenue and Expense. Other revenue and expense consists of the following:

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Operating Performance Indicators. The following performance indicators are commonly used in the hotel industry:

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Factors Affecting Our Operating Results. The primary factors affecting our operating results include overall demand for hotel rooms, the pace of new hotel development, or supply, and the relative performance of our operators in increasing revenue and controlling hotel operating expenses.

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Operating Results. The following table presents our operating results for our total portfolio for the years ended December 31, 2021 and 2020, including the amount and percentage change in the results between the two periods.

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Summary of Operating Results. The following items significantly impact the year-over-year comparability of our operations:

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Room Revenue. Room revenue increased $183.5 million, or 108.2%, in 2021 as compared to 2020 as follows:

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Food and Beverage Revenue. Food and beverage revenue increased $29.0 million, or 52.9%, in 2021 as compared to 2020 as follows:

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Other Operating Revenue. Other operating revenue increased $28.8 million, or 66.2%, in 2021 as compared to 2020 as follows:

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Hotel Operating Expenses. Hotel operating expenses, which are comprised of room, food and beverage, advertising and promotion, repairs and maintenance, utilities, franchise costs, property tax, ground lease and insurance and other hotel operating expenses increased $54.4 million, or 18.2%, in 2021 as compared to 2020 as follows:

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Other Property-Level Expenses. Other property-level expenses increased $21.6 million, or 43.2%, in 2021 as compared to 2020 as follows:

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Corporate Overhead Expense. Corporate overhead expense increased $12.1 million, or 43.1%, during 2021 as compared to 2020, including $11.1 million related to CEO transition costs as well as costs due to the retirement of our chief operating officer. Excluding transition and retirement costs, corporate overhead expense increased $1.0 million in 2021 as compared to 2020 as increased amortization of deferred stock compensation, recruitment expenses and audit fees were partially offset by decreased due diligence expenses.

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Depreciation and Amortization Expense. Depreciation and amortization expense decreased $8.4 million, or 6.1%, in 2021 as compared to 2020 as follows:

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Impairment Losses. Impairment losses totaled $2.7 million in 2021 and $146.9 million in 2020. In 2021, we recorded an impairment loss of $2.7 million on the Hilton New Orleans St. Charles due to Hurricane Ida-related damage at the hotel.

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During 2020, we recorded impairment losses of $144.6 million on three of the Five Disposed Hotels and $2.3 million related to the abandonment of a potential project to expand one of our hotels.

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Interest and Other Income (Loss). Interest and other income (loss) totaled a loss of $0.3 million in 2021 as compared to income of $2.8 million in 2020. During 2021, we accrued a post-closing contingency of $0.4 million to the current owner of a hotel we sold in 2018, and we recognized $0.1 million in interest income.

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During 2020, we recognized $2.6 million in interest income and $0.2 million in energy rebates due to energy efficient renovations at our hotels.

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Interest Expense. We incurred interest expense as follows (in thousands):

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Interest expense decreased $22.4 million, or 42.0%, in 2021 as compared to 2020 as follows:

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Interest expense on our debt and finance lease obligation decreased $14.1 million in 2021 as compared to 2020 primarily due to our 2021 and 2020 debt transactions, including the assignment of the loan secured by the Embassy Suites La Jolla to the hotel’s buyer, our partial repayments of the term loans, the repayment of the loan secured by the Renaissance Washington DC, our partial repayments of the senior notes and our assignment of the loan secured by the Hilton Times Square to the hotel’s mortgage holder, along with decreased interest on our variable rate debt. These decreases were partially offset by the draws on our credit facility and by the amendments on our unsecured debt, which increased the interest rate on our term loans and senior notes. Upon the sale of the Hyatt Centric Chicago Magnificent Mile in February 2022, interest expense on our debt and finance lease obligation will decrease $1.4 million on an annual basis due to the removal of the hotel’s finance lease right-of-use asset and the related finance lease obligation from our consolidated balance sheet.

