AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 8, 1998 REGISTRATION NO. 333-55807 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- AMENDMENT NO. 5 TO FORM S-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 --------------- HOST MARRIOTT, L.P. HMC MERGER CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS GOVERNING INSTRUMENT) DELAWARE 7011 52-2095412 MARYLAND 7011 53-0085950 (State or Other Jurisdiction (Primary Standard Industrial (I.R.S Employer Incorporation or Organization Classification Code Number) Identification No.) 10400 FERNWOOD ROAD BETHESDA, MARYLAND 20817 (301) 380-9000 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) --------------- CHRISTOPHER G. TOWNSEND GENERAL COUNSEL HOST MARRIOTT, L.P. HMC MERGER CORPORATION 10400 FERNWOOD ROAD BETHESDA, MARYLAND 20817 (301) 380-9000 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) --------------- COPIES TO: J. WARREN GORRELL, JR., ESQ. BRUCE W. GILCHRIST, ESQ. HOGAN & HARTSON L.L.P. 555 THIRTEENTH STREET, N.W. WASHINGTON, D.C. 20004-1109 (202) 637-5600 --------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. If the securities being registered on this form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. [_] --------------- CALCULATION OF REGISTRATION FEE - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- (1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(f) promulgated under the Securities Act of 1933, as amended. (2) Represents the expected number of OP Units, Common Shares or Notes (as applicable) issuable upon consummation of the transactions described herein. (3) Investors whose securities are exchanged or canceled will receive OP Units, which may be retained or exchanged for Common Shares or Notes. To the extent Common Shares or Notes are issued in exchange for OP Units, the proposed maximum aggregate offering price of the OP Units will be proportionately reduced and vice versa. Accordingly, no further fee is due for the registration of the Common Shares or Notes. (4) Represents the number of Common Shares issuable upon redemption of the OP Units. (5) $85,086.85 previously paid. The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a) may determine. - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
PROPOSED PROPOSED MAXIMUM TITLE OF EACH CLASS OF AMOUNT MAXIMUM AGGREGATE AMOUNT OF SECURITIES TO BE TO BE OFFERING OFFERING REGISTRATION REGISTERED REGISTERED PRICE(1) PRICE(1) FEE - ------------------------------------------------------------------------------- Units of Limited Partnership Interest.. 18,603,677(2) $15.50 $288,357,000 $85,065.32(3) - ------------------------------------------------------------------------------- Shares of Common Stock, par value $.01 per share........ 18,603,677(2) $15.50 $288,357,000 $-0-(3) - ------------------------------------------------------------------------------- 6.56% Callable Notes due December 15, 2005..... $ (2) N/A $247,971,597(3) $-0-(3) - ------------------------------------------------------------------------------- Shares of Common Stock, par value $.01 per share........ 18,603,677(4) $15.50 $288,357,000 $85,065.32 - ------------------------------------------------------------------------------- Total...................................................... $170,130.64(5) ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A + +REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE + +SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY + +OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT + +BECOMES EFFECTIVE. THIS PROSPECTUS/CONSENT SOLICITATION STATEMENT SHALL NOT + +CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL + +THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, + +SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION + +UNDER THE SECURITIES LAWS OF ANY SUCH STATE. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ SUBJECT TO COMPLETION DATED OCTOBER 8, 1998 PROSPECTUS/CONSENT SOLICITATION STATEMENT HOST MARRIOTT, L.P. HMC MERGER CORPORATION THE CONSENT SOLICITATION PERIOD EXPIRES AT 5:00 P.M., EASTERN TIME, ON DECEMBER , 1998, UNLESS EXTENDED (THE "SOLICITATION PERIOD"). Host Marriott Corporation ("Host") has adopted a plan to restructure its business operations so that it will qualify as a real estate investment trust ("REIT"). As part of this restructuring (the "REIT Conversion"), Host and its consolidated subsidiaries will contribute their full-service hotel properties and certain other businesses and assets to Host Marriott, L.P. (the "Operating Partnership") in exchange for units of limited partnership interest in the Operating Partnership ("OP Units") and the assumption of liabilities. The sole general partner of the Operating Partnership will be HMC Merger Corporation, a Maryland corporation to be renamed "Host Marriott Corporation" ("Host REIT"), the entity into which Host will merge as part of the REIT Conversion. Host REIT expects to qualify as a REIT beginning with its first full taxable year commencing after the REIT Conversion is completed, which Host REIT currently expects to be the year beginning January 1, 1999 (but which might not be until the year beginning January 1, 2000). As part of the REIT Conversion, the Operating Partnership is proposing to acquire by merger (the "Mergers") eight limited partnerships (the "Partnerships") that own full-service hotels in which Host or its subsidiaries are general partners. As more fully described in this Prospectus/Consent Solicitation Statement (the "Consent Solicitation"), limited partners of those Partnerships that participate in the Mergers will receive OP Units in exchange for their partnership interests in such Partnerships (with respect to the Partnerships, those limited partners of the Partnerships who are unaffiliated with Host are referred to herein as the "Limited Partners"). Limited Partners may elect to exchange such OP Units received in connection with the Mergers for either shares of common stock, par value $.01 per share, of Host REIT ("Common Shares") or unsecured 6.56% Callable Notes due December 15, 2005 issued by the Operating Partnership ("Notes"). Beginning one year after the Mergers, Limited Partners who retain OP Units will have the right to redeem their OP Units at any time and receive, at the election of Host REIT, either Common Shares of Host REIT on a one-for-one basis (subject to adjustment) or cash in an amount equal to the market value of such shares (the "Unit Redemption Right"). SEE "RISK FACTORS" BEGINNING ON PAGE 36 FOR MATERIAL RISKS RELEVANT TO AN INVESTMENT IN THE OP UNITS, COMMON SHARES OR NOTES, INCLUDING: . To the extent that the anticipated benefits of the REIT Conversion are reflected in the value of Host's common stock before the Effective Date, such benefits will not be shared with the Limited Partners. . No independent representative was retained to negotiate on behalf of the Limited Partners. If one had been, the terms of the Mergers may have been more favorable to the Limited Partners. . Other conflicts of interest exist in connection with structuring the Mergers and the REIT Conversion which may result in decisions that do not fully reflect the interests of all Limited Partners. . Host's shareholders and the Blackstone Entities, but not the Limited Partners, will benefit from any appreciation in the value of the shares of Crestline common stock distributed in connection with the Initial E&P Distribution (as defined herein). . There is no assurance that the value of the OP Units, Common Shares or Notes to be received by the Limited Partners in connection with the Mergers will equal the fair market value of their Partnership Interests. . Limited Partners who retain OP Units will not be able to redeem them pursuant to the Unit Redemption Right until one year following the Mergers. Until then, Limited Partners will bear the risk of illiquidity and of not being able to sell in a falling market. . There will be no public market for the Notes. The deemed value of the OP Units (or the Common Shares issued in exchange therefor) will exceed the principal amount of the corresponding Notes in all Partnerships. . The receipt of Common Shares or a Note in exchange for OP Units will be a fully taxable transaction and will result in "phantom income" for a Limited Partner with a "negative capital account" with respect to his Partnership Interest. . The preliminary estimated initial annual cash distributions of the Operating Partnership during the twelve months ending December 31, 1999 ($226 million) will exceed its estimated cash available for distribution and cash from contingent rents during the twelve months ending December 31, 1999, which would require borrowings of approximately $9 million (or $0.04 per OP Unit) to make such distributions, and the estimated initial cash distributions to the Limited Partners of MHP and MHP2 following the Mergers will be significantly less than the estimated cash distributions from operations of MHP and MHP2 during 1998. . If the REIT Conversion does not occur in time for Host REIT to elect REIT status effective January 1, 1999, the effectiveness of Host REIT's election could be delayed until January 1, 2000, which would result in Host REIT continuing to pay substantial corporate-level income taxes in 1999 (which would reduce the cash distributions per Common Share, but not the cash distributions per OP Unit) and could cause the Blackstone Acquisition not to be consummated. . The Mergers involve a fundamental change in the nature of the investment of a Limited Partner from an investment in a finite-life, fixed-portfolio partnership into an investment in an ongoing real estate company which will own and acquire additional hotels. . There is uncertainty at the time of voting as to the exact size and leverage of the Operating Partnership and the exact number of OP Units that may be received in the Mergers (which will not be known for approximately 25 trading days following the Mergers). . The Operating Partnership will be substantially dependent for its revenue upon the Lessees, Marriott International, Inc. and other companies that manage the Hotels and upon the Non-Controlled Subsidiaries, and the Operating Partnership will have limited control over the operations of the Hotels and no control over the Non-Controlled Subsidiaries. . Approval of the Merger and the related amendments to the partnership agreement by the requisite vote of the Limited Partners in a Partnership will bind all Limited Partners of such Partnership. . The inability of Host, the Operating Partnership and Host REIT to obtain one or more third-party consents prior to consummation of the Mergers and the REIT Conversion could have a material adverse effect on the Operating Partnership and Host REIT, and thus could reduce the value of the OP Units and Common Shares. . The Mergers will result in the Limited Partners being exposed to the general risks of ownership of hotels, leverage and the lack of restrictions on indebtedness of the Operating Partnership and Host REIT. . Actual or constructive ownership of more than 9.8% of the number or value of Host REIT's outstanding Common Shares and of more than 4.9% of the value of the OP Units (other than by Host REIT or The Blackstone Group) is prohibited, subject to waiver or modification by Host REIT or the Operating Partnership, as the case may be, in certain limited circumstances. . There are a variety of events and transactions that could cause a Limited Partner to recognize in the future all or a part of the gain that otherwise should be deferred by the retention of OP Units received in the Mergers. . Atlanta Marquis, Desert Springs, Hanover, MHP and PHLP are required to sell some of their personal property to an affiliate of the Operating Partnership in the Mergers, which may cause Limited Partners of such Partnerships (except Hanover) to recognize a relatively modest amount of taxable income as a result thereof (which income could be offset with any unused passive loss carryforwards). . Taxation of Host REIT as a regular corporation if it fails to qualify as a REIT, or taxation of the Operating Partnership as a corporation if it fails to qualify as a partnership for federal income tax purposes, would, among other things, result in a material decrease in cash available for distribution and a material reduction in the value of the Common Shares and OP Units. . No assurance can be provided that new legislation, Treasury Regulations, administrative interpretations or court decisions will not significantly change the tax laws with respect to Host REIT's qualification as a REIT or the federal income tax consequences of such qualification. THE GENERAL PARTNERS OF THE PARTNERSHIPS BELIEVE THAT THE MERGERS PROVIDE SUBSTANTIAL BENEFITS AND ARE FAIR TO THE LIMITED PARTNERS OF EACH PARTNERSHIP AND RECOMMEND THAT ALL LIMITED PARTNERS VOTE FOR THE MERGERS AND FOR THE RELATED AMENDMENTS TO THE PARTNERSHIP AGREEMENTS. SEE "BACKGROUND AND REASONS FOR THE MERGERS AND THE REIT CONVERSION--REASONS FOR THE MERGERS." The number of OP Units to be allocated to each Partnership will be based upon (i) its respective Exchange Value (as defined herein) and (ii) the price attributed to an OP Unit following the Mergers, determined as described herein (which, subject to adjustment, will not be less than $9.50 or greater than $15.50 per OP Unit) and will not be known at the time of voting. The number of Common Shares a Limited Partner may elect to receive in connection with the Mergers will equal the number of OP Units received. The principal amount of Notes that Limited Partners may elect to receive will be based upon their Partnership's Note Election Amount (as defined herein). See "Determination of Exchange Values and Allocation of OP Units." The estimated Exchange Values and Note Election Amounts set forth in this Consent Solicitation may increase or decrease as a result of various adjustments, and will be finally calculated shortly before the closing of the Mergers (the "Effective Date"). NEITHER THIS TRANSACTION NOR THESE SECURITIES HAVE BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS/CONSENT SOLICITATION STATEMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THE ATTORNEY GENERAL OF THE STATE OF NEW YORK HAS NOT PASSED ON OR ENDORSED THE MERITS OF THIS OFFERING. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL. THIS PROSPECTUS/CONSENT SOLICITATION STATEMENT IS ONLY AUTHORIZED FOR DELIVERY TO LIMITED PARTNERS WHEN ACCOMPANIED BY ONE OR MORE SUPPLEMENTS RELATING TO THE PARTNERSHIPS IN WHICH SUCH LIMITED PARTNERS HOLD INTERESTS. SEE "AVAILABLE INFORMATION." THE DATE OF THIS PROSPECTUS/CONSENT SOLICITATION STATEMENT IS OCTOBER , 1998. ii TABLE OF CONTENTS iii
PAGE ---- SUMMARY................................................................... 1 Forward-Looking Statements.............................................. 1 Certain Key Definitions................................................. 1 Overview................................................................ 4 Risk Factors............................................................ 7 The REIT Conversion..................................................... 15 The Mergers............................................................. 20 Reasons for the Mergers................................................. 24 Determination of Exchange Values and Allocation of OP Units............. 26 Description of the Common Share Election................................ 28 Description of the Note Election........................................ 29 Fairness Analysis and Opinion........................................... 29 Recommendation.......................................................... 30 Solicitation Materials.................................................. 30 Voting Procedures....................................................... 30 OP Unit Exchange Election Procedures.................................... 31 Federal Income Tax Consequences......................................... 31 Summary Financial Information........................................... 34 RISK FACTORS.............................................................. 36 Risks and Effects of the Mergers......................................... 36 Conflicts of Interest................................................... 36 Absence of Arm's Length Negotiations; No Independent Representative..... 37 Exchange Value May Not Equal Fair Market Value of the Partnerships' Hotels................................................................. 37 Allocation of OP Units to Host REIT Is Different from Allocation of OP Units to the Partnerships.............................................. 38 Allocations of OP Units to the Blackstone Entities and the Private Partnerships Were Not Determined by the Exchange Value Methodologies... 38 Price of OP Units or Common Shares Might Be Less than the Fair Market Value of the Partnership Interests..................................... 38 Inability of Limited Partners Who Retain OP Units to Redeem OP Units for One Year............................................................... 38 Value of the Notes Will Be Less than the Exchange Value................. 38 Cash Distributions May Exceed Cash Available for Distribution; Reduced Cash Distributions for Certain Limited Partners......................... 39 Timing of the REIT Conversion........................................... 39 Changes in the Fairness Opinion......................................... 40 Fundamental Change in the Nature of Investment; Potential Underperformance ...................................................... 40 Exposure to Market and Economic Conditions of Other Hotels.............. 40 Limited Partners Have No Cash Appraisal Rights.......................... 40 Uncertainties as to the Size and Leverage of the Operating Partnership.. 40 Other Uncertainties at the Time of Voting Include Number of OP Units to be Received............................................................ 41 Lack of Control over Hotel Operations................................... 41 Lack of Control over Non-Controlled Subsidiaries........................ 41 Dependence of the Operating Partnership upon Crestline.................. 42 Expiration of the Leases and Possible Inability to Find Other Lessees... 42 Requisite Vote of Limited Partners of Partnerships Binds All Limited Partners............................................................... 42 Inability to Obtain Third-Party Consents May Have a Material Adverse Effect................................................................. 42 Substantial Indebtedness of the Operating Partnership................... 42 No Limitation on Debt................................................... 43 Individual Assets May Outperform the Operating Partnership's Portfolio.. 43 Leases Could Impair the Sale or Other Disposition of the Operating Partnership's Hotels................................................... 43 Management Agreements Could Impair the Sale or Other Disposition of the Operating Partnership's Hotels......................................... 43 iv
PAGE ---- No Control over Major Decisions......................................... 44 Foregoing Potential Benefits of Alternatives to the REIT Conversion..... 44 No Partner Liability.................................................... 44 Dilution................................................................ 45 Risks of Ownership of OP Units and Common Shares......................... 45 Inability to Remove Host REIT as General Partner of the Operating Partnership............................................................ 45 Restrictions on Transfer of OP Units.................................... 45 Limitations on Acquisition of OP Units and Common Shares and Change in Control................................................................ 45 Possible Adverse Consequences of Limits on Ownership of Common Shares... 48 Possible Differing Fiduciary Duties of General Partners and Host REIT... 48 Effect on Common Share Price of Shares Available for Future Sale........ 49 Current Host Common Stock Price Is Not Necessarily Indicative of the Price of Host REIT Common Shares Following the REIT Conversion......... 49 Effect on Common Share Price of Market Conditions....................... 49 Effect on Common Share Price of Earnings and Cash Distributions......... 50 Effect on Common Share Price of Market Interest Rates................... 50 Effect on Common Share Price of Unrelated Events........................ 50 Dependence on External Sources of Capital............................... 50 Risks of Ownership of the Notes.......................................... 50 The Notes Are Unsecured................................................. 50 No Public Market for the Notes.......................................... 50 Limited Protection for Noteholders in the Event of a Restructuring or Similar Transaction.................................................... 50 Risks of Operation....................................................... 51 Competition in the Lodging Industry..................................... 51 General Real Estate Investment Risks.................................... 51 Rental Revenues from Hotels Subject to Prior Rights of Lenders.......... 52 Possible Underperformance of New Acquisitions........................... 52 Seasonality............................................................. 52 Illiquidity of Real Estate.............................................. 52 Limitations on Sale or Refinancing of Certain Hotels.................... 52 Hotels Subject to Ground Leases May Affect the Operating Partnership's Revenues............................................................... 52 Federal Income Tax Risks................................................. 53 Tax Consequences of the Mergers......................................... 53 Effects of Subsequent Events upon Recognition of Gain................... 54 Sale of Personal Property May Result in Gain to Limited Partners in Certain Partnerships................................................... 54 Election to Exchange OP Units for Common Shares......................... 55 Election to Exchange OP Units for Notes................................. 55 Exercise of Unit Redemption Right....................................... 55 Limited Partners Need to Consult with Their Own Tax Advisors............ 55 Failure of Host REIT to Qualify as a REIT................................ 56 General................................................................. 56 Required Distributions and Payments..................................... 56 Consequences of Failure to Qualify as a REIT............................ 57 Earnings and Profits Attributable to "C" Corporation Taxable Years...... 57 Treatment of Leases..................................................... 57 Other Tax Liabilities; Host REIT's Substantial Deferred and Contingent Tax Liabilities........................................................ 57 Failure of the Operating Partnership to Qualify as a Partnership........ 58 Miscellaneous Risks...................................................... 58 Dependence upon Key Personnel........................................... 58 Potential Litigation Related to the REIT Conversion..................... 58 Risk Involved in Investments through Partnerships or Joint Ventures..... 59 v
PAGE ---- Changes in Laws......................................................... 59 Uninsured Loss.......................................................... 59 Americans with Disabilities Act......................................... 59 Other Regulatory Issues................................................. 60 Possible Environmental Liabilities...................................... 60 CONFLICTS OF INTEREST..................................................... 61 Substantial Benefits to Related Parties.................................. 61 Affiliated General Partners.............................................. 61 Leasing Arrangements..................................................... 61 Different Tax Consequences upon Sale or Refinancing of Certain Hotels.... 62 Partnership Agreement.................................................... 62 Potential Conflicts Involving Marriott International and Crestline....... 62 Absence of Arm's Length Negotiations; No Independent Representative...... 62 Potential AAA Conflicts.................................................. 63 Policies with Respect to Conflicts of Interest........................... 63 BACKGROUND AND REASONS FOR THE MERGERS AND THE REIT CONVERSION............ 64 Background of the Partnerships........................................... 64 Background of the Mergers and the REIT Conversion........................ 68 Reasons for the Mergers.................................................. 71 Compensation and Distributions to the General Partners and Marriott International........................................................... 75 Alternatives to the Mergers.............................................. 76 Recommendation of the General Partners................................... 78 DETERMINATION OF EXCHANGE VALUES AND ALLOCATION OF OP UNITS............... 79 Overview................................................................. 79 Methodology for Determining Exchange Values.............................. 79 Price of OP Units to Pay Exchange Values to Limited Partners............. 87 Determination of Value of the General Partners' Interests in the Partnerships and Allocation of OP Units to the General Partners......... 88 FAIRNESS ANALYSIS AND OPINION............................................. 89 Fairness Analysis........................................................ 89 Fairness Opinion......................................................... 92 THE MERGERS AND THE REIT CONVERSION....................................... 95 General.................................................................. 95 The REIT Conversion...................................................... 95 The Mergers.............................................................. 101 Conditions to Consummation of the Mergers................................ 103 Extension, Amendment and Termination of the Mergers...................... 104 Effect of REIT Conversion on Non-Participating Partnerships.............. 104 Expenses................................................................. 105 Accounting Treatment..................................................... 105 BUSINESS AND PROPERTIES................................................... 106 Business of the Operating Partnership.................................... 106 General.................................................................. 106 Business Objectives...................................................... 107 Business Strategy........................................................ 107 Hotel Lodging Industry................................................... 110 Hotel Lodging Properties................................................. 111 vi
PAGE ---- Hotel Properties......................................................... 115 1998 Acquisitions........................................................ 117 Blackstone Acquisition................................................... 117 Investments in Affiliated Partnerships................................... 118 Marketing................................................................ 118 Competition.............................................................. 119 Relationship with HM Services............................................ 119 Relationship with Marriott International; Marriott International Distribution............................................................ 119 Employees................................................................ 120 Environmental and Regulatory Matters..................................... 120 Legal Proceedings........................................................ 120 The Leases............................................................... 122 The Management Agreements................................................ 126 Noncompetition Agreement................................................. 130 Indebtedness............................................................. 131 DISTRIBUTION AND OTHER POLICIES........................................... 135 Distribution Policy...................................................... 135 Investment Policies...................................................... 138 Financing Policies....................................................... 139 Lending Policies......................................................... 139 Conflicts of Interest Policies........................................... 139 Policies with Respect to Other Activities................................ 140 SELECTED FINANCIAL DATA................................................... 141 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION...................................................... 143 Lack of Comparability Following the Mergers and the REIT Conversion...... 143 Historical Results of Operations......................................... 143 First Two Quarters 1998 Compared to First Two Quarters 1997 (Historical)............................................................ 143 1997 Compared to 1996 (Historical)....................................... 145 1996 Compared to 1995 (Historical)....................................... 147 Pro Forma Results of Operations.......................................... 148 100% Participation with No Notes Issued--First Two Quarters 1998 Compared to First Two Quarters 1997 (Pro Forma).................................. 149 100% Participation with Notes Issued--First Two Quarters 1998 Compared to First Two Quarters 1997 (Pro Forma)..................................... 150 100% Participation with No Notes Issued--1997 Compared to 1996 (Pro Forma).................................................................. 151 100% Participation with Notes Issued--1997 Compared to 1996 (Pro Forma).. 152 Liquidity and Capital Resources.......................................... 153 MANAGEMENT................................................................ 162 Directors and Executive Officers of Host REIT............................ 162 Committees of the Board of Directors .................................... 164 Compensation of Directors ............................................... 165 Executive Compensation................................................... 165 Aggregated Stock Option Exercises and Year-End Value..................... 167 Long-Term Incentive Plan................................................. 168 Employment Agreements.................................................... 168 1998 Employee Benefits Allocation Agreement.............................. 168 Comprehensive Stock Incentive Plan....................................... 169 Stock Purchase Plan...................................................... 170 vii
PAGE ---- 401(k) Plan.............................................................. 170 Deferred Compensation Plan............................................... 170 Limitation of Liability and Indemnification.............................. 171 Indemnification Agreements............................................... 172 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................ 173 Relationship Between Host and Marriott International..................... 173 Relationship Between Host and Host Marriott Services Corporation......... 176 Relationship Between Host and Crestline Capital Corporation After the Initial E&P Distribution................................................ 177 PRINCIPAL SECURITY HOLDERS................................................ 180 DESCRIPTION OF OP UNITS................................................... 182 General.................................................................. 182 Formation................................................................ 182 Purposes, Business and Management........................................ 182 Host REIT May Not Engage in Other Businesses; Conflicts of Interest...... 183 Distributions; Allocations of Income and Loss............................ 183 Borrowing by the Operating Partnership................................... 184 Reimbursement of Host REIT; Transactions with Host REIT and its Affiliates.............................................................. 184 Liability of Host REIT and Limited Partners.............................. 184 Exculpation and Indemnification of Host REIT............................. 185 Sales of Assets.......................................................... 185 Removal or Withdrawal of Host REIT; Transfer of Host REIT's Interests.... 185 Certain Voting Rights of Holders of OP Units During the First Year Following the Mergers................................................... 186 Restrictions on Transfers of Interests by Limited Partners............... 186 Unit Redemption Right.................................................... 187 No Withdrawal by Limited Partners........................................ 188 Issuance of Limited Partnership Interests................................ 188 Meetings; Voting......................................................... 188 Amendment of the Partnership Agreement................................... 188 Books and Reports........................................................ 189 Power of Attorney........................................................ 189 Dissolution, Winding Up and Termination.................................. 190 Ownership Limitation..................................................... 190 DESCRIPTION OF CAPITAL STOCK ............................................. 191 General.................................................................. 191 Common Shares............................................................ 191 Preferred Shares......................................................... 192 Power to Issue Additional Common Shares and Preferred Shares............. 192 Restrictions on Ownership and Transfer................................... 192 Transfer Agent and Registrar............................................. 195 CERTAIN PROVISIONS OF MARYLAND LAW AND HOST REIT'S CHARTER AND BYLAWS..... 196 Number of Directors; Classification and Removal of Board of Directors; Other Provisions........................................................ 196 Changes in Control Pursuant to Maryland Law.............................. 197 Advance Notice of Director Nominations and New Business.................. 197 Meetings of Shareholders; Call of Special Meetings; Shareholder Action in Lieu of Meeting by Unanimous Consent.................................... 198 Merger, Consolidation, Share Exchange and Transfer of Assets of Host REIT.................................................................... 198 Amendments to Host REIT's Charter and Bylaws............................. 199 Anti-Takeover Effect of Certain Provisions of Maryland Law and Host REIT's Charter and Bylaws............................................... 199 Marriott International Purchase Right.................................... 199 Shareholder Rights Plan.................................................. 199 viii
PAGE ---- DESCRIPTION OF THE NOTES.................................................. 201 General.................................................................. 201 Principal and Interest................................................... 201 Redemption............................................................... 202 Limitation on Incurrence of Indebtedness................................. 202 Merger, Consolidation or Sale............................................ 203 Events of Default, Notice and Waiver..................................... 203 Modification of the Indenture............................................ 205 Satisfaction and Discharge............................................... 205 No Conversion Rights..................................................... 205 Governing Law............................................................ 205 COMPARISON OF OWNERSHIP OF PARTNERSHIP INTERESTS, OP UNITS AND COMMON SHARES............................................................ 206 ERISA CONSIDERATIONS...................................................... 230 Status of Host REIT and the Operating Partnership Under ERISA............ 230 FEDERAL INCOME TAX CONSEQUENCES........................................... 231 Introduction............................................................. 231 Summary of Tax Opinions.................................................. 232 Tax Status of the Operating Partnership.................................. 234 Tax Consequences of the Mergers.......................................... 236 Tax Treatment of Limited Partners Who Exercise Their Right to Make the Common Share Election or the Note Election.............................. 250 Tax Treatment of Limited Partners Who Hold OP Units Following the Mergers................................................................. 251 Federal Income Taxation of Host REIT Following the Mergers............... 263 Taxation of Taxable U.S. Shareholders of Host REIT Generally............. 275 Backup Withholding for Host REIT Distributions........................... 277 Taxation of Tax-Exempt Shareholders of Host REIT......................... 278 Taxation of Non-U.S. Shareholders of Host REIT........................... 278 Tax Aspects of Host REIT's Ownership of OP Units......................... 281 Other Tax Consequences for Host REIT and Its Shareholders................ 281 VOTING PROCEDURES......................................................... 283 Distribution of Solicitation Materials................................... 283 Form W-9 and FIRPTA Certification or Withholding Certificate Required.... 283 No Special Meetings...................................................... 284 Required Limited Partner Vote and Other Conditions....................... 284 OP UNIT EXCHANGE ELECTION PROCEDURES...................................... 288 Description of the Common Share Election................................. 288 Description of the Note Election......................................... 289 Election Procedures...................................................... 289 Form W-9 and FIRPTA Certification or Withholding Certificate Required.... 289 EXPERTS................................................................... 290 LEGAL MATTERS............................................................. 290 AVAILABLE INFORMATION..................................................... 290 GLOSSARY.................................................................. 292 INDEX TO FINANCIAL STATEMENTS............................................. F-1 APPENDICES Appendix A--Form of Amended and Restated Agreement of Limited Partnership of Host Marriott, L.P. Appendix B--Fairness Opinion of American Appraisal Associates, Inc. Appendix C--Tax Opinion of Hogan & Hartson L.L.P. with respect to the Mergers Appendix D--Form of Tax Opinion of Hogan & Hartson L.L.P. with Respect to Qualification of Host REIT as a REIT Appendix E--Estimated Adjusted Basis of Limited Partners in Partnership Interests and "Share" of Limited Partners in Partnership Liabilities ix SUMMARY This Summary does not purport to be complete and is qualified in its entirety by the more detailed information appearing elsewhere in this Prospectus/Consent Solicitation Statement, including the appendices and supplements hereto (this "Consent Solicitation"), and is presented solely to provide an overview of the transactions described in detail in the remainder of this Consent Solicitation and of the business and investment considerations and risks related to the proposed transactions. Prospective investors are advised not to rely on this Summary, but to carefully review this entire Consent Solicitation. The information contained herein, unless otherwise indicated, assumes the REIT Conversion (including the Blackstone Acquisition), occurs, all Partnerships (as defined herein) participate and no Common Shares or Notes (as defined herein) are issued (the "Full Participation Scenario"). FORWARD-LOOKING STATEMENTS Certain matters discussed herein or delivered in connection with this Consent Solicitation are forward-looking statements. Certain, but not necessarily all, of such forward-looking statements can be identified by the use of forward- looking terminology, such as "believes," "expects," "may," "will," "should," "estimates" or "anticipates" or the negative thereof or other variations thereof or comparable terminology. All forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual transactions, results, performance or achievements of the Operating Partnership or Host REIT to be materially different from any future transactions, results, performance or achievements expressed or implied by such forward-looking statements. The cautionary statements set forth under the caption "Risk Factors" and elsewhere in this Consent Solicitation identify important factors with respect to such forward-looking statements, including the following factors that could affect such forward-looking statements: (i) national and local economic and business conditions that will, among other things, affect demand for hotels and other properties, the level of rates and occupancy that can be achieved by such properties and the availability and terms of financing; (ii) the ability to maintain the properties in a first-class manner (including meeting capital expenditure requirements); (iii) the ability of the Operating Partnership or Host REIT to compete effectively in areas such as access, location, quality of accommodations and room rate structures; (iv) the ability of the Operating Partnership or Host REIT to acquire or develop additional properties and the risk that potential acquisitions or developments may not perform in accordance with expectations; (v) the ability of Host to obtain required consents of shareholders, lenders, debt holders, partners and ground lessors of Host and its affiliates and of other third parties in connection with the REIT Conversion and to consummate all of the transactions constituting the REIT Conversion (including the Blackstone Acquisition); (vi) changes in travel patterns, taxes and government regulations which influence or determine wages, prices, construction procedures and costs; (vii) governmental approvals, actions and initiatives, including the need for compliance with environmental and safety requirements, and changes in laws and regulations or the interpretation thereof; (viii) the effects of tax legislative action; and (ix) in the case of Host REIT, the timing of Host REIT's election to be taxed as a REIT and the ability of Host REIT to satisfy complex rules in order to qualify for taxation as a REIT for federal income tax purposes and to operate effectively within the limitations imposed by these rules. Although the Operating Partnership and Host REIT believe the expectations reflected in such forward-looking statements are based upon reasonable assumptions, they can give no assurance that their expectations will be attained or that any deviations will not be material. The Operating Partnership and Host REIT undertake no obligation to publicly release the result of any revisions to these forward- looking statements that may be made to reflect any future events or circumstances. CERTAIN KEY DEFINITIONS The following terms have the meanings set forth below. See the "Glossary" at page 291 for the definitions of other capitalized terms used in this Consent Solicitation. 1 Host Marriott Corporation, a Delaware "Host"........................ corporation, and either the general partner or an affiliate of the general partner of each Partnership, or, as the context may require, Host Marriott Corporation together with its subsidiaries or any of such subsidiaries. "Host REIT"................... HMC Merger Corporation, a Maryland corporation, which will be the sole general partner of the Operating Partnership and the successor to Host, or, as the context may require, HMC Merger Corporation, together with its subsidiaries or any of such subsidiaries. In connection with the REIT Conversion, HMC Merger Corporation will change its name to "Host Marriott Corporation." "Operating Partnership"....... Host Marriott, L.P., a Delaware limited partnership, or, as the context may require, such entity together with its subsidiaries, including the Non-Controlled Subsidiaries (as defined herein), or any of them; also means Host when used to describe such entity on a pro forma basis before the REIT Conversion. "Company"..................... Host (to the extent of its business and assets to be contributed to the Operating Partnership) with respect to periods prior to the REIT Conversion, and Host REIT and the Operating Partnership collectively with respect to the period after the REIT Conversion. "Partnership"................. Any of Atlanta Marriott Marquis II Limited Partnership, a Delaware limited partnership ("Atlanta Marquis"); Desert Springs Marriott Limited Partnership, a Delaware limited partnership ("Desert Springs"); Hanover Marriott Limited Partnership, a Delaware limited partnership ("Hanover"); Marriott Diversified American Hotels, L.P., a Delaware limited partnership ("MDAH"); Marriott Hotel Properties Limited Partnership, a Delaware limited partnership ("MHP"); Marriott Hotel Properties II Limited Partnership, a Delaware limited partnership ("MHP2"); Mutual Benefit Chicago Marriott Suite Hotel Partners, L.P. ("Chicago Suites"), a Rhode Island limited partnership; and Potomac Hotel Limited Partnership, a Delaware limited partnership ("PHLP"); or, as the context may require, any such entity together with its subsidiaries, or any of such subsidiaries. "General Partner"............. The general partner of a Partnership, each of which general partner is a wholly owned, direct or indirect subsidiary of Host (except in the case of PHLP, in which Host is the general partner). "Limited Partners"............ The limited partners, excluding those affiliated with Host, of the Partnerships. "Partnership Interests"....... The interests of the Limited Partners in their respective Partnerships. 2 The limited partnership interests in the "OP Units".................... Operating Partnership. "Common Shares"............... Shares of common stock, par value $.01 per share, of Host REIT. "Note"........................ An unsecured 6.56% Callable Note due December 15, 2005 of the Operating Partnership with a principal amount equal to the Note Election Amount of the Limited Partner's Partnership Interest. "Crestline"................... Crestline Capital Corporation (formerly HMC Senior Communities, Inc.), a Delaware corporation, or, as the context may require, such entity together with the Lessees (as defined herein) and its other subsidiaries or any of them, which currently is a wholly owned subsidiary of Host but will become a separate public company as part of the REIT Conversion. "Non-Controlled The one or more taxable corporations in which Subsidiaries"................. the Operating Partnership will own 95% of the economic interest but no voting stock and which will hold various assets contributed by Host and its subsidiaries to the Operating Partnership, which assets, if owned directly by the Operating Partnership, could jeopardize Host REIT's status as a REIT. "Private Partnership"......... A partnership (other than a Partnership) or limited liability company that owns one or more full-service Hotels and that, prior to the REIT Conversion, is partially but not wholly owned by Host or one of its subsidiaries. The Private Partnerships are not participating in the Mergers. "Hotel Partnership"........... Any Partnership or Private Partnership. "Merger"...................... The proposed merger of a subsidiary of the Operating Partnership (a "Merger Partnership") into a Partnership pursuant to this Consent Solicitation, in which the Partnership will be the surviving entity and will become a subsidiary of the Operating Partnership. "Blackstone Acquisition"...... The expected acquisition from The Blackstone Group and a series of funds controlled by Blackstone Real Estate Partners (collectively, the "Blackstone Entities") of ownership of, or controlling interests in, twelve hotels and a mortgage loan secured by a thirteenth hotel in exchange for OP Units, the assumption of certain liabilities and other consideration, including up to 18% of the shares of Crestline common stock, to the extent such acquisition is consummated. "Initial E&P Distribution".... One or more taxable distributions by Host or Host REIT to its shareholders in connection with the REIT Conversion consisting of shares of common stock of Crestline and cash or other consideration in an amount to be determined. 3 "REIT Conversion"............. (i) The contribution by Host of its wholly owned Hotels, its interests in the Hotel Partnerships and certain other businesses and assets to the Operating Partnership, (ii) the recently completed refinancing and amendment of the debt securities and certain credit facilities of Host substantially in the manner described herein, (iii) the Mergers (if and to the extent consummated), (iv) the acquisition (whether by merger or otherwise) by the Operating Partnership of certain Private Partnerships or interests therein (if and to the extent consummated), (v) the Blackstone Acquisition (if and to the extent consummated), (vi) the creation and capitalization of the Non-Controlled Subsidiaries, (vii) the merger of Host into Host REIT and the distribution by Host or Host REIT of Crestline common stock and cash or other consideration to its shareholders and the Blackstone Entities in connection with the Initial E&P Distribution (as defined herein), (viii) the leasing of the Hotels to subsidiaries of Crestline or others and (ix) such other related transactions and steps occurring prior to, substantially concurrent with or within a reasonable time after the Effective Date as Host may determine in its sole discretion to be necessary or desirable to complete or facilitate the transactions contemplated herein or otherwise to permit Host REIT to elect to be treated as a REIT for federal income tax purposes for the first full taxable year commencing after the Mergers. OVERVIEW This Consent Solicitation is being furnished to the Limited Partners of each Partnership to solicit their approval of a Merger of their Partnership with a subsidiary of the Operating Partnership, which has been formed primarily to continue and expand the full-service hotel ownership business of Host, operating together with its general partner, Host REIT, as an umbrella partnership REIT (an "UPREIT"). If the requisite Limited Partners of each Partnership consent to a Merger of their respective Partnership and to certain related amendments to the respective Partnership's partnership agreement and the other conditions for consummation of a Merger (including completion of the REIT Conversion) are satisfied or waived, the Operating Partnership will acquire such Partnership (a "Participating Partnership") by merger and the Limited Partners of such Participating Partnership will receive OP Units. The number of OP Units to be received by the Limited Partners in the Mergers will be based upon the average closing price on the NYSE of a Host REIT Common Share for the first 20 trading days after the Effective Date of the Mergers (but, subject to adjustment, will not be less than $9.50 or greater than $15.50 per OP Unit even if such average trading price is less than $9.50 or greater than $15.50 per Common Share). The maximum and minimum prices per OP Unit will be reduced if the Blackstone Acquisition is not consummated and, as a result thereof, the Initial E&P Distribution exceeds $2.50 per Host or Host REIT common share. Each Limited Partner can elect, at any time prior to the end of the Election Period (as defined herein), to receive either Common Shares or a Note in exchange for all OP Units received in the Mergers. The General Partners, the Operating Partnership and Host REIT believe that participation in the Mergers will provide the following benefits to Limited Partners: . The opportunity to receive regular cash distributions per OP Unit equal to the distributions paid on each Host REIT Common Share; . The ability to participate in the operations of a larger, more diverse enterprise with growth opportunities and generally lower leverage; 4 . The ability to receive, in exchange for their OP Units, freely tradeable Host REIT Common Shares in connection with the Mergers; . The ability of Limited Partners who retain OP Units, at any time beginning one year following the Mergers, to liquidate their investment in the Operating Partnership for cash based upon the price of Host REIT Common Shares or, at the election of Host REIT, Host REIT Common Shares; and . The deferral, for Limited Partners who retain OP Units, of recognition of at least a substantial portion of any built-in taxable gain attributable to their Partnership Interests generally until such time as each Limited Partner elects to trigger such gain. Host and the General Partners are proposing the Mergers in connection with a plan adopted by Host to restructure its business operations so that it will qualify as a real estate investment trust (a "REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). Host REIT expects to qualify as a REIT beginning with its first full taxable year commencing after the REIT Conversion is completed, which currently is expected to be the year commencing January 1, 1999 (but which might not be until the year beginning January 1, 2000). Host's reasons for engaging in the REIT Conversion include the following: . Host believes the REIT structure, as a more tax efficient structure, will provide improved operating results through changing economic conditions and all phases of the hotel economic cycle. . Host believes the REIT Conversion, which will reduce corporate-level taxes and the need to incur debt to reduce corporate taxes through interest deductions, will improve its financial flexibility and allow it to continue to strengthen its balance sheet by reducing its overall debt to equity ratio over time. . As a REIT, Host believes it will be able to compete more effectively with other public lodging real estate companies that already are organized as REITs and to make performance comparisons with its peers more meaningful. . By becoming a dividend paying company, Host believes its shareholder base will expand to include investors attracted by yield as well as asset quality. . Host believes the adoption of the UPREIT structure will facilitate tax- deferred acquisitions of other hotels (such as in the case of the Blackstone Acquisition and the Mergers). Host believes that these benefits justify the REIT Conversion even if the REIT Conversion does not occur in time for Host REIT to elect REIT status effective January 1, 1999 (in which event the effectiveness of Host's REIT election could be delayed until January 1, 2000). The primary business objectives of the Operating Partnership and Host REIT will be to (i) achieve long-term sustainable growth in "Funds From Operations" (defined as net income (or loss) computed in accordance with generally accepted accounting principles ("GAAP"), excluding gains (or losses) from debt restructuring and sales of properties, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures) and cash flow per OP Unit or Common Share, (ii) increase asset values by improving and expanding the initial Hotels, as appropriate, (iii) acquire additional existing and newly developed upscale and luxury full-service hotels in targeted markets, (iv) develop and construct upscale and luxury full- service hotels and (v) potentially pursue other real estate investments. If the REIT Conversion is consummated as contemplated (including the Blackstone Acquisition), the Operating Partnership is expected initially to own, or have controlling interests in, approximately 125 full-service hotels, located throughout the United States and Canada containing approximately 58,500 rooms and operating primarily under the Marriott, Ritz-Carlton, Four Seasons, Swissotel and Hyatt brand names (the "Hotels"). 5 Because REITs are not permitted under current federal income tax law to derive revenues directly from the operation of hotels, the Operating Partnership will lease the Hotels to lessees (the "Lessees") that will operate the Hotels under the existing management agreements and pay rent to the Operating Partnership, as more fully described herein. The Lessees generally will be wholly owned indirect subsidiaries of Crestline. Crestline, which currently is a wholly owned subsidiary of Host, will become a separate public company when Host or Host REIT distributes the common stock of Crestline and cash or other consideration to its existing shareholders and the Blackstone Entities in connection with the Initial E&P Distribution. Shares of Host REIT and Crestline will become separately traded securities and the companies will operate independently. There will be no overlap between the boards of Host REIT and Crestline. There will be a substantial overlap of shareholders of the two companies initially, but this overlap will diverge over time. As the first step in a strategy to acquire non-Marriott as well as Marriott branded hotels, Host has entered into an agreement with the Blackstone Entities to acquire from the Blackstone Entities ownership of, or controlling interests in, twelve upscale and luxury full-service hotel properties (the "Blackstone Hotels") and certain other related assets (including a mortgage loan secured by an additional hotel) in exchange for a combination of cash and the assumption of debt totalling $862 million, 43.7 million OP Units (based upon a negotiated value of $20.00 per OP Unit), and up to 18% of the shares of Crestline common stock and other consideration. If the Blackstone Acquisition is consummated, the interests in the Blackstone Hotels will be contributed by the Blackstone Entities to the Operating Partnership as part of the REIT Conversion. The Blackstone Hotels will be leased to Lessees that are subsidiaries of Crestline and will continue to be managed under their existing management agreements. See "Business and Properties--Blackstone Acquisition." The following table sets forth certain information as of June 19, 1998 (or, in the case of average daily rate, average occupancy and revenues per available room ("REVPAR"), for the twenty-four weeks then ended ("First Two Quarters 1998")) for the Hotels that are expected to comprise the Operating Partnership's initial full-service lodging portfolio: - -------- (1) REVPAR is a commonly used indicator of market performance of hotels. REVPAR measures daily room revenues generated on a per room basis by combining the average daily room rate charged and the average daily occupancy achieved. REVPAR excludes food and beverage and other ancillary revenues generated by the hotel. (2) Currently included in Host's consolidated financial statements. (3) Atlanta Marquis has an 80% residual interest in the Atlanta Marriott Marquis Hotel. (4) Includes Marriott's Harbor Beach Resort, in which MHP owns a 50.5% interest. (5) Includes the Santa Clara Marriott, in which MHP2 owns a 50% interest and Host owns the remaining 50% interest. (6) Includes the Tampa Westshore Marriott and the Raleigh Crabtree Marriott, which are currently consolidated by Host. A subsidiary of Host provided 100% nonrecourse financing totaling approximately $35 million to PHLP, in which Host owns the sole general partner interest, for the acquisition of these two hotels. (7) Includes the hotels owned by Atlanta Marquis, Desert Springs, Hanover, MHP and MHP2. (8) Includes the hotels owned by all Hotel Partnerships and the Blackstone Hotels, assuming the Full Participation Scenario. 6
NUMBER NUMBER AVERAGE AVERAGE CURRENT OWNER OF HOTELS OF ROOMS DAILY RATE OCCUPANCY REVPAR(1) ------------- --------- -------- ---------- --------- --------- Atlanta Marquis(2)(3)..... 1 1,671 $138.66 69.1% $ 95.81 Desert Springs(2)......... 1 884 214.47 79.7 170.93 Hanover(2)................ 1 353 142.62 71.5 101.97 MHP(2)(4)................. 2 2,127 176.75 85.0 150.24 MHP2(2)(5)................ 4 3,411 152.56 80.4 122.66 Chicago Suites............ 1 256 159.98 82.0 131.18 MDAH...................... 6 1,692 114.66 77.0 88.29 PHLP(6)................... 8 3,181 117.81 81.1 95.54 Blackstone Hotels......... 12 5,520 175.53 72.0 126.41 Host (historical)(6)(7)... 101 49,019 145.04 78.6 114.02 Host (pro forma)(6)(8).... 126 58,603 146.18 77.8 113.67 RISK FACTORS The following is a summary of the material risks associated with the Mergers. This summary is qualified in its entirety by the detailed discussion in the section entitled "Risk Factors" contained in this Consent Solicitation. Some of the significant matters Limited Partners should consider carefully include: . Substantial Benefits to Related Parties. Host REIT and its subsidiaries will realize substantial benefits from the Mergers and the REIT Conversion, including savings from a substantial reduction in corporate- level income taxes expected as a result of the REIT Conversion. To the extent that the anticipated benefits of the REIT Conversion are reflected in the value of Host's common stock before the Effective Date, such benefits will not be shared with the Limited Partners. The benefits to Host of the REIT Conversion will be reduced if one or more of the Partnerships do not participate in a Merger, thereby creating a conflict of interest for the General Partners in connection with the Mergers. . Absence of Arm's Length Negotiations. No independent representative was retained to negotiate on behalf of the Limited Partners. Although the General Partners have obtained the Appraisals (as defined herein) and the Fairness Opinion (as defined herein) from American Appraisal Associates, Inc., an independent, nationally recognized hotel valuation and financial advisory firm ("AAA"), AAA has not negotiated with the General Partners or Host and has not participated in establishing the terms of the Mergers. Consequently, the terms and conditions of the Mergers may have been more favorable to the Limited Partners if such terms and conditions were the result of arm's length negotiations. . Other Conflicts of Interest. The Mergers, the REIT Conversion and the recommendations of the General Partners involve the following conflicts of interest because of the relationships among Host, Host REIT, the Operating Partnership, the General Partners and Crestline. The General Partners, which are all subsidiaries of Host (except for PHLP, in which Host is the General Partner), must assess whether a Merger is fair and equitable to and advisable for the Limited Partners of its Partnership. This assessment involves considerations that are different from those relevant to the determination of whether the Mergers and the REIT Conversion are advisable for Host and its shareholders. The considerations relevant to that determination which create a conflict of interest include Host's belief that the REIT Conversion is advisable for its shareholders, the benefits of the REIT Conversion to Host will be greater if the Partnerships participate and Host REIT will benefit if the value of the OP Units received by the Limited Partners in the Mergers is less than the value of their Partnership Interests. In addition, the terms of the Leases of the Hotels, including the Participating Partnerships' Hotels, will be determined by Host and the terms of the Partnership Agreement, including provisions which benefit Host REIT, have been determined by Host. Such conflicts may result in decisions that do not fully reflect the interests of all Limited Partners. . Exchange Value May Not Equal Fair Market Value of the Partnerships' Hotels. Each Limited Partner of a Participating Partnership who retains OP Units or elects to exchange OP Units for Common Shares will receive consideration with a deemed value equal to the Exchange Value of such Limited Partner's Partnership Interest. The determination of the Exchange Value of each Partnership involves numerous estimates and assumptions. There is no assurance that the Exchange Value of a Partnership will equal the fair market value of the Hotels and other assets contributed by such Partnership. See "Determination of Exchange Values and Allocation of OP Units." . Allocation of OP Units to Host REIT Is Different from Allocation of OP Units to the Partnerships. Following the REIT Conversion, Host REIT will own a number of OP Units equal to the number of shares of Host common stock outstanding on the Effective Date (including the OP Units to be received by the General Partners and other subsidiaries of Host in the Mergers and the OP Units to be acquired from Limited Partners who elect to receive Common Shares in connection with the Mergers) and, if Host has outstanding shares of preferred stock at the time of the REIT Conversion, a corresponding number of preferred partnership interests in the Operating Partnership. Host REIT's OP Units, in the aggregate, should fairly represent the market value of Host REIT but may not be equal to the fair market or net asset value of the Hotels and other assets that Host will contribute to the Operating Partnership. The 7 Partnerships will receive OP Units in the Mergers with a deemed value equal to the Exchange Value of such Partnership. The different methods of allocating OP Units to Host REIT and the Partnerships may result in Limited Partners not receiving the fair market value of their Partnership Interests and Host REIT receiving a higher percentage of the interests in the Operating Partnership. See "Determination of Exchange Values and Allocation of OP Units." . Allocations of OP Units to the Blackstone Entities and the Private Partnerships Were Not Determined by the Exchange Value Methodologies. The price and other terms of the acquisitions of certain Private Partnerships and the Blackstone Acquisition (and thus the allocation of OP Units resulting therefrom) were determined by arm's length negotiations. The assets to be acquired in the Blackstone Acquisition did not generate, in the aggregate, pro forma net income for 1997 or the First Two Quarters 1998. If the partners' interests in the Private Partnerships and the assets of the Blackstone Entities had been valued by the same methodologies used to determine the Exchange Values in the Mergers, the value of the OP Units to be allocated to such partners or the Blackstone Entities may have been less than they actually will receive. The different methods of allocating OP Units may result in the Limited Partners receiving relatively less for their Partnership Interests than the partners in the Private Partnerships and the Blackstone Entities. . Price of OP Units or Common Shares Might Be Less than the Fair Market Value of the Partnership Interests. The price of an OP Unit for purposes of the Mergers will be equal to the average closing price on the NYSE of a Host REIT Common Share for the first 20 trading days after the Effective Date of the Mergers (but it will not be less than $9.50 or greater than $15.50 per OP Unit). This pricing mechanism has the effect of fixing the minimum and maximum number of OP Units to be issued in the Mergers. It is likely that, either initially or over time, the value of the publicly traded Common Shares of Host REIT (and therefore the value of the OP Units) will diverge from the deemed value of the OP Units used for purposes of the Mergers. This could result in the Limited Partners receiving OP Units or Common Shares with an actual value that is less than either the price of the OP Units for purposes of the Mergers or the fair market value of their Partnership Interests. . Inability of Limited Partners Who Retain OP Units to Redeem OP Units for One Year. Limited Partners who retain OP Units received in the Mergers will be unable to redeem such OP Units for one year following the Mergers. Until then, Limited Partners will bear the risk of illiquidity and of not being able to sell in a falling market. . Value of the Notes Will be Less than the Exchange Value. In exchange for OP Units received in a Merger, each Limited Partner may elect to receive an unsecured, seven-year Note of the Operating Partnership with a principal amount equal to the Note Election Amount of his Partnership Interest. The deemed value of the OP Units will exceed the principal amount of the corresponding Notes in all Partnerships (because the Exchange Values will be higher than the Note Election Amounts) and there is no assurance that the Note a Limited Partner receives will have a value equal to either (i) the fair market value of the Limited Partner's share of the Hotels and other assets owned by his Partnership or (ii) the principal amount of the Notes. There will be no public market for the Notes. If the Notes are sold, they may sell at prices substantially below their issuance price. Noteholders are likely to receive the full principal amount of a Note only if they hold the Note to maturity, which is December 15, 2005, or if the Operating Partnership repays the Notes prior to maturity. Because the Notes are unsecured obligations of the Operating Partnership, they will be effectively subordinated to all secured debt of the Operating Partnership and all obligations of both the Participating Partnerships and the Operating Partnership's other subsidiaries. See "Description of the Notes." As of June 19, 1998, on a pro forma basis assuming the Full Participation Scenario, the Operating Partnership would have had aggregate consolidated debt of approximately $5.6 billion (including $567 million of debentures related to the Convertible Preferred Securities) to which the Notes were effectively subordinated or which ranks equally with such Notes. 8 . Cash Distributions May Exceed Cash Available for Distribution; Reduced Cash Distributions for Certain Limited Partners. The preliminary estimated initial annual cash distributions of the Operating Partnership during the twelve months ending December 31, 1999 ($226 million) will exceed its estimated cash available for distribution ($163 million) and cash from contingent rents ($54 million) during the twelve months ending December 31, 1999 (totaling $217 million), which would require borrowings of approximately $9 million (or $0.04 per OP Unit) to make such distributions in accordance with the Operating Partnership's distribution policy. Moreover, if estimated cash from contingent rents were less than $54 million, then the Operating Partnership also would be required to borrow any such shortfall in order to make such distributions. In addition, the estimated initial annual cash distributions of the Operating Partnership or Host REIT to the Limited Partners of MHP and MHP2 per Partnership Unit ($7,645 and $12,862, respectively) will be less than the estimated cash distributions from operations of MHP and MHP2 per Partnership Unit ($16,000 and $27,164, respectively) during 1998. . Timing of the REIT Conversion. Host intends to cause the REIT Conversion to be completed as soon as possible, but there is no assurance that it will be completed during 1998 in time for Host REIT to elect REIT status effective January 1, 1999. The deadline for consummation of the Mergers is June 30, 1999, unless extended by mutual agreement of the Operating Partnership and the General Partners to a date no later than December 31, 1999. If the REIT Conversion does not occur in 1998, the effectiveness of Host REIT's election could be delayed to January 1, 2000, which would result in Host REIT continuing to pay substantial corporate-level income taxes in 1999 (which would reduce Host REIT's estimated cash distributions per Common Share during 1999 to $0.52 per Common Share, but not the Operating Partnership's estimated cash distributions of $0.84 per OP Unit) and could cause the Blackstone Acquisition not to be consummated. . Fundamental Change in Nature of Investment; Potential Underperformance. The Mergers and the REIT Conversion involve a fundamental change in the nature of a Limited Partner's investment from holding an interest in one or more Partnerships, some of which were structured as tax shelter or tax credit investments, and each of which is a finite-life entity, has a fixed portfolio of one or more Hotels and distributes the cash flow from the operation of such Hotels to its Limited Partners, to holding a direct or indirect interest in the Operating Partnership, an ongoing real estate company with an expected portfolio of approximately 125 Hotels that (i) collects and distributes to its limited partners rents received from the Lessees (which will bear the risks and receive the direct benefits of the Hotels' operations), (ii) has the ability to acquire additional hotels and (iii) is able to reinvest proceeds from sales or refinancings of existing Hotels in other hotels. In addition, each Limited Partner's investment will change from one that allows a Limited Partner to receive a return of capital in the form of distributions from any net proceeds of a sale or refinancing of a Partnership's assets to an investment in which a Limited Partner who retains OP Units likely would realize a return of capital only through the exercise of the Unit Redemption Right. Those Limited Partners who elect to receive Common Shares in connection with the Mergers will hold an equity interest in a publicly traded REIT that (i) provides immediate liquidity, (ii) intends to make distributions to its shareholders in an amount equal to at least 95% of its taxable income, (iii) allows shareholders to influence management by participation in the election of directors and (iv) realizes substantial corporate tax savings as long as certain requirements are met. A Limited Partner's share of the liquidation proceeds, if any, from the sale of a Partnership's Hotel or Hotels could be higher than the amount realized upon exercise of the Unit Redemption Right, the sale of Common Shares received in connection with the Mergers or payments on any Note received by a Limited Partner who elects to exchange his OP Units for such Note. An investment in the Operating Partnership or Host REIT may not outperform an investment in any individual Partnership. See "Comparison of Ownership of Partnership Interests, OP Units and Common Shares." . Exposure to Market and Economic Conditions of Other Hotels. As a result of the Mergers, Limited Partners in Participating Partnerships who retain OP Units or elect to receive Common Shares in 9 connection with the Mergers will own interests in a much larger enterprise with a broader range of assets than any of the Partnerships individually. A material adverse change affecting the Operating Partnership's assets will affect all Limited Partners regardless of whether a particular Limited Partner previously was an investor in such affected assets. Each Partnership owns discrete assets, and the Mergers and the REIT Conversion will significantly diversify the types and geographic locations of the Hotels in which the Limited Partners will have interests. As a result, the Hotels owned by the Operating Partnership may be affected differently by economic and market conditions than those Hotel(s) previously owned by an individual Partnership. . Limited Partners Have No Cash Appraisal Rights. Limited Partners of Participating Partnerships who vote against the Merger will not have a right to receive cash based upon an appraisal of their Partnership Interests. . Uncertainties as to the Size and Leverage of the Operating Partnership. The Limited Partners cannot know at the time they vote on a Merger the exact size and amount of leverage of the Operating Partnership. Host is an existing operating company that regularly issues and repays debt, acquires additional hotels and disposes of existing hotels. Also, some or all of the Partnerships may elect not to participate in a Merger (a "Non-Participating Partnership"). In addition, outside partners in certain Private Partnerships may not consent to a lease of their partnership's Hotel(s). In either such case, Host will contribute its interests in such Partnerships and Private Partnerships to the Operating Partnership, but the Operating Partnership may, in turn, contribute such interests to a Non-Controlled Subsidiary, which will be subject to corporate-level income taxation. Host also may repurchase outstanding securities or issue new debt or equity securities prior to the consummation of the Mergers and the REIT Conversion. . Other Uncertainties at the Time of Voting Include the Number of OP Units to be Received. There are several other uncertainties at the time the Limited Partners must vote on the Mergers, including (i) the exact Exchange Value for each Partnership (which will be adjusted for changes in lender and capital expenditure reserves, deferred maintenance and other items prior to the Effective Date), (ii) the price of the OP Units for purposes of the Mergers, which will be determined by reference to the post-Merger trading prices of Host REIT's Common Shares (but will not be less than $9.50 or greater than $15.50) and which, together with the Exchange Value, will determine the number of OP Units (or Common Shares) the Limited Partners of each Participating Partnership will receive and (iii) the exact principal amount of the Notes that may be received in exchange for OP Units, which cannot be known until after the Note Election Amount is determined. For these reasons, the Limited Partners cannot know at the time they vote on a Merger these important aspects of the Merger and they will not know the number of OP Units received in a Merger until approximately 25 trading days after the Merger. . Current Host Common Stock Price Is Not Necessarily Indicative of the Price of Host REIT Common Shares Following the REIT Conversion. Host's current stock price is not necessarily indicative of how the market will value Host REIT Common Shares following the REIT Conversion. The current stock price of Host reflects the current market valuation of Host's current business and assets (including the Crestline common stock and cash or other consideration to be distributed in connection with the Initial E&P Distribution) and not solely the business and assets of Host REIT following the REIT Conversion. Host's current stock price also is affected by general market conditions. . Lack of Control over Hotel Operations and Non-Controlled Subsidiaries. Due to current federal income tax law restrictions on a REIT's ability to derive revenues directly from the operation of a hotel, the Operating Partnership will lease virtually all of its consolidated Hotels to the Lessees, which will operate the Hotels by continuing to retain the existing managers of the Hotels (the "Managers") pursuant to the existing long-term management agreements (the "Management Agreements"). The Operating Partnership will not operate the Hotels or participate in the decisions affecting the daily operations of the Hotels. The Operating Partnership will have only a limited ability to require the Lessees or the Managers to operate or manage the Hotels in any particular manner and no ability to govern any particular aspect 10 of their day-to-day operation or management. The Operating Partnership also will not own any of the voting stock of the Non-Controlled Subsidiaries, which may own, in the aggregate, up to 20% by value of the Operating Partnership's assets. Therefore, the Operating Partnership will be dependent for its revenue upon the ability of the Lessees and the Managers to operate and manage the Hotels and the Non-Controlled Subsidiaries to operate and manage their businesses. . Dependence upon Crestline. Crestline and its subsidiaries will be the Lessees of substantially all of the Hotels and their rent payments will be the primary source of Host REIT's revenues. Crestline's financial condition and ability to meet its obligations under the Leases will determine the Operating Partnership's ability to make distributions to holders of OP Units, including Host REIT, and Host REIT's ability, in turn, to make distributions to its shareholders. As of June 19, 1998, on a pro forma basis, after giving effect to the REIT Conversion, Crestline would have had approximately $315 million of indebtedness (including $100 million due to Host REIT to pay for hotel working capital purchased from Host REIT but not including guarantees of obligations of Crestline's subsidiaries under the Leases and the Management Agreements) and Crestline can incur additional indebtedness in the future. There can be no assurance that Crestline will have sufficient assets, income and access to financing to enable it to satisfy its obligations under the Leases. In addition, the credit rating of the Operating Partnership and Host REIT will be affected by the general creditworthiness of Crestline. . Expiration of the Leases and Possible Inability to Find Other Lessees. The Leases generally will expire seven to ten years after the Effective Date, and there can be no assurance that the affected Hotels will be relet to the Lessees (or if relet, will be relet on terms as favorable to the Operating Partnership). If the Hotels are not relet to the Lessees, the Operating Partnership will be required to find other lessees, which lessees must meet certain requirements set forth in the Management Agreements and the Code. There can be no assurance that satisfactory lessees could be found or as to the terms and conditions on which the Operating Partnership would be able to relet the Hotels or enter into new leases with such lessees, which could result in a failure of Host REIT to qualify as a REIT or in reduced cash available for distribution. . Requisite Vote of Limited Partners of Partnerships Binds All Limited Partners. For each Partnership, approval of a Merger and the related amendments to its partnership agreement by the requisite vote of the Limited Partners, as described in "Voting Procedures--Required Limited Partner Vote and Other Conditions," will cause the Partnership to participate in the Merger and will bind all Limited Partners of such Partnership, including Limited Partners who voted against or abstained from voting with respect to the Merger and the related amendments to its partnership agreement. . Inability to Obtain Third-Party Consents May Have a Material Adverse Effect. There are numerous third-party consents which are required to be obtained in order to consummate the Mergers and the REIT Conversion. The inability of Host, the Operating Partnership or Host REIT to obtain one or more such consents could cause a default under cross-default provisions of the Company's principal credit facilities or otherwise have a material adverse effect on the Operating Partnership and Host REIT and thus could reduce the value of the OP Units and Common Shares. . Competition in the Lodging Industry. The profitability of the Hotels is subject to general economic conditions, the management abilities of the Managers (including primarily Marriott International), competition, the desirability of particular locations and other factors relating to the operation of the Hotels. The full-service segment of the lodging industry, in which virtually all of the Hotels operate, is highly competitive and the Hotels generally operate in geographical markets that contain numerous competitors. The Hotels' success will be dependent, in large part, upon their ability to compete in such areas as access, location, quality of accommodations, room rate structure, the quality and scope of food and beverage facilities and other services and amenities. The lodging industry, including the Hotels (and thus the Operating Partnership), may be adversely affected in the future by (i) national and regional economic conditions, (ii) changes in travel patterns, (iii) taxes and government regulations which 11 influence or determine wages, prices, interest rates, construction procedures and costs, (iv) the availability of credit and (v) other factors beyond the control of the Operating Partnership. . Substantial Indebtedness of the Operating Partnership. The Operating Partnership will have substantial indebtedness. As of June 19, 1998, on a pro forma basis assuming the Full Participation Scenario, the Operating Partnership had outstanding indebtedness totaling approximately $5.6 billion (including $567 million of debentures related to the Convertible Preferred Securities), which represents an approximately 62% debt-to- total market capitalization ratio on a pro forma basis at such date (based upon a price per Common Share of Host REIT of $12.50). The Operating Partnership's business is capital intensive, and it will have significant capital requirements in the future. The Operating Partnership's leverage level could affect its ability to (i) obtain financing in the future, (ii) undertake refinancings on terms and subject to conditions deemed acceptable by the Operating Partnership, (iii) make distributions to partners (including Host REIT), (iv) pursue its acquisition strategy or (v) compete effectively or operate successfully under adverse economic conditions. . No Limitation on Debt. There are no limitations in Host REIT's or the Operating Partnership's organizational documents which limit the amount of indebtedness either may incur, although both the Notes and the Operating Partnership's other debt instruments will contain certain restrictions on the amount of indebtedness that the Operating Partnership may incur. . Rental Revenues from Hotels Subject to Prior Rights of Lenders. In accordance with the mortgage loan agreements with respect to outstanding indebtedness of certain Hotel Partnerships, the rental revenues received by such Hotel Partnerships under certain Leases first will be used to satisfy the debt service on such outstanding indebtedness with only the cash flow remaining after debt service being available to satisfy other obligations of the Hotel Partnership (including paying property taxes and insurance, funding the required FF&E reserves for the Hotels and capital improvements and paying debt service with respect to unsecured debt) and to make distributions to holders of OP Units (including Host REIT). . Ownership Limitations. No person or persons acting as a group may own, actually or constructively (as determined under the applicable Code provisions), (i) in excess of 9.8% of the number or value of outstanding Common Shares of Host REIT or (ii) in excess of 4.9% of the value of the OP Units (other than Host REIT and The Blackstone Group), subject to waiver or modification by Host REIT or the Operating Partnership, as the case may be, in certain limited circumstances. . Anti-Takeover Effect of Certain Provisions of Host REIT's Charter and Bylaws, Maryland Law and the Shareholder Rights Plan. The Articles of Incorporation (the "Charter") and Bylaws of Host REIT to be effective upon completion of the merger of Host with and into Host REIT, as well as provisions of Maryland law, contain certain provisions that could have the effect of delaying, deferring or preventing a change in control of Host REIT. These provisions could limit the price that certain investors might be willing to pay in the future for Common Shares. Certain of these provisions provide for a staggered board and allow Host REIT to issue, without shareholder approval, preferred shares or other stock having rights senior to those of the Common Shares. The Board of Directors also is authorized, without a vote of shareholders, to classify or reclassify unissued common or preferred shares into another class or series of shares. Other provisions impose various procedural and other requirements that could make it difficult for shareholders to effect certain corporate actions. The Charter also provides that no person or persons acting as a group may own more than 9.8% (in number or value) of the outstanding shares of any class or series of shares of Host REIT. Host REIT also intends to adopt a Shareholder Rights Plan to replace the existing stockholder rights plan of Host. Host REIT also will become subject to the business combination and control share provisions under Maryland law. Marriott International, Inc. ("Marriott International") has the right to purchase up to 20% of each class of Host's outstanding voting stock at the then fair market value upon the occurrence of certain change of control (or potential change of control) events involving Host, which right will continue in effect after the Mergers until June 2017, 12 subject to certain limitations intended to protect the REIT status of Host REIT. See "Certain Provisions of Maryland Law and Host REIT's Charter and Bylaws." . Effect of Subsequent Events upon Recognition of Gain. Even though the Limited Partners of the Participating Partnerships (other than those who elect to receive Common Shares or a Note in exchange for OP Units in connection with the Mergers) generally are not expected to recognize significant taxable gain at the time of the Mergers, there are a variety of events and transactions (including the sale of one or more of the Hotels or the reduction of indebtedness securing one or more of the Hotels or, possibly, with respect to the MHP Limited Partners, the transfer of MHP's interest in the Harbor Beach Resort to a Non-Controlled Subsidiary in connection with the REIT Conversion in the event that certain third-party consents to the MHP Merger and the REIT Conversion are not obtained) that could cause a Limited Partner to recognize all or a part of the gain that otherwise has been deferred through the REIT Conversion. See "Federal Income Tax Consequences--Tax Consequences of the Mergers--Effect of Subsequent Events." Certain Hotels (including the Blackstone Hotels) will be covered by agreements with third parties which will restrict the Operating Partnership's ability to dispose of those properties or refinance their debt. In addition, if Atlanta Marquis participates in the Mergers, the Operating Partnership will succeed to an existing agreement that will restrict its ability to dispose of the Atlanta Marquis Hotel or to refinance the debt secured by such Hotel without compensating certain outside partners for the resulting adverse tax consequences. The partnership agreement of the Operating Partnership, which is substantially in the form attached hereto as Appendix A (the "Partnership Agreement"), does not impose any restrictions on the Operating Partnership's ability to dispose of the Hotels or to refinance debt secured by the Hotels (but the Operating Partnership is obligated to pay any taxes Host REIT incurs as a result of such transactions). In addition, the Partnership Agreement provides that Host REIT, as general partner of the Operating Partnership, is not required to take into account the tax consequences of the limited partners in deciding whether to cause the Operating Partnership to undertake specific transactions (but the Operating Partnership is obligated to pay any taxes that Host REIT incurs as a result of such transactions) and the limited partners have no right to approve or disapprove such transactions. See "Description of OP Units--Sales of Assets." . Sale of Personal Property May Result in Gain to Limited Partners in Certain Partnerships. In order to facilitate the participation of Atlanta Marquis, Desert Springs, Hanover, MHP and PHLP in the Mergers without adversely affecting Host REIT's qualification as a REIT, the Operating Partnership will require, as part of the Mergers, that Atlanta Marquis, Desert Springs, Hanover, MHP and PHLP sell a portion of the personal property associated with the Hotels owned by such Partnerships to a Non- Controlled Subsidiary. These sales will be taxable transactions and, with the exception of the sale by Hanover, may result in an allocation of a relatively modest amount of ordinary recapture income by each Partnership to its Limited Partners. This income, if any, will be allocated to each Limited Partner in the same proportion and to the same extent that such Limited Partner was allocated any deductions directly or indirectly giving rise to the treatment of such gains as recapture income. A Limited Partner who receives such an allocation of recapture income would not be entitled to any special distribution from his Partnership in connection with the sale of personal property. . Election to Exchange OP Units for Common Shares. A Limited Partner who elects to receive Common Shares in exchange for his OP Units in connection with the Mergers (the "Common Share Election") will be treated as having made a fully taxable disposition of his OP Units, which likely would be deemed to occur at the time his right to receive the Common Shares becomes fixed (which would be January 22, 1999 if the Effective Date of the Mergers is December 30, 1998). If such Limited Partner has a "negative capital account" with respect to his Partnership Interest, he will recognize "phantom income" (i.e., the income recognized would exceed the value of the Common Shares by the amount of his negative capital account). See "Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Exercise Their Right to Make the Common Share Election or the Note Election." Limited Partners who elect to 13 receive Common Shares in connection with the Mergers will not receive the Crestline common stock or any other portion of the Initial E&P Distribution, which will have been distributed before they become shareholders of Host REIT (approximately 25 trading days after the Effective Date of the Mergers). . Election to Exchange OP Units for Notes. A Limited Partner who elects to receive a Note in exchange for his OP Units in connection with the Mergers (the "Note Election") will be treated as having made a taxable disposition of his OP Units, which likely would