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Noncash changes in the fair market value of our derivatives caused interest expense to decrease $8.1 million in 2021 as compared to 2020.

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The amortization of deferred financing costs caused interest expense to decrease $0.2 million in 2021 as compared to 2020.

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Our weighted average interest rate per annum, including our variable rate debt obligation, was approximately 3.7% and 3.8% at December 31, 2021 and 2020, respectively. Approximately 64.0% and 70.6% of our outstanding notes payable had fixed interest rates, including the effects of interest rate swap agreements, at December 31, 2021 and 2020, respectively.

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Gain on Sale of Assets. Gain on sale of assets totaled $152.5 million and $34.3 million in 2021 and 2020, respectively. In 2021, we recognized a $3.7 million gain on the sale of the Renaissance Westchester and a $148.8 million gain on the sale of the Embassy Suites La Jolla.

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In 2020, we recognized a $0.2 million gain on the sale of the Renaissance Harborplace and a $34.1 million gain on the sale of the Renaissance Los Angeles Airport.

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(Loss) Gain on Extinguishment of Debt, Net. (Loss) gain on extinguishment of debt, net totaled a net loss of $0.1 million in 2021 and a net gain of $6.1 million in 2020. During 2021, we recognized a loss of $0.4 million related to the write-off of deferred financing fees associated with the repayments of a portion of our term loans and the assignment of the mortgage secured by the Embassy Suites La Jolla to the hotel’s buyer. In addition, we recognized a gain of $0.3 million associated with the assignment of the

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Hilton Times Square to the hotel’s mortgage holder due to reassessments of the potential employee-related obligations currently held in escrow.

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During 2020, we recognized a gain of $6.4 million related to the assignment of the Hilton Times Square to the hotel’s mortgage holder. In addition, we recognized a loss of $0.3 million related to the write-off of deferred financing fees associated with the repayments of a portion of our unsecured senior notes and the mortgage secured by the Renaissance Washington DC.

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Income Tax Provision, Net. Income tax provision, net was incurred as follows (in thousands):

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We lease our hotels to the TRS Lessee and its subsidiaries, which are subject to federal and state income taxes. In addition, we and the Operating Partnership may also be subject to various state and local income taxes.

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In 2021, we recognized a net current income tax provision of $0.1 million, resulting from current state income tax expense.

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In 2020, we recognized a net current income tax benefit of $0.8 million, resulting from tax credits and refunds, net of combined current federal and state income tax expense. In addition, we recorded a full valuation allowance of $7.4 million on our deferred tax assets because we were no longer assured that we would be able to realize these assets due to uncertainties regarding how long the COVID-19 pandemic would last or what the long-term impact would be on our hotel operations.

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Loss from Consolidated Joint Venture Attributable to Noncontrolling Interest. Loss from consolidated joint venture attributable to noncontrolling interest, which represents the outside 25.0% interest in the entity that owns the Hilton San Diego Bayfront, totaled $1.3 million and $5.8 million in 2021 and 2020, respectively.

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Preferred Stock Dividends and Redemption Charges. Preferred stock dividends and redemption charges increased $7.8 million, or 60.9%, in 2021 as compared to 2020 due to the issuances of our Series G preferred stock, Series H preferred stock and Series I preferred stock, as well as the redemptions of our Series E preferred stock and Series F preferred stock.