be deemed to occur on the Effective Date of the Mergers (which currently is expected to occur on December 30, 1998). A Limited Partner who receives a Note may be eligible to defer at least a portion, but not all, of that gain under the "installment sale" rules until principal on the Note is paid. A Limited Partner with a "negative capital account" with respect to his Partnership Interest who elects to receive a Note in connection with the Mergers will recognize "phantom income" in that amount in any event at the time the taxable disposition is deemed to occur. See "Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Exercise Their Right to Make the Common Share Election or the Note Election." . Failure of Host REIT to Qualify as a REIT for Tax Purposes. Taxation of Host REIT as a corporation if it fails to qualify as a REIT, and Host REIT's subsequent liability for federal, state and local taxes on its income and property, would, among other things, have the effect of reducing cash available for distribution to Host REIT's shareholders and materially reducing the value of the Common Shares and OP Units. . Failure of the Operating Partnership to Qualify as a Partnership for Tax Purposes. Taxation of the Operating Partnership as a corporation if it fails to qualify as a partnership and the Operating Partnership's subsequent liability for federal, state and local income taxes would, among other things, have the effect of reducing cash available for distribution to holders of OP Units and Common Shares, would cause Host REIT to fail to qualify as a REIT for tax purposes and would cause the holders of OP Units to recognize substantial taxable gain at the time the Operating Partnership ceases to qualify as a partnership. . Failure of the Leases to Qualify as Leases. If one or more of the Leases of the Hotels to the Lessees were to be disregarded for tax purposes (for example, because a Lease was determined to lack economic substance), Host REIT would fail to qualify as a REIT and the Operating Partnership might be treated as a corporation for federal income tax purposes, which would have a material adverse impact on the Limited Partners and the value of the OP Units and the Common Shares. . Change in Tax Laws. No assurance can be provided that new legislation, Treasury Regulations, administrative interpretations or court decisions will not significantly change the tax laws with respect to Host REIT's qualification as a REIT or the federal income tax consequences of such qualification. . Limited Partners Need to Consult with Their Own Tax Advisors. Because the specific tax attributes of a Limited Partner and the facts regarding such Limited Partner's interest in his Partnership could have a material impact on the tax consequences to such Limited Partner of the Mergers (including the decision whether to elect to receive Common Shares or a Note in exchange for OP Units in connection with the Mergers) and the subsequent ownership and disposition of OP Units, Common Shares or a Note, it is essential that each Limited Partner consult with his own tax advisors regarding the application of federal, foreign, state and local tax laws to such Limited Partner's personal tax situation. . Effect of Possible Classification as a Publicly Traded Partnership on Passive Losses. There is a significant possibility that the Operating Partnership could be classified as a "publicly traded partnership," in which event the Limited Partners would not be able to use suspended passive activity losses from other investments (including from the Partnerships) to offset income from the Operating Partnership. It is estimated that each Limited Partner in Atlanta Marquis, Chicago Suites, Desert Springs, MDAH and MHP who purchased his Partnership Interest at the time of the original offering of such 14 Interests, has held such Partnership Interest continuously since that time and whose Partnership Interest has been his only investment in a passive activity, would have a passive activity loss carryforward as of December 31, 1998. . Host REIT's Substantial Deferred Tax and Contingent Liabilities. Host REIT will have substantial deferred tax liabilities attributable to Host's assets and operations that are likely to be recognized in the next ten years (notwithstanding Host REIT's status as a REIT), and the IRS could assert substantial additional liabilities for taxes against Host for taxable years prior to the time Host REIT qualifies as a REIT. Under the terms of the REIT Conversion and the Partnership Agreement, the Operating Partnership will be responsible for paying (or reimbursing Host REIT for the payment of) all such tax liabilities, as well as any other liabilities (including contingent liabilities and liabilities attributable to litigation that Host REIT may incur), whether such liabilities are incurred by reason of Host's activities prior to the REIT Conversion or the activities of Host REIT subsequent thereto. THE REIT CONVERSION The transactions summarized below collectively constitute the REIT Conversion. If the required shareholder and partner approvals for the various transactions are obtained and other conditions to the different steps in the REIT Conversion are satisfied or waived, these transactions are expected to occur at various times prior to the end of 1998 (or as soon thereafter as practicable). The Mergers of the Participating Partnerships are expected to occur at the final stage of the REIT Conversion. The Operating Partnership and the General Partners are seeking the approval of the Mergers and the related partnership agreement amendments at this time, in advance of satisfaction of all other contingencies, in order to determine how the Partnerships will fit into the UPREIT structure following the REIT Conversion, which Host desires to implement during 1998 in order to permit Host REIT to qualify as a REIT for its 1999 taxable year. Consummation of the Mergers is not conditioned on the REIT Conversion being completed in time for Host REIT to elect REIT status effective January 1, 1999. If the REIT Conversion does not occur in time for Host REIT to elect REIT status effective January 1, 1999, the effectiveness of Host REIT's election could be delayed until January 1, 2000, which would result in Host REIT continuing to pay substantial corporate-level income taxes in 1999 (which would reduce Host REIT's cash distributions per Common Share but not the Operating Partnership's cash distributions per OP Unit) and could cause the Blackstone Acquisition not to be consummated. In view of the complexity of the REIT Conversion and the number of transactions that must occur to complete the REIT Conversion, Host and the General Partners believe that it is beneficial both to the Limited Partners and the shareholders of Host to complete the REIT Conversion as soon as practicable, even if the REIT Conversion cannot be completed prior to January 1, 1999. If Host REIT's election to be taxed as a REIT is not effective on January 1, 1999, Host REIT intends to operate following the REIT Conversion in a manner that would permit it to qualify as a REIT at the earliest time practicable, and it might pursue a merger with another entity or other transaction that would permit it to commence a new taxable year and elect REIT status prior to January 1, 2000. Host REIT in any event would elect to be treated as a REIT for federal income tax purposes not later than its taxable year commencing January 1, 2000. It is a condition to the Mergers that they be completed by June 30, 1999, unless the General Partners and the Operating Partnership mutually agree to extend that deadline to a date no later than December 31, 1999. . Contribution of Host's Lodging Assets to the Operating Partnership. As a preliminary step, at various times during 1998, Host will contribute its wholly owned full-service hotel assets, its interests in the Hotel Partnerships (other than its interests in the General Partners, who will remain in existence as subsidiaries of Host REIT and will receive OP Units in the Mergers) and its other assets (excluding its senior living assets and the cash or other consideration to be distributed in connection with the Initial E&P Distribution and certain other de minimis assets that cannot be contributed to the Operating Partnership) to the Operating Partnership in exchange for (i) a number of OP Units equal to the number of outstanding shares of common stock of Host at the time of the REIT Conversion (reduced by the number of OP Units to be received by the General Partners and other subsidiaries of Host in the Mergers), (ii) preferred partnership 15 interests in the Operating Partnership corresponding to any shares of Host preferred stock outstanding at the time of the REIT Conversion and (iii) the assumption by the Operating Partnership of all liabilities of Host (including past and future contingent liabilities), other than liabilities of Crestline. Following these contributions, the Operating Partnership and its subsidiaries will directly or indirectly own all of Host's wholly owned hotels, substantially all of Host's interests in the Hotel Partnerships and all of Host's other assets (excluding its senior living assets and the cash or other consideration to be distributed in connection with the Initial E&P Distribution and certain other de minimis assets that cannot be contributed to the Operating Partnership). . Debt Refinancing. In August 1998, Host refinanced $1.55 billion of outstanding public bonds (the "Bond Refinancing") through offers to purchase such debt securities for cash and a concurrent solicitation of consents to amend the terms of the debt securities to facilitate the transactions constituting the REIT Conversion. Host obtained the funds for the Bond Refinancing primarily from the issuance of new debt securities and a new $1.25 billion credit facility (the "New Credit Facility"). See "Business and Properties--Indebtedness." . Treatment of Convertible Preferred Securities. In the REIT Conversion, the Operating Partnership will assume primary liability for repayment of the $567 million of convertible subordinated debentures of Host underlying the $550 million of outstanding Quarterly Income Preferred Securities of Host ("Convertible Preferred Securities"). As the successor to Host, Host REIT also will be liable on the debentures and the debentures will become convertible into Common Shares, but the Operating Partnership will have primary responsibility for payment of the debentures, including all costs of conversion. Upon conversion by a Convertible Preferred Securities holder, the Operating Partnership will acquire Common Shares from Host REIT in exchange for an equal number of OP Units and distribute the Common Shares to the Convertible Preferred Securities holder. As a result of the distribution of Crestline common stock and the cash or other consideration to Host REIT shareholders in connection with the Initial E&P Distribution, the conversion ratio of the Convertible Preferred Securities will be adjusted to take into account certain effects of the REIT Conversion. See "Business and Properties-- Indebtedness." . The Mergers. On the Effective Date, each Participating Partnership will merge with a Merger Partnership. The Participating Partnerships will be the surviving entities of the Mergers and will continue in existence as indirect subsidiaries of the Operating Partnership. In the Mergers, each Limited Partner will receive a number of OP Units with a deemed value equal to the Exchange Value of his respective Partnership Interests. If a Limited Partner elects to receive Common Shares or a Note in exchange for OP Units in connection with the Mergers, such Limited Partner will, upon receipt of his OP Units, tender (or be deemed to tender) all of such OP Units to Host REIT in exchange for an equal number of Common Shares or to the Operating Partnership in exchange for a Note with a principal amount equal to the Note Election Amount of his Partnership Interests. The General Partners and other subsidiaries of Host will also receive OP Units in exchange for their interests in the Partnerships and the General Partners will continue as wholly owned direct or indirect subsidiaries of Host REIT. Partnerships that do not participate in a Merger will continue as separate partnerships, but the Operating Partnership would contribute some or all of the interests in certain of these Partnerships (such as Atlanta Marquis, Desert Springs, Hanover, MHP and MHP2) that it receives from Host and its subsidiaries to a Non-Controlled Subsidiary. . Restructuring of the Private Partnerships. The Operating Partnership will acquire the partnership interests from unaffiliated partners of four Private Partnerships in exchange for OP Units and, accordingly, will own all of the interests in those Private Partnerships. For the remaining Private Partnerships, (i) the Operating Partnership will be a partner in the partnership if the unaffiliated partners consent to a lease of the partnership's Hotel(s) to a Lessee or (ii) if the requisite consents to enter into a lease are not obtained, the Operating Partnership may transfer its interest in such partnership to a Non-Controlled Subsidiary. 16 . The Blackstone Acquisition. Subject to various terms and conditions, the Operating Partnership expects to acquire from the Blackstone Entities ownership of, or controlling interests in, twelve hotels and two mortgage loans, one secured by one of the acquired hotels and one secured by an additional hotel. In addition, Host REIT will acquire a 25% interest in the Swissotel management company from the Blackstone Entities, which Host REIT will transfer to Crestline. If the Blackstone Acquisition is consummated, the Operating Partnership expects to issue approximately 43.7 million OP Units (based upon a negotiated value of $20.00 per OP Unit), assume debt and make cash payments totaling approximately $862 million and distribute up to 18% of the shares of Crestline common stock and other consideration to the Blackstone Entities. . Contribution of Assets to Non-Controlled Subsidiaries. The Operating Partnership will organize the Non-Controlled Subsidiaries to hold various assets (not exceeding, in the aggregate, 20% by value of the assets of the Operating Partnership) contributed by Host and its subsidiaries to the Operating Partnership. The direct ownership of most of these assets by the Operating Partnership could jeopardize Host REIT's status as a REIT. These assets primarily will consist of partnership or other interests in hotels which are not leased, certain furniture, fixtures and equipment used in the Hotels and certain international hotels in which Host owns interests. In exchange for the contribution of these assets to the Non-Controlled Subsidiaries, the Operating Partnership will receive nonvoting common stock representing 95% of the total economic interests of the Non-Controlled Subsidiaries. In addition, the Operating Partnership and, prior to the Mergers, Atlanta Marquis, Desert Springs, Hanover, MHP and PHLP (assuming they participate in the Mergers) will sell to a Non-Controlled Subsidiary an estimated $200 million in value of personal property associated with certain Hotels for notes or cash that has been contributed or loaned to the Non-Controlled Subsidiary by the Operating Partnership, or a combination thereof. The Operating Partnership could not lease this personal property to the Lessees without potentially jeopardizing Host REIT's qualification as a REIT. The Non- Controlled Subsidiary will lease such personal property to the applicable Lessees. The Host Marriott Employee Statutory Trust, the beneficiaries of which will be certain employees of Host REIT and a designated charity (the "Host Employee Trust"), and possibly certain other investors will acquire all of the voting common stock representing the remaining 5% of the total economic interests, and 100% of the control, of each Non- Controlled Subsidiary. See "The Mergers and the REIT Conversion--The REIT Conversion." . Leases of Hotels. The Operating Partnership, its subsidiaries and its controlled partnerships, including the Participating Partnerships, will lease virtually all of their Hotels to the Lessees pursuant to leases with initial terms ranging generally from seven to ten years (the "Leases"). See "Business and Properties--The Leases." The leased Hotels will be operated by the Lessees under their existing brand names pursuant to their existing long-term Management Agreements, which will be assigned to the Lessees for the terms of the applicable Leases, but under which the Operating Partnership will remain obligated. See "Business and Properties--The Management Agreements." . Host REIT Merger and Initial E&P Distribution. Host will merge into Host REIT upon obtaining shareholder approval of the merger. Pursuant to the merger agreement, Host shareholders will receive, for each share of Host common stock, one Host REIT Common Share. In connection with the REIT Conversion, Host or Host REIT will make the Initial E&P Distribution. The aggregate value of the Crestline common stock and the cash or other consideration to be distributed to Host or Host REIT shareholders and the Blackstone Entities is currently estimated to be approximately $525 million to $625 million (approximately $2.10 to $2.50 per share to the Host or Host REIT shareholders). The actual amount of the distribution will be based in part upon the estimated amount of accumulated earnings and profits of Host as of the last day of its taxable year in which the Host merger into Host REIT is consummated. To the extent that the distributions made in connection with the Initial E&P Distribution are not sufficient to eliminate Host's estimated accumulated earnings and profits, Host REIT will make one or more additional taxable distributions to its shareholders (in the form of cash or securities) prior to 17 the last day of its first full taxable year as a REIT (currently expected to be December 31, 1999) in an amount intended to be sufficient to eliminate such earnings and profits, and the Operating Partnership will make corresponding distributions to all holders of OP Units (including Host REIT) in an amount sufficient to permit Host REIT to make such additional distributions. See "The Mergers and the REIT Conversion--The REIT Conversion--Host REIT Merger and Initial E&P Distribution." Limited Partners who elect to receive Common Shares in connection with the Mergers will not receive the Crestline common stock or any other portion of the Initial E&P Distribution, which will have been distributed before they become shareholders of Host REIT (approximately 25 trading days after the Effective Date of the Mergers). In addition, under the terms of the Blackstone Acquisition, the Blackstone Entities are entitled to receive a pro rata portion of the same consideration received by Host REIT's shareholders in connection with the Initial E&P Distribution except to the extent the Blackstone Entities elected to receive additional OP Units in lieu thereof. The payment to the Blackstone Entities of Crestline common stock and other consideration is expected to be approximately $90 million to $110 million if the REIT Conversion and the Blackstone Acquisition are consummated. 18 Following the REIT Conversion, assuming the Full Participation Scenario, the organizational structure of Host REIT is expected to be as follows: [LOGO OF FLOW CHART APPEARS HERE] - -------- (1) Represents Limited Partners and others who retain OP Units and do not elect to receive Common Shares or Notes; excludes Host and its subsidiaries. Percentage ownership in the Operating Partnership assumes all Limited Partners elect to retain OP Units. (2) Also will include Limited Partners who elect to receive Common Shares in exchange for the OP Units received in the Mergers. Immediately following the merger of Host into Host REIT and the distribution by Host or Host REIT of Crestline common stock to its shareholders and the Blackstone Entities, the shareholders of Crestline will consist of the shareholders of Host REIT (other than Limited Partners who elect to receive Common Shares in connection with the Mergers) and the Blackstone Entities. The common ownership of the two public companies, however, will diverge over time. (3) Percentage ownership in the Operating Partnership assumes no Limited Partners elect to receive either Common Shares or Notes in connection with the Mergers and that the price per Common Share is $15.50, which is the maximum price per OP Unit for purposes of the Mergers. (4) The Operating Partnership will own all or substantially all of the equity interests in the Participating Partnerships, certain Private Partnerships and other Host subsidiaries that own Hotels, both directly and through other direct or indirect, wholly owned subsidiaries of the Operating Partnership or Host REIT. Host will contribute its partial equity interests in the Non-Participating Partnerships and those Private Partnerships whose partners have not elected to exchange their interests for OP Units to the Operating Partnership, and the Operating Partnership will either hold such partial interests or contribute them to the Non-Controlled Subsidiaries. 19 Ownership Interests in the Operating Partnership Following the Mergers and the REIT Conversion. Following the Mergers and the REIT Conversion, the Operating Partnership is expected to be owned as set forth below: OWNERSHIP OF THE OPERATING PARTNERSHIP - -------- (1) Assumes that all Partnerships participate in the Mergers, that the Blackstone Acquisition is consummated, that all Limited Partners elect to retain OP Units and that the price of an OP Unit is $15.50, which is the maximum price for purposes of the Mergers. The percentage interest of Host REIT will increase, and the percentage interest of the Limited Partners will decrease, if Limited Partners elect to receive Common Shares or Notes in exchange for their OP Units in connection with the Mergers. THE MERGERS Issuance of OP Units. If Limited Partners holding the requisite percentage of outstanding Partnership Interests in a Partnership vote to approve a Merger and certain related amendments to the Partnership's partnership agreement, then such Participating Partnership will merge with a Merger Partnership, with the Participating Partnership being the surviving entity. Each Limited Partner of the Participating Partnership will receive OP Units with a deemed value equal to the Exchange Value of such Limited Partner's Partnership Interests. Limited Partners who retain OP Units will be issued such OP Units promptly following the twentieth trading day following the Effective Date. The General Partners and other Host subsidiaries that own limited partner interests in the Partnerships also will receive OP Units in exchange for their general and limited partner interests in the Partnerships, respectively. The price attributed to an OP Unit, the Exchange Value of each Partnership and the allocation of OP Units will be established in the manner described in detail under "Determination of Exchange Values and Allocation of OP Units." Unit Redemption Right. Beginning one year after the Mergers, Limited Partners who retain OP Units will have the right to redeem their OP Units at any time, upon ten business days' notice to the Operating Partnership, and receive, at the election of Host REIT, either Common Shares of Host REIT on a one-for-one basis (subject to adjustment) or cash in an amount equal to the market value of such shares ( the "Unit Redemption Right"). Limited Partners must redeem at least 1,000 OP Units (or all remaining OP Units owned by the holder of OP Units if less than 1,000 OP Units) each time the Unit Redemption Right is exercised. See "Description of OP Units--Unit Redemption Right." Right to Exchange OP Units for Common Shares. At any time during the period commencing on the date hereof and ending at 5:00 p.m., Eastern time, on the fifteenth trading day after the Effective Date (the "Election Period"), Limited Partners can elect (or revoke any such election previously made) to tender all of the OP Units they will receive in a Merger (if their Partnership approves the Merger) to Host REIT in exchange for an equal number of Common Shares. The Common Shares, which will be issued promptly following the twentieth trading day after the Effective Date of the Mergers, will be freely tradeable and listed on the NYSE. A Limited Partner who makes the Common Share Election will be treated as having made a taxable disposition of his OP Units, which likely would be deemed to occur at the time his right to receive the Common Shares becomes fixed (which would be January 22, 1999 if the Effective Date of the Mergers is December 30, 1998). See "Description of Capital Stock" and "Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Exercise Their Right to Make the Common Share Election or the Note Election." 20
ENTITY PERCENTAGE INTEREST(1) ------ ---------------------- Host REIT............................................. 75.8% Limited Partners of the Partnerships.................. 6.9 Private Partnerships.................................. 1.1 Blackstone Entities................................... 16.2 ----- TOTAL............................................... 100.0% ===== Right to Exchange OP Units for Notes. At any time during the Election Period, Limited Partners can elect (or revoke any such election previously made) to tender all of the OP Units they will receive in a Merger (if their Partnership approves the Merger) to the Operating Partnership in exchange for a Note. The principal amount of the Note received by a Limited Partner will be equal to the Note Election Amount of his Partnership Interest, which will be less than the value of the OP Units that such Limited Partner otherwise would have received (because the Note Election Amount will be less than the Exchange Value for all Partnerships). The Notes will be issued promptly following the twentieth trading day after the Effective Date of the Mergers. Holders of Notes will receive interest payments on a semi-annual basis on June 15 and December 15 of each year at the rate of 6.56% per annum from and after the Effective Date of the Mergers. A Limited Partner who makes the Note Election will be treated as having made a taxable disposition of his OP Units, which likely would be deemed to occur on the Effective Date of the Mergers (which currently is expected to occur on December 30, 1998). See "Description of the Notes" and "Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Exercise Their Right to Make the Common Share Election or the Note Election." Distribution Policy. The Operating Partnership and Host REIT intend to pay regular quarterly distributions to holders of OP Units and Common Shares, respectively. Host REIT and the Operating Partnership anticipate that distributions will be paid during January, April, July and October of each year, except that the first distribution in 1999 is expected to be paid at the end of February if the REIT Conversion is completed in 1998. The Operating Partnership intends to distribute an amount that will enable Host REIT to distribute to its shareholders an amount equal to 100% of its taxable income (other than capital gains, which will be addressed on a case-by- case basis) for each year no later than the end of January of the following year. The Operating Partnership anticipates that distributions generally will be paid from cash available for distribution (generally equal to cash from operations less capital expenditures and principal amortization on indebtedness); however, to the extent that cash available for distribution is insufficient to make such distributions, the Operating Partnership intends to borrow funds in order to make distributions consistent with this policy. Based upon Host's preliminary estimates of Host REIT's taxable income for the twelve months ending December 31, 1999, Host and the Operating Partnership currently estimate that this policy will result in an initial annual distribution by the Operating Partnership of approximately $0.84 per OP Unit ($0.21 per quarter) during the twelve months ending December 31, 1999. If Host's preliminary estimate of $226 million of cash distributions by the Operating Partnership during the twelve months ending December 31, 1999 proves accurate but the Operating Partnership's cash available for distribution were only equal to its estimated cash available for distribution ($163 million) and cash from contingent rents ($54 million) during 1999 totaling $217 million (or $0.80 per OP Unit), then the Operating Partnership would be required to borrow approximately $9 million (or $0.04 per OP Unit) to make such distributions. Moreover, if estimated cash from contingent rents were less than $54 million, then the Operating Partnership also would be required to borrow any such shortfall in order to make such distributions. While the Operating Partnership does not believe this will be necessary, it believes it would be able to borrow the necessary amounts under the New Credit Facility or from other sources and that any such borrowing would not have a material adverse effect on its financial condition or results of operations. The distributions to shareholders per Common Share are expected to be in an amount equal to the amount distributed by the Operating Partnership per OP Unit. However, if the REIT Conversion is not completed until after January 1, 1999, then Host REIT's distributions to shareholders in 1999 would be lower than the Operating Partnership's distributions per OP Unit (by the amount of Host REIT's 1999 corporate income tax payments) until its REIT election becomes effective, which would be no later than January 1, 2000. The Operating Partnership intends to make distributions during 1999 at the estimated level of $0.84 per OP Unit even if the REIT election of Host REIT were not effective until January 1, 2000, which would result in estimated distributions by Host REIT (after estimated federal and state income tax payments) of $0.52 per Common Share for the full year 1999. Distributions will be made in the discretion of the Board of Directors of Host REIT and will be affected by a number of factors, many of which are beyond the control of Host REIT and the Operating Partnership. In order to maintain its qualification as a REIT under the Code, Host REIT is required to distribute (within a certain 21 period after the end of each year) at least 95% of its REIT taxable income for such year. See "Distribution and Other Policies--Distribution Policy." Host REIT and the Operating Partnership intend to establish a dividend reinvestment plan. 1998 Partnership Distributions. Limited Partners at the Effective Date of the Mergers who retain OP Units will receive cash distributions from their respective Partnerships for all of 1998 and, if the Mergers do not occur in 1998, any portion of 1999 prior to the Mergers for which they do not receive a cash distribution from the Operating Partnership. Cash distributions will be made by each Partnership in accordance with its partnership agreement on or before June 1, 1999 in respect of 1998 operations and, if the Mergers do not occur prior to January 1, 1999, within 90 days after the Effective Date of the Mergers in respect of any 1999 operations. The General Partners of Chicago Suites, Hanover, MDAH and PHLP do not expect that these Partnerships will make any distributions in respect of 1998 operations. Limited Partners at the Effective Date of the Mergers who receive Common Shares in exchange for OP Units pursuant to the Common Share Election will participate in the same distributions from the Partnerships as Limited Partners who retain OP Units and will receive distributions from Host REIT with respect to periods after their Common Shares are issued, which distributions are expected to equal the amount distributed with respect to the OP Units for such periods (although Host REIT's distributions to shareholders would be lower than the Operating Partnership's distributions to holders of OP Units (by the amount of Host REIT's 1999 corporate income tax payments) if the REIT Conversion does not occur in 1998 and Host REIT is unable to elect REIT status effective January 1, 1999). Neither the Operating Partnership nor Host REIT anticipates making distributions after the Effective Date of the Mergers and prior to the issuance of Common Shares to those Limited Partners who elect to exchange their OP Units for Common Shares. Limited Partners at the Effective Date of the Mergers who receive a Note in exchange for OP Units pursuant to the Note Election will participate in the same distributions from the Partnerships as Limited Partners who retain OP Units but will not receive any distributions from the Operating Partnership with respect to periods after the Notes are issued. Ownership Interests of Host in the Partnerships. The table below sets forth the current ownership interests of Host in the Partnerships. Following the REIT Conversion, assuming all of the Partnerships participate in the Mergers, the Partnerships will be owned by the Operating Partnership. Limited Partner Vote Required for the Mergers. In the case of Atlanta Marquis, a majority of Class A limited partner interests must be present in person or by proxy to establish a quorum and must vote to approve the Merger. Host and its affiliates own 0.28% of the outstanding Class A limited partner interests and will vote them in favor of the Merger. In the case of each of Chicago Suites and PHLP, the approval required for each Merger is a majority of the outstanding limited partner interests in such Partnership. Host owns no limited partner interests in Chicago Suites and will vote its 0.06% limited partner interests in PHLP in favor of the Merger. In MDAH, a majority of limited partner interests must vote to approve the Merger. Host is not entitled to vote its 0.60% limited partner interest in MDAH on the Merger. In the case of Desert Springs, Hanover, MHP and MHP2, a majority of the limited partner interests held by Limited Partners must be present in person or by proxy for the vote to be recognized and a majority of the limited partner interests actually voting on the Merger must vote for the Merger to approve it. Host is required to vote all of its limited partner interests in Hanover, MHP and MHP2 in the same manner as the majority of the other limited partner interests actually voting on the matter 22
PARTNERSHIP LIMITED PARTNER INTERESTS GENERAL PARTNER INTERESTS ----------- ------------------------- ------------------------- Atlanta Marquis.......... Class A 0.28% 1.00% Class B 100.00 Chicago Suites........... 0.00 1.00 Desert Springs........... 0.00 1.00 Hanover.................. 47.62 5.00 MDAH..................... 0.60 1.00 MHP...................... 48.33 1.00 MHP2..................... 52.75 1.00 PHLP..................... 0.06 1.00 vote. Host or its subsidiaries own a 47.62%, 48.33% and 52.75% limited partner interest in Hanover, MHP and MHP2, respectively. Host does not own any limited partner interests in Desert Springs. The approval of the Merger by the requisite percentage of limited partner interests of a Partnership will cause the Partnership to participate in the Merger so long as the amendments to the partnership agreement are also approved and will bind all Limited Partners of such Partnership, including Limited Partners who voted against or abstained from voting with respect to the Merger. See "Voting Procedures--Limited Partner Required Vote and Other Conditions--Required Limited Partner Vote for the Mergers." Amendments to the Partnership Agreements. In order to consummate each Merger as currently proposed, there are a number of amendments required to be made to the partnership agreements of the Partnerships. Limited Partners must vote separately on the Merger and the amendments to the partnership agreement, but the Merger will not be consummated unless both the Merger and the amendments to the partnership agreement are approved. The effectiveness of such amendments will be conditioned upon the Partnership's participation in a Merger. The required amendments generally include: (i) permitting the Partnership to enter into the Leases with the Lessees; (ii) reducing to one the number of appraisals of the fair market value of a Partnership's Hotel(s) that the Partnership must obtain before the General Partner can cause a Partnership to sell its assets to the General Partner or an affiliate; and (iii) other amendments required to allow the transactions constituting the Mergers or otherwise necessary or desirable to consummate the Mergers or the REIT Conversion. Limited Partner Vote Required for the Amendments to the Partnership Agreements. In the case of Atlanta Marquis, a majority of Class A limited partner interests must be present in person or by proxy to establish a quorum and must vote to approve the amendments to the partnership agreement. Host and its affiliates own 0.28% of the outstanding Class A limited partner interests and will vote them in favor of the amendments. In the case of each of Chicago Suites and PHLP, the approval required for the amendments to the partnership agreement is a majority of the outstanding limited partner interests in such Partnership. Host owns no limited partner interests in Chicago Suites and will vote its 0.06% limited partner interests in PHLP in favor of the amendments. In MDAH, a majority of limited partner interests must vote to approve the amendments to the partnership agreement. Host is not entitled to vote its 0.60% limited partner interest in MDAH on the amendments. In the case of Desert Springs, Hanover, MHP and MHP2, a majority of the limited partner interests held by Limited Partners must be present in person or by proxy for the vote to be recognized and a majority of the limited partner interests actually voting on the amendments to the partnership agreements must vote for the amendments to the partnership agreements to approve them. Host is required to vote all of its limited partner interests in Hanover, MHP and MHP2 in the same manner as the majority of the other limited partner interests actually voting on the matter vote. Host or its subsidiaries own a 47.62%, 48.33% and 52.75% limited partner interest in Hanover, MHP and MHP2, respectively. Host does not own any limited partner interests in Desert Springs. See "Voting Procedures--Required Limited Partner Vote and Other Conditions--Required Limited Partner Vote for the Amendments to the Partnership Agreements." Effective Time of the Mergers. The effective time of each Merger (the "Effective Time") will be after the merger of Host into Host REIT becomes effective and the shares of Crestline common stock and other consideration are distributed to Host or Host REIT's shareholders in connection with the Initial E&P Distribution, which is expected to occur during the final stage of the REIT Conversion. The Effective Time currently is expected to occur on or about December 30, 1998, subject to satisfaction or waiver of the conditions to the Mergers, but there is no assurance that it will occur at such time. Conditions to Consummation of the Mergers. Participation by each Partnership in a Merger is subject to the satisfaction or waiver of certain conditions, including, among others: . Limited Partner Approvals. Limited Partners holding the requisite percentage of Partnership Interests in such Partnership shall have approved the Merger and the amendments to the partnership agreement (as described above). 23 . Host Shareholder Approval. Shareholders owning 66 2/3% of the outstanding shares of Host's common stock shall have approved the merger of Host into Host REIT and such merger shall have been consummated. . REIT Qualification. Host's Board of Directors shall have determined, based upon the advice of counsel, that Host REIT can elect to be treated as a REIT for federal income tax purposes effective no later than the first full taxable year commencing after the REIT Conversion is completed (which might not be until the year commencing January 1, 2000 if the REIT Conversion is not completed until after December 31, 1998), and Host REIT shall have received an opinion of counsel substantially to such effect. . NYSE Listing. The Common Shares shall have been listed on the NYSE. . Third-Party Consents. All required governmental and other third-party consents to the Mergers and the REIT Conversion, including consents of lenders, Marriott International and certain of its subsidiaries and ground lessors and consents to transfer material operating licenses and permits and the Management Agreements, shall have been received, except for such consents as would not reasonably be expected to have a material adverse effect on the business, financial condition or results of operations of Host REIT, the Operating Partnership and their subsidiaries taken as a whole. . No Adverse Tax Legislation. The United States Congress shall not have enacted legislation, or proposed legislation with a reasonable possibility of being enacted, that would have the effect of (i) substantially impairing the ability of Host REIT to qualify as a REIT or the Operating Partnership to qualify as a partnership, (ii) substantially increasing the federal tax liabilities of Host REIT resulting from the REIT Conversion or (iii) substantially reducing the expected benefits to Host REIT resulting from the REIT Conversion. The determination that this condition has been satisfied will be made by Host, in its discretion. . Completion of Mergers by June 30, 1999. The Mergers must have been completed by June 30, 1999, unless the Operating Partnership and the General Partners have mutually agreed to extend the deadline to a date no later than December 31, 1999. The obligation of the Operating Partnership to consummate a Merger is subject to satisfaction or waiver of the same or similar conditions. Merger Expenses. All costs and expenses incurred in connection with the proposed Mergers (the "Merger Expenses"), whether or not the Mergers are approved by the Partnerships, will be borne by the Operating Partnership, although in certain instances, transfer and recordation taxes and fees are reflected in the Exchange Values and Note Election Amounts. The Operating Partnership also will bear all other costs and expenses incurred by Host and its subsidiaries in connection with the REIT Conversion (the "REIT Conversion Expenses"). See "The Mergers and the REIT Conversion--Expenses." REASONS FOR THE MERGERS The Mergers are being proposed at this time for three principal reasons: . First, the General Partners believe that the expected benefits of the Mergers to the Limited Partners, as set forth below, outweigh the risks of the Mergers to the Limited Partners, as set forth in "Risk Factors." . Second, the General Partners believe that participation in the REIT Conversion through the Mergers is better for the Limited Partners than the alternatives of continuing each Partnership as a standalone entity, liquidating the Partnership, reorganizing the Partnership into a separate REIT or pursuing a merger of one or more Partnerships with another REIT or UPREIT, especially in light of the opportunity to receive OP Units, Common Shares or Notes in connection with the Mergers. See "Determination of Exchange Values and Allocation of OP Units" and "Background and Reasons for the Mergers and the REIT Conversion--Alternatives to the Mergers." 24 . Third, Host is proposing the Mergers at this time to each Partnership because consummation of the Merger as to each Partnership will enable Host to obtain the full benefits of the REIT Conversion with respect to its interests in such Partnership, while also giving the other partners of the Partnership the opportunity to enjoy the benefits of the REIT Conversion. See "Risk Factors--Risks and Effects of the Mergers-- Conflicts of Interest--Substantial Benefits to Related Parties." The expected benefits from the Mergers to the Limited Partners include the following: . Liquidity. The REIT Conversion will offer Limited Partners liquidity with respect to their investments in the Partnerships because Limited Partners can receive freely tradeable Host REIT Common Shares by electing to exchange OP Units for Common Shares in connection with the Mergers or, for those Limited Partners who retain OP Units, at any time commencing one year following the Mergers, by exercising their Unit Redemption Right, subject to certain limited exceptions. Host has approximately 204 million shares of common stock outstanding and is expected to have a total common equity market capitalization of approximately $3.4 billion after giving effect to the Initial E&P Distribution (based on a price of $12.50 per Host REIT Common Share). The election to exchange OP Units for Common Shares in connection with the Mergers or the exercise of the Unit Redemption Right, however, generally would result in recognition of taxable income or gain. . Regular Quarterly Cash Distributions. The General Partners expect that the Operating Partnership will make regular quarterly cash distributions to holders of OP Units and that Host REIT will make regular quarterly cash distributions to holders of Common Shares. Host expects that these distributions will be higher than the estimated cash distributions from operations during 1998 of all Partnerships except MHP and MHP2, and in any event, the ability to receive distributions quarterly and in regular amounts would be enhanced. For additional information regarding historical and estimated future distributions for the Partnerships, see "Background and Reasons for the Mergers and the REIT Conversion--Reasons for the Mergers." . Substantial Tax Deferral for Limited Partners Not Electing to Exchange OP Units for Common Shares or Notes. The General Partners expect that Limited Partners of the Participating Partnerships who do not elect to receive Common Shares or Notes in exchange for OP Units in connection with the Mergers generally should be able to obtain the benefits of the Mergers while continuing to defer recognition for federal income tax purposes of at least a substantial portion, if not all, of the gain with respect to their Partnership Interests that otherwise would be recognized in the event of a liquidation of the Partnership or a sale or other disposition of its assets in a taxable transaction (although Limited Partners in Atlanta Marquis, Desert Springs, MHP and PHLP may recognize a relatively modest amount of ordinary income as the result of required sales of personal property by each such Partnership to a Non-Controlled Subsidiary in order to facilitate Host REIT's qualification as a REIT). Thereafter, such Limited Partners generally should be able to defer at least a substantial portion of such built-in gain until they elect to exercise their Unit Redemption Right or one or more of the Hotels currently owned by their Partnership are sold or otherwise disposed of in a taxable transaction by the Operating Partnership or the debt now secured by such Hotels is repaid, prepaid or substantially reduced. The federal income tax consequences of the Mergers are highly complex and, with respect to each Limited Partner, are dependent upon many variables, including the particular circumstances of such Limited Partner. See "Federal Income Tax Consequences--Tax Consequences of the Mergers." Each Limited Partner is urged to consult with his own tax advisors as to the consequences of a Merger in light of his particular circumstances. . Risk Diversification. Participation in a Merger, as well as future hotel acquisitions by the Operating Partnership, will reduce the dependence upon the performance of, and the exposure to the risks associated with, any particular Hotel or group of Hotels currently owned by an individual Partnership and spread such risk over a broader and more varied portfolio, including more diverse geographic locations and multiple brands. See "Business and Properties--Business Objectives." 25 . Reduction in Leverage and Interest Costs. It is expected that the Operating Partnership will have a leverage to value ratio (approximately 62%) that is lower than the leverage to value ratios for five of the Partnerships (Atlanta Marquis, Chicago Suites, Desert Springs, Hanover and PHLP), and that is not significantly different than the leverage ratios for MDAH, MHP and MHP2. . Growth Potential. The General Partners believe that the Limited Partners, by directly or indirectly owning interests in a publicly traded real estate company focused primarily on a more diverse and growing upscale and luxury full-service hotel portfolio, will be able to participate in growth opportunities that would not otherwise be available to them. . Greater Access to Capital. With publicly traded equity securities, a larger base of assets and a substantially greater equity value than any of the Partnerships individually, Host REIT expects to have greater access to the capital necessary to fund the Operating Partnership's operations and to consummate acquisitions on more attractive terms than would be available to any of the Partnerships individually. This greater access to capital should provide greater financial stability to the Operating Partnership and reduce the level of risk associated with refinancing existing loans upon maturity, as compared to the Partnerships individually. . Public Market Valuation of Assets. In most instances, the units of limited partnership interest of each Partnership ("Partnership Units") currently trade at a discount to the net asset value of the Partnership's assets. The General Partners believe that by exchanging interests in their existing, non-traded, finite-life limited partnerships with a fixed portfolio for interests in an ongoing real estate company focused primarily on a more diverse and growing full-service hotel portfolio and providing valuation based upon publicly traded Common Shares of Host REIT, the Limited Partners will have the opportunity to participate in the recent trend toward ownership of real estate through a publicly traded entity, which, in many instances (although not currently), has resulted at various times in market valuations of public real estate companies in excess of the estimated net asset values of those companies. There can be no assurance, however, that the Common Shares of Host REIT will trade at a premium to the private market values of the Operating Partnership's assets or that they will not trade at a discount to private market values. Also, the benefit of Host's conversion to a REIT will not be shared by the Limited Partners if and to the extent that such benefit is reflected in the market valuation of Host's common stock prior to the REIT Conversion. DETERMINATION OF EXCHANGE VALUES AND ALLOCATION OF OP UNITS Following consummation of the REIT Conversion, OP Units are expected to be owned by the following groups: . Host REIT, which will own a number of OP Units equal to the number of outstanding Common Shares of Host REIT. These OP Units will consist of (i) the OP Units to be acquired in exchange for the contribution of Host's full-service hotel assets and other assets (excluding its senior living assets and the cash or other consideration to be distributed to shareholders of Host or Host REIT and certain other de minimis assets), subject to all liabilities of Host (including past and future contingent liabilities), other than liabilities of Crestline, (ii) the OP Units to be received by the General Partners and other Host subsidiaries with respect to their interests in the Partnerships and (iii) the OP Units to be acquired from Limited Partners who elect to receive Common Shares in connection with the Mergers. The OP Units received by the General Partners and other Host subsidiaries attributable to their interests in the Partnerships will be valued in the same manner as the OP Units attributable to the Limited Partners and will be determined in accordance with the distribution provisions in the partnership agreements of the Partnerships. On a pro forma basis, as of June 19, 1998, Host REIT would have owned approximately 204 million OP Units, based upon the number of outstanding shares of Host common stock at that time, of which the General Partners and other Host subsidiaries would have owned approximately 17.7 million OP Units received with respect to their interests in the Partnerships. If Host issues any shares of preferred 26 stock prior to the REIT Conversion, Host REIT also will own a number of preferred partnership interests in the Operating Partnership equal to the number of outstanding shares of preferred stock. . The Blackstone Entities, which will receive approximately 43.7 million OP Units in exchange for the contribution of the Blackstone Hotels and certain other related assets, subject to certain liabilities. . Limited Partners of the Participating Partnerships, who will receive in the Mergers a number of OP Units based upon the Exchange Values of their respective Partnership Interests and the price per OP Unit (other than Limited Partners who elect to exchange such OP Units for Common Shares or Notes). . Partners unaffiliated with Host in four Private Partnerships, who have agreed to exchange their interests in their Private Partnerships for OP Units based upon the value of their interests in their Private Partnerships, as determined by negotiation with Host. In the Mergers, the Limited Partners of each Participating Partnership will receive in exchange for their Partnership Interests a number of OP Units with an aggregate deemed value equal to the Exchange Value of their Partnership Interests. The price of an OP Unit for this purpose will be equal to the average closing price on the NYSE of a Host REIT Common Share for the 20 trading days after the Effective Date of the Mergers (but, subject to adjustment, will not be less than $9.50 or greater than $15.50 per OP Unit). The maximum and minimum prices per OP Unit will be reduced if the Blackstone Acquisition is not consummated and, as a result thereof, the Initial E&P Distribution exceeds $2.50 per Host or Host REIT common share. The Limited Partners will become partners in the Operating Partnership at the Effective Time of the Mergers, but the OP Units will not be issued to the Limited Partners until promptly after the twentieth trading day following the Effective Date of the Mergers (which would be promptly after January 29, 1999 if the Effective Date of the Mergers is December 30, 1998). The Exchange Value of each Partnership is equal to the greatest of its Adjusted Appraised Value, Continuation Value and Liquidation Value, each of which has been determined as follows: . Adjusted Appraised Value. The General Partners have retained AAA to determine the market value of each of the Hotels as of March 1, 1998 (the "Appraised Value"). The "Adjusted Appraised Value" of a Partnership equals the Appraised Value of its Hotels, adjusted as of the Final Valuation Date (as defined herein) for lender reserves, capital expenditure reserves, existing indebtedness (including a "mark to market" adjustment to reflect the fair market value of such indebtedness), certain deferred maintenance costs, deferred management fees and transfer and recordation taxes and fees. . Continuation Value. The General Partners have adopted estimates prepared by AAA for each Partnership of the discounted present value, as of January 1, 1998, of the limited partners' share of estimated future cash distributions and estimated net sales proceeds (plus lender reserves) assuming that the Partnership continues as an operating business for twelve years and its assets are sold on December 31, 2009 for their then estimated market value (the "Continuation Value"). . Liquidation Value. The General Partners have estimated for each Partnership the net proceeds to limited partners resulting from the assumed sale as of December 31, 1998 of the Hotels(s) of the Partnership, each at its Adjusted Appraised Value (after eliminating any "mark to market" adjustment and adding back the deduction for transfer taxes and fees, if any, made in deriving the Adjusted Appraised Value) less (i) estimated liquidation costs, expenses and contingencies equal to 2.5% of Appraised Value and (ii) prepayment penalties or defeasance costs, as applicable (the "Liquidation Value"). For a complete description of the above methodologies, see "Determination of Exchange Values and Allocation of OP Units--Methodology for Determining Exchange Values." Each of the three valuation methodologies is dependent upon a number of estimates, variables and assumptions, including the assumptions used by AAA in preparing the Appraised Values of the Hotels, as well as varying market conditions. No assurance can be given that the estimated values would be accurate under actual conditions. See "Background and Reasons for the Mergers and the REIT Conversion--Alternatives to the Mergers." The following table sets forth the estimated Exchange Value of each Partnership (based upon the greatest of its estimated Adjusted Appraised Value, estimated Continuation Value and estimated Liquidation Value), the 27 estimated minimum number of OP Units to be received (based upon the maximum price of $15.50 per OP Unit) and the estimated Note Election Amount for each Partnership, all on a per Partnership Unit basis as of the Initial Valuation Date. The number of Common Shares received in exchange for OP Units by a Limited Partner who elects to receive Common Shares will equal the number of OP Units received by such Limited Partner. The estimated Exchange Values set forth below may increase or decrease as a result of various adjustments, which will be finally calculated immediately prior to the closing of the Mergers but will not change as a result of less than all of the Partnerships participating in the Mergers. The actual number of OP Units to be received by the Limited Partners will be based on the average closing price on the NYSE of a Host REIT Common Share for the 20 trading days after the Effective Date (but will not be less than $9.50 or greater than $15.50 per OP Unit) and will not be finally determined until such time. ESTIMATED EXCHANGE VALUES, MINIMUM NUMBER OF OP UNITS AND NOTE ELECTION AMOUNTS (ALL AMOUNTS ON A PER PARTNERSHIP UNIT BASIS)/(1)/ - -------- (1) A Partnership Unit in all of the Partnerships except Chicago Suites ($35,000) and PHLP ($10,000) represents an original investment of $100,000. (2) Estimated Exchange Value is equal to the greatest of estimated Adjusted Appraised Value, estimated Continuation Value and estimated Liquidation Value. (3) Assumes the price of an OP Unit is $15.50, which is the maximum price for purposes of the Mergers. (4) The principal amount of Notes is equal to the greater of (i) the Liquidation Value or (ii) 80% of the Exchange Value (the "Note Election Amount"). (5) The estimated Adjusted Appraised Value and the estimated Liquidation Value for PHLP are zero because PHLP's outstanding debt is greater than the Appraised Value of the Hotels and the value of other assets, net of liabilities, owned by PHLP. DESCRIPTION OF THE COMMON SHARE ELECTION Limited Partners who desire to exchange their OP Units with Host REIT for Common Shares must indicate their election on the OP Unit Exchange Election Form and deliver such form to the Operating Partnership at any time prior to the end of the Election Period (which election may be revoked, and if revoked, made again, at any time prior to the end of the Election Period). At their discretion, the Operating Partnership and Host REIT may elect to extend the Election Period. Even if a Limited Partner votes against the Merger, he may still choose to exchange his OP Units for Common Shares in the event the Merger is approved. A Limited Partner of a Participating Partnership who fails to timely and properly return the OP Unit Exchange Election Form will receive and retain OP Units. Each Limited Partner in a Participating Partnership who timely and properly elects to exchange his OP Units for Common Shares (and who has not timely revoked such election at any time during the Election Period) will tender (or be deemed to have tendered) all of the OP Units he receives in the Merger to Host REIT for an equal number of Common Shares. The Common Shares will be issued to the Limited Partner promptly following the twentieth trading day after the Effective Date of the Mergers (which would be promptly after January 29, 1999 if the Effective Date of the Mergers is December 30, 1998). The Common Shares are 28
ESTIMATED ESTIMATED MINIMUM ESTIMATED ADJUSTED ESTIMATED ESTIMATED ESTIMATED NUMBER OF NOTE APPRAISED CONTINUATION LIQUIDATION EXCHANGE OP ELECTION PARTNERSHIP VALUE VALUE VALUE VALUE(2) UNITS(3) AMOUNT(4) ----------- --------- ------------ ----------- --------- --------- --------- Atlanta Marquis......... $ 41,570 $ 45,425 $ 402 $ 45,425 2,931 $ 36,340 Chicago Suites.......... 33,133 24,184 31,149 33,133 2,138 31,149 Desert Springs.......... 40,880 33,536 27,617 40,880 2,637 32,704 Hanover................. 123,202 98,090 88,474 123,202 7,949 98,562 MDAH.................... 109,216 89,340 98,343 109,216 7,046 98,343 MHP..................... 140,032 141,074 124,261 141,074 9,102 124,261 MHP2.................... 237,334 211,263 205,140 237,334 15,312 205,140 PHLP.................... 0/(5)/ 5,040 0/(5)/ 5,040 325 4,032 expected to receive quarterly cash distributions in the same amount as the cash distributions with respect to each OP Unit. See "Description of Capital Stock-- Common Shares." DESCRIPTION OF THE NOTE ELECTION Limited Partners who desire to exchange their OP Units with the Operating Partnership for a Note must indicate their election on the OP Unit Exchange Election Form and deliver such form to the Operating Partnership at any time prior to the end of the Election Period (which election may be revoked, and if revoked made again, at any time prior to the end of the Election Period). Even if a Limited Partner votes against the Merger, he still may choose to exchange his OP Units for a Note in the event the Merger is approved. A Limited Partner of a Participating Partnership who fails to timely and properly return the OP Unit Exchange Election Form will receive and retain OP Units. Each Limited Partner in a Participating Partnership who timely and properly elects to exchange his OP Units for a Note (and who has not timely revoked such election at any time during the Election Period) will tender (or be deemed to have tendered) all of the OP Units he receives in the Merger to the Operating Partnership for the Note. The Note will be issued to the Limited Partner promptly following the twentieth trading day after the Effective Date of the Mergers (which would be promptly after January 29, 1999 if the Effective Date of the Mergers is December 30, 1998). The Notes will (i) be unsecured obligations of the Operating Partnership, (ii) have a principal amount equal to the Note Election Amount of a Limited Partner's Partnership Interests, (iii) mature on December 15, 2005 (approximately seven years after the closing of the Mergers), (iv) bear interest at 6.56% per annum, which was determined based on 120% of the applicable federal rate as of the Record Date (which was 5.47%), payable semi-annually on June 15 and December 15 each year commencing from and after the Effective Date of the Mergers, (v) provide for optional prepayment by the Operating Partnership at any time without penalty and mandatory prepayment of principal from a ratable portion of the net proceeds (after repayment of debt, sales expenses and deferred management fees) realized from any sale of any Hotels formerly owned by the Limited Partner's Partnership and from certain excess refinancing proceeds and (vi) provide for the payment of the remaining principal balance at maturity. See "Description of the Notes." FAIRNESS ANALYSIS AND OPINION Fairness Analysis. The General Partners believe that the Mergers provide substantial benefits and are fair to the Limited Partners of each Partnership and recommend that all Limited Partners vote for the Mergers. In arriving at this conclusion, the General Partners have relied primarily on the following factors, as well as other factors described under "Fairness Analysis and Opinion--Fairness Analysis:" (i) their view that the expected benefits of the Mergers for the Limited Partners outweigh the risks and potential detriments of the Mergers to the Limited Partners (see "Background and Reasons for the Mergers and the REIT Conversion--Reasons for the Mergers"); (ii) their view that the value of the OP Units allocable to the Limited Partners on the basis of the Exchange Value established for each Partnership represents fair consideration for the interests held by the partners of such Partnership and is fair to the Limited Partners from a financial point of view; and (iii) the fairness opinion of AAA, as described below. Fairness Opinion. AAA, an independent, nationally recognized hotel valuation and financial advisory firm, has rendered the fairness opinion (the "Fairness Opinion"), attached as Appendix B to this Consent Solicitation, which sets forth the Appraised Values of the Hotels and concludes that: (i) the Exchange Value and the methodologies and underlying assumptions used to determine the Exchange Value, the Adjusted Appraised Value, the Continuation Value and the Liquidation Value of each Partnership (including, without limitation, the assumptions used to determine the various adjustments to the Appraised Values of the Hotels) are fair and reasonable, from a financial point of view, to the Limited Partners of each Partnership; and (ii) the methodologies used to determine the value of an OP Unit and the allocation of the equity interest in the Operating Partnership to be received by the limited partners of each Partnership are fair and reasonable to the Limited Partners of each Partnership. See "Fairness Analysis and Opinion--Fairness Opinion." 29 RECOMMENDATION FOR THE REASONS STATED HEREIN, THE GENERAL PARTNERS BELIEVE THAT THE MERGERS PROVIDE SUBSTANTIAL BENEFITS AND ARE FAIR TO THE LIMITED PARTNERS OF EACH PARTNERSHIP AND RECOMMEND THAT ALL LIMITED PARTNERS VOTE FOR THE MERGERS AND FOR THE RELATED AMENDMENTS TO THE PARTNERSHIP AGREEMENTS. SEE "FAIRNESS ANALYSIS AND OPINION--FAIRNESS ANALYSIS." SOLICITATION MATERIALS This Consent Solicitation (including the accompanying transmittal letter), together with the consent form (the "Consent Form") and the Questions and Answers (the "Q & A") constitute the "Solicitation Materials" being distributed to Limited Partners to obtain their consents to the Mergers and the amendments to the partnership agreements. The date of first distribution of this Consent Solicitation is October , 1998. VOTING PROCEDURES The voting procedures applicable to Limited Partners of each Partnership are set forth in this Consent Solicitation under the heading "Voting Procedures-- Required Limited Partner Vote and Other Conditions." LIMITED PARTNERS ARE BEING ASKED TO VOTE SEPARATELY ON THE MERGER AND THE PROPOSED AMENDMENTS TO THE PARTNERSHIP AGREEMENT OF HIS PARTNERSHIP, BUT A PARTNERSHIP WILL NOT PARTICIPATE IN A MERGER UNLESS BOTH PROPOSALS ARE APPROVED. A Limited Partner may mark the Consent Form to vote "FOR," "AGAINST" or "ABSTAIN" with respect to participation in a Merger by his Partnership and "FOR," "AGAINST" or "ABSTAIN" with respect to the amendments to the partnership agreement of his Partnership. THE FAILURE OF A LIMITED PARTNER OF ATLANTA MARQUIS, CHICAGO SUITES, MDAH AND PHLP TO VOTE OR AN ABSTENTION WILL HAVE THE SAME EFFECT AS IF SUCH LIMITED PARTNER HAD VOTED HIS PARTNERSHIP INTERESTS "AGAINST" A MERGER AND "AGAINST" THE AMENDMENTS TO THE PARTNERSHIP AGREEMENTS. THE FAILURE OF A LIMITED PARTNER OF DESERT SPRINGS, HANOVER, MHP AND MHP2 TO VOTE WILL MEAN THAT SUCH LIMITED PARTNER'S PARTNERSHIP INTEREST WILL NOT BE COUNTED FOR PURPOSES OF ESTABLISHING THE NUMBER OF LIMITED PARTNER INTERESTS REQUIRED TO RECOGNIZE THE VOTE AND MAY AFFECT THE MANNER IN WHICH HOST IS REQUIRED TO VOTE ITS LIMITED PARTNER INTERESTS. AN ABSTENTION BY A LIMITED PARTNER OF DESERT SPRINGS, HANOVER, MHP AND MHP2 WILL BE COUNTED FOR PURPOSES OF ESTABLISHING THE NUMBER OF LIMITED PARTNER INTERESTS REQUIRED TO HAVE THE VOTE RECOGNIZED BUT WILL EFFECTIVELY BE COUNTED AS A VOTE "AGAINST" A MERGER AND "AGAINST" THE AMENDMENTS TO THE PARTNERSHIP AGREEMENTS. The period during which consents will be solicited pursuant to this Consent Solicitation (the "Solicitation Period") will commence on the date this Consent Solicitation and the other Solicitation Materials are first distributed to the Limited Partners and will continue until the later of (i) December , 1998 or (ii) such later date as the Operating Partnership may elect, in its sole and absolute discretion. Any Consent Form RECEIVED by the Operating Partnership (in original or by facsimile) prior to 5:00 p.m., Eastern time, on the last day of the Solicitation Period will be effective, provided that such Consent Form has been properly signed. FOR ALL OF THE PARTNERSHIPS, A CONSENT FORM THAT IS PROPERLY SIGNED BUT NOT MARKED WILL BE VOTED "FOR" A MERGER AND "FOR" THE AMENDMENTS TO THE PARTNERSHIP AGREEMENT. A Limited Partner who has submitted a Consent Form may withdraw or revoke the Consent Form at any time prior to the expiration of the Solicitation Period. Investor Lists. Under Rule 14a-7 of the Exchange Act, each Partnership is required, upon the written request of a Limited Partner, to provide to the requesting Limited Partner (i) a statement of the approximate number of Limited Partners in such Limited Partner's Partnership; and (ii) the estimated cost of mailing a proxy statement, form of proxy or other similar communication to such Limited Partners. In addition, a Limited Partner has the right, at his option, either to (a) have his Partnership mail (at such Limited Partner's expense) copies of 30 any proxy statement, proxy form or other soliciting material furnished by the Limited Partner to the Partnership's Limited Partners designated by the Limited Partner; or (b) have the Partnership deliver to the requesting Limited Partner, within five business days of the receipt of the request, a reasonably current list of the names, addresses and class of units held by the Partnership's Limited Partners. The right to receive the list of Limited Partners is subject to the requesting Limited Partner's payment of the cost of mailing and duplication at a rate of $0.15 per page. See "Voting Procedures--Required Limited Partner Vote and Other Conditions--Investor Lists." OP UNIT EXCHANGE ELECTION PROCEDURES Limited Partners who desire to exchange their OP Units for Common Shares or a Note must timely and properly complete and return the OP Unit Exchange Election Form. A Limited Partner must make such election (or revoke any election previously made) at any time during the Election Period, which will commence on the first day of the Solicitation Period and will continue until 5:00 p.m., Eastern time, on the fifteenth trading day after the Effective Date of the Mergers (which would be January 22, 1999 if the Effective Date of the Mergers is December 30, 1998), unless extended. A Limited Partner who has returned an OP Unit Exchange Election Form may withdraw or revoke such election at any time prior to the expiration of the Election Period by either submitting a later dated OP Unit Exchange Election Form or notifying the Operating Partnership in writing that he wishes to withdraw such previous election. FEDERAL INCOME TAX CONSEQUENCES Tax Consequences of the Mergers. Based upon certain assumptions and representations of the General Partners, the Operating Partnership, Host and Host REIT, Hogan & Hartson L.L.P., counsel to Host, Host REIT and the Operating Partnership, has opined that, except for any gain attributable to the sale of personal property to a Non-Controlled Subsidiary, the Mergers will not result in the recognition of taxable gain or loss at the time of the Mergers to a Limited Partner (i) who does not elect to receive Common Shares or a Note in exchange for his OP Units in connection with the Mergers; (ii) who does not exercise his Unit Redemption Right on a date sooner than the date two years after the date of the consummation of the Mergers; (iii) who does not receive a cash distribution (or a deemed cash distribution resulting from relief from liabilities, including as a result of the prepayment of indebtedness associated with the Limited Partner's Partnership) in connection with the Mergers or the REIT Conversion in excess of such Limited Partner's aggregate adjusted basis in his Partnership Interest at the time of the Mergers; (iv) who is not required to recognize gain by reason of an election by other Limited Partners in his Partnership to receive Common Shares or Notes in exchange for their OP Units in connection with the Mergers (which, in counsel's opinion, described below, should not be the result of such election); and (v) whose "at risk" amount does not fall below zero as a result of the Mergers or the REIT Conversion. With respect to the foregoing potential exceptions to nonrecognition treatment, Hogan & Hartson L.L.P. has opined as follows: (i) it is more likely than not that a Limited Partner's exercise of the Unit Redemption Right more than one year after the date of consummation of the REIT Conversion but less than two years after such date will not cause the Merger itself to be a taxable transaction for such Limited Partner (or for the other Limited Partners of such Partnership); (ii) it is more likely than not that a Limited Partner who does not elect to exchange his OP Units for Common Shares or a Note in connection with the Mergers will not be required to recognize gain by reason of another Limited Partner's exercise of either such election; and (iii) a Limited Partner's relief from Partnership liabilities allocable to such Limited Partner in connection with the Mergers or the REIT Conversion (including as a result of the repayment of Partnership indebtedness in connection with the REIT Conversion) will not cause such Limited Partner to recognize taxable gain at the time of the REIT Conversion unless (and only to the extent that) the amount thereof exceeds such Limited Partner's adjusted basis in his Partnership Interest at the time of the Mergers. See "Federal Income Tax Consequences-- Summary of Tax Opinions." An opinion of counsel, however, does not bind the Internal Revenue Service (the "IRS") or the courts, and no assurance can be provided that any such opinion will not be challenged by the IRS or will be sustained by a court if so challenged. With one exception, neither Host REIT, the Operating Partnership, nor the 31 General Partners have sought any ruling from the IRS with respect to the consequences of the Mergers or the REIT Conversion. See "Federal Income Tax Consequences--Tax Consequences of the Mergers--IRS Ruling Request Regarding Allocation of Partnership Liabilities." (The foregoing assumes that the ability to exercise the Common Share Election or the Note Election either is not a separate property right for federal income tax purposes or does not have any ascertainable value. The Operating Partnership believes that the ability to exercise the Common Share Election or the Note Election is not property and, even if it were property, does not have any independent ascertainable value, given the nature and terms of the OP Units and the terms and limited duration of the election arrangements. If, however, the ability to exercise such elections were considered property and to have an ascertainable value, Limited Partners could recognize gain in amount up to the amount of such value (whether or not they exercise such elections). With respect to the Limited Partners' relief from Partnership liabilities in connection with the Mergers and REIT Conversion, the General Partners and the Operating Partnership have determined, based upon the intended allocation of Operating Partnership liabilities following the REIT Conversion and certain information compiled by the General Partners, that no Limited Partner whose adjusted basis in his Partnership Interest is the same as or greater than the basis of a Limited Partner who purchased his Partnership Interest in the original offering by the Partnership of the Partnership Interests and who has held such Partnership Interest at all times since (referred to herein as an "Original Limited Partner's Adjusted Basis") and who does not elect to exchange the OP Units will recognize taxable gain at the time of the Mergers as a result either of relief from Partnership liabilities allocable to such Limited Partner or a reduction in his "at risk" amount below zero. See "Federal Income Tax Consequences--Tax Consequences of the Mergers--Relief from Liabilities/Deemed Cash Distribution." A Limited Partner whose adjusted basis in his Partnership Interest is less than the Original Limited Partner's Adjusted Basis for that Partnership, however, could recognize gain, depending upon his particular circumstances. Even though a Limited Partner who does not elect to exchange his OP Units and whose adjusted basis in his Partnership Interest is the same as or greater than the Original Limited Partner's Adjusted Basis for that Partnership is not expected to recognize gain at the time of the REIT Conversion, a variety of events and transactions subsequent to the REIT Conversion could cause such a Limited Partner to recognize all or part of the gain that has been deferred through the REIT Conversion. See "Federal Income Tax Consequences--Tax Consequences of the Mergers--Effect of Subsequent Events." The Partnership Agreement provides that Host REIT is not required to take into account the tax consequences for the limited partners of the Operating Partnership in deciding whether to cause the Operating Partnership to undertake specific transactions (but the Operating Partnership is obligated to pay any taxes that Host REIT incurs as a result of such transactions) and the limited partners have no right to approve or disapprove such transactions. See "Description of OP Units--Sales of Assets." The particular tax consequences of the Mergers and the REIT Conversion for a Limited Partner will depend upon a number of factors related to the tax situation of that individual Limited Partner and the Partnership of which he is a Limited Partner, including, without limitation, such factors as the Limited Partner's adjusted tax basis in his Partnership Interest, the extent to which the Limited Partner has unused passive losses with respect to his Partnership Interest or other investments generating passive activity losses that could offset income arising from the Mergers and the REIT Conversion, the amount of income (if any) required to be recognized by reason of the sale by the Limited Partners' Partnership of personal property to a Non-Controlled Subsidiary, the actual allocation of Operating Partnership liabilities to the Limited Partner following the Mergers and the REIT Conversion and the amount of built-in gain with respect to the Hotel(s) contributed to the Operating Partnership by the Partnership in which he is a Limited Partner. A Limited Partner who elects to exchange his OP Units for Common Shares in connection with the Mergers will be treated as having made a fully taxable disposition of his OP Units, which likely would be deemed to occur at the time that the right to receive Common Shares becomes fixed (which the Operating Partnership will 32 treat as occurring on January 22, 1999 if the Effective Date of the Mergers is December 30, 1998). The amount realized in connection with such disposition will equal the sum of the fair market value of the Common Shares received, plus the portion of the Operating Partnership's liabilities allocable to the Limited Partner for federal income tax purposes. To the extent the amount realized exceeds the Limited Partner's adjusted tax basis in his OP Units, the Limited Partner will recognize gain. Such Limited Partner will not be able to defer any portion of the gain realized from the exchange of OP Units for Common Shares under the "installment sale" rules. See "Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Exercise Their Right to Make the Common Share Election or the Note Election." A Limited Partner who elects to exchange his OP Units for a Note in connection with the Mergers will be treated as having made a taxable disposition of his OP Units, which likely would be deemed to occur on the Effective Date of the Mergers (which currently is expected to occur on December 30, 1998). The amount realized in connection with such disposition will equal the sum of the "issue price" of the Note (i.e., the principal amount of the Note), plus the portion of the Operating Partnership's liabilities allocable to the Limited Partner for federal income tax purposes. To the extent the amount realized exceeds the Limited Partner's adjusted tax basis in his OP Units, the Limited Partner will recognize gain. Such Limited Partner may be eligible to defer at least a portion of that gain under the "installment sale" rules (see "Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Exercise Their Right to Make the Common Share Election or the Note Election") but those rules would not permit the Limited Partner to defer all of the gain (including any gain attributable to the Limited Partner's "negative capital account" and any gain attributable to depreciation recapture) and may require that the Limited Partner who defers gain pay to the IRS interest on a portion of the resulting tax that has been deferred. The discussion of federal income tax consequences in this Consent Solicitation is not exhaustive of all possible tax consequences. For example, it does not give a detailed discussion of any state, local or foreign tax considerations. In addition, except to the extent discussed under the heading "Federal Income Tax Consequences--Taxation of Non-U.S. Shareholders of Host REIT," it does not purport to deal with tax consequences that might be relevant to foreign corporations and persons who are not citizens or residents of the United States. The gain, if any, required to be recognized by a Limited Partner as a consequence of the Mergers (including any gain recognized as a result of the sale of personal property by the Limited Partner's Partnership or as a result of making the Common Share Election or the Note Election) can be offset by unused passive activity losses from his Partnership and other investments. EACH LIMITED PARTNER IS STRONGLY URGED TO CONSULT WITH HIS OWN TAX ADVISOR TO DETERMINE THE IMPACT OF SUCH LIMITED PARTNER'S PERSONAL TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES OF THE MERGERS AND THE REIT CONVERSION TO SUCH LIMITED PARTNER. Qualification of Host REIT as a REIT. Host REIT expects to qualify as a REIT for federal income tax purposes effective for its first full taxable year commencing after the REIT Conversion is completed, which Host REIT currently expects to be the year beginning January 1, 1999 (but which might not be until the year beginning January 1, 2000). If it so qualifies, Host REIT will be permitted to (i) deduct dividends paid to its shareholders, allowing the income represented by such dividends to avoid taxation at the entity level and to be taxed only at the shareholder level and (ii) treat retained net capital gains in a manner so that such gains are taxed at the Host REIT level but effectively avoid taxation at the shareholder level. Host REIT, however, will be subject to a separate corporate income tax on any gains recognized during the ten years following the REIT Conversion that are attributable to "built-in" gain with respect to the assets that Host owned at the time of the REIT Conversion (which tax would be paid by the Operating Partnership). Host REIT has substantial deferred tax liabilities that 33 are likely to be recognized as "built-in" gain (or by a Non-Controlled Subsidiary) during such period without any corresponding receipt of cash, and the Operating Partnership will be responsible for paying such taxes. Host REIT's ability to qualify as a REIT will depend upon its continuing satisfaction following the REIT Conversion of various requirements related to the nature of its assets, the sources of its income and the distributions to its shareholders, including a requirement that Host REIT distribute to its shareholders at least 95% of its taxable income each year. Sale of Personal Property. In order to protect Host REIT's ability to qualify as a REIT, the Operating Partnership may require, immediately prior to the Mergers, that certain of the Participating Partnerships (specifically, Atlanta Marquis, Desert Springs, Hanover, MHP and PHLP) sell a portion of the personal property associated with the Hotels owned by such Partnerships to a Non- Controlled Subsidiary. These sales will be taxable transactions and may result in a special allocation of any ordinary recapture income by each such Partnership (other than Hanover) to its Limited Partners. This income, if any, will be allocated to each such Limited Partner in the same proportion and to the same extent that such Limited Partner previously was allocated any deductions directly or indirectly giving rise to the treatment of such gains as recapture income. A Limited Partner who receives such an allocation of recapture income will not be entitled to any special distribution from his Partnership in connection with the sale of personal property. SUMMARY FINANCIAL INFORMATION The following table sets forth unaudited pro forma financial and other information for the Company and Host REIT and combined consolidated historical financial information for Host. The following summary financial information should be read in conjunction with the financial statements and notes thereto and Management's Discussion and Analysis of Results of Operations and Financial Condition included elsewhere in this Consent Solicitation. The unaudited pro forma financial statements as of June 19, 1998 and for the fiscal year ended January 2, 1998 and the twenty-four weeks ended June 19, 1998 ("First Two Quarters 1998") for the 100% Participation and Single Partnership presentations are presented as if the REIT Conversion occurred as of June 19, 1998 for the pro forma balance sheets and at the beginning of the fiscal year for the pro forma statements of operations. The unaudited REIT 2000 pro forma information assumes that the REIT Conversion occurs on January 1, 1999, the Blackstone Acquisition does not occur and Host does not become a REIT until January 1, 2000. The pro forma information incorporates certain assumptions that are described in the Notes to the Unaudited Pro Forma Financial Statements included elsewhere in this Consent Solicitation. The pro forma information does not purport to represent what the Company's or Host REIT's financial position or results of operations would actually have been if these transactions had, in fact, occurred on such date or at the beginning of the period indicated, or to project the Company's or Host REIT's financial position or results of operations at any future date or for any future period. In addition, the historical information contained in the following table is not comparable to the operations of the Company or Host REIT on a going-forward basis because the historical information relates to an operating entity which owns and operates hotels and senior living communities, while the Company will own the Hotels but will lease them to the Lessees and receive rental payments in connection therewith. 34 SUMMARY FINANCIAL INFORMATION (IN MILLIONS) AS OF JUNE 19, 1998
COMPANY PRO FORMA HOST REIT PRO FORMA ------------------------------------- ------------------------------------- HOST FISCAL YEAR 1997 FISCAL YEAR 1997 HISTORICAL ------------------------------------- ------------------------------------- ---------- SINGLE SINGLE 100% PARTNERSHIP REIT 2000 100% PARTNERSHIP REIT 2000 PARTICIPATION PARTICIPATION WITH PARTICIPATION PARTICIPATION WITH WITH NO WITH NO NOTES NO NOTES WITH NO WITH NO NOTES NO NOTES FISCAL NOTES ISSUED ISSUED ISSUED(1) NOTES ISSUED ISSUED ISSUED(1) YEAR 1997 ------------- ------------- --------- ------------- ------------- --------- ---------- REVENUES: Hotel revenues.... $ -- $ 226 $ -- $ -- $ 226 $ -- $1,093 Rental revenues... 1,119 873 997 1,119 873 997 -- Other revenues.... 1 19 1 1 19 1 54 ------ ------ ----- ------ ------ ----- ------ Total revenues.. 1,120 1,118 998 1,120 1,118 998 1,147 ------ ------ ----- ------ ------ ----- ------ OPERATING COSTS AND EXPENSES: Hotel............. 589 582 502 589 582 502 649 Other............. 11 11 11 11 11 11 49 ------ ------ ----- ------ ------ ----- ------ Total operating costs and expenses........ 600 593 513 600 593 513 698 ------ ------ ----- ------ ------ ----- ------ Operating profit... 520 525 485 520 525 485 449 Minority interest.. (10) (45) (10) (16) (49) (10) (32) Corporate expenses........... (44) (44) (44) (44) (44) (44) (47) REIT Conversion expenses........... -- -- -- -- -- -- -- Interest expense... (468) (445) (420) (430) (407) (382) (302) Dividends on Convertible Preferred Securities......... -- -- -- (37) (37) (37) (37) Interest income.... 27 25 34 27 25 34 52 ------ ------ ----- ------ ------ ----- ------ Income (loss) before income taxes.............. 25 16 45 20 13 46 83 Benefit (provision) for income taxes... (1) (1) (2) (1) (1) (19) (36) ------ ------ ----- ------ ------ ----- ------ Income (loss) before extraordinary items ................... $ 24 $ 15 $ 43 $ 19 $ 12 $ 27 $ 47 ====== ====== ===== ====== ====== ===== ====== COMPANY PRO FORMA HOST REIT PRO FORMA ------------------------------------- ------------------------------------- HOST FIRST TWO QUARTERS 1998 FIRST TWO QUARTERS 1998 HISTORICAL ------------------------------------- ------------------------------------- ---------- SINGLE SINGLE 100% PARTNERSHIP REIT 2000 100% PARTNERSHIP REIT 2000 PARTICIPATION PARTICIPATION WITH PARTICIPATION PARTICIPATION WITH FIRST TWO WITH NO WITH NO NOTES NO NOTES WITH NO NOTES WITH NO NOTES NO NOTES QUARTERS NOTES ISSUED ISSUED ISSUED(1) ISSUED ISSUED ISSUED(1) 1998 ------------- ------------- --------- ------------- ------------- --------- ---------- REVENUES: Hotel revenues.... $ -- $ 136 $ -- $ -- $ 136 $ -- $ 652 Rental revenues... 342 265 303 342 265 303 -- Other revenues.... 3 21 3 3 21 3 95 ------------- ------------- --------- ------------- ------------- --------- ---------- Total revenues.. 345 422 306 345 422 306 747 ------------- ------------- --------- ------------- ------------- --------- ---------- OPERATING COSTS AND EXPENSES: Hotel............. 265 282 224 265 282 224 343 Other............. 5 5 5 5 5 5 30 ------------- ------------- --------- ------------- ------------- --------- ---------- Total operating costs and expenses........ 270 287 229 270 287 229 373 ------------- ------------- --------- ------------- ------------- --------- ---------- Operating profit... 75 135 77 75 135 77 374 Minority interest.. (11) (46) (11) 28 (24) 10 (30) Corporate expenses........... (20) (20) (20) (20) (20) (20) (21) REIT Conversion expenses........... -- -- -- -- -- -- (6) Interest expense... (216) (202) (192) (198) (184) (174) (162) Dividends on Convertible Preferred Securities......... -- -- -- (17) (17) (17) (17) Interest income.... 13 12 17 13 12 17 25 ------------- ------------- --------- ------------- ------------- --------- ---------- Income (loss) before income taxes.............. (159) (121) (129) (119) (98) (107) 163 Benefit (provision) for income taxes... 8 6 6 6 5 44 (67) ------------- ------------- --------- ------------- ------------- --------- ---------- Income (loss) before extraordinary items ................... $(151) $(115) $(123) $(113) $ (93) $ (63) $ 96 ============= ============= ========= ============= ============= ========= ========== - ---- (1) Assumes all Partnerships participate in the Mergers, the REIT conversion occurs on January 1, 1999, the Blackstone Acquisition does not occur and that Host does not become a REIT until January 1, 2000. 35