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Preferred stock dividends and redemption charges were incurred as follows (in thousands):

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Non-GAAP Financial Measures. We use the following “non-GAAP financial measures” that we believe are useful to investors as key supplemental measures of our operating performance: EBITDAre; Adjusted EBITDAre, excluding noncontrolling interest; FFO attributable to common stockholders; Adjusted FFO attributable to common stockholders; and Existing Portfolio revenues. These measures should not be considered in isolation or as a substitute for measures of performance in accordance with GAAP. In addition, our calculation of these measures may not be comparable to other companies that do not define such terms exactly the same as the Company. These non-GAAP measures are used in addition to and in conjunction with results presented in accordance with GAAP. They should not be considered as alternatives to net income (loss), cash flow from operations, or any other operating performance measure prescribed by GAAP. These non-GAAP financial measures reflect additional ways of viewing our operations that we believe, when viewed with our GAAP results and the reconciliations to the corresponding GAAP financial measures, provide a more complete understanding of factors and trends affecting our business than could be obtained absent this disclosure. For example, we believe that Existing Portfolio revenues are useful to both us and investors in evaluating our operating performance by removing the impact of non-hotel results such as the amortization of contract intangibles. We also believe that our use of Existing Portfolio revenues is useful to both us and our investors as it facilitates the comparison of our operating results from period to period by removing fluctuations caused by acquisitions and dispositions. We strongly encourage investors to review our financial information in its entirety and not to rely on a single financial measure.

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We present EBITDAre in accordance with guidelines established by the National Association of Real Estate Investment Trusts (“NAREIT”), as defined in its September 2017 white paper “Earnings Before Interest, Taxes, Depreciation and Amortization for Real Estate.” We believe EBITDAre is a useful performance measure to help investors evaluate and compare the results of our operations from period to period in comparison to our peers. NAREIT defines EBITDAre as net income (calculated in accordance with GAAP) plus interest expense, income tax expense, depreciation and amortization, gains or losses on the disposition of depreciated property (including gains or losses on change in control), impairment write-downs of depreciated property and of investments in unconsolidated affiliates caused by a decrease in the value of depreciated property in the affiliate, and adjustments to reflect the entity’s share of EBITDAre of unconsolidated affiliates.

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We make additional adjustments to EBITDAre when evaluating our performance because we believe that the exclusion of certain additional items described below provides useful information to investors regarding our operating performance, and that the presentation of Adjusted EBITDAre, excluding noncontrolling interest, when combined with the primary GAAP presentation of net income, is beneficial to an investor’s complete understanding of our operating performance. In addition, we use both EBITDAre and Adjusted EBITDAre, excluding noncontrolling interest as measures in determining the value of hotel acquisitions and dispositions. We adjust EBITDAre for the following items, which may occur in any period, and refer to this measure as Adjusted EBITDAre, excluding noncontrolling interest:

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The following table reconciles our net income (loss) to EBITDAre and Adjusted EBITDAre, excluding noncontrolling interest for our total portfolio for the years ended December 31, 2021 and 2020 (in thousands):

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Adjusted EBITDAre, excluding noncontrolling interest increased $155.4 million, or 176.2%, in 2021 as compared to 2020 primarily due to the following:

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We believe that the presentation of FFO attributable to common stockholders provides useful information to investors regarding our operating performance because it is a measure of our operations without regard to specified noncash items such as real estate depreciation and amortization, any real estate impairment loss and any gain or loss on sale of real estate assets, all of which are based on historical cost accounting and may be of lesser significance in evaluating our current performance. Our presentation of FFO attributable to common stockholders conforms to the NAREIT definition of “FFO applicable to common shares.” Our presentation

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may not be comparable to FFO reported by other REITs that do not define the terms in accordance with the current NAREIT definition, or that interpret the current NAREIT definition differently than we do.

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We also present Adjusted FFO attributable to common stockholders when evaluating our operating performance because we believe that the exclusion of certain additional items described below provides useful supplemental information to investors regarding our ongoing operating performance, and may facilitate comparisons of operating performance between periods and our peer companies. We adjust FFO attributable to common stockholders for the following items, which may occur in any period, and refer to this measure as Adjusted FFO attributable to common stockholders:

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The following table reconciles our net income (loss) to FFO attributable to common stockholders and Adjusted FFO attributable to common stockholders for our total portfolio for the years ended December 31, 2021 and 2020 (in thousands):

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Adjusted FFO attributable to common stockholders increased $164.9 million, or 105.3%, in 2021 as compared to 2020 primarily due to the same reasons noted in the discussion above regarding Adjusted EBITDAre, excluding noncontrolling interest.