COMPANY PRO FORMA HOST REIT PRO FORMA ------------------------------------------ ------------------------------------------ SINGLE SINGLE PARTNERSHIP REIT 2000 PARTNERSHIP REIT 2000 100% PARTICIPATION PARTICIPATION WITH 100% PARTICIPATION PARTICIPATION WITH WITH NO NOTES WITH NO NOTES NO NOTES WITH NO NOTES WITH NO NOTES NO NOTES HOST ISSUED ISSUED ISSUED(1) ISSUED ISSUED ISSUED(1) HISTORICAL ------------------ ------------- --------- ------------------ ------------- --------- ---------- BALANCE SHEET DATA: Property and equipment, net.................... $7,026 $6,504 $5,576 $7,026 $6,504 $5,576 $5,698 Total assets........... 8,082 7,610 6,826 8,082 7,610 6,826 6,765 Debt, excluding convertible debt....... 5,025 4,723 4,425 5,025 4,723 4,425 3,784 Convertible debt ...... 567 567 567 -- -- -- -- Total liabilities...... 6,664 6,415 6,033 6,460 6,076 5,724 4,917 Convertible Preferred Securities............. -- -- -- 550 550 550 550 Limited Partner interests of third parties at redemption value.................. 989 712 333 -- -- -- -- Equity................. 429 483 460 1,072 984 552 1,298 RISK FACTORS In considering whether to approve a Merger, Limited Partners should consider carefully, among other factors, the material risks described below. RISKS AND EFFECTS OF THE MERGERS CONFLICTS OF INTEREST. The Mergers, the REIT Conversion and the recommendations of the General Partners involve conflicts of interest because of the relationships among Host, Host REIT, the Operating Partnership, the General Partners and Crestline. SUBSTANTIAL BENEFITS TO RELATED PARTIES. To the extent that the anticipated benefits of the REIT Conversion are reflected in the value of Host's common stock prior to the Effective Date, such benefits will not be shared with the Limited Partners. In addition, following the REIT Conversion, current Host shareholders (together with the Blackstone Entities), but not the Limited Partners, will own the common stock of Crestline and will benefit from the terms of the Leases to the extent net revenues exceed rental payments and other expenses. The Mergers will facilitate the consummation, and enable Host to reap the full benefits, of the REIT Conversion. By converting to a REIT, Host expects to benefit from the advantages enjoyed by REITs in raising capital and acquiring additional assets, participating in a larger group of comparable companies and increasing its potential base of shareholders. Also, Host will realize significant savings through the substantial reduction of its future corporate-level income taxes. The benefits to Host of the REIT Conversion will be reduced if one or more of the Partnerships do not participate in a Merger, thereby creating a conflict of interest for the General Partners in connection with the Mergers. AFFILIATED GENERAL PARTNERS. Host has varying interests in each of the Partnerships and subsidiaries of Host act as General Partner of each of the Partnerships (except for PHLP, in which Host is the General Partner). Each General Partner has an independent obligation to assess whether the Merger is fair and equitable to and advisable for the Limited Partners of its Partnership. This assessment involves considerations that are different from those relevant to the determination of whether the Mergers and the REIT Conversion are advisable for Host and its shareholders. The considerations relevant to that determination which create a conflict of interest include Host's belief that the REIT Conversion is advisable for its shareholders, the benefits of the REIT Conversion to Host will be greater if the Partnerships participate and Host REIT will benefit if the value of the OP Units received by the Limited Partners in the Mergers is less than the value of their Partnership Interests. While each General Partner has sought faithfully to discharge its obligations to its Partnership, there is an inherent conflict of interest in having the General Partners determine the terms on which the Operating Partnership, which is controlled by Host, will acquire the Partnerships, for which Host or its subsidiaries are the General Partners, since no arm's length negotiations are possible because Host is on both sides of the transaction. LEASING ARRANGEMENTS. Conflicts of interest exist in connection with establishing the terms of the leasing arrangements being entered into as part of the REIT Conversion. The General Partners, all of which are subsidiaries of Host (except in the case of PHLP, in which Host is the General Partner), are recommending the Mergers, and Host is responsible for establishing the terms of the Mergers and the REIT Conversion, including the Leases. The common stock of Crestline will be distributed to Host's or Host REIT's shareholders and the Blackstone Entities. Accordingly, Host's or Host REIT's shareholders and the Blackstone Entities, as the initial shareholders of Crestline, will potentially benefit from the terms of the Leases to the extent net revenues exceed rental payments and other expenses but Limited Partners will not because they will not receive shares of Crestline common stock. POTENTIAL AAA CONFLICTS. A conflict of interest may exist in that AAA has been retained to perform the Appraisals and also provide the Fairness Opinion which, among other things, opines as to the methodologies and underlying assumptions that AAA used in performing the Appraisals. AAA has been retained by the General Partners (consisting of Host and its subsidiaries) to determine the Appraised Values of the Hotels and the Continuation Values of the Partnerships and to render the Fairness Opinion. Host has previously retained AAA to perform appraisals and render fairness and solvency opinions in connection 36 with other transactions, and there is the possibility that Host REIT and the Operating Partnership will retain AAA to perform similar tasks in the future. DIFFERENT TAX CONSEQUENCES UPON SALE OR REFINANCING OF CERTAIN HOTELS. Certain holders of OP Units may experience different and more adverse tax consequences compared to those experienced by other holders of OP Units or by holders of Common Shares upon the sale of, or the reduction of indebtedness on, any of the Hotels. Therefore, such holders, including Host REIT and its subsidiaries, may have different objectives regarding the appropriate pricing and timing of any sale or refinancing of an individual Hotel. As provided in the Partnership Agreement, Host REIT, as general partner of the Operating Partnership, is not required to take into account the tax consequences to the limited partners in deciding whether to cause the Operating Partnership to undertake specific transactions (but the Operating Partnership is obligated to pay any taxes Host REIT incurs as a result of such transactions) and the limited partners have no right to approve or disapprove such transactions. PARTNERSHIP AGREEMENT. Conflicts of interest exist in connection with establishing the terms of the Partnership Agreement, including provisions which benefit Host REIT, all of which were determined by Host. RELATIONSHIPS WITH MARRIOTT INTERNATIONAL AND CRESTLINE. Marriott International currently serves as manager for all but 16 of Host's Hotels, and will continue to manage those Hotels pursuant to the Management Agreements that will be assigned to the Lessees. In addition, Marriott International acts as manager of hotels that will compete with Host REIT's Hotels. As a result, Marriott International may make decisions regarding competing lodging facilities which it manages that would not necessarily be in the best interests of Host REIT or the Lessees. Further, J.W. Marriott, Jr. and Richard E. Marriott, who are brothers, currently serve as directors of Host and directors (and, in the case of J.W. Marriott, Jr., also an officer ) of Marriott International. After the REIT Conversion, J.W. Marriott, Jr. will serve as a director of Host REIT and will continue to serve as a director of Marriott International, and Richard E. Marriott will serve as Chairman of the Board of Host REIT and continue to serve as a director of Marriott International. J.W. Marriott, Jr. and Richard E. Marriott also beneficially own (as determined for securities law purposes) approximately 10.6% and 10.2%, respectively, of the outstanding shares of common stock of Marriott International, and will beneficially own approximately 5.32% and 5.30%, respectively, of the outstanding shares of common stock of Crestline (but neither will serve as an officer or director thereof). As a result, J.W. Marriott, Jr. and Richard E. Marriott may have a potential conflict of interest with respect to their obligations as directors of Host REIT in connection with any decisions regarding Marriott International itself (including decisions relating to the Management Agreements involving the Hotels), Marriott International's management of competing lodging properties and Crestline's leasing and other businesses that would not necessarily be in the best interests of Host REIT. These conflicts of interest could result in decisions that do not fully reflect the interests of all Limited Partners. For a discussion of the Operating Partnership's policies and agreements designed to minimize any adverse effects from future conflicts of interest, see "Distribution and Other Policies--Conflicts of Interest Policies." ABSENCE OF ARM'S LENGTH NEGOTIATIONS; NO INDEPENDENT REPRESENTATIVE. No independent representative was retained to negotiate on behalf of the Limited Partners. AAA, which performed the Appraisals and rendered the Fairness Opinion, has not negotiated with the General Partners or Host and has not participated in establishing the terms of the Mergers. Consequently, the terms and conditions of the Mergers may have been more favorable to the Limited Partners if such terms and conditions were the result of arm's length negotiations. In this regard, the Fairness Opinion specifically does not conclude that other methodologies for determining the Exchange Values of the Partnerships and/or the value of the OP Units might not have been more favorable to the Limited Partners. EXCHANGE VALUE MAY NOT EQUAL FAIR MARKET VALUE OF THE PARTNERSHIPS' HOTELS. Each Limited Partner of a Participating Partnership who retains OP Units or elects to exchange OP Units for Common Shares will receive consideration with a deemed value equal to the Exchange Value of such Limited Partner's Partnership 37 Interest. The determination of the Exchange Value of each Partnership involves numerous estimates and assumptions. There is no assurance that the Exchange Value of a Partnership will equal the fair market value of the Hotels and other assets contributed by such Partnership. See "Determination of Exchange Values and Allocation of OP Units." ALLOCATION OF OP UNITS TO HOST REIT IS DIFFERENT FROM ALLOCATION OF OP UNITS TO THE PARTNERSHIPS. Following the REIT Conversion, Host REIT will own a number of OP Units equal to the number of shares of Host common stock outstanding on the Effective Date (including the OP Units to be received by the General Partners and Host subsidiaries in the Mergers and the OP Units to be acquired from the Limited Partners who elect to receive Common Shares in connection with the Mergers) and, if Host has outstanding shares of preferred stock at the time of the REIT Conversion, a corresponding number of preferred partnership interests in the Operating Partnership. Host REIT's OP Units, in the aggregate, should fairly represent the market value of Host REIT but may not be equal to the fair market or net asset value of the Hotels and other assets that Host will contribute to the Operating Partnership. The Partnerships will receive OP Units in the Mergers with a deemed value equal to the Exchange Value of such Partnership. The different methods of allocating OP Units to Host REIT and the Partnerships may result in Limited Partners not receiving the fair market value of their Partnership Interests and Host REIT receiving a higher percentage of the interests in the Operating Partnership. See "Determination of Exchange Values and Allocation of OP Units." ALLOCATIONS OF OP UNITS TO THE BLACKSTONE ENTITIES AND THE PRIVATE PARTNERSHIPS WERE NOT DETERMINED BY THE EXCHANGE VALUE METHODOLOGIES. The price and other terms of the acquisitions of certain Private Partnerships and the Blackstone Acquisition (and thus the allocation of OP Units resulting therefrom) were determined by arm's length negotiations. The assets to be acquired in the Blackstone Acquisition did not generate, in the aggregate, pro forma net income for 1997 or the First Two Quarters 1998. If the partners' interests in the Private Partnerships and the assets of the Blackstone Entities had been valued by the same methodologies used to determine the Exchange Values in the Mergers, the value of the OP Units to be allocated to such partners or the Blackstone Entities may have been less than they actually will receive. The different methods of allocating OP Units may result in the Limited Partners receiving relatively less for their Partnership Interests than the partners in the Private Partnerships and the Blackstone Entities. PRICE OF OP UNITS OR COMMON SHARES MIGHT BE LESS THAN THE FAIR MARKET VALUE OF THE PARTNERSHIP INTERESTS. The price of an OP Unit for purposes of the Mergers will be equal to the average closing price on the NYSE of a Host REIT Common Share for the first 20 trading days after the Effective Date of the Mergers (but it will not be less than $9.50 or greater than $15.50 per OP Unit). This pricing mechanism has the effect of fixing the minimum and maximum number of OP Units to be issued in the Mergers. It is likely that, either initially or over time, the value of the publicly traded Common Shares of Host REIT (and therefore the value of the OP Units) will diverge from the deemed value of the OP Units used for purposes of the Mergers. This could result in the Limited Partners receiving OP Units or Common Shares with an actual value that is less than either the price of the OP Units for purposes of the Mergers or the fair market value of their Partnership Interests. INABILITY OF LIMITED PARTNERS WHO RETAIN OP UNITS TO REDEEM OP UNITS FOR ONE YEAR. Limited Partners who retain OP Units received in the Mergers will be unable to redeem such OP Units for one year following the Mergers. Until then, Limited Partners will bear the risk of illiquidity and of not being able to sell in a falling market. VALUE OF THE NOTES WILL BE LESS THAN THE EXCHANGE VALUE. In exchange for OP Units received in a Merger, each Limited Partner may elect to receive an unsecured, seven-year Note of the Operating Partnership with a principal amount equal to the Note Election Amount of his Partnership Interest. The determination of the Note Election Amount is based upon numerous assumptions and estimates. The deemed value of the OP Units will exceed the principal amount of the corresponding Notes in all Partnerships (because the Exchange Values will be higher than the Note Election Amounts) and there is no assurance that the Note a Limited Partner receives will have a value equal to either (i) the fair market value of the Limited Partner's share of the Hotels and other 38 assets owned by his Partnership or (ii) the principal amount of the Notes. There will be no public market for the Notes. If the Notes are sold, they may sell at prices substantially below their issuance price. Noteholders are likely to receive the full principal amount of a Note only if they hold the Note to maturity, which is December 15, 2005, or if the Operating Partnership repays the Notes prior to maturity. Because the Notes are unsecured obligations of the Operating Partnership, they will be effectively subordinated to all secured debt of the Operating Partnership and all obligations of both the Participating Partnerships and the Operating Partnership's other subsidiaries. See "Description of the Notes." As of June 19, 1998, on a pro forma basis assuming the Full Participation Scenario, the Operating Partnership would have had aggregate consolidated debt of approximately $5.6 billion (including $567 million of debentures related to the Convertible Preferred Securities) to which the Notes were effectively subordinated or which ranks equally with such Notes. CASH DISTRIBUTIONS MAY EXCEED CASH AVAILABLE FOR DISTRIBUTION; REDUCED CASH DISTRIBUTIONS FOR CERTAIN LIMITED PARTNERS. Distributions will be made at the discretion of Host REIT's Board of Directors and will be affected by a number of factors, including the rental payments received by the Operating Partnership from the Lessees with respect to the Leases of the Hotels, the operating expenses of the Operating Partnership, the level of borrowings and interest expense incurred in borrowing, the Operating Partnership's financial condition and cash available for distribution, the taxable income of Host REIT and the Operating Partnership, the effects of acquisitions and dispositions of assets, unanticipated capital expenditures and distributions required to be made on any preferred units issued by the Operating Partnership. To the extent that cash available for distribution (generally cash from operations less capital expenditures and principal amortization of indebtedness) is insufficient to pay distributions in accordance with the Operating Partnership's distribution policy or to maintain the REIT qualification of Host REIT, the Operating Partnership intends to borrow to make such distributions. The preliminary estimated initial annual cash distributions of the Operating Partnership during the twelve months ending December 31, 1999 ($226 million) will exceed its estimated cash available for distribution ($163 million) and cash from contingent rents ($54 million) during the twelve months ending December 31, 1999 (totaling $217 million), which would require borrowings of approximately $9 million (or $0.04 per OP Unit) to make such distributions in accordance with the Operating Partnership's distribution policy. Moreover, if estimated cash from contingent rents were less than $54 million, then the Operating Partnership also would be required to borrow any such shortfall in order to make such distributions. Actual results may vary substantially from the estimates and no assurance can be given that the Operating Partnership's estimates will prove accurate or that any level of distributions will be made or sustained. In addition, the estimated initial annual cash distributions of the Operating Partnership or Host REIT to the Limited Partners of MHP and MHP2 per Partnership Unit ($7,645 and $12,862, respectively) will be less than the estimated cash distributions from operations of MHP and MHP2 per Partnership Unit ($16,000 and $27,164, respectively) during 1998. TIMING OF THE REIT CONVERSION. Host currently expects to complete the REIT Conversion during 1998, which would permit Host REIT to qualify as a REIT for its 1999 taxable year, but it is not a condition to the Mergers that the REIT Conversion be completed in time for Host REIT to elect REIT status effective January 1, 1999. If the REIT Conversion does not occur in time for Host REIT to elect REIT status effective January 1, 1999, the effectiveness of Host REIT's election could be delayed until January 1, 2000, which would result in Host REIT continuing to pay substantial corporate-level income taxes in 1999 (which would reduce Host REIT's cash distributions per Common Share during 1999 to $0.52 per Common Share but not the Operating Partnership's estimated cash distributions of $0.84 per OP Unit) and could cause the Blackstone Acquisition not to be consummated. In view of the complexity of the REIT Conversion and the number of transactions that must occur to complete the REIT Conversion, Host and the General Partners believe that it is beneficial both to the Limited Partners and the shareholders of Host to complete the REIT Conversion as soon as practicable, even if the REIT Conversion cannot be completed prior to January 1, 1999. If Host REIT's election to be taxed as a REIT is not effective on January 1, 1999, Host REIT intends to operate following the REIT Conversion in a manner that would permit it to qualify as a REIT at the earliest time practicable, and it might pursue a merger with another entity or other transaction that would permit it to commence a new taxable year and elect REIT status prior to January 1, 2000. Host REIT in any event would elect to be treated as a REIT for federal income tax purposes no later than its taxable year commencing January 1, 2000. It is a condition to the Mergers that 39 they be completed by June 30, 1999, unless the General Partners and the Operating Partnership mutually agree to extend that deadline to a date no later than December 31, 1999. CHANGES IN THE FAIRNESS OPINION. The Fairness Opinion will be updated by AAA only if so requested by the Operating Partnership. If no such request is made, changes may occur from the date of the Fairness Opinion to the Effective Date of the Mergers that might affect the conclusions expressed in the Fairness Opinion, some of which could be material. FUNDAMENTAL CHANGE IN THE NATURE OF INVESTMENT; POTENTIAL UNDERPERFORMANCE. The Mergers and the REIT Conversion involve a fundamental change in the nature of a Limited Partner's investment from holding an interest in one or more Partnerships, some of which were structured as tax shelter or tax credit investments, and each of which is a finite-life entity that expires between the years 2063 and 2106, own only one or a fixed portfolio of (or controlling interests in) Hotels and distribute the cash flow from the operation of such Hotels to its partners, to holding a direct or indirect interest in the Operating Partnership, an ongoing real estate company, that (i) is expected to initially own interests in up to approximately 125 Hotels, (ii) will distribute to its partners the rents received from the Lessees (which will operate the Hotels and bear the risks and receive the direct benefits of the Hotels), (iii) has the ability to acquire additional hotels (including hotels with additional brands) and (iv) will be able to reinvest proceeds from sales or refinancings of existing Hotels in additional hotels. Those Limited Partners who elect to receive Common Shares in connection with the Mergers will hold an equity interest in a publicly traded REIT that (i) provides immediate liquidity, (ii) intends to make distributions to its shareholders in an amount equal to at least 95% of its taxable income, (iii) allows shareholders to influence management by participation in the election of directors and (iv) realizes substantial corporate tax savings as long as certain requirements are met. In addition, the Operating Partnership does not anticipate that it will distribute to its limited partners the proceeds from properties that are sold or refinancings, but instead generally will reinvest such proceeds to repay indebtedness, acquire additional existing properties, develop new properties or fund capital expenditure or other working-capital needs. Thus, in contrast to an investment in the Partnerships, Limited Partners who retain OP Units will not be able to realize a return of capital through distributions of sale and refinancing proceeds. Instead, Limited Partners will be able to realize a return of capital primarily through the exercise of their Unit Redemption Right, thereby receiving cash or, if the OP Units are redeemed for Common Shares, by selling the Common Shares received as a result thereof. A Limited Partner's share of the liquidation proceeds, if any, from the sale of a Partnership's Hotel or Hotels could be higher than the amount realized upon exercise of the Unit Redemption Right, the sale of Common Shares received in connection with the Mergers or payments on any Note received by a Limited Partner in connection with the Mergers. An investment in the Operating Partnership or Host REIT may not outperform an investment in any individual Partnership. See "Comparison of Ownership of Partnership Interests, OP Units and Common Shares." EXPOSURE TO MARKET AND ECONOMIC CONDITIONS OF OTHER HOTELS. As a result of the Mergers, Limited Partners in Participating Partnerships who retain OP Units or elect to receive Common Shares in connection with the Mergers will own interests in a much larger enterprise with a broader range of assets than any of the Partnerships individually. A material adverse change affecting the Operating Partnership's assets will affect all Limited Partners regardless of whether a particular Limited Partner previously was an investor in such affected assets. Each Partnership owns discrete assets, and the Mergers and the REIT Conversion will significantly diversify the types and geographic locations of the Hotels in which the Limited Partners will have interests. As a result, the Hotels owned by the Operating Partnership may be affected differently by economic and market conditions than those Hotel(s) previously owned by an individual Partnership. LIMITED PARTNERS HAVE NO CASH APPRAISAL RIGHTS. Limited Partners of Participating Partnerships who vote against the Merger will not have a right to receive cash based upon an appraisal of their Partnership Interests. UNCERTAINTIES AS TO THE SIZE AND LEVERAGE OF THE OPERATING PARTNERSHIP. The Limited Partners cannot know at the time they vote on a Merger the exact size and amount of leverage of the Operating Partnership. Host 40 is an existing operating company that regularly issues and repays debt, acquires additional hotels and disposes of existing hotels. Also, some or all of the Partnerships may elect not to participate in a Merger. In addition, outside partners in certain Private Partnerships may not consent to a lease of their partnership's Hotel(s). In either such case, Host will contribute its interests in such Partnerships and Private Partnerships to the Operating Partnership but the Operating Partnership may contribute such interests to a Non-Controlled Subsidiary, which will be subject to corporate-level income taxation. Host also may repurchase outstanding securities or issue new debt or equity securities prior to the consummation of the Mergers and the REIT Conversion. OTHER UNCERTAINTIES AT THE TIME OF VOTING INCLUDE NUMBER OF OP UNITS TO BE RECEIVED. There are several other uncertainties at the time the Limited Partners must vote on the Mergers, including (i) the exact Exchange Value for each Partnership (which will be adjusted for changes in lender and capital expenditure reserves, deferred maintenance and other items prior to the Effective Date), (ii) the price of the OP Units for purposes of the Mergers, which will be determined by reference to the post-Merger trading prices of Host REIT's Common Shares (but will not be less than $9.50 or greater than $15.50) and which, together with the Exchange Value, will determine the number of OP Units (or Common Shares) the Limited Partners of each Participating Partnership will receive and (iii) the exact principal amount of the Notes that may be received in exchange for OP Units, which cannot be known until after the Note Election Amount has been determined. For these reasons, the Limited Partners cannot know at the time they vote on a Merger these important aspects of the Merger and they will not know the number of OP Units received in a Merger until approximately 25 trading days after the Merger. LACK OF CONTROL OVER HOTEL OPERATIONS. Due to current federal income tax law restrictions on a REIT's ability to derive revenues directly from the operation of a hotel, the Operating Partnership will lease virtually all of its consolidated Hotels to the Lessees, which will operate the Hotels by continuing to retain the Managers pursuant to the Management Agreements. The Operating Partnership will not operate the Hotels or participate in the decisions affecting the daily operations of the Hotels. The Operating Partnership will have only limited ability to require the Lessees or the Managers to operate or manage the Hotels in any particular manner and no ability to govern any particular aspect of their day-to-day operation or management. Even if Host REIT's management believes the Lessees or the Managers are operating or managing the Hotels inefficiently or in a manner that does not result in the maximization of rental payments to the Operating Partnership under the Leases, the Operating Partnership has only a limited ability to require the Lessees or the Managers to change their method of operation or management. Therefore, the Operating Partnership will be dependent for its revenue upon the ability of the Lessees and the Managers to operate and manage the Hotels. The Operating Partnership is limited to seeking redress only if the Lessees violate the terms of the Leases and then only to the extent of the remedies set forth therein. Remedies under the Leases include the Operating Partnership's ability to terminate a Lease upon certain events of default such as the Lessee's failure to pay rent or failure to maintain certain net worth requirements and breaches of other specified obligations under the Leases. See "Business and Properties--The Leases." Termination of a Lease, however, could impair Host REIT's ability to qualify as a REIT for federal income tax purposes unless another suitable lessee could be found. LACK OF CONTROL OVER NON-CONTROLLED SUBSIDIARIES. The Non-Controlled Subsidiaries will hold various assets (not exceeding, in the aggregate, 20% by value of the assets of the Operating Partnership), consisting primarily of interests in hotels which are not leased, certain furniture, fixtures and equipment used in the Hotels and certain international hotels. The direct ownership or control of most of these assets by the Operating Partnership could jeopardize Host REIT's status as a REIT. Although the Operating Partnership will own 95% of the total economic interests of the Non-Controlled Subsidiaries, the Host Employee Trust and possibly certain other investors will own all of the voting common stock of the Non-Controlled Subsidiaries (which will represent the remaining 5% of the total economic interest thereof). As the owner of the voting stock of the Non-Controlled Subsidiaries, the Host Employee Trust and possibly certain other investors will select the directors of the Non-Controlled Subsidiaries, who will be responsible for overseeing the operations of those entities. As a result, the Operating Partnership will have no control over the operation or management of the hotels or other assets owned by the Non-Controlled Subsidiaries even though it will depend upon the Non-Controlled Subsidiaries for a significant portion of 41 its revenues (and the activities of the Non-Controlled Subsidiaries could cause the Operating Partnership to be in default under its principal debt facilities). DEPENDENCE OF THE OPERATING PARTNERSHIP UPON CRESTLINE. Crestline and its subsidiaries will be the Lessees of substantially all of the Hotels and their rent payments will be the primary source of the Operating Partnership's revenues. Crestline's financial condition and ability to meet its obligations under the Leases will determine the Operating Partnership's ability to make distributions to its partners (including Host REIT) and Host REIT's ability, in turn, to make distributions to its shareholders. As of June 19, 1998, on a pro forma basis, after giving effect to the REIT Conversion, Crestline would have had approximately $315 million of indebtedness (including $100 million due to Host REIT to pay for hotel working capital purchased from Host REIT but not including guarantees of obligations of Crestline's subsidiaries under the Leases and the Management Agreements) and Crestline can incur additional indebtedness in the future. There can be no assurance that Crestline will have sufficient assets, income and access to financing to enable it to satisfy its obligations under the Leases. In addition, the credit rating of the Operating Partnership and Host REIT will be affected by the general creditworthiness of Crestline. EXPIRATION OF THE LEASES AND POSSIBLE INABILITY TO FIND OTHER LESSEES. The Leases generally will expire seven to ten years after the Effective Date, and there can be no assurance that the affected Hotels will be relet to the Lessees (or if relet, will be relet on terms as favorable to the Operating Partnership). If the Hotels are not relet to the Lessees, the Operating Partnership will be required to find other lessees, which lessees must meet certain requirements set forth in the Management Agreements and the Code. There can be no assurance that satisfactory lessees could be found or as to the terms and conditions on which the Operating Partnership would be able to relet the Hotels or enter into new leases with such lessees, which could result in a failure of Host REIT to qualify as a REIT or in reduced cash available for distribution. REQUISITE VOTE OF LIMITED PARTNERS OF PARTNERSHIPS BINDS ALL LIMITED PARTNERS. For each Partnership, approval of a Merger and the related amendments to its partnership agreement by the requisite vote of the Limited Partners, as described in "Voting Procedures--Required Limited Partner Vote and Other Conditions," will cause the Partnership to participate in the Merger and will bind all Limited Partners of such Partnership, including Limited Partners who voted against or abstained from voting with respect to the Merger and the related amendments to its partnership agreement. INABILITY TO OBTAIN THIRD-PARTY CONSENTS MAY HAVE A MATERIAL ADVERSE EFFECT. There are numerous third-party consents which are required to be obtained in order to consummate the Mergers and the REIT Conversion. These include consents of many hotel project lenders, ground lessors, joint venture partners, Marriott International and others. The inability of Host, the Operating Partnership or Host REIT to obtain one or more such consents could cause a default under the cross-default provisions of the Company's principal credit facilities. Although the Operating Partnership will not consummate any Merger or the REIT Conversion unless it believes that the inability of Host, the Operating Partnership or Host REIT to obtain one or more consents would not reasonably be expected to have a material adverse effect on the Company's business, financial condition or results of operations, there can be no assurance that such a material adverse effect will not occur, which could reduce the value of the OP Units and Common Shares. SUBSTANTIAL INDEBTEDNESS OF THE OPERATING PARTNERSHIP. The Operating Partnership will have substantial indebtedness. As of June 19, 1998, on a pro forma basis assuming the Full Participation Scenario, the Operating Partnership had outstanding indebtedness totaling approximately $5.6 billion (including $567 million of debentures relating to the Convertible Preferred Securities), which represents an approximately 62% debt-to-total market capitalization ratio on a pro forma basis at such date (based upon a price per Common Share of Host REIT of $12.50). The Operating Partnership's business is capital intensive and it will have significant capital requirements in the future. The Operating Partnership's leverage level could affect its ability to (i) obtain financing in the future, (ii) undertake refinancings on terms and subject to conditions deemed acceptable by the Operating Partnership, (iii) make distributions to partners (including Host REIT), (iv) pursue its acquisition strategy or (v) compete effectively or operate successfully under adverse economic conditions. In the event that 42 the Operating Partnership's cash flow and working capital are not sufficient to fund the Operating Partnership's expenditures or to service its indebtedness, the Operating Partnership would be required to raise additional funds through capital contributions, the refinancing of all or part of its indebtedness, the incurrence of additional permitted indebtedness or the sale of assets. There can be no assurance that any of these sources of funds would be available, if at all, in amounts sufficient for the Operating Partnership to meet its obligations. Moreover, even if the Operating Partnership were able to meet its obligations, its leveraged capital structure could significantly limit its ability to finance its acquisition program and other capital expenditures, to compete effectively or to operate successfully, especially under adverse economic conditions. NO LIMITATION ON DEBT. Host REIT will have a policy of incurring debt only if, immediately following such incurrence, its debt-to-total market capitalization ratio on a pro forma basis would be 60% or less. However, there are no limitations in Host REIT's or the Operating Partnership's organizational documents that limit the amount of indebtedness that either entity may incur, although both the Notes and the Operating Partnership's other debt instruments will contain certain restrictions on the amount of indebtedness that the Operating Partnership may incur. Accordingly, the Board of Directors could alter or eliminate this policy from time to time to the extent permitted by its debt agreements. If this policy were changed, the Operating Partnership could become more highly leveraged, resulting in an increase in debt service payments that could adversely affect the Operating Partnership's cash flow and, consequently, the cash available for distribution to holders of OP Units and Common Shares and could increase the risk of default on the Operating Partnership's indebtedness. INDIVIDUAL ASSETS MAY OUTPERFORM THE OPERATING PARTNERSHIP'S PORTFOLIO. If consummated as contemplated, the Mergers and the REIT Conversion will combine into a single entity all of the assets and liabilities associated with the Participating Partnerships, the Private Partnerships and Host, as well as the Blackstone Hotels. Assets of certain Participating Partnerships may, over time, outperform the OP Units, which represent undivided interests in all of the assets of the Operating Partnership. Although the Exchange Values of the Participating Partnerships will be determined in part by the estimated future cash flows of such Partnerships, Limited Partners of a Participating Partnership that would outperform the Operating Partnership if allowed to continue as a separate entity will nonetheless receive the same rate of return per OP Unit as the rest of the limited partners of the Operating Partnership. In addition, the return that such Limited Partners receive on their investment in the Operating Partnership could be lower than the return that their Partnership would have provided if it had not participated in the Merger. LEASES COULD IMPAIR THE SALE OR OTHER DISPOSITION OF THE OPERATING PARTNERSHIP'S HOTELS. Each Lease generally provides for a termination payment if the Lease is terminated by the Operating Partnership prior to the expiration of the term of such Lease (including due to a change in the federal income tax laws that allows the Operating Partnership to operate the Hotels without jeopardizing Host REIT's status as a REIT), except following a default by a Lessee and in certain other circumstances (including in connection with the sale of up to 12 Hotels without a termination payment) or unless the Operating Partnership leases to the Lessee a comparable substitute hotel. The termination fee is equal to the fair market value of the Lessee's leasehold interest in the remaining term of the Lease. The payment of such termination fee under the Leases could have the effect of impairing the ability of the Operating Partnership to sell its Hotels if market conditions otherwise warrant such a sale and would reduce the net proceeds of any such sale. See "Business and Properties--The Leases--Termination of Leases upon Disposition of Hotels." MANAGEMENT AGREEMENTS COULD IMPAIR THE SALE OR OTHER DISPOSITION OF THE OPERATING PARTNERSHIP'S HOTELS. Marriott International serves as the manager for all but 16 of the Operating Partnership's Hotels and provides various other services to Host and its subsidiaries. Although the Lessees will have primary liability under the Management Agreements as long as the Leases are in effect, the Operating Partnership will remain liable thereunder. The Hotels generally may not be sold or otherwise transferred unless the transferee assumes the Management Agreements relating thereto and meets certain other conditions. The possible desire of the Operating Partnership, from time to time, to finance, refinance or effect a sale of any of the properties managed by Marriott International or another manager may, depending upon the structure of such transactions, result in a need to modify the Management Agreements with Marriott International or such other manager with respect to 43 such property. Any such modification proposed by the Operating Partnership may not be acceptable to Marriott International or such other manager, and the lack of consent from Marriott International or such other manager could adversely affect the Operating Partnership's ability to consummate such financing, refinancing or sale. In addition, certain situations could arise where actions taken by Marriott International or another manager in its capacity as manager of competing lodging properties would not necessarily be in the best interests of the Operating Partnership. Nevertheless, the Operating Partnership believes that there is sufficient mutuality of interest between the Operating Partnership and Marriott International or another manager to result in a mutually productive relationship. NO CONTROL OVER MAJOR DECISIONS. Currently, Limited Partners of the Partnerships generally have the right to vote on certain major transactions, such as (i) a sale of all or substantially all of a Partnership's assets, (ii) a merger or consolidation of a Partnership with another entity, (iii) incurrence of certain types and amounts of debt, (iv) amendments to the partnership agreement or (v) removal of the General Partner, although all such matters (except removal of the General Partner) also require the approval of the General Partner. In contrast, limited partners of the Operating Partnership generally will have no voting rights as to management (including a change in control of management), debt financing (including reduction of mortgage indebtedness, except in certain limited circumstances), sale or other disposition of one or more Hotels (except with respect to a sale of all or substantially all of the Hotels, although Host REIT's percentage interest in the Operating Partnership and its ability to vote such interests give it the ability to determine the outcome of that vote) or removal of Host REIT as general partner of the Operating Partnership. See "Description of OP Units-- Removal or Withdrawal of Host REIT; Transfer of Host REIT's Interests," "-- Borrowing by the Operating Partnership" and "--Sales of Assets." However, limited partners of the Operating Partnership will have certain voting rights during the first year following the Mergers. See "Description of OP Units-- Certain Voting Rights of Holders of OP Units During the First Year Following the Mergers." After the REIT Conversion, substantially all actions taken by the Operating Partnership will be based upon decisions made by the management and Board of Directors (as constituted from time to time) of Host REIT, in its absolute discretion, as the sole general partner of the Operating Partnership. FOREGOING POTENTIAL BENEFITS OF ALTERNATIVES TO THE REIT CONVERSION. The alternatives to participation in the REIT Conversion through a Merger include continuation of a Partnership, sale of the Partnership's assets and liquidation, reorganization as a separate REIT or merger of the Partnership with an existing REIT or UPREIT. Continuation of a Partnership in accordance with its existing business plan would not subject the Partnership to the risks associated with a Merger or change the Limited Partners' voting rights or the policy governing their cash distributions. Liquidation of a Partnership would allow Limited Partners to receive the net proceeds from the sale of the Partnership's assets and would permit valuation of the Partnership's assets through negotiations with prospective purchasers (in many cases unrelated third parties), making it unnecessary to rely upon other valuation methods to estimate fair market value. Such a sale and liquidation, however, would result in substantial taxable income for many Limited Partners at the time of liquidation. Reorganization of a Partnership as a separate REIT would allow certain Limited Partners to receive REIT shares immediately and achieve liquidity (but such REIT shares would represent an investment in a substantially smaller company with substantially fewer publicly held shares) and to continue their investment only in their existing Hotel(s) (although Limited Partners with negative capital accounts would be required to recognize gain to the extent thereof upon formation of the separate REIT). Merger of a Partnership with an existing REIT would give Limited Partners liquidity (or in the case of a merger with an UPREIT, tax deferral advantages) but would benefit Limited Partners more than the Mergers only if the consideration received had a value in excess of the value of the OP Units to be received in the Mergers. See "Background and Reasons for Mergers and the REIT Conversion-- Alternatives to the Mergers." NO PARTNER LIABILITY. The merger agreements pursuant to which subsidiaries of the Operating Partnership will merge with the Partnerships provide that the Operating Partnership will have no recourse against any of the partners in the Participating Partnerships in the event the Operating Partnership suffers a loss as the result of an inaccuracy in any representation or warranty made by the Partnership in such merger agreements. 