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Liquidity and Capital Resources

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During the periods presented, our sources of cash included our operating activities and working capital, as well as proceeds from hotel dispositions, our credit facility, issuances of both common and preferred stock and contributions from our joint venture partner. Our primary uses of cash were for capital expenditures for hotels and other assets, acquisitions of hotels and other assets, operating expenses, including funding the negative cash flow at our hotels, repurchases of our common stock, redemptions of our preferred stock, repayments of our credit facility and notes payable, dividends and distributions on our common and preferred stock and distributions to our joint venture partner. We cannot be certain that traditional sources of funds will be available in the future.

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Operating activities. Our net cash provided by or used in operating activities fluctuates primarily as a result of changes in hotel revenue and the operating cash flow of our hotels. Our net cash provided by or used in operating activities may also be affected by changes in our portfolio resulting from hotel acquisitions, dispositions or renovations. Net cash provided by operating activities was $28.4 million in 2021 as compared to net cash used in operating activities of $116.7 million in 2020. The net increase in cash provided by operating activities in 2021 as compared to 2020 was primarily due to the resumption in operations at our hotels in 2021, combined with an increase in travel demand.

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Investing activities. Our net cash provided by or used in investing activities fluctuates primarily as a result of acquisitions, dispositions and renovations of hotels and other assets. Net cash provided by or (used in) investing activities in 2021 and 2020 was as follows (in thousands):

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In 2021, we received total proceeds of $183.6 million from our sales of two hotels, consisting of $17.1 million for the Renaissance Westchester and $166.5 million for the Embassy Suites La Jolla. In addition, we received a deposit of $4.0 million from the buyer of the Hyatt Centric Chicago Magnificent Mile, which we sold in February 2022. These cash inflows were offset as we paid a total of $363.5 million to acquire two hotels and other assets, consisting of $195.6 million for the Montage Healdsburg, $167.7 million for the Four Seasons Resort Napa Valley, and $0.1 million for additional dry boat slips at the Oceans Edge Resort & Marina. We also invested $63.7 million for renovations and additions to our portfolio and other assets and paid $0.1 million for an interest rate cap derivative on debt secured by the Hilton San Diego Bayfront.

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In 2020, we received total proceeds of $166.7 million from our sales of two hotels, consisting of $76.9 million for the Renaissance Harborplace and $89.9 million for the Renaissance Los Angeles Airport. This cash inflow was partially offset as we paid $1.4 million to purchase additional wet boat and dry boat slips at the Oceans Edge Resort & Marina, invested $51.4 million for renovations and additions to our portfolio and other assets and paid $0.1 million for an interest rate cap derivative on debt secured by the Hilton San Diego Bayfront.

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Financing activities. Our net cash provided by or used in financing activities fluctuates primarily as a result of our distributions paid, issuance and repurchase of common stock, issuance and repayment of our credit facility and notes payable, debt restructurings and issuance and redemption of other forms of capital, including preferred equity. Net cash used in financing activities in 2021 and 2020 was as follows (in thousands):

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During 2021, we received total gross proceeds of $215.0 million on our preferred stock offerings, including $115.0 million from the issuance of 4,600,000 shares of our Series H preferred stock and $100.0 million from the issuance of 4,000,000 shares of our Series I preferred stock, and we paid a total of $7.3 million in offering costs on our Series G preferred stock, Series H preferred stock and Series I preferred stock. We used $190.0 million of the proceeds received from our preferred stock offerings to redeem in full all 4,600,000 shares of our Series E preferred stock and all 3,000,000 shares of our Series F preferred stock. In addition, we received gross proceeds of $38.4 million from the issuance of 2,913,682 shares of our common stock under our ATM Program and paid $0.8 million in related offering costs. We also drew $110.0 million from our credit facility and received a $1.4 million contribution from our joint venture partner. These net cash inflows were offset as we paid the following: $4.9 million to repurchase common stock to satisfy the tax obligations in connection with the vesting of restricted common stock issued to employees; $110.0 million to repay all amounts outstanding on our credit facility; $79.9 million in principal payments on our notes payable, including $76.7 million to repay

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a portion of our term loans and $3.2 million in scheduled principle payments on our notes payable; $0.4 million in deferred financing costs related to the amendments on our unsecured debt; and $13.7 million in dividends to our preferred stockholders.

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In 2020, we drew $300.0 million from our credit facility and received $2.3 million in contributions from our joint venture partner. These cash inflows were offset as we paid the following: $103.9 million to repurchase 9,770,081 shares of our outstanding common stock; $4.0 million to repurchase common stock to satisfy the tax obligations in connection with the vesting of restricted common stock issued to employees; $300.0 million to repay all amounts outstanding on our credit facility; $149.7 million in principal payments on our notes payable, including $35.0 million to repay a portion of our senior notes, $107.9 million to repay the mortgage loan secured by the Renaissance Washington DC and $6.8 million in scheduled principal payments on our notes payable; $28.0 million to extinguish the debt secured by the Hilton Times Square and assign our leasehold interest in the hotel to its mortgage holder, including a $20.0 million payment to the mortgage holder, $3.2 million and $0.8 million in FF&E restricted cash and hotel unrestricted cash, respectively, given to the mortgage holder, a $1.3 million payment for a labor dispute at the hotel and a total of $2.7 million in payments for legal, tax and other miscellaneous costs; $4.4 million in deferred financing costs related to the amendments on our unsecured debt; $156.3 million in dividends and distributions to our common and preferred stockholders; and $2.0 million in distributions to our joint venture partner.

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Future. While operations have improved in 2021 as compared to 2020, our hotels continue to operate well below pre-pandemic levels. We believe the ongoing effects of the COVID-19 pandemic, including the spread of its variants and labor challenges, on our operations will continue to have a negative impact on our financial results and liquidity in 2022. As previously noted, several of our hotels are operating at reduced, albeit increasing, capacities due to COVID-19; therefore, our traditional source of cash from operating activities has been significantly reduced. Despite these challenges, we believe that we have sufficient liquidity, as well as access to our credit facility and capital markets, to withstand the current decline in our operating cash flow. We expect our primary sources of cash will continue to be our working capital and credit facility, dispositions of hotel properties, including our sale of the Hyatt Centric Chicago Magnificent Mile in February 2022 for gross proceeds of $67.5 million, and proceeds from public and private offerings of debt securities and common and preferred stock. However, there can be no assurance any future asset sales will be successfully completed or that the capital markets will be available to us on favorable terms or at all.

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We expect our primary uses of cash to be for operating expenses, including funding the cash flow needs at our hotels, capital investments in our hotels, repayment of principal on our notes payable and possibly on our unsecured debt, interest expense, dividends on our preferred stock and acquisitions of hotels or interests in hotels.

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At this time, we have not reinstated our common stock dividend and may not need to pay a quarterly common stock dividend in 2022. The resumption in quarterly common stock dividends will be determined by our board of directors after considering our obligations under our various financing agreements, projected taxable income, compliance with our debt covenants, long-term operating projections, expected capital requirements and risks affecting our business. We have taken additional steps to preserve our liquidity, including the deferral of portions of our planned 2021 capital improvements into our portfolio, as well as the temporary suspension of our stock repurchase program.