44 DILUTION. While currently there are no specific proposals for the Operating Partnership to issue OP Units beyond those to be issued in the REIT Conversion and the Blackstone Acquisition, the Operating Partnership expects to pursue acquisitions of additional hotels. These acquisitions may be financed through the issuance of OP Units or other limited partnership interests directly to property owners or to Host REIT in exchange for cash. Any such OP Units or other limited partnership interests in the Operating Partnership may have certain preferences. Additional issuances of equity securities of Host REIT or OP Units in connection with acquisitions of additional hotels or offerings of securities for cash may occur in the discretion of Host REIT's Board of Directors, and would result in proportional reductions of the percentage ownership interests of the limited partners (or other holders of OP Units) of the Operating Partnership. See "Description of OP Units." RISKS OF OWNERSHIP OF OP UNITS AND COMMON SHARES INABILITY TO REMOVE HOST REIT AS GENERAL PARTNER OF THE OPERATING PARTNERSHIP. The Partnership Agreement provides that limited partners may not remove Host REIT as general partner of the Operating Partnership with or without cause (unless neither the general partner nor its parent entity is a "public company," in which case the general partner may be removed with or without cause by limited partners holding percentage interests in the Operating Partnership ("Percentage Interests") that are more than 50% of the aggregate Percentage Interests of the outstanding limited partnership interests entitled to vote thereon, including any such interests held by the general partner). The inability to remove Host REIT as general partner may not be in the best interests of the limited partners of the Operating Partnership. See "Description of OP Units--Removal or Withdrawal of Host REIT; Transfer of Host REIT's Interests." RESTRICTIONS ON TRANSFER OF OP UNITS. The Partnership Agreement contains restrictions on the ability of limited partners to transfer their OP Units, except in certain limited circumstances, without the prior written consent of Host REIT. See "Description of OP Units--Restrictions on Transfers of Interests by Limited Partners." LIMITATIONS ON ACQUISITION OF OP UNITS AND COMMON SHARES AND CHANGE IN CONTROL. Host REIT's Charter and Bylaws, the Partnership Agreement, the Shareholder Rights Plan (to be adopted by Host REIT to replace Host's existing shareholder rights plan) and Maryland law contain a number of provisions that could delay, defer or prevent a transaction or a change of control of Host REIT that might involve a premium price for holders of Common Shares or otherwise be in their best interests, including the following: OWNERSHIP LIMIT. The 9.8% ownership limit described under "--Possible Adverse Consequences of Limits on Ownership of Common Shares" below may have the effect of precluding a change in control of Host REIT by a third party without the consent of the Board of Directors, even if such change in control would be in the interest of the limited partners of the Operating Partnership or shareholders of Host REIT (and even if such change in control would not reasonably jeopardize the REIT status of Host REIT). STAGGERED BOARD. The Charter will provide that the Board of Directors initially shall consist of eight members and may be thereafter increased or decreased in accordance with the Bylaws of Host REIT, provided that the total number of directors may not be fewer than three nor more than 13. Pursuant to Host REIT's Bylaws, the number of directors shall be fixed by the Board of Directors within the limits set forth in the Charter. The Board of Directors of Host REIT will be divided into three classes of directors. The terms of the first, second and third classes will expire in 1999, 2000 and 2001, respectively. Directors for each class will be chosen for a three-year term upon the expiration of the then current class' term, beginning in 1999. The staggered terms for directors may affect the shareholders' ability to effect a change in control of Host REIT, even if a change in control would be in the interest of the limited partners of the Operating Partnership or shareholders of Host REIT. REMOVAL OF BOARD OF DIRECTORS. Host REIT's Charter will provide that, except for any directors who may be elected by holders of a class or series of shares of capital stock other than the Common Shares, directors may be removed only for cause and only by the affirmative vote of shareholders holding at least two-thirds of the shares then outstanding and entitled to be cast for the election of directors. Vacancies on the Board of Directors may be filled by the concurring vote of a majority of the remaining directors and, in 45 the case of a vacancy resulting from the removal of a director by the shareholders by at least two-thirds of all the votes entitled to be cast in the election of directors. PREFERRED SHARES; CLASSIFICATION OR RECLASSIFICATION OF UNISSUED SHARES OF CAPITAL STOCK WITHOUT SHAREHOLDER APPROVAL. Host REIT's Charter provides that the total number of shares of stock of all classes which Host REIT has authority to issue is 800,000,000 shares of stock, initially consisting of 750,000,000 Common Shares and 50,000,000 shares of preferred stock. The Board of Directors is authorized, without a vote of shareholders, to classify or reclassify any unissued shares of stock, including Common Shares into preferred shares or vice versa, and to establish the preferences and rights of any preferred or other class or series of shares to be issued. The issuance of preferred shares or other shares having special preferences or rights could have the effect of delaying or preventing a change in control of Host REIT even if a change in control would be in the interest of the shareholders of Host REIT or limited partners of the Operating Partnership. Because the Board of Directors will have the power to establish the preferences and rights of additional classes or series of shares without a shareholder vote, the Board of Directors may afford the holders of any such class or series preferences, powers and rights, including voting rights, senior to the rights of holders of the Common Shares. CONSENT RIGHTS OF THE LIMITED PARTNERS. Under the Partnership Agreement, Host REIT generally will be able to merge or consolidate with another entity with the consent of partners holding Percentage Interests that are more than 50% of the aggregate Percentage Interests of the outstanding partnership interests entitled to vote thereon (including any such partnership interests held by Host REIT) as long as the holders of OP Units either will receive or will have the right to receive the same consideration as the holders of Common Shares. Host REIT, as holder of a majority of the OP Units, would be able to control the outcome of such vote. Under the Charter, the approval of the holders of at least two-thirds of the outstanding Host REIT Common Shares generally is necessary to effectuate such merger or consolidation. MARYLAND BUSINESS COMBINATION LAW. Under the Maryland General Corporation Law (the "MGCL"), certain "business combinations" (including certain issuances of equity securities) between a Maryland corporation and any person who owns 10% or more of the voting power of the corporation's then outstanding shares (an "Interested Shareholder") or an affiliate of the Interested Shareholder are prohibited for five years after the most recent date in which the Interested Shareholder becomes an Interested Shareholder. Thereafter, any such business combination must be approved by a supermajority (80%) of outstanding voting shares, and by two-thirds of voting shares other than voting shares held by an Interested Shareholder unless, among other conditions, the corporation's common shareholders receive a minimum price (as defined in the MGCL) for their shares and the consideration is received in cash or in the same form as previously paid by the Interested Shareholder. Host REIT will be subject to the Maryland business combination statute. MARYLAND CONTROL SHARE ACQUISITION LAW. Under the MGCL, "control shares" acquired in a "control share acquisition" have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the matter, excluding shares owned by the acquiror and by officers or directors who are employees of the corporation. "Control shares" are voting shares which, if aggregated with all other such shares previously acquired by the acquiror or in respect of which the acquiror is able to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), would entitle the acquiror to exercise voting power in electing directors within one of the following ranges of voting power: (i) one-fifth or more but less than one-third, (ii) one-third or more but less than a majority or (iii) a majority or more of the voting power. Control shares do not include shares the acquiring person is then entitled to vote as a result of having previously obtained shareholder approval. A "control share acquisition" means the acquisition of control shares, subject to certain exceptions. Host REIT will be subject to these control share provisions of Maryland law. ADVANCE NOTICE OF DIRECTOR NOMINATIONS AND NEW BUSINESS. The Bylaws of Host REIT impose certain advance notice requirements that must be met for nominations of persons for election to the Board of Directors and the proposal of business to be considered by shareholders. The advance notice provisions contained in the Bylaws generally require nominations and new business proposals by shareholders to be 46 delivered to the Secretary of Host REIT not later than the close of business on the 60th day nor earlier than the close of business on the 90th day before the date on which Host REIT mailed its proxy materials for the prior year's annual meeting of shareholders. MEETINGS OF SHAREHOLDERS; CALL OF SPECIAL MEETINGS; SHAREHOLDER ACTION IN LIEU OF MEETING BY UNANIMOUS CONSENT. Host REIT's Bylaws provide that annual meetings of shareholders shall be held on a date and at the time set by the Board of Directors during the month of May each year (commencing in May 1999). Special meetings of the shareholders may be called by the President or the Board of Directors or on the written request of shareholders entitled to cast a majority of all the votes entitled to be cast at the meeting. Any action required or permitted to be taken by the shareholders must be effected at a duly called annual or special meeting of shareholders or by unanimous written consent. MERGER, CONSOLIDATION, SHARE EXCHANGE AND TRANSFER OF ASSETS OF HOST REIT. Pursuant to Host REIT's Charter, subject to the terms of any class or series of capital stock at the time outstanding, Host REIT may merge with or into another entity, may consolidate with one or more other entities, may participate in a share exchange or may transfer its assets within the meaning of the MGCL if approved (i) by the Board of Directors in the manner provided in the MGCL and (ii) by shareholders by the affirmative vote of two-thirds of all the votes entitled to be cast on the matter (except that any merger of Host REIT with or into a trust organized for the purpose of changing Host REIT's form of organization from a corporation to a trust will require the approval of shareholders of Host REIT by the affirmative vote only of a majority of all the votes entitled to be cast on the matter). Under the MGCL, certain mergers may be accomplished without a vote of shareholders and a share exchange need be approved by a Maryland successor only by its Board of Directors. A voluntary dissolution of Host REIT also would require the affirmative vote of two-thirds of all the votes entitled to be cast on the matter. AMENDMENTS TO HOST REIT'S CHARTER AND BYLAWS. The provisions contained in Host REIT's Charter relating to restrictions on transferability of the Common Shares, the classified Board and fixing the size of the Board within the range set forth in the Charter, as well as the provisions relating to removal of directors and the filling of Board vacancies may be amended only by a resolution adopted by the Board of Directors and approved by shareholders by the affirmative vote of the holders of not less than two- thirds of the votes entitled to be cast on the matter. As permitted under the MGCL, the Charter and Bylaws of Host REIT provide that directors have the exclusive right to amend the Bylaws. Amendments of this provision of the Charter also would require Board action and approval by two-thirds of all votes entitled to be cast on the matter. MARRIOTT INTERNATIONAL PURCHASE RIGHT. In connection with Host's spinoff of Marriott International in 1993, Marriott International obtained the right to purchase up to 20% of each class of Host's outstanding voting shares at the then fair market value upon the occurrence of certain change of control events involving Host (the "Marriott International Purchase Right"). The Marriott International Purchase Right will continue in effect after the Mergers (until June 2017), subject to certain limitations intended to protect the REIT status of Host REIT. The Marriott International Purchase Right may have the effect of discouraging a takeover of Host REIT, because any person considering acquiring a substantial or controlling block of Host REIT Common Shares will face the possibility that its ability to obtain or exercise control would be impaired or made more expensive by the exercise of the Marriott International Purchase Right. SHAREHOLDER RIGHTS PLAN. Host REIT intends to adopt a Shareholder Rights Plan to replace the existing Host shareholder rights plan. The new Shareholder Rights Plan is expected to provide, among other things, that upon the occurrence of certain events, shareholders will be entitled to purchase from Host REIT a newly created series of junior preferred shares, subject to Host REIT's Ownership Limit. The preferred share purchase rights will be triggered by the earlier to occur of (i) ten days following the date of a public announcement that a person or group acting in concert has acquired, or obtained the right to acquire, beneficial ownership of 20% or more of the outstanding Common Shares or (ii) ten business days following the commencement of or announcement of an intention to make a tender or exchange offer, the consummation of which would result in the acquiring person becoming the beneficial owner of 20% or more of such outstanding Common Shares. The preferred share purchase rights would cause substantial dilution 47 to a person or group that attempts to acquire Host REIT on terms not approved by the Board of Directors. See "Description of Capital Stock" and "Certain Provisions of Maryland Law and Host REIT's Charter and Bylaws." POSSIBLE ADVERSE CONSEQUENCES OF LIMITS ON OWNERSHIP OF COMMON SHARES. To maintain its qualification as a REIT for federal income tax purposes, not more than 50% in value of the outstanding shares of capital stock of Host REIT may be owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities). See "Federal Income Tax Consequences-- Federal Income Taxation of Host REIT Following the Mergers--Requirements for Qualification." In addition, a person who owns, directly or by attribution, 10% or more of an interest in a tenant of Host REIT (or a tenant of any partnership in which Host REIT is a partner) cannot own, directly or by attribution, 10% or more of the shares of Host REIT without jeopardizing Host REIT's qualification as a REIT. Primarily to facilitate maintenance of its qualification as a REIT for federal income tax purposes, the ownership limit under the Host REIT Charter will prohibit ownership, directly or by virtue of the attribution provisions of the Code, by any person or persons acting as a group of more than 9.8% of the issued and outstanding Common Shares (subject to an exception for Common Shares held prior to the REIT Conversion so long as the holder thereof would not own more than 9.9% in value of the outstanding shares of Host REIT) and will prohibit ownership, directly or by virtue of the attribution provisions of the Code, by any person or persons acting as a group of more than 9.8% of the issued and outstanding shares of any class or series of Host REIT's preferred shares (collectively, the "Ownership Limit"). The Board of Directors, in its sole and absolute discretion, may waive or modify the Ownership Limit with respect to one or more persons who would not be treated as "individuals" for purposes of the Code if it is satisfied, based upon information required to be provided by the party seeking the waiver and upon an opinion of counsel satisfactory to the Board of Directors, that ownership in excess of this limit will not cause a person who is an individual to be treated as owning shares in excess of the Ownership Limit, applying the applicable constructive ownership rules, and will not otherwise jeopardize Host REIT's status as a REIT for federal income tax purposes (for example, by causing any tenant of the Operating Partnership or any of the Hotel Partnerships (including, but not limited to, Crestline and the Lessees) to be considered a "related party tenant" for purposes of the REIT qualification rules). Common Shares acquired or held in violation of the Ownership Limit will be transferred automatically to a trust for the benefit of a designated charitable beneficiary, and the person who acquired such Common Shares in violation of the Ownership Limit will not be entitled to any distributions thereon, to vote such Common Shares or to receive any proceeds from the subsequent sale thereof in excess of the lesser of the price paid therefor or the amount realized from such sale. A transfer of Common Shares to a person who, as a result of the transfer, violates the Ownership Limit may be void under certain circumstances, and, in any event, would deny the transferee any of the economic benefits of owning Common Shares in excess of the Ownership Limit. See "Description of Capital Stock-- Restrictions on Ownership and Transfer." The Ownership Limit may have the effect of delaying, deferring or preventing a change in control and, therefore, could adversely affect the shareholders' ability to realize a premium over the then-prevailing market price for the Common Shares in connection with such transaction. POSSIBLE DIFFERING FIDUCIARY DUTIES OF GENERAL PARTNERS AND HOST REIT. The General Partners, Host REIT, as general partner of the Operating Partnership, and the Board of Directors of Host REIT, respectively, owe fiduciary duties to their constituent owners. Although some courts have interpreted the fiduciary duties of the Board of Directors in the same way as the duties of a general partner in a limited partnership, it is unclear whether, or to what extent, there are differences in such fiduciary duties. It is possible that the fiduciary duties of the directors of Host REIT to the shareholders may be less than those of the General Partners to their respective limited partners or Host REIT, as general partner of the Operating Partnership, to the limited partners of the Operating Partnership. The Partnership Agreement contains a specific provision to the effect that Host REIT, as general partner of the Operating Partnership, is under no obligation to consider the separate interests of the limited partners of the Operating Partnership in taking partnership action and also contains broad exculpatory language. Since the partnership agreements of the Partnerships do not contain the same provisions, the fiduciary duties of Host REIT, as general partner of the Operating Partnership, to the limited partners of the Operating 48 Partnership may be less than those of the General Partners to their respective Limited Partners. See "Comparison of Ownership of Partnership Interests, OP Units and Common Shares--Fiduciary Duties." EFFECT ON COMMON SHARE PRICE OF SHARES AVAILABLE FOR FUTURE SALE. Sales of a substantial number of Common Shares, or the perception that such sales could occur, could adversely affect prevailing market prices for Common Shares. Limited Partners who elect to receive Common Shares in connection with the Mergers will be able to sell such shares at any time after they are received (unless held by an affiliate of Host REIT). Beginning July 1, 1999, half of the approximately 43.7 million OP Units expected to be issued in the Blackstone Acquisition will become redeemable pursuant to their Unit Redemption Right, an additional 25% will be redeemable on October 1, 1999, and the balance will be redeemable on January 1, 2000, which means it is possible for the Blackstone Entities to convert all of their OP Units into Common Shares prior to, or concurrently with, the first time the Limited Partners who retain OP Units would be able to exercise their Unit Redemption Right and possibly causing the price of the Common Shares to decrease prior to such Limited Partners being able to sell their Common Shares. In addition, beginning at least one year after the Effective Date (or after a lesser period in certain circumstances), other holders of OP Units, including Limited Partners who retain OP Units received in the Mergers, may be able to sell Common Shares received upon exercise of their Unit Redemption Right in the public market pursuant to registration or exemptions from registration. Further, a substantial number of Common Shares would, pursuant to employee benefit plans, be issued or reserved for issuance from time to time, including Common Shares reserved for issuance pursuant to options granted prior to the Mergers and the REIT Conversion, and these Common Shares would be available for sale in the public markets from time to time pursuant to exemptions from registration or upon registration. Moreover, the issuance of additional Common Shares by Host or Host REIT in the future (including any Common Shares that may be issued in connection with the Initial E&P Distribution) would be available for sale in the public markets. Although not yet certain, it is currently contemplated that the Initial E&P Distribution will include a nontransferable right entitling Host shareholders who receive the Initial E&P Distribution and the Blackstone Entities to elect to receive either a specified dollar amount of cash or a specified fraction of a share of Host common stock (or a Host REIT Common Share if the merger of Host into Host REIT has occurred). No prediction can be made about the effect that future sales of Common Shares would have on the market price of the Common Shares. CURRENT HOST COMMON STOCK PRICE IS NOT NECESSARILY INDICATIVE OF THE PRICE OF HOST REIT COMMON SHARES FOLLOWING THE REIT CONVERSION. Host's current stock price is not necessarily indicative of how the market will value Host REIT Common Shares following the REIT Conversion, because of the effect of the distribution of the Crestline common stock and cash or other consideration in connection with the Initial E&P Distribution, the acquisition of additional assets in connection with the REIT Conversion, including the Blackstone Acquisition, and the change in Host's organization from a taxable corporation to a REIT. The current stock price of Host reflects the current market valuation of Host's current business and assets (including the Crestline common stock and the cash or other consideration that may be distributed in connection with the Initial E&P Distribution), a significant portion of which (except for the Crestline common stock and cash or other consideration to be distributed and certain other de minimis assets) will be contributed directly or indirectly to the Operating Partnership and will comprise the core of the Operating Partnership's business and assets following the REIT Conversion. Host's common stock price is also affected by general market conditions. EFFECT ON COMMON SHARE PRICE OF MARKET CONDITIONS. As with other publicly traded equity securities, the value of the Common Shares will depend upon various market conditions, which may change from time to time. Among the market conditions that may affect the value of the Common Shares are the following: (i) the extent of institutional investor interest in Host REIT, (ii) the general market perception of REITs in general and hotel REITs in particular and the attractiveness of their equity securities in comparison to other equity securities (including securities issued by other real estate-based companies), (iii) Host REIT's financial performance, (iv) changes in the tax laws affecting REITs (particularly REITs that primarily own hotels) and (v) general stock and bond market conditions. Although the Limited Partners of a Participating Partnership will receive OP Units with an aggregate deemed value equal to the Exchange Value of their Partnership Interests in the Merger, there 49 can be no assurance that the Common Shares would not trade at prices below this deemed value at the time of or after the REIT Conversion, thereby reducing the value of such OP Units below the Exchange Value, or that the Common Shares will not trade at prices below the value of Host REIT's business and assets. EFFECT ON COMMON SHARE PRICE OF EARNINGS AND CASH DISTRIBUTIONS. It is generally believed that the market value of the equity securities of a REIT is primarily based upon the market's perception of the REIT's growth potential for its core portfolio, the value of its real estate portfolio and its prospects for accretive acquisitions and development. The combination of these factors creates a market perception of a REIT's current and potential future cash distributions, whether from operations, sales, acquisitions, development or refinancings, and is secondarily based upon the value of the underlying assets. For that reason, Common Shares may trade at prices that are higher or lower than the net asset value per Common Share or per OP Unit. To the extent Host REIT retains operating cash flow for investment purposes, working capital reserves or other purposes rather than distributing such cash flow to shareholders, these retained funds, while increasing the value of Host REIT's underlying assets, may not correspondingly increase the market price of the Common Shares. The failure of Host REIT to meet the market's expectation with regard to future earnings and cash distributions would likely adversely affect the market price of the Common Shares. EFFECT ON COMMON SHARE PRICE OF MARKET INTEREST RATES. One of the factors that will influence the price of the Common Shares will be the dividend yield on the Common Shares (as a percentage of the price of the Common Shares) relative to market interest rates. Thus, an increase in market interest rates may lead prospective purchasers of Common Shares to expect a higher dividend yield, which would adversely affect the market price of the Common Shares. EFFECT ON COMMON SHARE PRICE OF UNRELATED EVENTS. As with other publicly traded equity securities, the value of the Common Shares will depend upon various market conditions, including conditions unrelated to real estate investments generally. Thus, events which depress equity market prices may not have any effect on real estate market values, with the result that the Common Shares may trade at prices below Host REIT's net asset value. DEPENDENCE ON EXTERNAL SOURCES OF CAPITAL. As with other REITs, but unlike corporations generally, Host REIT's ability to reduce its debt and finance its growth largely must be funded by external sources of capital because Host REIT generally will have to distribute to its shareholders 95% of its taxable income in order to qualify as a REIT (including taxable income where Host REIT does not receive corresponding cash). Host REIT's access to external capital will depend upon a number of factors, including general market conditions, the market's perception of Host REIT's growth potential, its current and potential future earnings, cash distributions and the market price of the Common Shares. RISKS OF OWNERSHIP OF THE NOTES THE NOTES ARE UNSECURED. The Notes, which are prepayable at any time, are unsecured obligations of the Operating Partnership. Thus, the Notes will be effectively subordinated to any secured debt of the Operating Partnership and to all obligations of the Hotel Partnerships and all other subsidiaries of the Operating Partnership. As of June 19, 1998, on a pro forma basis assuming the Full Participation Scenario, the Operating Partnership and its subsidiaries would have had aggregate consolidated debt to which the Notes would be effectively subordinated or which ranks equally with such Notes of approximately $5.6 billion (including $567 million of debentures relating to the Convertible Preferred Securities). NO PUBLIC MARKET FOR THE NOTES. There will be no public market for the Notes. If the Notes are sold, they may sell at prices substantially below their issuance price. Noteholders are likely to receive the full principal amount of a Note only if they hold the Note to maturity, which is December 15, 2005, or if the Operating Partnership repays the Notes prior to maturity. LIMITED PROTECTION FOR NOTEHOLDERS IN THE EVENT OF A RESTRUCTURING OR SIMILAR TRANSACTION. Other than (i) certain restrictions on the incurrence of indebtedness, (ii) a financial covenant requiring the Operating 50 Partnership to maintain certain coverage ratios and (iii) the customary requirements that the surviving entity in any business combination assume the obligations under the Notes and the Indenture and be in full compliance with all of the provisions of the Indenture, the Indenture does not contain any special provisions protecting Noteholders in the event of a restructuring, reorganization or similar transaction involving the Operating Partnership, which could increase the risk that the Notes may not be paid in full at maturity. See "Description of the Notes." RISKS OF OPERATION COMPETITION IN THE LODGING INDUSTRY. The profitability of the Hotels is subject to general economic conditions, the management abilities of the Managers (including primarily Marriott International), competition, the desirability of particular locations and other factors relating to the operation of the Hotels. The full-service segment of the lodging industry in which the Hotels primarily operate is highly competitive and the Hotels generally operate in geographical markets that contain numerous competitors. The Hotels' success will be dependent, in large part, upon their ability to compete in such areas as access, location, quality of accommodations, room rate structure, the quality and scope of food and beverage facilities and other services and amenities. Although the competitive position of each of the Company's hotel properties differs from market to market, the Company believes that its properties generally compare favorably to their competitive set in the markets in which they operate on the basis of these factors. Furthermore, the Company's strategy is to affiliate its properties with managers operating under the highest quality brand names in the industry which the Company believes will enhance their competitive position. Nonetheless, there can be no assurance that these managers will maintain the quality of their brand names. Furthermore, competing properties may be built or existing products enhanced such that they offer characteristics more favorable than those offered by the Company's properties. See "Business and Properties--Competition." The lodging industry, including the Hotels (and thus the Operating Partnership), may be adversely affected in the future by (i) national and regional economic conditions, (ii) changes in travel patterns, (iii) taxes and government regulations which influence or determine wages, prices, interest rates, construction procedures and costs, (iv) the availability of credit and (v) other factors beyond the control of the Operating Partnership. GENERAL REAL ESTATE INVESTMENT RISKS. Partners of the Operating Partnership will continue to bear risks associated with real estate investments. The yields available from equity investments in real estate and the Operating Partnership's ability to service debt depend, in large part, upon the amount of rental revenues generated, expenses incurred and capital expenditures required in the operation of its business. The Operating Partnership's income and ability to make distributions to its partners will be dependent upon the rent payable by the Lessees exceeding the amounts required for debt service, property taxes and other expenses payable by the Operating Partnership (including required FF&E reserves and capital expenditures). The rental payments payable by the Lessees will be affected in part by the sales generated by the Managers from operation of the Hotels. The Lessees' ability to pay rent accrued under the Leases will depend in significant part upon the ability of the Managers to generate gross sales in excess of its requirements to meet operating expenses. The Operating Partnership's rental income from the Hotels may, therefore, directly or indirectly, be adversely affected by a number of factors, including the general economic climate, local real estate conditions, such as an oversupply of, or a reduction in demand for, hotel space, the attractiveness of the Hotels to consumers, the quality, philosophy and performance of management, the ability of the Lessees to maximize rental payments to Host REIT, the ability of the Manager to effectively operate the Hotels, competition from comparable hotels, changes in room rates and increases in operating costs due to inflation and other factors, which increases may not necessarily be passed through fully to guests. In addition, the Operating Partnership's rental income from the Hotels and real estate values also are affected by such factors as the cost of compliance with government regulation, including zoning and tax laws, the potential for liability under applicable laws, interest rate levels and the availability of financing. Certain significant expenditures associated with each equity investment in a Hotel (such as mortgage payments, if any, real estate taxes and maintenance costs) also may not decrease even though circumstances cause a reduction in the Operating Partnership's rental income from the Hotel. If any of the above occurs, the Operating Partnership's ability to make distributions to its partners, including Host REIT, and Host REIT's ability, in turn, to make distributions to its shareholders, could be adversely affected. 51 RENTAL REVENUES FROM HOTELS SUBJECT TO PRIOR RIGHTS OF LENDERS. In accordance with the mortgage loan agreements with respect to outstanding indebtedness of certain Hotel Partnerships, the rental revenues received by such Hotel Partnerships under certain Leases first will be used to satisfy the debt service on such outstanding indebtedness with only the cash flow remaining after debt service being available to satisfy other obligations of the Hotel Partnership (including paying property taxes and insurance, funding the required FF&E reserves for the Hotels and capital improvements and paying debt service with respect to unsecured debt) and to make distributions to the holders of OP Units (including Host REIT). POSSIBLE UNDERPERFORMANCE OF NEW ACQUISITIONS. In the future, the Operating Partnership expects to pursue acquisitions of additional full-service hotels and other types of real estate. Acquisitions entail the risk that such investments will fail to perform in accordance with expectations. The Operating Partnership anticipates that, in certain circumstances, it may use OP Units as consideration to acquire hotels from tax-sensitive sellers and, in connection with such acquisitions, it may agree to certain restrictions on the Operating Partnership's ability to sell, or reduce the amount of mortgage indebtedness on, such acquired hotels, which may increase the Operating Partnership's leverage and which may impair the Operating Partnership's ability to take actions that would otherwise be in the best interests of its limited partners. SEASONALITY. The hotel industry is seasonal in nature. The seasonality of the industry may, from time to time, affect either the amount of rent that accrues under the Leases or the ability of the Lessees to make timely rent payments under the Leases. An inability of the Lessees to make timely rent payments to the Operating Partnership could adversely affect the ability of the Operating Partnership to make distributions to partners (including Host REIT) and Host REIT's ability, in turn, to make distributions to its shareholders. ILLIQUIDITY OF REAL ESTATE. Real estate investments are relatively illiquid and, therefore, will tend to limit the ability of the Operating Partnership to sell and purchase hotels promptly in response to changes in economic or other conditions. This could make it difficult for the Operating Partnership to sell any of its Hotels, even if a sale were in the interest of limited partners. LIMITATIONS ON SALE OR REFINANCING OF CERTAIN HOTELS. For reasons relating to federal income tax considerations, the agreements by which the Operating Partnership will acquire certain Hotels (or obtain consent to lease certain Hotels to the Lessees) will also restrict the ability of the Operating Partnership to dispose of or refinance the debt secured by such Hotels for varying periods from the Effective Date, depending on the Hotel. Similarly, upon acquiring the Blackstone Hotels, the Operating Partnership will agree not to dispose of the Blackstone Hotels for ten years (although the Operating Partnership may dispose of up to 50% of the value of the assets contributed to the Operating Partnership by the Blackstone Entities commencing after five years). In addition, if Atlanta Marquis participates in the Mergers, the Operating Partnership will succeed to an existing agreement that will restrict its ability to dispose of the Hotel owned by Atlanta Marquis or to refinance the debt secured by such Hotel without compensating certain outside partners for resulting adverse tax consequences. Thus, even if it were in the best interests of the Operating Partnership and its limited partners to sell or refinance the debt secured by any of these Hotels, it may be difficult or impossible for the Operating Partnership to do so during their respective lock- out periods. HOTELS SUBJECT TO GROUND LEASES MAY AFFECT THE OPERATING PARTNERSHIP'S REVENUES. Of the approximately 125 Hotels in which the Operating Partnership initially is expected to hold an interest, approximately 45 are subject to ground leases. Such ground leases generally require increases in ground rent payments every five years. To the extent that the rents payable under the Leases do not increase at the same rate as the increases under the ground leases, it could affect the Operating Partnership's cash available for distribution and its ability to make distributions to partners, including Host REIT, and Host REIT's ability, in turn, to make distributions to its shareholders. In addition, any sale of a Hotel encumbered by a ground lease would be made subject to such ground lease and the value realized by the Operating Partnership in such sale might not be as high if such Hotel were not sold subject to such ground lease. 52 FEDERAL INCOME TAX RISKS TAX CONSEQUENCES OF THE MERGERS. The Operating Partnership has received an opinion of Hogan & Hartson L.L.P., counsel to Host, Host REIT and the Operating Partnership, based upon certain assumptions and representations of the General Partners, the Operating Partnership, Host and Host REIT, to the effect that, except for any gain attributable to the sale of personal property by a Partnership to a Non-Controlled Subsidiary, the Mergers will not result in the recognition of taxable income or gain by a Limited Partner at the time of the Mergers (i) who does not elect to receive Common Shares or a Note in exchange for his OP Units in connection with the Mergers; (ii) who does not exercise his Unit Redemption Right on a date sooner than the date two years after the date of the consummation of the Mergers; (iii) who does not receive a cash distribution (or deemed cash distribution resulting from relief from liabilities, including as a result of the prepayment of indebtedness associated with the Limited Partner's Partnership) in excess of such Limited Partner's aggregate adjusted tax basis in his Partnership Interest at the time of the Mergers; (iv) who is not required to recognize gain by reason of the election by another Limited Partner in his Partnership to receive Common Shares or a Note in exchange for his OP Units in connection with the Mergers (which in counsel's opinion, described below, should not be the result of either such election); and (v) whose "at risk" amount does not fall below zero as a result of the Mergers or the REIT Conversion. The General Partners and the Operating Partnership do not believe, with regard to a Limited Partner who acquired his Partnership Interest in the original offering of such Partnership Interests, who has held that Interest at all times since the offering and who does not elect to exchange the OP Units, that the Mergers will result in such Limited Partner (a) receiving a distribution (or deemed distribution) of cash in excess of such Limited Partner's adjusted tax basis in his Partnership Interest or (b) having his "at risk" amount fall below zero. The adjusted tax basis of a Limited Partner who did not acquire his Partnership Interest in the original offering of such Partnership Interests, however, could vary materially from the adjusted tax basis of a Limited Partner who did. Therefore, depending on the adjusted tax basis of such a Limited Partner in his Partnership Interest, the Mergers could result in the receipt by such Limited Partner of a cash distribution (or deemed cash distribution) in excess of such Limited Partner's adjusted tax basis in his Partnership Interest, and, accordingly, could result in the recognition of taxable income or gain by such Limited Partner. (The foregoing assumes that the ability to exercise the Common Share Election or the Note Election either is not a separate property right for federal income tax purposes or does not have any ascertainable value. The Operating Partnership believes that the ability to exercise the Common Share Election or the Note Election is not property and, even if it were property, does not have any independent ascertainable value, given the nature and terms of the OP Units and the terms and limited duration of the election arrangements. If, however, the ability to exercise such elections were considered property and to have an ascertainable value, Limited Partners could recognize gain in amount up to the amount of such value (whether or not they exercise such elections)). Hogan & Hartson L.L.P. is of the opinion that it is more likely than not that a Limited Partner who does not elect to exchange his OP Units for Common Shares or a Note in connection with the Mergers will not be required to recognize gain by reason of another Limited Partner's exercise of either such election. With respect to a Limited Partner's exercise of his Unit Redemption Right, Hogan & Hartson L.L.P. is of the opinion that it is more likely than not that a Limited Partner's exercise of his Unit Redemption Right more than one year after the date of consummation of the Mergers but less than two years after such date will not cause the Merger itself to be a taxable transaction for the Limited Partner (or for the other Limited Partners of such Partnership). Opinions of counsel, however, do not bind the IRS or the courts, and no assurance can be provided that such opinions will not be challenged by the IRS or will be sustained by a court if so challenged. The particular tax consequences of the Mergers and the REIT Conversion for a Limited Partner will depend upon a number of factors related to the tax situation of that individual Limited Partner and the Partnership of which he is a Limited Partner, including such factors as the Limited Partner's aggregate adjusted tax basis in his Partnership Interest, the extent to which the Limited Partner has unused passive activity losses arising in connection with his investment in the Partnership or other investments that could offset income arising from the Mergers and the REIT Conversion, the amount of income (if any) required to be recognized by reason of the sale by the Limited Partner's Partnership of personal property to a Non-Controlled Subsidiary in connection with the REIT Conversion, the allocation of Operating Partnership liabilities to the Limited Partner following the 53 Mergers and the REIT Conversion and the amount of built-in gain with respect to the Hotels owned by the Partnership of which he is a Limited Partner. See "Federal Income Tax Consequences--Summary of Tax Opinions." The Operating Partnership has consulted with its advisors in connection with structuring the Mergers and the REIT Conversion, but, with one exception, has not sought a ruling from the IRS as to the tax consequences of the Mergers and the REIT Conversion. See "Federal Income Tax Consequences--Tax Consequences of the Mergers--IRS Ruling Request Regarding Allocation of Partnership Liabilities." EACH LIMITED PARTNER IS URGED TO CONSULT WITH HIS OWN TAX ADVISOR BEFORE DETERMINING WHETHER TO APPROVE OF AND PARTICIPATE IN THE MERGERS IN ORDER TO DETERMINE THE ANTICIPATED TAX CONSEQUENCES OF THE MERGERS FOR SUCH LIMITED PARTNER. There is a significant possibility that the Operating Partnership will be considered to be a "publicly traded partnership." Host REIT and the Operating Partnership expect to receive an opinion prior to the Effective Date from Hogan & Hartson L.L.P. to the effect that, even if the Operating Partnership were a "publicly traded partnership," it would qualify as a partnership for federal income tax purposes because, based upon factual representations made by Host, Host REIT and the Operating Partnership as to the proposed method of operation of the Operating Partnership after the Mergers and the REIT Conversion, at least ninety percent (90%) of its income will consist of "qualifying income," as defined in the Code. See "Federal Income Tax Consequences--Tax Status of the Operating Partnership." In this regard, the Partnership Agreement will prohibit any person or persons acting as a group (other than Host REIT and The Blackstone Group) from holding in excess of 4.9% of the value of the interests in the Operating Partnership. If the Operating Partnership were a publicly traded partnership that qualifies as a partnership for federal income tax purposes because of the "qualifying income" exception, however, a Limited Partner could be subject to certain special rules applicable to publicly traded partnerships. In particular, a Limited Partner would be unable to use passive activity losses from other passive activities (including his investment in his Partnership) to offset his allocable share of Operating Partnership gain and income, and any Operating Partnership losses allocable to a Limited Partner could be used only as an offset against such Limited Partner's allocable share of future Operating Partnership income and gain and not against income and gain from other passive activities. EFFECTS OF SUBSEQUENT EVENTS UPON RECOGNITION OF GAIN. In addition to any gain that might be recognized at the time of the Mergers by the Limited Partners who retain OP Units, there are a variety of subsequent events and transactions, including (i) the sale or other taxable disposition of one or more of the Hotels owned by the Partnerships, (ii) the refinancing or repayment of certain liabilities secured by one or more of the Hotels owned by the Partnerships, (iii) the issuance of additional OP Units, including in connection with the issuance of Common Shares or other equity interests by Host REIT and the acquisition of additional properties by the Operating Partnership in exchange for OP Units or other equity interests in the Operating Partnership, (iv) an increase to the basis of the Hotels owned by the Partnerships resulting from capital expenditures, (v) the elimination over time of the disparity between the current tax basis of the Hotels owned by the Partnerships and the "book basis" of such Hotels (based upon their fair market value at the time of the Mergers) and (vi) with respect to the MHP Limited Partners only, possibly, the transfer of MHP's interest in the Harbor Beach Resort to a Non-Controlled Subsidiary in connection with the REIT Conversion (in the event that certain third-party consents to the REIT Conversion are not obtained) that could cause a Limited Partner who retains OP Units to recognize part or all of the taxable gain that otherwise has been deferred pursuant to the Mergers. Certain Hotels (including the Blackstone Hotels) will be covered by agreements that will restrict the ability of the Operating Partnership to dispose of such Hotels or refinance the debt secured by them. In addition, if Atlanta Marquis participates in the Mergers, the Operating Partnership will succeed to an existing agreement that will restrict its ability to dispose of the Hotel owned by Atlanta Marquis or to refinance the debt secured by such Hotel without compensating certain outside partners for resulting adverse tax consequences. See "--Limitations on Sale or Refinancing of Certain Hotels" above. The Partnership Agreement does not impose any restrictions on the Operating Partnership's ability to dispose of the Hotels owned by the Partnerships, however, or to refinance or repay debt secured by the Hotels owned by the Partnerships (or to direct that a Partnership engage in such a transaction), but the Operating Partnership is obligated to pay any taxes Host REIT 54 incurs as a result of such transactions. In addition, Host REIT, as general partner of the Operating Partnership, is not required to take into account the tax consequences