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We believe that the steps we have taken to maintain an appropriate cash position and preserve our financial flexibility, combined with the amendments to our unsecured debt, our already strong balance sheet and our low leverage will be sufficient to allow us to navigate through this crisis. Given the unprecedented impact of COVID-19 on the global market and our hotel operations, we cannot, however, assure you that our forecast or the assumptions we used to estimate our liquidity requirements will be correct. In addition, the magnitude and duration of the COVID-19 pandemic is uncertain. We cannot accurately estimate the impact on our business, financial condition or operational results with reasonable certainty.

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Cash Balance. As of December 31, 2021, our unrestricted cash balance was $120.5 million. We believe that our current unrestricted cash balance and our ability to draw the $500.0 million capacity available for borrowing under the unsecured revolving credit facility will enable us to successfully manage our Company while operations at our hotels are reduced.

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Certain of our loan agreements contain cash trap provisions that may be triggered if the performance of the hotels securing the loans decline. These provisions were triggered in January 2021 for the loan secured by the JW Marriott New Orleans, and in May 2021 for the loan secured by the Hilton San Diego Bayfront. As of December 31, 2021, no excess cash generated by the hotels was held in lockbox accounts for the benefit of the lenders. The cash trap provisions triggered on these two loans will remain until the hotels reach profitability levels that terminate the cash traps.

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Debt. As of December 31, 2021, we had $611.4 million of consolidated debt, $162.7 million of cash and cash equivalents, including restricted cash, and total assets of $3.0 billion. We believe that by maintaining appropriate debt levels, staggering maturity dates and maintaining a highly flexible structure, we will have lower capital costs than more highly leveraged companies, or companies with limited flexibility due to restrictive corporate-level financial covenants.

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In July and December 2020, we completed amendments to our unsecured debt, consisting of the credit facility, term loans and senior notes (the “Unsecured Debt Amendments”). Among other provisions, the Unsecured Debt Amendments included a waiver of required financial covenants through the end of the first quarter of 2022, with quarterly testing resuming for the period ending March 31, 2022. In July 2021, we amended the Unsecured Debt Amendments, which removed certain restrictions in place during the covenant waiver period ending March 31, 2022. The restrictions removed include the limitation on the aggregate value of unencumbered hotel acquisitions we can complete and, provided that an event of default has not occurred, the requirement to prepay our unsecured debt using net proceeds received from asset sales or equity issuances. In November 2021, we further amended the Unsecured Debt Agreements, providing financial covenant relief through the end of the third quarter of 2022, with the first quarterly covenant test as of the period ending September 30, 2022, subject to the satisfaction of certain conditions. Additional key terms of the November 2021 Unsecured Debt Amendments include:

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While we currently believe we will meet the terms of our unsecured debt financial covenants once such covenants become effective again in 2022, should a resurgence in COVID-19 case counts or a more invasive variant sufficiently disrupt hotel demand in 2022, it is possible that we may fail to satisfy our unsecured debt financial covenant tests. As noted above, due to COVID-19, several of our hotels are operating at reduced, albeit increasing, capacities. Our future liquidity will depend on the gradual return of guests, particularly group business, to our hotels and the stabilization of demand throughout our portfolio.

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In November and December 2021, we drew a total of $110.0 million under the credit facility to fund a portion of our purchase of the Four Seasons Resort Napa Valley. We repaid the outstanding balance of $110.0 million in December 2021. As of December 31, 2021, we had no amount outstanding on the revolving portion of our credit facility, with $500.0 million of capacity available for additional borrowing under the facility. Our ability to draw on the revolving portion of the credit facility may be subject to our compliance with various financial covenants on our secured and unsecured debt. The revolving portion of the credit facility agreement matures in April 2023, but may be extended for two six-month periods to April 2024, upon the payment of applicable fees and satisfaction of certain customary conditions.

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In December 2021, we used a portion of the proceeds we received from the sale of the Embassy Suites La Jolla to repay $65.6 million on our Term Loan 1 and $11.1 million on our Term Loan 2, resulting in a Term Loan 1 balance of $19.4 million and a Term Loan 2 balance of $88.9 million as of December 31, 2021.

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In December 2021, we exercised our second option to extend the maturity of the $220.0 million loan secured by the Hilton San Diego Bayfront from December 2021 to December 2022. In addition, we purchased an interest rate cap derivative for $0.1 million that will continue to cap the floating rate interest on the loan at 6.0% until December 2022. We intend to exercise the remaining one-year option to extend the maturity to December 2023.

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In December 2021, we assigned the note secured by the Embassy Suites La Jolla, which had an outstanding balance of $56.6 million, to the hotel’s buyer in conjunction with the sale of the hotel.

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As of December 31, 2021, all of our outstanding debt had fixed interest rates or had been swapped to fixed interest rates, except the $220.0 million non-recourse mortgage on the Hilton San Diego Bayfront, which is subject to an interest rate cap agreement that caps the floating interest rate at 6.0% until December 2022. Our remaining mortgage debt is in the form of single asset non-recourse loans rather than cross-collateralized multi-property pools. In addition to our mortgage debt, as of December 31, 2021, we have two unsecured corporate-level term loans as well as two unsecured corporate-level senior notes.

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We may in the future seek to obtain mortgages on one or more of our unencumbered hotels (subject to certain stipulations under our unsecured term loans and senior notes), 14 of which were held by subsidiaries whose interests were pledged to our credit facility as of December 31, 2021. Subsequent to the sale of the Hyatt Centric Chicago Magnificent Mile in February 2022, we have 14 unencumbered hotels, 13 of which are currently held by subsidiaries whose interest are pledged to our credit facility. Our 14 unencumbered hotels include: Boston Park Plaza; Embassy Suites Chicago; Four Seasons Resort Napa Valley; Hilton Garden Inn Chicago Downtown/Magnificent Mile; Hilton New Orleans St. Charles; Hyatt Regency San Francisco; Marriott Boston Long Wharf; Montage Healdsburg; Oceans Edge Resort & Marina; Renaissance Long Beach; Renaissance Orlando at SeaWorld®; Renaissance Washington DC; The Bidwell Marriott Portland; and Wailea Beach Resort. Should we obtain secured financing on any or all of our unencumbered hotels, the amount of capital available through our credit facility or future unsecured borrowings may be reduced.

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Contractual Obligations

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The following table summarizes our payment obligations and commitments as of December 31, 2021 (in thousands):

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Capital Expenditures and Reserve Funds

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We believe we maintain each of our hotels in good repair and condition and in general conformity with applicable franchise and management agreements, ground, building and airspace leases, laws and regulations. Our capital expenditures primarily relate to the ongoing maintenance of our hotels and are budgeted in the reserve accounts described in the following paragraph. We also incur capital expenditures for cyclical renovations, hotel repositionings and development. We invested $63.7 million in our portfolio and other assets during 2021 and $51.4 million in 2020. As of December 31, 2021, we have contractual construction commitments totaling $71.7 million for ongoing renovations. As noted above, in light of the COVID-19 pandemic, we elected to conserve cash by deferring a portion of our planned 2020 and 2021 non-essential capital improvements into our portfolio. In February 2021, however, we entered into an agreement with Marriott to rebrand the Renaissance Washington DC to The Westin Washington DC, upon substantial completion of a repositioning of the hotel. If we renovate or develop additional hotels or other assets in the future, our capital expenditures will likely increase.

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With respect to our hotels that are operated under management or franchise agreements with major national hotel brands and for all of our hotels subject to first mortgage liens, we are obligated to maintain an FF&E reserve account for future planned and emergency-related capital expenditures at these hotels. The amount funded into each of these reserve accounts is determined pursuant to the management, franchise and loan agreements for each of the respective hotels, ranging between zero and 5.0% of the respective hotel’s applicable annual revenue. As of December 31, 2021, our balance sheet includes restricted cash of $24.1 million, which was held in FF&E reserve accounts for future capital expenditures at the majority of our hotels. According to certain loan agreements, reserve funds are to be held by the lenders or managers in restricted cash accounts, and we are not required to spend the entire amount in such reserve accounts each year. In light of the COVID-19 pandemic, some of our third-party managers suspended the requirement to fund into the FF&E reserves throughout 2021; however, this suspension has since ended, and all FF&E Reserve accounts will be funded in 2022.