to the limited partners in deciding whether to cause the Operating Partnership to undertake specific transactions (but the Operating Partnership is obligated to pay any taxes that Host REIT incurs as a result of such transactions), and the limited partners generally have no right to approve or disapprove such transactions. See "Description of OP Units--Sales of Assets" and "--Borrowing by the Operating Partnership." SALE OF PERSONAL PROPERTY MAY RESULT IN GAIN TO LIMITED PARTNERS IN CERTAIN PARTNERSHIPS. In order to facilitate the participation of Atlanta Marquis, Desert Springs, Hanover, MHP and PHLP in the Mergers without adversely affecting Host REIT's qualification as a REIT, the Operating Partnership will require, as part of the Mergers, that such Partnerships sell a portion of the personal property associated with the Hotels owned by such Partnerships to a Non-Controlled Subsidiary. These sales will be taxable transactions and, with the exception of the sale by Hanover, may result in an allocation of a relatively modest amount of ordinary recapture income by each Partnership to its Limited Partners. This income, if any, will be allocated to each Limited Partner in the same proportion and to the same extent that such Limited Partner was allocated any deductions directly or indirectly giving rise to the treatment of such gains as recapture income. A Limited Partner who receives such an allocation of recapture income will not be entitled to any special distribution from his Partnership in connection with the sale of personal property. ELECTION TO EXCHANGE OP UNITS FOR COMMON SHARES. A Limited Partner who elects to exchange his OP Units for Common Shares in connection with the Mergers will be treated as having made a fully taxable disposition of his OP Units, which likely would be deemed to occur at the time that the right to receive Common Shares becomes fixed (which the Operating Partnership will treat as occurring on January 22, 1999, if the Effective Date of the Mergers is December 30, 1998). The amount realized in connection with such disposition will equal the sum of the fair market value of the Common Shares received, plus the portion of the Operating Partnership's liabilities allocable to the Limited Partner for federal income tax purposes. To the extent the amount realized exceeds the Limited Partner's adjusted tax basis in his OP Units, the Limited Partner will recognize gain. If a Limited Partner has a "negative capital account" with respect to his OP Units, he will recognize "phantom income" (i.e., the income recognized would exceed the value of the Common Shares by the amount of his negative capital account). See "Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Exercise Their Right to Make the Common Share Election or the Note Election." ELECTION TO EXCHANGE OP UNITS FOR NOTES. A Limited Partner who elects to receive a Note in exchange for his OP Units in connection with the Mergers will be treated as having made a taxable disposition of his OP Units, which likely would be deemed to occur on the Effective Date of the Mergers (which currently is expected to be December 30, 1998). The amount realized in connection with such disposition will equal the sum of the "issue price" of the Note (i.e., the principal amount of the Note) plus the portion of the Operating Partnership's liabilities allocable to the Limited Partner for federal income tax purposes. To the extent the amount realized exceeds the Limited Partner's adjusted tax basis in his OP Units, the Limited Partner will recognize gain. A Limited Partner may be eligible to defer at least a portion of that gain under the "installment sale" rules until principal on the Note is paid (see "Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Exercise Their Right to Make the Common Share Election or the Note Election") but those rules will not permit a Limited Partner to defer all of the gain recognized (for example, gain attributable to his "negative capital account" and income attributable to "depreciation recapture") and may require that a Limited Partner who defers gain pay to the IRS interest on a portion of the resulting tax that has been deferred. A Limited Partner with a "negative capital account" with respect to his Partnership Interest who elects to receive a Note will recognize "phantom income" in that amount at the time the taxable disposition is deemed to occur in any event. EXERCISE OF UNIT REDEMPTION RIGHT. The receipt of either cash or Common Shares, as determined by Host REIT, by a Limited Partner in connection with the exercise of such Limited Partner's Unit Redemption Right will be a taxable transaction and likely will result in the recognition by the Limited Partner of substantial gain for federal income tax purposes. The amount realized in connection with a Limited Partner's exercise of his 55 Unit Redemption Right will equal the sum of either the amount of cash or the fair market value of the Common Shares received plus the portion of the Operating Partnership's liabilities allocable to the OP Units redeemed for federal income tax purposes. To the extent the amount realized exceeds the Limited Partner's adjusted basis in the redeemed OP Units, the Limited Partner will recognize gain. See "Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following the Mergers--Dissolution of the Operating Partnership" and "--Tax Treatment of Exercise of Unit Redemption Right." State and local income and transfer taxes may apply to such a redemption as well. LIMITED PARTNERS NEED TO CONSULT WITH THEIR OWN TAX ADVISORS. Because the specific tax attributes of a Limited Partner and the facts regarding such Limited Partner's interest in his Partnership could have a material impact on the tax consequences to such Limited Partner of the Mergers (including the decision whether to elect to receive Common Shares or Notes in exchange for OP Units in connection with the Mergers) and the subsequent ownership and disposition of OP Units, Common Shares or Notes, it is essential that each Limited Partner consult with his own tax advisors regarding the application of federal, foreign and state and local tax laws to such Limited Partner's personal tax situation. FAILURE OF HOST REIT TO QUALIFY AS A REIT. GENERAL. Host REIT intends to operate so as to qualify as a REIT under the Code effective for Host REIT's first taxable year commencing following the REIT Conversion. A REIT generally is not taxed at the corporate level on income it currently distributes to its shareholders as long as it distributes currently at least 95% of its taxable income (excluding net capital gain). No assurance can be provided, however, that Host REIT will so qualify or be able to remain so qualified or that new legislation, Treasury Regulations, administrative interpretations or court decisions will not significantly change the tax laws with respect to Host REIT's qualification as a REIT or the federal income tax consequences of such qualification. In this regard, Host REIT expects to receive an opinion of Hogan & Hartson L.L.P. prior to the Effective Date to the effect that Host REIT, effective for its first full taxable year commencing following the REIT Conversion, will be organized in conformity with the requirements for qualification as a REIT under the Code, and that Host REIT's proposed method of operation will enable it to satisfy the requirements for qualification and taxation as a REIT. This opinion will be conditioned upon the completion of the REIT Conversion and upon certain factual representations made by Host REIT and the Operating Partnership as to matters relating to the organization and operation of Host REIT, the Operating Partnership, the Hotel Partnerships, the Subsidiary Partnerships, the Non- Controlled Subsidiaries, the Host Employee Trust and Crestline and the Lessees. In addition, this opinion will be based upon the factual representations of Host REIT concerning its business and properties as set forth in this Consent Solicitation and will assume that the actions described in this Consent Solicitation are completed in a timely fashion. Moreover, an opinion of counsel does not bind the IRS or the courts, and no assurance can be provided that such opinion will not be challenged by the IRS or will be sustained by a court if so challenged. REQUIRED DISTRIBUTIONS AND PAYMENTS. In order to qualify as a REIT, Host REIT will be required each year to distribute to its shareholders at least 95% of its net taxable income (excluding any net capital gain). Due to certain transactions entered into in prior years, Host REIT is expected to recognize substantial amounts of "phantom" taxable income in future years that is not matched by cash flow or EBITDA to the Operating Partnership or Host REIT. As discussed below in "--Earnings and Profits Attributable to "C' Corporation Taxable Years," to qualify as a REIT, Host REIT also will have to distribute to its shareholders not later than the end of its first taxable year as a REIT an amount equal to the earnings and profits ("E&P") accumulated by Host and its subsidiaries and not distributed before or at the time of the REIT Conversion (including any increases thereto resulting from subsequent IRS audits of years prior to Host REIT's first taxable year as a REIT). In addition, Host REIT will be subject to a 4% nondeductible excise tax on the amount, if any, by which certain distributions made by it with respect to the calendar year are less than the sum of (i) 85% of its ordinary income, (ii) 95% of its capital gain net income for that year, and (iii) any undistributed taxable income from prior periods. Host REIT intends to make distributions to its shareholders to comply with the 95% distribution requirement and to avoid the nondeductible excise tax and will rely for this purpose on distributions from the Operating 56 Partnership. However, differences in timing between taxable income and cash available for distribution due to, among other things, the seasonality of the hospitality industry and the fact that some taxable income will be "phantom" income (i.e., taxable income that is not matched by cash flow or EBITDA to the Operating Partnership) could require the Operating Partnership to borrow funds or to issue additional equity to enable Host REIT to meet the 95% distribution requirement (and therefore to maintain its REIT status) and to avoid the nondeductible excise tax. The Operating Partnership also is required to pay (or reimburse Host REIT for) all taxes and other liabilities and expenses that Host REIT incurs, including taxes and liabilities attributable to periods and events prior to the REIT Conversion and any taxes that Host REIT must pay in the event it were to fail to qualify as a REIT. In addition, the Operating Partnership's inability to retain earnings (resulting from Host REIT's 95% and other distribution requirements) will generally require the Operating Partnership to refinance debt that matures with additional debt or equity. There can be no assurance that any of these sources of funds, if available at all, would be available to meet the Operating Partnership's distribution and tax obligations. CONSEQUENCES OF FAILURE TO QUALIFY AS A REIT. If Host REIT fails to qualify as a REIT, it will be subject to federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates. In addition, unless entitled to relief under certain statutory provisions, Host REIT will be disqualified from treatment as a REIT for the four taxable years following the year during which REIT qualification is lost. The additional tax would significantly reduce the cash available for distribution by Host REIT to its shareholders. Failure of Host REIT to qualify as a REIT could reduce materially the value of the Common Shares and OP Units and would cause all distributions to shareholders to be taxable as ordinary income to the extent of Host REIT's current and accumulated E&P (although, subject to certain limitations under the Code, corporate distributees may be eligible for the dividends received deduction with respect to these distributions). See "Federal Income Tax Consequences--Federal Income Taxation of Host REIT Following the Mergers--Failure of Host REIT to Qualify as a REIT." Failure of Host REIT to qualify as a REIT also would result in a default under the New Senior Notes and the New Credit Facility. EARNINGS AND PROFITS ATTRIBUTABLE TO "C" CORPORATION TAXABLE YEARS. In order to qualify as a REIT, Host REIT cannot have at the end of any taxable year any undistributed E&P that is attributable to a "C" corporation taxable year. A REIT has until the close of its first taxable year as a REIT in which it has non-REIT E&P to distribute such accumulated E&P. Host REIT will be required to distribute this E&P prior to the end of 1999 (the first taxable year for which the REIT election of Host REIT currently is expected to be effective). Failure to do so would result in disqualification of Host REIT as a REIT at least for taxable year 1999. Host REIT believes that the Initial E&P Distribution, together with any additional distributions of non-REIT E&P made after the REIT Conversion but prior to December 31, 1999, will be sufficient to distribute all of the non-REIT E&P as of December 31, 1999, but there are substantial uncertainties relating to the estimate of Host REIT's non-REIT E&P and the value of noncash consideration to be distributed as part of the Initial E&P Distribution and, thus, there can be no assurance that this requirement will be met. Hogan & Hartson L.L.P. will not provide any opinion as to the amount of Host's undistributed E&P and will rely, for purposes of its opinion as to the qualification of Host REIT as a REIT, upon a representation from Host and Host REIT that Host REIT will not have any undistributed E&P as of the end of 1999. See "Federal Income Tax Consequences--Federal Income Taxation of Host REIT Following the Mergers-- Requirements for Qualification." TREATMENT OF LEASES. To qualify as a REIT, a REIT must satisfy two gross income tests. Rent paid pursuant to the Leases will constitute substantially all of the gross income of Host REIT. In order for the rent paid pursuant to the Leases to constitute qualifying income for purposes of the gross income tests, (a) the Leases must be respected as true leases for federal income tax purposes and not be treated as service contracts, joint ventures or some other type of arrangement, and (b) the Lessees must not be regarded as "related party tenants" (as defined in the Code). Host REIT expects that Hogan & Hartson L.L.P. will provide to Host REIT prior to the Effective Date an opinion to the effect that, based upon certain representations of Host REIT regarding the terms of the Leases and the expectations of Host REIT and the Lessees with respect thereto, the Leases will be respected as leases for federal income tax purposes. An opinion of counsel, however, does not bind the IRS or the courts and this determination ultimately will depend upon the accuracy of the factual representations of Host 57 REIT regarding the Leases. In this regard, if the Leases were not respected as true leases for federal income tax purposes or if the Lessees were regarded as "related party tenants," Host REIT would not be able to satisfy either of the two gross income tests applicable to REITs and, as a result, would lose its REIT status. Accordingly, Host REIT would be subject to corporate level income taxation, which would significantly reduce the cash available for distribution to its shareholders. See "Federal Income Tax Consequences--Federal Income Taxation of Host REIT Following the Mergers--Income Tests Applicable to REITs." OTHER TAX LIABILITIES; HOST REIT'S SUBSTANTIAL DEFERRED AND CONTINGENT TAX LIABILITIES. Even if Host REIT qualifies as a REIT, it will be subject, through the Operating Partnership and the Hotel Partnerships, to certain federal, state and local taxes on its income and property. See "Federal Income Tax Consequences-- Federal Income Taxation of Host REIT Following the Mergers--General." In addition, Host REIT will be subject to tax at the regular corporate rate (currently 35%) upon its share of any gain recognized as a result of any sale by the Operating Partnership or the Hotel Partnerships (within the 10-year period beginning on the Effective Date) of assets, including the Hotels, in which interests were acquired by the Operating Partnership from Host and its subsidiaries as part of the Mergers and the REIT Conversion to the extent that such gain existed as of the first day of Host REIT's first taxable year as a REIT. Host has substantial deferred tax liabilities that likely will be recognized by Host REIT in the next ten years as "built-in gain" under these rules (or by a Non-Controlled Subsidiary), without any corresponding receipt of cash by Host REIT from the Operating Partnership. The Operating Partnership is obligated under the Partnership Agreement and the terms of the REIT Conversion to pay all such taxes incurred by Host REIT, as well as any liabilities that the IRS may assert against Host REIT for corporate income taxes for taxable years prior to the time Host REIT qualifies as a REIT. The Non-Controlled Subsidiaries will be taxable "C" corporations and will pay federal and state income tax on their net income at the full applicable corporate rates. Holders of OP Units will be subject to state and local taxation in the jurisdictions in which the Operating Partnership directly or indirectly holds real property and such holders will be required to file periodic tax returns in at least some of those jurisdictions. The Operating Partnership will initially own Hotels located in 28 different states and the District of Columbia. FAILURE OF THE OPERATING PARTNERSHIP TO QUALIFY AS A PARTNERSHIP. The Operating Partnership and Host REIT have received an opinion of Hogan & Hartson L.L.P. to the effect that the Operating Partnership will be treated as a partnership for federal income tax purposes. An opinion of counsel, however, does not bind the IRS or the courts, and no assurance can be provided that such opinion will not be challenged by the IRS or will be sustained by a court if so challenged. If the IRS were to treat successfully the Operating Partnership as an entity that is taxable as a corporation, Host REIT would cease to qualify as a REIT because the value of Host REIT's ownership interest in the Operating Partnership would exceed 5% of Host REIT's assets and because Host REIT would be considered to hold more than 10% of the voting securities of another corporation. See "Federal Income Tax Consequences--Federal Income Taxation of Host REIT Following the Mergers--Asset Tests Applicable to REITs." Moreover, the imposition of a corporate tax on the Operating Partnership would reduce significantly the amount of cash available for distribution to its limited partners. See "Federal Income Tax Consequences--Tax Status of the Operating Partnership" and "--Tax Aspects of Host REIT's Ownership of OP Units." MISCELLANEOUS RISKS DEPENDENCE UPON KEY PERSONNEL. The Operating Partnership is dependent upon the efforts of the executive officers of Host REIT. While the Operating Partnership believes that it could find replacements for these key personnel, the loss of their services could have a significant adverse effect on the operations of the Operating Partnership. The Operating Partnership does not intend to obtain key-man life insurance with respect to any of the executive officers of Host REIT. POTENTIAL LITIGATION RELATED TO THE REIT CONVERSION. Over the last several years, business reorganizations involving the combination of several partnerships into a single entity occasionally have given rise to investor lawsuits. These lawsuits have involved claims against the general partners of the participating partnerships, the partnerships themselves and related persons involved in the structuring of, or benefiting from, the conversion or reorganization, as well as claims against the surviving entity and its directors and officers. For 58 example, limited partners of five of the six limited partnerships controlled by Host that own limited service and extended-stay hotels have filed a lawsuit against Host and the general partners (which are subsidiaries of Host) of such limited partnerships alleging, among other things, breaches of their fiduciary duties in connection with a potential consolidation transaction. Certain other lawsuits are pending against Host and its affiliates by limited partners in certain Partnerships (specifically, Atlanta Marquis, Desert Springs, MHP, MHP2 and PHLP). If any lawsuits are filed in connection with any Merger or other part of the REIT Conversion, such lawsuits could delay the closing of such Merger or the REIT Conversion or result in substantial damage claims against the Operating Partnership, Host REIT or the General Partners of the Partnerships. The Partnerships are each obligated to indemnify their General Partner for claims against them arising from their role as general partner other than to the extent they are guilty of negligence, fraud, misconduct or breach of fiduciary duty. Because the Operating Partnership will be acquiring the Participating Partnerships through the Mergers, Host REIT and the Operating Partnership indirectly will be subject to the indemnification obligations of the Partnerships to their general partners and any obligations of the Partnerships to pay damages to the extent not covered by any available insurance. See "Business and Properties--Legal Proceedings." In the event any pending lawsuits or any new lawsuits filed against any of the Partnerships or the General Partners in connection with the REIT Conversion or the Mergers are not resolved by final court action or settled before the Effective Date, the Exchange Values of such Partnerships will be adjusted to account for a litigation reserve and other contingent liabilities. RISK INVOLVED IN INVESTMENTS THROUGH PARTNERSHIPS OR JOINT VENTURES. Instead of purchasing hotel properties directly, the Operating Partnership may invest as a co-venturer. Joint venturers often have shared control over the operation of the joint venture assets. Therefore, such investments may, under certain circumstances, involve risks such as the possibility that the co-venturer in an investment might become bankrupt, or have economic or business interests or goals that are inconsistent with the business interests or goals of the Operating Partnership, or be in a position to take action contrary to the instructions or the requests of the Operating Partnership or contrary to the Operating Partnership's policies or objectives. Consequently, actions by a co- venturer might result in subjecting hotel properties owned by the joint venture to additional risk. Although the Operating Partnership generally will seek to maintain sufficient control of any joint venture to permit the Operating Partnership's objectives to be achieved, it may be unable to take action without the approval of its joint venture partners or its joint venture partners could take actions binding on the joint venture without the Operating Partnership's consent. Additionally, should a joint venture partner become bankrupt, the Operating Partnership could become liable for such partner's share of joint venture liabilities. CHANGES IN LAWS. Increases in real estate or business improvement district taxes will not result in increased rental payments to the Operating Partnership under the Leases, with the result that they may adversely affect the Operating Partnership's cash flow from operations and its ability to maintain the expected level of distributions. Similarly, changes in laws increasing the potential liability for environmental conditions existing at Hotels or increasing the restrictions on discharges or other conditions, as well as changes in laws affecting construction and safety requirements, may result in significant unanticipated capital expenditures, which, to the extent such expenditures must be borne by the Operating Partnership as the lessor of the Hotels, would adversely affect the Operating Partnership's cash flow from operations and its ability to make distributions to limited partners, including Host REIT, and Host REIT's ability, in turn to make distributions to its stockholders. UNINSURED LOSS. The Operating Partnership will carry comprehensive liability, fire, flood, extended coverage and rental loss (for rental losses extending up to 12 months) insurance with respect to its Hotels with policy specifications and insured limits customarily carried for similar hotels. Certain types of losses (such as from earthquakes and environmental hazards), however, may be either uninsurable or not economically insurable. Should an uninsured loss occur, the Operating Partnership could lose both its capital invested in, and anticipated profits from, one or more of its Hotels. AMERICANS WITH DISABILITIES ACT. The Hotels must comply with Title III of the Americans with Disabilities Act (the "ADA") to the extent that such Hotels are "public accommodations" or "commercial facilities" as defined by the ADA. The ADA may require removal of structural barriers to access by persons 59 with disabilities in certain public areas of the Operating Partnership's Hotels where such removal is readily achievable. The Operating Partnership believes that the Hotels will not be required to make substantial non-budgeted capital expenditures to address the requirements of the ADA. However, noncompliance with the ADA could result in substantial capital expenditures to remove structural barriers, as well as the imposition of fines or an award of damages to private litigants which might adversely affect the Operating Partnership's ability to make expected distributions to limited partners, including Host REIT, and Host REIT's ability, in turn, to make distributions to its shareholders. Under the Leases, the Operating Partnership would be required to fund all such expenditures. OTHER REGULATORY ISSUES. The Operating Partnership's Hotels will be subject to various forms of regulation in addition to the ADA, including building codes, regulations pertaining to fire safety and other regulations which may from time to time be enacted. The Operating Partnership may be required to incur significant costs to comply with any future changes in such regulations. POSSIBLE ENVIRONMENTAL LIABILITIES. Under various federal, state and local laws, ordinances and regulations, owners or operators of real estate may be required to investigate and clean up certain hazardous substances released at a property, and may be held liable to a governmental entity or to third parties for property damage or personal injuries and for investigation and clean-up costs incurred by the parties in connection with any contamination. In addition, some environmental laws create a lien on a contaminated site in favor of the government for damages and costs it incurs in connection with the contamination. The presence of contamination or the failure to remediate contamination may adversely affect the owner's ability to sell or lease real estate or to borrow using the real estate as collateral. No assurances can be given that (i) a prior owner, operator or occupant, such as a tenant, did not create a material environmental condition not known to the Operating Partnership, (ii) a material environmental condition with respect to any Hotel does not exist or (iii) future uses or conditions (including, without limitation, changes in applicable environmental laws and regulations) will not result in the imposition of environmental liability. In addition, no assurances can be given that all potential environmental liabilities have been identified or properly quantified. Moreover, no assurances can be given that (i) future laws, ordinances, or regulations will not impose any material environmental liability or (ii) the current environmental condition of the Hotels will not be affected by the condition of land or operations in the vicinity of the Hotels (such as the presence of underground storage tanks) or by third parties unrelated to the Operating Partnership. 60 CONFLICTS OF INTEREST The Mergers and the REIT Conversion were initiated by Host and are being proposed by Host, Host REIT, the Operating Partnership and the General Partners, which are Host or its subsidiaries. The terms and conditions of the Mergers and the REIT Conversion and the structure of the Operating Partnership also were formulated by Host, Host REIT, the General Partners and the Operating Partnership. See "Background and Reasons for the Mergers and the REIT Conversion--Background of the Mergers and the REIT Conversion." As discussed below, the establishment of the terms of the Mergers and REIT Conversion, the recommendation by the General Partners with respect to the Mergers and the related amendments to the partnership agreements and the operation of the Operating Partnership involve conflicts of interest. In resolving any conflicts of interest, each of the General Partners must act in accordance with its fiduciary duties to the Limited Partners of its Partnership. The directors of Host REIT, which will be the sole general partner of the Operating Partnership, also must act in accordance with their fiduciary duties to the shareholders of Host REIT and, to a certain extent, the limited partners of the Operating Partnership as limited by the Partnership Agreement. See "Comparison of Ownership of Partnership Interests, OP Units and Common Shares--Fiduciary Duties" for a general description of these duties. SUBSTANTIAL BENEFITS TO RELATED PARTIES To the extent that the anticipated benefits of the REIT Conversion are reflected in the value of Host's common stock prior to the Effective Date, the Limited Partners will not enjoy the effect of such benefits on the value of their investment. In addition, following the REIT Conversion, current Host shareholders (together with the Blackstone Entities), but not the Limited Partners, will own the common stock of Crestline and will benefit from the terms of the Leases to the extent net revenues exceed rental payments and other expenses. The Mergers will facilitate the consummation, and enable Host to reap the full benefits, of the REIT Conversion. By converting to a REIT, Host expects to benefit from the advantages enjoyed by REITs in raising capital and acquiring additional assets, participating in a larger group of comparable companies and increasing its potential base of shareholders. Also, Host will realize significant savings through the substantial reduction of its future corporate-level income taxes. The benefits to Host of the REIT Conversion will be reduced if one or more of the Partnerships do not participate in a Merger, thereby creating a conflict of interest for the General Partners in connection with the Mergers. AFFILIATED GENERAL PARTNERS Host has varying interests in each of the Partnerships, and subsidiaries of Host act as General Partner of each of the Partnerships (except for PHLP, in which Host is the General Partner). Each General Partner has an independent obligation to assess whether the Merger is fair and equitable to and advisable for the Limited Partners of its Partnership. This assessment involves considerations that are different from those relevant to the determination of whether the Mergers and the REIT Conversion are advisable for Host and its shareholders. The considerations relevant to such determination which create a conflict of interest include Host's belief that the REIT Conversion is advisable for its shareholders, the benefits of the REIT Conversion to Host will be greater if the Partnerships participate and Host REIT will benefit if the value of the OP Units received by the Limited Partners in the Mergers is less than the value of their Partnership Interests. While each General Partner has sought faithfully to discharge its obligations to its Partnership, there is an inherent conflict of interest in having the General Partners determine the terms on which the Operating Partnership, which is controlled by Host, will acquire the Partnerships, for which Host or its subsidiaries are the General Partners, since no arm's length negotiations are possible because Host is on both sides of the transaction. LEASING ARRANGEMENTS Conflicts of interest exist in connection with establishing the terms of the leasing arrangements being entered into as part of the REIT Conversion. The General Partners, all of which are subsidiaries of Host (except 61 in the case of PHLP, in which Host is the General Partner), are recommending the Mergers, and Host is responsible for establishing the terms of the Mergers and the REIT Conversion, including the Leases. The common stock of Crestline will be distributed to Host's or Host REIT's shareholders. Accordingly, Host's or Host REIT's shareholders and the Blackstone Entities, as the initial shareholders of Crestline, will potentially benefit from the terms of the Leases to the extent net revenues exceed rental payments and other expenses but Limited Partners will not because they will not receive shares of Crestline common stock. DIFFERENT TAX CONSEQUENCES UPON SALE OR REFINANCING OF CERTAIN HOTELS Certain holders of OP Units may experience different and more adverse tax consequences compared to those experienced by other holders of OP Units or by holders of Common Shares upon the sale of, or the reduction of indebtedness encumbering, any of the Hotels. Therefore, such holders, including Host REIT and its subsidiaries, may have different objectives regarding the appropriate pricing and timing of any sale or refinancing of an individual Hotel. As provided in the Partnership Agreement, Host REIT, as general partner of the Operating Partnership, is not required to take into account the tax consequences of the limited partners of the Operating Partnership in deciding whether to cause the Operating Partnership to undertake specific transactions (but the Operating Partnership is obligated to pay any taxes Host REIT incurs as a result of such transactions), and the limited partners have no right to approve or disapprove such transactions. PARTNERSHIP AGREEMENT Conflicts of interest exist in connection with establishing the terms of the Partnership Agreement, including provisions which benefit Host REIT, all of which were determined by Host. POTENTIAL CONFLICTS INVOLVING MARRIOTT INTERNATIONAL AND CRESTLINE Marriott International currently serves as manager for all but 16 of Host's Hotels, and will continue to manage those Hotels pursuant to the Management Agreements that will be assigned to the Lessees. In addition, Marriott International acts as manager of hotels that will compete with Host REIT's Hotels. As a result, Marriott International may make decisions regarding competing lodging facilities which it manages that would not necessarily be in the best interests of Host REIT or the Lessees. Further, J.W. Marriott, Jr. and Richard E. Marriott, who are brothers, currently serve as directors of Host and directors (and, in the case of J.W. Marriott, Jr., also an officer) of Marriott International. After the REIT Conversion, J.W. Marriott, Jr. will serve as a director of Host REIT and will continue to serve as a director of Marriott International, and Richard E. Marriott will serve as Chairman of the Board of Host REIT and continue to serve as a director of Marriott International. J.W. Marriott, Jr. and Richard E. Marriott also beneficially own (as determined for securities law purposes) approximately 10.6% and 10.2%, respectively, of the outstanding shares of common stock of Marriott International, and will beneficially own approximately 5.32% and 5.30%, respectively, of the outstanding shares of common stock of Crestline (but neither will serve as an officer or director thereof). As a result, J.W. Marriott, Jr. and Richard E. Marriott may have a potential conflict of interest with respect to their obligations as directors of Host REIT in connection with any decisions regarding Marriott International itself (including decisions relating to the Management Agreements involving the Hotels), Marriott International's management of competing lodging properties and Crestline's leasing and other businesses that would not necessarily be in the best interests of Host REIT. ABSENCE OF ARM'S LENGTH NEGOTIATIONS; NO INDEPENDENT REPRESENTATIVE No independent representative was retained to negotiate on behalf of the Limited Partners because the Mergers contain both substantive protections for the Limited Partners (the Appraisals and the Fairness Opinion) and procedural protections for the Limited Partners (the vote required in all instances is a majority of limited partner interests and in those Partnerships where Host or its affiliates own significant percentages of limited partner interest, a majority of unaffiliated Limited Partners have the ability to approve or disapprove the Mergers, including the related amendments to the partnership agreements). In addition, none of the partnership agreements or applicable law impose such a requirement. Although the General Partners have obtained the Appraisals and 62 the Fairness Opinion from AAA, AAA has not negotiated with the General Partners or Host and has not participated in establishing the terms of the Mergers. Consequently, the terms and conditions of the Mergers may have been more favorable to the Limited Partners if such terms and conditions were the result of arm's length negotiations. See "Fairness Analysis and Opinion." In this regard, the Fairness Opinion specifically does not conclude that other methodologies for determining the Exchange Values of the Partnerships and/or the value of the OP Units might not have been more favorable to the Limited Partners. POTENTIAL AAA CONFLICTS A conflict of interest may exist in that AAA has been retained to perform the Appraisals and also provide the Fairness Opinion which, among other things, opines as to the methodologies and underlying assumptions that AAA used in performing the Appraisals. AAA has been retained by the General Partners (consisting of Host and its subsidiaries) to determine the Appraised Values of the Hotels and to render the Fairness Opinion. Host has previously retained AAA to perform appraisals and give fairness and solvency opinions in connection with other transactions, and there is the possibility that Host REIT and the Operating Partnership will retain AAA to perform similar tasks in the future. POLICIES WITH RESPECT TO CONFLICTS OF INTEREST The Operating Partnership has adopted certain policies and will enter into agreements with Host REIT and its affiliates designed to minimize the adverse effects from these potential conflicts of interest. See "Distribution and Other Policies--Conflicts of Interest Policies" and "Business and Properties-- Noncompetition Agreements." There can be no assurance, however, that the policies and agreements always will be successful in eliminating the influence of such conflicts, and if they are not successful, decisions could be made at the Host REIT level that might fail to reflect fully the interests of the limited partners of the Operating Partnership. 63 BACKGROUND AND REASONS FOR THE MERGERS AND THE REIT CONVERSION BACKGROUND OF THE PARTNERSHIPS Formation of the Partnerships. From 1982 through 1990, Host sponsored the eight Partnerships, which were formed to acquire, own and operate full-service hotels operating under the Marriott brand name. Each Partnership is a Delaware limited partnership, except Chicago Suites, which is a Rhode Island limited partnership. The Partnerships raised capital from approximately 5,900 investors in eight offerings. The Partnerships are "public" partnerships within the meaning of the applicable Commission guidelines, and separate wholly owned subsidiaries of Host are the sole general partners of each Partnership (except for PHLP, for which Host itself acts as general partner). The Hotels owned by the Partnerships are managed by Marriott International and its subsidiaries. The table below sets forth the capital raised in the original offerings, distributions made and number of Hotels owned by each of the Partnerships as of June 19, 1998: HISTORICAL INFORMATION CONCERNING THE PARTNERSHIPS - -------- (1) Includes distributions to the General Partners or their affiliates as holders of Partnership Units (but not distributions to them in their capacities as general partner). (2) A Partnership Unit in all of the Partnerships except Chicago Suites ($35,000) and PHLP ($10,000) represents an original investment of $100,000. (3) Includes approximately $8,600 per Partnership Unit of payments related to the reallocation of tax losses resulting from the 1990 debt refinancing. (4) Atlanta Marquis has an 80% residual interest in the Atlanta Marriott Marquis Hotel. (5) Aggregate distributions do not include $8 million ($8,000 per Partnership Unit) distributed in August 1998 and $6.5 million ($6,500 per Partnership Unit) expected to be distributed in November 1998. Also does not include any part of the $8.8 million in retained excess refinancing proceeds that would be distributed if not expended to complete the expansion of the Orlando Hotel. Number of Hotels owned includes Marriott's Harbor Beach Resort, in which MHP owns a 50.5% interest. (6) Aggregate Distributions do not include $5 million ($6,700 per Partnership Unit) distributed in August 1998 and $4.2 million ($5,600 per Partnership Unit) expected to be distributed in November 1998. Number of Hotels owned includes the Santa Clara Marriott, in which MHP2 owns a 50% interest and Host owns the remaining 50% interest. (7) Includes distributions to a limited partner who is not a holder of any of the 335 Partnership Units. The following paragraphs describe, on a partnership-by-partnership basis, the original investment objectives of each Partnership and the extent to which such objectives have been met. Atlanta Marquis. The offering of interests in Atlanta Marriott Marquis Limited Partnership (the predecessor of Atlanta Marquis), which was completed in 1985, was intended to provide investors with an opportunity to benefit from investment tax credits, tax losses, expected increasing cash flow from both the lease and operation of the Atlanta Marriott Marquis Hotel as well as potential capital appreciation. Based upon a 64