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Seasonality and Volatility

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As is typical of the lodging industry, we experience some seasonality in our business as indicated in the table below. Revenue for certain of our hotels is generally affected by seasonal business patterns (e.g., the first quarter is strong in Hawaii, Key West, New Orleans and Orlando, the second quarter is strong for the Mid-Atlantic business hotels, and the fourth quarter is strong for Hawaii, Key West and the California counties of Napa and Sonoma). Quarterly revenue also may be adversely affected by renovations and repositionings, our managers’ effectiveness in generating business and by events beyond our control, such as economic and business conditions, including a U.S. recession, trade conflicts and tariffs, changes impacting global travel, regional or global economic slowdowns, any flu or disease-related pandemic that impacts travel or the ability to travel, including the COVID-19 pandemic, the adverse effects of climate change, the threat of terrorism, terrorist events, civil unrest, government shutdowns, events that reduce the capacity or availability of air travel, increased competition from other hotels in our markets, new hotel supply or alternative lodging options and unexpected changes in business, commercial travel, leisure travel and tourism. Revenues for the Existing Portfolio by quarter for 2019 is provided in the table below (dollars in thousands), which information indicates the consistent seasonality of our results. While 2021 and 2020 revenues for the Existing Portfolio are not comparable to 2019 due to the COVID-19 pandemic and temporary suspension of operations at certain hotels, the information is presented in the table below for illustrative purposes.

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Inflation

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Inflation affects our expenses, including, without limitation, by increasing such costs as wages, employee-related benefits, food, commodities, taxes, property and liability insurance, utilities and borrowing costs. In addition, our hotel expenses may increase at higher rates than hotel revenue.

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Critical Accounting Estimates

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Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities.

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

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If a hotel is considered to be impaired, the related assets are adjusted to their estimated fair value and an impairment loss is recognized. The impairment loss recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. We perform a fair value assessment, using one or more discounted cash flow analyses to estimate the fair value of the hotel, taking into account the hotel’s expected cash flow from operations, our estimate of how long we will own the hotel and the estimated proceeds from the disposition of the hotel. When multiple cash flow analyses are prepared, a probability is assigned to each cash flow analysis based upon the estimated likelihood of each scenario. The factors addressed in determining estimated proceeds from disposition include anticipated operating cash flow in the year of disposition and terminal capitalization rate. Our judgment is required in determining the discount rate applied to estimated cash flows, the estimated growth of revenues and expenses, net operating income (loss) and margins, the need for capital expenditures, as well as specific market and economic conditions.

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In addition, the acquisition of a hotel property or other entity requires an analysis of the transaction to determine if it qualifies as the purchase of a business or an asset. If the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, then the transaction is an asset acquisition. Transaction costs associated with asset acquisitions are capitalized and subsequently depreciated over the life of the related asset, while the same costs associated with a business combination are expensed as incurred and included in corporate overhead on our consolidated statements of operations. Also, asset acquisitions are not subject to a measurement period, as are business combinations.

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We review any uncertain tax positions and, if necessary, we will record the expected future tax consequences of uncertain tax positions in the consolidated financial statements. Tax positions not deemed to meet the “more-likely-than-not” threshold are recorded as a tax benefit or expense in the current year. We are required to analyze all open tax years, as defined by the statute of limitations, for all major jurisdictions, which includes federal and certain states.

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New Accounting Standards and Accounting Changes

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See Note 2 to the accompanying consolidated financial statements for additional information relating to recently issued accounting pronouncements.

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