AGGREGATE AGGREGATE DISTRIBUTIONS TO DISTRIBUTIONS TO LIMITED PARTNERS PER TOTAL LIMITED PARTNERS PARTNERSHIP UNIT NO. OF LIMITED PARTNER THROUGH THROUGH HOTELS PARTNERSHIP CAPITAL RAISED JUNE 19, 1998/(1)/ JUNE 19, 1998/(1)//(2)/ OWNED - ----------- --------------- ------------------ ----------------------- ------ (IN THOUSANDS) (IN THOUSANDS) (IN DOLLARS) Atlanta Marquis......... $ 53,000 $ 23,188 $ 43,751/(3)/ 1/(4)/ Chicago Suites.......... 11,642 2,819/(7)/ 8,342 1 Desert Springs.......... 88,020 84,332 93,702 1 Hanover................. 8,269 622 7,405 1 MDAH.................... 40,615 9,738 23,671 6 MHP..................... 100,000 59,824/(5)/ 59,824/(5)/ 2/(5)/ MHP2.................... 73,115 120,452/(6)/ 161,681/(6)/ 4/(6)/ PHLP.................... 18,000 0 0 8 financial forecast that reflected the General Partner's judgment, in light of the facts and circumstances at the time, with respect to the most likely set of conditions and the most likely course of action (and subject to the various assumptions, risks, qualifications, limitations and uncertainties described therein and in the related private placement memorandum), it was estimated that tax savings through 1989 would be $76,226 per Partnership Unit for an investor in the 50% tax bracket (including a $7,845 tax credit in 1985), cash flow to the Class A Limited Partners was expected to begin in 1986 and increase through 1994 to an annual level of 12.2% of a Class A Limited Partner's original investment, and it was assumed for the purpose of the forecast that investors would receive a return of all their investment from a sale of the underlying land to the partnership owning the hotel and a distribution from assumed excess refinancing proceeds in 1994. Thereafter, Class A Limited Partners would continue to benefit from ownership of the Hotel. The financial forecast did not assume a sale of Atlanta Marquis' Hotel. Through June 19, 1998, Atlanta Marquis Class A Limited Partners have received distributions from cash flow of $35,127, tax credits of up to $7,500 and allocations of tax losses of approximately $208,700 (which have been offset in part by subsequent allocations of taxable income of approximately $4,600), plus $8,624 of payments per Partnership Unit received with respect to the reallocation of certain tax losses resulting from the 1990 debt refinancing (assuming each Atlanta Marquis Limited Partner classified these amounts as purchase price adjustments as the General Partner advised). Due to changes in the tax law occurring after the date of the original offering (including, in particular, the changes enacted as part of the Tax Reform Act of 1986) that, among other things, reduced the marginal tax rates applicable to individuals and limited the use of certain tax losses by individuals, the tax losses allocated to the Atlanta Marquis Limited Partners did not likely result in tax savings of the magnitude originally forecast. Chicago Suites. The offering, which was completed in 1989, was intended to (i) preserve and protect Chicago Suites Limited Partners' capital, (ii) generate cash distributions to the Chicago Suites Limited Partners that would be sheltered in whole or in part from current federal income taxation and (iii) realize expected increases in both annual cash distributions from operations and potential long-term appreciation in the value of Chicago Suites' Hotel. Based upon a financial forecast and facts and circumstances at the time (and subject to the various assumptions, risks, qualifications, limitations and other uncertainties described therein and in the related private placement memorandum), it was estimated that cash flow to the Chicago Suites Limited Partners would commence in 1989 and increase through 1994 to an annual level of 11% of a Limited Partner's original investment and that in 1994 investors would receive a return of all capital invested through an assumed refinancing. Thereafter, through 2003, it was estimated that Chicago Suites Limited Partners would receive cash distributions at an annual level of approximately 4% of their original investment. The financial forecast did not assume a sale of Chicago Suites' Hotel. Through June 19, 1998, Chicago Suites Limited Partners have received distributions from cash flow of $8,342 and no return of capital per Partnership Unit. Desert Springs. The offering, which was completed in 1987, was intended to provide investors with an opportunity to benefit from substantial cash flow in the early years of the Partnership from the rent to be received under an airline equipment lease and from the Desert Springs' Hotel operating lease with expected increasing cash flow and potential capital appreciation in later years from the operation of Desert Springs' Hotel. Based upon a financial forecast and facts and circumstances at the time (and subject to the various assumptions, risks, qualifications, limitations and other uncertainties described therein and in the related private placement memorandum), it was estimated that (i) cash distributions on a tax-sheltered basis to the Desert Springs Limited Partners would commence in 1987 at approximately 12.3% of a Limited Partner's original investment and increase to approximately 14.4% of a Limited Partner's original investment in 1991 and (ii) Desert Springs Limited Partners would receive $50,000 per Partnership Unit on a tax-sheltered basis from assumed excess refinancing proceeds in 1991. Thereafter, Desert Springs Limited Partners would continue to benefit from ownership of Desert Springs' Hotel and the airline equipment. The financial forecast did not assume a sale of Desert Springs' Hotel. Desert Springs Limited Partners received cash distributions in connection with the sale of the airline equipment through 1996 of $19,851 per Partnership Unit. Through June 19, 1998, Desert Springs Limited Partners have received distributions from cash flow of $48,851 and a return of capital of $25,000 per Partnership Unit. 65 Hanover. The offering, which was completed in 1986, was intended to provide investors with an opportunity to benefit from expected increasing cash flow from the operation of Hanover's Hotel as well as potential capital appreciation and tax benefits. Based upon a financial forecast (which assumed, among other things, rent payable under the operating lease would be sufficient to provide an annual 10% priority return to the Partnership) and facts and circumstances at the time (and subject to the various assumptions, risks, qualifications, limitations and other uncertainties described therein and in the related private placement memorandum), it was estimated that (i) cash distributions on a tax-free basis to the Hanover Limited Partners would commence in 1987 at approximately 12.7% of a Limited Partner's original investment and increase to approximately 15.5% of a Limited Partner's original investment in 1991 and (ii) Hanover Limited Partners would receive $100,000 per Partnership Unit on a tax-free basis from assumed refinancing proceeds ($50,000 per Partnership Unit in 1991 and $50,000 per Partnership Unit in 1996). Thereafter, Hanover Limited Partners would continue to benefit from ownership of Hanover's Hotel. The financial forecast did not assume a sale of Hanover's Hotel. Through June 19, 1998, Hanover Limited Partners have received distributions from cash flow of $7,405 and no return of capital per Partnership Unit. In April 1997, Host completed a tender offer for Partnership Units of Hanover in which it acquired 40 Partnership Units for an aggregate consideration of $1.6 million or $40,000 per Partnership Unit. MDAH. The offering, which was completed in 1990, was intended to (i) provide semi-annual cash distributions which were anticipated to be free from significant current federal income taxation through 1999 (assuming tax losses from MDAH were carried forward to offset MDAH income in later years), (ii) allow Limited Partners to participate in the potential long-term appreciation in the value of MDAH's Hotels and (iii) preserve investor capital. Based upon a financial forecast and facts and circumstances at the time (and subject to the various assumptions, risks, qualifications, limitations and other uncertainties described therein and in the related private placement memorandum), it was estimated that MDAH Limited Partners could expect cash distributions to be made at an annualized rate of 9.2% of a Limited Partner's original investment for 1990, 11.8% for 1991 and 12.3% for 1992. The average annual cash return was expected to be 15.9% of a Limited Partner's original investment for each of the ten fiscal years ending December 31, 1999. The financial forecast did not assume a sale of MDAH's Hotels. Through June 19, 1998, MDAH Limited Partners have received distributions from cash flow of $23,671 and no return of capital per Partnership Unit. MHP. The offering, which was completed in 1985, was intended to provide investors with an opportunity to benefit from expected increasing cash flow from the operation of MHP's Hotels as well as potential capital appreciation, investment tax credits and tax losses. Based upon a financial forecast and facts and circumstances at the time (and subject to the various assumptions, risks, qualifications, limitations and other uncertainties described therein and in the related private placement memorandum), it was estimated that (i) cash flow to the MHP Limited Partners would commence in 1987 and increase through 1995 to an annual level of 16.9% of a Limited Partner's original investment and (ii) the MHP Limited Partners would receive $100,000 per Partnership Unit on a tax-free basis from assumed refinancing proceeds ($50,000 per Partnership Unit in 1991 and $50,000 per Partnership Unit in 1995). In addition, tax savings through 1990 were forecast to be $79,581 per Partnership Unit for an MHP Limited Partner in the 50% tax bracket (including a $6,197 tax credit in 1986). Tax savings were forecast to continue through 1995 and would total $88,588 per Partnership Unit. Thereafter, MHP Limited Partners would continue to benefit from ownership of MHP's Hotels. The financial forecast did not assume a sale of MHP's Hotels. On November 17, 1993, one of MHP's hotels, the Warner Center Hotel, was foreclosed upon. Through June 19, 1998, MHP Limited Partners have received distributions from cash flow of $52,824, tax credits of $6,010 and allocations of tax losses of approximately $149,600 (which have been offset in part by subsequent allocations of taxable income of approximately $38,200 and capital gains of approximately $26,200) and a return of capital of $7,000 per Partnership Unit. In addition, $8,000 per Partnership Unit was distributed in August 1998 and $6,500 per Partnership Unit is expected to be distributed in November 1998. An additional $8.8 million of retained excess refinancing proceeds also would be distributed to the extent not expended to complete the expansion of the Orlando Hotel. Due to changes in the tax law occurring after the date of the original offering (including, in particular, the changes enacted as part of the Tax Reform Act of 1986) that, among other things, reduced the marginal tax rates applicable to individuals and limited the use of certain tax losses by individuals, the tax losses allocated to the MHP Limited Partners did not likely result in tax savings of the magnitude originally forecast. In January 1997, Host completed a tender offer for Partnership Units of MHP 66 in which it acquired 463.75 Partnership Units for an aggregate consideration of $37.1 million or $80,000 per Partnership Unit. MHP2. The offering, which was completed in 1989, was intended to provide investors with an opportunity to benefit from (i) potential semi-annual cash distributions from operations of MHP2's Hotels, which distributions were anticipated to be free from significant current federal income taxation through 1997 (assuming losses from MHP2 were carried forward to offset MHP2 income in later years), (ii) potential long-term appreciation in the value of MHP2's Hotels and (iii) the preservation of investor capital. Based upon a financial forecast and facts and circumstances at the time (and subject to the assumptions, various risks, qualifications, limitations and other uncertainties described therein and in the related private placement memorandum), it was estimated that cash distributions to the MHP2 Limited Partners would commence in 1989 at an annualized rate of approximately 9.6% of a Limited Partner's original investment, which annualized rate was expected to increase to approximately 24% of a Limited Partner's adjusted invested capital for 1998. It was also forecast that the Limited Partners would receive a distribution (which was expected to be free from current federal income taxation) from assumed refinancing proceeds of approximately $60,400 per Partnership Unit in 1993. Thereafter, the MHP2 Limited Partners would continue to benefit from ownership of MHP2's Hotels. The financial forecast did not assume a sale of MHP2's Hotels. Through June 19, 1998, MHP2 Limited Partners have received distributions from cash flow of $161,681 and no return of capital per Partnership Unit. In addition, $6,700 per Partnership Unit was distributed from cash flow in August 1998 and $5,600 per Partnership Unit is expected to be distributed in November 1998. In June 1996, Host completed a tender offer for Partnership Units of MHP2 in which it acquired 377 Partnership Units for an aggregate consideration of $56.6 million or $150,000 per Partnership Unit. PHLP. The offering, which was completed in 1982, was intended to provide investors with the opportunity for tax benefits, potential cash flow distributions and capital appreciation. Based upon a financial forecast and facts and circumstances at the time (and subject to the various assumptions, risks, qualifications, limitations and other uncertainties described therein and in the related private placement memorandum), it was estimated that cash available for distribution was not expected to be significant for some years, reaching 6.2% of a PHLP Limited Partner's original investment in 1993 and rising to 20.7% of a PHLP Limited Partner's original investment by 1996. The financial forecast did not assume a sale of PHLP's Hotels. On January 31, 1986, PHLP sold the Denver West hotel to Host. In 1993 and 1994, the Raleigh Crabtree, Tampa Westshore and Point Clear hotels were foreclosed upon. In 1994, PHLP repurchased the Raleigh Crabtree and Tampa Westshore hotels using proceeds from two loans advanced by a subsidiary of Host. On August 22, 1995, PHLP sold the Dallas/Fort Worth hotel to a wholly owned subsidiary of Host and used the proceeds to pay down debt. Through June 19, 1998, PHLP Limited Partners have received no distributions from cash flow, tax credits up to $1,588 and allocations of tax losses of approximately $128,000 (which have been offset in part by subsequent allocations of taxable income of approximately $21,300 and capital gains of approximately $49,600) and no return of capital per Partnership Unit. Due to changes in the tax law occurring after the date of the original offering (including, in particular, the changes enacted as part of the Tax Reform Act of 1986) that, among other things, reduced the marginal tax rates applicable to individuals and limited the use of certain tax losses by individuals, the tax losses allocated to the PHLP Limited Partners did not likely result in tax savings of the magnitude originally forecast. Anticipated Holding Periods. None of the offering documents of the Partnerships indicated any anticipated holding period, although the offering documents included hypothetical assumed sale dates for purposes of providing illustrative financial forecasts. Based upon the disclosure, which contained appropriate cautionary language, limited partners could reasonably have expected that they would receive substantial benefits through distributions from some combination (depending upon the particular Partnership) of operations, tax benefits and refinancing proceeds and, at some indefinite future date when market conditions were favorable, and assuming a sale would be advisable for the partners, from a sale of the Partnership's assets. Investment Liquidity. Since the Partnership Units of the Partnerships are not listed on any national or regional stock exchange, nor quoted on any automated quotations system, there has been limited liquidity available to Limited Partners. No formal market for such Partnership Units exists and sales activity in the Partnership Units has been limited and sporadic. 67 The information in the following table shows the highest, lowest and weighted average prices for sales of the Partnership Units in the Partnerships as reported to the General Partners for the twelve months ended April 15, 1998, the date immediately prior to the public announcement of the REIT Conversion. These prices are not indicative of total return to investors in the respective Partnerships because prior cash distributions and tax benefits received by each Limited Partner are not reflected in the price. There can be no assurance that transactions in Partnership Units of any Partnership have not occurred at prices either above the highest price or below the lowest price set forth below. PARTNERSHIP UNIT PRICES (ALL PRICE INFORMATION ON A PER PARTNERSHIP UNIT BASIS) - -------- (1) Based upon the estimated Exchange Values of Partnership Interests in each Partnership. The estimated Exchange Value is equal to the greatest of estimated Adjusted Appraised Value, estimated Continuation Value and estimated Liquidation Value. The actual Exchange Values will be determined as of the Final Valuation Date. The amounts in this column represent the estimated Exchange Value that would be allocable to Limited Partners per Partnership Unit. (2) The $42,200 highest price per Partnership Unit paid for a Partnership Unit of Desert Springs was determined based on the price paid for one-half of a Partnership Unit prior to a distribution of $25,000 per Partnership Unit of capital proceeds from a refinancing. (3) Includes 40 Hanover Partnership Units purchased by Host pursuant to a tender offer at a price of $40,000 per Partnership Unit on April 12, 1997. Excluding the tender offer purchases, there was a single Partnership Unit sold at a price of $20,500. BACKGROUND OF THE MERGERS AND THE REIT CONVERSION Host and the other General Partners are proposing the Mergers in connection with a plan adopted by Host to restructure its business operations so that it will qualify as a REIT under the Code. Host REIT expects to qualify as a REIT beginning with its first full taxable year commencing after the REIT Conversion is completed, which currently is expected to be the year commencing January 1, 1999. Host's reasons for engaging in the REIT Conversion include the following: . Host believes the REIT structure, as a more tax efficient structure, will provide improved operating results through changing economic conditions and all phases of the hotel economic cycle. . Host believes the REIT Conversion, which will reduce corporate-level taxes and the need to incur debt to reduce corporate taxes through interest deductions, will improve its financial flexibility and allow it to continue to strengthen its balance sheet by reducing its overall debt to equity ratio over time. . As a REIT, Host believes it will be able to compete more effectively with other public lodging real estate companies that already are organized as REITs and to make performance comparisons with its peers more meaningful. . By becoming a dividend paying company, Host believes its shareholder base will expand to include investors attracted by yield as well as asset quality. . Host believes the adoption of the UPREIT structure will facilitate tax- deferred acquisitions of other hotels (such as in the case of the Blackstone Acquisition and the Mergers). 68
TRANSACTION NUMBER OF PERIOD PARTNERSHIP WEIGHTED ESTIMATED ORIGINAL 12 MONTHS UNITS HIGHEST LOWEST AVERAGE EXCHANGE PARTNERSHIP COST ENDED TRADED PRICE PRICE PRICE VALUE(1) - ----------- -------- ----------- ----------- -------- -------- -------- --------- Atlanta Marquis......... $100,000 4/15/98 31.0 $ 37,000 $ 20,000 $ 32,430 $ 45,425 Chicago Suites.......... 35,000 4/15/98 49.5 14,300 10,000 10,182 33,133 Desert Springs.......... 100,000 4/15/98 31.0 42,200(2) 10,000 23,526 40,880 Hanover................. 100,000 4/15/98 41.0 40,000(3) 20,500 39,524 123,202 MDAH.................... 100,000 4/15/98 46.0 45,600 20,000 38,475 109,216 MHP..................... 100,000 4/15/98 6.0 91,500 40,000 68,150 141,074 MHP2.................... 100,000 4/15/98 4.0 155,000 150,000 153,750 237,334 PHLP.................... 10,000 4/15/98 .6666 871 871 871 5,040 Host believes that these benefits justify the REIT Conversion even if the REIT Conversion does not occur in time for Host REIT to elect REIT status effective January 1, 1999 (in which event, the effectiveness of Host's REIT election could be delayed until January 1, 2000). Host explored the possibility of engaging in a business combination with a so-called "paired share" REIT, Santa Anita, in December 1996 and January 1997. Based upon an analysis of potential costs, the pricing of the transaction, the time required to complete such a transaction and the possible legislative risks associated with the "paired share" structure, Host decided not to pursue such a transaction. During the fourth quarter of 1997, Host began to explore internally the possibility of reorganizing as a REIT on a stand-alone basis. Host analyzed the various consents that would need to be obtained and other requirements that would need to be met in order to restructure its assets and operations (including its indirect interests in the Partnerships and the Private Partnerships) in order to qualify as a REIT. In light of the importance of its relationship with Marriott International as the manager of substantially all of Host's Hotels, Host began preliminary discussions with Marriott International during January 1998 in order to ascertain whether or not Marriott International would cooperate in Host's potential conversion to a REIT. In February 1998, Host tentatively concluded that it would be desirable for the Operating Partnership to use OP Units to acquire the Partnerships and the Private Partnerships, subject to determination of satisfactory terms and conditions for such acquisitions. In order to determine the feasibility of this approach, Host commenced preliminary discussions in February and March 1998 with the outside partners of certain Private Partnerships to determine whether or not they would have an interest in such a transaction. Host went to these partners directly because, unlike with the Partnerships, in each case there were a small number of partners with whom Host could negotiate directly and such negotiations were permissible under applicable securities laws without making a public offering (and, in fact, such negotiations would need to be completed and the Private Partnerships receiving OP Units would need to be under contract before a registration statement could be filed to offer OP Units to the Limited Partners in the Mergers). In February 1998, the General Partners retained AAA to commence work on the Appraisals and to render a fairness opinion if an agreement were reached with Host to acquire the Partnerships (subject to the requisite Limiter Partner approvals) because the General Partners recognized that the Appraisals would be important in determining the terms of any such acquisition by Host and that it was important to get started as soon as possible, even if a transaction did not materialize, due to the lengthy process involved in a public offering of OP Units to the Limited Partners. In March 1998, Host also entered into discussions with the Blackstone Group regarding the potential acquisition of the twelve full-service hotels and certain other assets owned by the Blackstone Entities because Host believed that these hotels represented the premier hotel portfolio on the market and an acquisition would be consistent with its desire to pursue a strategy of owning both Marriott and other upscale and luxury hotel brands. In April 1998, Host and the Operating Partnership entered into agreements with the Blackstone Entities for the Blackstone Acquisition and concurrently reached a decision and publicly announced that it would be advantageous, both for its shareholders and for the outside investors in the Partnerships, as discussed in the following paragraphs, if Host were to convert to a REIT and offer to the Partnerships the opportunity to participate in the REIT Conversion through the Mergers. In May and June 1998, Host and the Operating Partnership entered into agreements to acquire the interests of certain outside partners in four Private Partnerships. Each of these transactions is contingent upon the REIT Conversion. On June 2, 1998, the Operating Partnership filed a registration statement for the OP Units to be issued to the Limited Partners of the Partnerships in the Mergers. Host decided to propose the Mergers for the Partnerships in connection with its decision to convert to a REIT because (i) the Partnerships have numerous limited partners and therefore Host could not negotiate with the Limited Partners individually and (ii) Host's acquisition policy is to acquire full- service hotels and the Partnerships represented all but one of the widely-held full-service partnerships affiliated with Host that it did not wholly own. In addition, Host believed it would be beneficial to the Limited Partners to provide the tax deferral advantage of OP Units in the Mergers and in order to do so, the offer of such equity securities could be made only through a public offering. Also, the Mergers, by themselves, would still have required the Operating Partnership to lease the Hotels owned by the Partnerships if they were to result in liquidity for the Limited 69 Partners due to the tax rules regarding "publicly traded partnerships." Neither Host nor the General Partners consulted with any investors in the Partnerships regarding the Mergers prior to the April 1998 public announcement of the proposed REIT Conversion. In deciding to pursue and ultimately recommend a Merger, the General Partner of each Partnership considered and evaluated two principal alternatives: (i) continuation of the Partnership as a separate entity in a manner consistent with its current long-term business strategy and (ii) liquidation of the Partnership. The considerations involved in the analysis of these alternatives are described below in "--Reasons for the Mergers," "--Alternatives to the Mergers" and "Fairness Analysis and Opinion." Each General Partner also recognized that two additional types of transactions, a reorganization of the Partnership as a separate REIT or a merger with another REIT or UPREIT, would be possible alternatives to a Merger. For the reasons described below, however, the General Partners did not pursue either such alternative because each General Partner believed that the speculative theoretical benefits of these alternatives were outweighed by their disadvantages and by the benefits of a Merger. Each General Partner recognized that its Partnership could be reorganized as a separate independent REIT whose shares could be listed for trading on an exchange. The General Partners do not believe that this alternative would be as beneficial to Limited Partners as the Mergers for the following reasons, among others: (i) each separate REIT, on a standalone basis, would (a) be a relatively small public company, with a substantially smaller capitalization and public float than Host REIT, (b) have relatively high leverage, particularly for a public REIT, (c) likely need to be externally advised rather than internally managed and (d) have only one or a few assets (depending on the Partnership), all of which would likely adversely affect the trading value of the shares of the separate REIT; (ii) the organization of a separate REIT (unless in an UPREIT structure) would be a taxable transaction for all Limited Partners with "negative capital accounts" for tax purposes to the extent of those negative capital accounts; (iii) if the separate REIT were to raise additional capital contemporaneously, this would cause the organization of the separate REIT to be a fully taxable transaction for all Limited Partners (unless in an UPREIT structure); (iv) the organization of a separate REIT for certain Partnerships (including Atlanta Marquis, Desert Springs, Hanover, MHP, MHP2 and PHLP) could have a material adverse impact on the tax and/or economic positions of Host and the General Partners in those Partnerships, and, therefore, the General Partners of those Partnerships would not favor this alternative; and (v) the reorganization of a Partnership as a separate REIT would have required the Partnership's Hotel(s) to be leased to a third-party lessee, which would have required the consent and cooperation of Marriott International, and Marriott International was under no obligation to provide such consent or cooperation (and might have affirmatively opposed such arrangements with respect to certain of the Hotels owned by certain Partnerships). The General Partners believe that these disadvantages generally outweigh any speculative advantages of reorganizing one or more of the Partnerships as separate REITs (particularly in light of the General Partners' assessments of the benefits to the Limited Partners of participation in the Mergers and the REIT Conversion), and certain of the disadvantages would make this alternative practically impossible for certain of the Partnerships to attain. Each General Partner also recognized that its Partnership could pursue a merger with another REIT, particularly another UPREIT (including possibly a merger with one of the "paired share" UPREITs that specializes in lodging properties). The General Partners do not believe that this alternative would be as beneficial to the Limited Partners as the Mergers for the following reasons, among others: (i) such a merger, unless consummated with a REIT organized in the UPREIT format, would be a fully taxable transaction for the Limited Partners, with the result that the Limited Partners would lose the ability to individually plan the timing of the recognition of their taxable gain; (ii) the General Partners believe that the Marriott lodging brands are among the most respected and widely recognized brand names in the lodging industry and that the Limited Partners would derive greater benefit from owning an interest in an UPREIT that specializes in owning Marriott-brand hotels, together with the diversity provided by the Hyatt, Ritz-Carlton, Four Seasons and Swissotel brand hotels that the Operating Partnership will own; (iii) the acquisition of certain of the Partnerships (including Atlanta Marquis, Desert Springs, Hanover, MHP, MHP2 and PHLP) by another REIT specializing in the ownership and operation of lodging properties could have a material adverse impact on the tax and/or economic positions of Host and the 70 General Partners in those Partnerships, and, therefore, the General Partners of those Partnerships would not favor this alternative; and (iv) the merger of a Partnership with another REIT (or UPREIT), including the leasing of a Partnership's Hotel(s) to a third-party lessee, would have required the consent and cooperation of Marriott International, and Marriott International was under no obligation to provide such consent or cooperation (and might have affirmatively opposed such a transaction at least with respect to certain of the Hotels owned by certain of the Partnerships). The General Partners believe that these disadvantages generally outweigh any speculative advantage that might be obtained from pursuing a merger transaction with another REIT or UPREIT (particularly in light of the General Partners' assessments of the benefits to the Limited Partners of participation in the Mergers and the REIT Conversion), and that certain of the disadvantages would make this alternative practically impossible for certain of the Partnerships to attain. Due to current federal income tax law restrictions on a REIT's ability to derive revenues directly from the operation of a hotel, Host recognized that it would be necessary to lease its hotels to one or more lessees just as other hotel REITs have done. Host desired to have a single lessee (or multiple lessees controlled by a single person) in order to achieve substantial uniformity in its lease terms and avoid protracted negotiations with multiple parties over the terms of the lease arrangements, all of which would have been more complicated as a result of the existing long-term management agreements with Marriott International. Host also did not seriously attempt to restructure the existing Marriott International management agreements as leases (and Marriott International has not offered to do so in any of the negotiations with Host to date) because Host understands that Marriott International's general policy is to manage rather than lease hotels and Host also believed that Marriott International was unlikely to be an acceptable lessee of hotels operating under other brand names. Primarily for these reasons, and in order to give the economic benefit of the lessee's interest in the leases to Host's shareholders at the time of the REIT Conversion, Host decided to enter into leases with Crestline and its subsidiaries and distribute the stock of Crestline to Host's shareholders. Host believed that Crestline was a more appropriate lessee than a newly formed company because Crestline already had an independent business and substantial assets and net worth and, thus, could perform well as a separate publicly traded company. While Host recognized that, as with other REITs that own hotels, there would be additional administrative and operating complexities that would result from leasing its hotels to another party with separate interests and economic objectives, Host believed that the advantages of the REIT Conversion substantially outweighed these disadvantages. If the required shareholder and partner approvals for the various transactions are obtained and other conditions to the different steps in the REIT Conversion are satisfied or waived, these transactions are expected to occur at various times prior to the end of 1998 (or as soon thereafter as practicable). The Mergers of the Participating Partnerships are expected to occur at the final stage of the REIT Conversion. The Operating Partnership and the General Partners are seeking the approval of the Mergers and the related partnership agreement amendments at this time, in advance of satisfaction of all other contingencies, in order to determine how the Partnerships will fit into the UPREIT structure following the REIT Conversion, which Host desires to implement during 1998 in order to permit Host REIT to qualify as a REIT for its 1999 taxable year. Consummation of the Mergers is not conditioned on the REIT Conversion being completed in time for Host REIT to elect REIT status effective January 1, 1999. If the REIT Conversion does not occur in time for Host REIT to elect REIT status effective January 1, 1999, the effectiveness of Host REIT's election could be delayed until January 1, 2000, which would result in Host REIT continuing to pay substantial corporate-level income taxes in 1999 (which would reduce Host REIT's cash distributions per Common Share but not the Operating Partnership's cash distributions per OP Unit) and could cause the Blackstone Acquisition not to be consummated. In view of the complexity of the REIT Conversion and the number of transactions that must occur to complete the REIT Conversion, Host and the General Partners believe that it is beneficial both to the Limited Partners and the shareholders of Host to complete the REIT Conversion as soon as practicable, even if the REIT Conversion cannot be completed prior to January 1, 1999. If Host REIT's election to be taxed as a REIT is not effective on January 1, 1999, Host REIT intends to operate following the REIT Conversion in a manner that would permit it to qualify as a REIT at the earliest time practicable, and it might pursue a merger with another entity or other transaction that would permit it to commence a new taxable year and elect REIT status prior to January 1, 2000. 71 Host REIT in any event would elect to be treated as a REIT for federal income tax purposes not later than its taxable year commencing January 1, 2000. It is a condition to the Mergers that they be completed by June 30, 1999, unless the General Partners and the Operating Partnership mutually agree to extend that deadline to a date no later than December 31, 1999. REASONS FOR THE MERGERS The Mergers are being proposed at this time for three principal reasons: . First, the General Partners believe that the expected benefits of the Mergers to the Limited Partners, as set forth below, outweigh the risks of the Mergers to the Limited Partners, as set forth in "Risk Factors." . Second, the General Partners believe that participation in the REIT Conversion through the Mergers is better for the Limited Partners than the alternatives of continuing each Partnership as a standalone entity or liquidating the Partnership, reorganizing the Partnership into a separate REIT or pursuing a merger of one or more Partnerships with another REIT or UPREIT because (i) the Limited Partners will have the opportunity to receive OP Units, Common Shares or Notes and to acquire an interest in a larger, more diversified hotel company, (ii) the Exchange Value is equal to the highest estimated value that would be derived by Limited Partners from the three valuation alternatives, (iii) for all but three Partnerships, the estimated Adjusted Appraised Value is substantially higher than either the estimated Continuation Value or the estimated Liquidation Value, (iv) Limited Partners will obtain liquidity by electing to exchange the OP Units they receive for freely tradeable Host REIT Common Shares or, if they elect to retain such OP Units, such OP Units will be redeemable for Common Shares or cash, at Host REIT's option, commencing one year after the Effective Date and (v) Limited Partners will receive regular quarterly cash distributions which, for all Partnerships except for MHP and MHP2, are expected to be significantly greater than estimated cash distributions from operations from their current Partnerships during 1998 and for PHLP will represent the first cash distributions received from their investments. See "Determination of Exchange Values and Allocation of OP Units." . Third, Host is proposing the Mergers at this time to each Partnership because consummation of the Merger as to each Partnership will enable Host to obtain the full benefits of the REIT Conversion with respect to its interests in such Partnership, while also giving the other partners of the Partnership the opportunity to enjoy the benefits of the REIT Conversion. See "Risk Factors--Risks and Effects of the Mergers-- Conflicts of Interest--Substantial Benefits to Related Parties." The expected benefits from the Mergers to the Limited Partners include the following: Liquidity. Limited Partners' Partnership Units currently represent relatively illiquid investments. Although there is a limited resale market for Partnership Units, the trading volume is thin and the recent trading prices of outstanding Partnership Units in each of the Partnerships are less than the estimated Exchange Value of Partnership Units in each Partnership, except for Desert Springs. See "Partnership Unit Prices" above. The REIT Conversion will offer Limited Partners liquidity with respect to their investments in the Partnerships because Limited Partners can receive freely tradeable Host REIT Common Shares by electing to exchange OP Units for Common Shares in connection with the Mergers or by exercising their Unit Redemption Right, at any time after one year following the Mergers. Limited Partners thereby would be able to receive, at Host REIT's election, either Common Shares of Host REIT or the cash equivalent thereof. Host has approximately 204 million shares of common stock outstanding and is expected to have a total common equity market capitalization of approximately $3.4 billion after giving effect to the Initial E&P Distribution (based on a price of $12.50 per Host REIT Common Share). The election to exchange OP Units for Common Shares in connection with the Mergers or the exercise of the Unit Redemption Right, however, generally would result in recognition of taxable income or gain. Regular Quarterly Cash Distributions. Over each of the last five full calendar years, only MHP2 Limited Partners have received cash distributions in each year. Generally, over the last five full calendar years, Limited Partners in the other Partnerships, except for Chicago Suites, Hanover and PHLP, have received some cash 72 distributions. In contrast, because Host REIT is required to distribute at least 95% of its REIT taxable income, the General Partners expect that the Operating Partnership will make regular quarterly cash distributions to holders of OP Units (including Host REIT) and that Host REIT will make regular quarterly cash distributions to holders of Common Shares. Host expects that these distributions will be higher than the estimated cash distributions from operations during 1998 of all Partnerships except MHP and MHP2, and, in any event, the ability to receive distributions quarterly and in regular amounts would be enhanced. The ability to receive regular quarterly cash distributions on a pro rata basis also will mitigate the absence of any preferential distribution rights of the Limited Partners under the partnership agreements of Chicago Suites, Hanover and MHP2 and will further benefit the Limited Partners of Atlanta Marquis due to the absence of the General Partner's preferential distribution rights. Management expects to fund such distributions through cash available for distribution and, if necessary, additional borrowings. Distributions will be made in the discretion of Host REIT's Board of Directors. See "Distribution and Other Policies--Distribution Policy." As a substantial holder of OP Units, Host REIT would also receive regular quarterly cash distributions, with such cash distributions expected to be in an amount at least sufficient to permit Host REIT to make cash distributions with respect to the Common Shares as required by the Code provisions relating to REITs. There can be no assurance that Host REIT will be able to make such cash distributions in the future. Upon exercise of the Unit Redemption Right, Limited Partners who receive Common Shares would be entitled to receive cash distributions with respect to such Common Shares in an amount per Common Share expected to be equal to the amount distributed per OP Unit. The following table sets forth the cash distributions from operations per Partnership Unit for all of the Partnerships during 1997, actual and expected distributions from operations during 1998 and the expected distributions during 1999 estimated to be paid by the Operating Partnership to the Limited Partners of each Partnership if the Mergers and the REIT Conversion occur (computed assuming the Effective Date is December 30, 1998). CASH DISTRIBUTIONS FROM OPERATIONS (PER PARTNERSHIP UNIT) - -------- (1) Represents actual cash distributions made through August 20, 1998 and expected cash to be distributed during the period from August 21, 1998 through December 31, 1998. (2) Based upon preliminary estimated annual distributions during the twelve months ending December 31, 1999 of $0.84 per OP Unit. Limited Partners are cautioned that this amount may change and the changes may be material. See "Distribution and Other Policies--Distribution Policy." Does not include amounts, if any, to be distributed by the Partnerships from third and fourth quarter 1998 operations which will be distributed before June 1, 1999. (3) Represents a distribution of $5,000 per Partnership Unit from excess funds that had been accumulated for refinancing costs. (4) Represents a return of capital of approximately $25,000 per Partnership Unit. Substantial Tax Deferral for Limited Partners Not Electing to Exchange OP Units for Common Shares or Notes. The General Partners expect that Limited Partners of the Participating Partnerships who do not elect to receive Common Shares or a Note in exchange for OP Units in connection with the Mergers generally should be able to obtain the benefits of the Mergers while continuing to defer recognition for federal income tax purposes 73
ESTIMATED 1999 DISTRIBUTIONS ACTUAL AND FOLLOWING THE EXPECTED MERGERS AND 1997 1998 THE REIT PARTNERSHIP DISTRIBUTIONS DISTRIBUTIONS(1) CONVERSION(2) ----------- ------------- ---------------- ------------- Atlanta Marquis.................... $ 0 $ 5,000(3) $2,462 Chicago Suites..................... 0 0 1,796 Desert Springs..................... 25,000(4) 2,500 2,215 Hanover............................ 0 0 6,677 MDAH............................... 3,453 0 5,919 MHP................................ 7,700 16,000 7,645 MHP2............................... 29,880 27,164 12,862 PHLP............................... 0 0 273 of at least a substantial portion, if not all, of the gain with respect to their Partnership Interests that otherwise would be recognized in the event of a liquidation of the Partnership or a sale or other disposition of its assets in a taxable transaction (although Limited Partners in Atlanta Marquis, Desert Springs, MHP and PHLP may recognize a relatively modest amount of ordinary income as the result of required sales of personal property by such Partnership to a Non-Controlled Subsidiary). Thereafter, such Limited Partners generally should be able to defer at least a substantial portion of such built-in gain until they elect to exercise their Unit Redemption Right or one or more of the Hotels currently owned by their Partnership are sold or otherwise disposed of in a taxable transaction by the Operating Partnership or, in certain cases, the debt now secured by such Hotels is repaid, prepaid or substantially reduced. The federal income tax consequences of the Mergers are highly complex and, with respect to each Limited Partner, are dependent upon many variables, including the particular circumstances of such Limited Partner. See "Federal Income Tax Consequences--Tax Consequences of the Mergers." Each Limited Partner is urged to consult with his own tax advisors as to the consequences of the Mergers in light of his particular circumstances. Risk Diversification. Upon consummation of the REIT Conversion, each Limited Partner's investment will be converted from an investment in an individual Partnership owning from one to eight hotels into an investment in an enterprise that is expected initially to own or control approximately 125 Hotels and is expected to have a total market capitalization of approximately $3.4 billion. Participation in a Merger, as well as future hotel acquisitions by the Operating Partnership, will reduce the dependence upon the performance of, and the exposure to the risks associated with, any particular Hotel or group of Hotels currently owned by an individual Partnership and spread such risk over a broader and more varied portfolio, including more diverse geographic locations and multiple brands. See "Business and Properties-- Business Objectives." Reduction in Leverage and Interest Costs. It is expected that the Operating Partnership will have a lower leverage to value ratio (approximately 62%) than five of the Partnerships (Atlanta Marquis, Chicago Suites, Desert Springs, Hanover and PHLP), which have leverage ratios that range from between approximately 65% and 80% (calculated as a percentage of Exchange Value). The Operating Partnership's leverage ratio is not expected to be significantly different than the leverage ratios for MDAH, MHP and MHP2, which have leverage ratios that range from approximately 55% to 60%. The Operating Partnership's leverage level generally will result in interest and debt service savings and greater financial stability. Growth Potential. The General Partners believe that the conversion of each Limited Partner's investment into an investment in the Operating Partnership or Host REIT will allow Limited Partners to participate in growth opportunities that would not otherwise be available to them. Host REIT will be a publicly traded real estate company focused primarily on a more diverse and growing full-service hotel portfolio. The General Partners believe that substantial opportunities exist to acquire or develop full-service hotel properties at attractive prices and that the Partnerships are not in a position to take advantage of such opportunities because of (i) their lack of access to additional sources of capital on favorable terms, (ii) restrictions on additional acquisitions and development imposed by the partnership agreements of the Partnerships and (iii) the fact that the Partnerships have already committed their capital and generally are not authorized to raise additional funds for (or reinvest net sale or refinancing proceeds in) new investments, absent amendment of the partnership agreements of the Partnerships or approval by a majority of the outstanding Partnership Interests. The Operating Partnership's structure as part of an UPREIT should provide it with substantial flexibility to structure acquisitions of additional hotels utilizing debt, cash, OP Units or Common Shares (or any combination thereof). In particular, the ability of the Operating Partnership to issue OP Units in the future for the purpose of acquiring additional properties may permit the Operating Partnership to structure acquisitions of hotel properties on a tax- deferred basis to the sellers (i.e., sellers of properties generally will be able to exchange their ownership interests in those properties for OP Units without incurring an immediate income tax liability). Greater Access to Capital. With publicly traded equity securities, a larger base of assets and a greater equity value than any of the Partnerships individually, Host REIT expects to have greater access to the capital necessary to fund the Operating Partnership's operations and to consummate acquisitions on more attractive terms than would be available to any of the Partnerships individually. Host REIT and the Operating Partnership 74 should have more sources of capital available to it than the Partnerships through access to the public equity and debt capital markets, as well as from more traditional sources of real estate financing. This greater access to capital should provide greater financial stability to the Operating Partnership and reduce the level of risk associated with refinancing existing loans upon maturity, as compared to the Partnerships individually. Public Market Valuation of Assets. In most instances, the Partnership Units of each Partnership currently trade at a discount to the net asset value of the Partnership's assets. The General Partners believe that by exchanging interests in their existing, non-traded, finite-life limited partnerships with a fixed portfolio for interests in an ongoing real estate company focused primarily on a more diverse and growing full-service hotel portfolio and providing valuation based upon publicly traded Common Shares of Host REIT, the Limited Partners will have the opportunity to participate in the recent trend toward ownership of real estate through a publicly traded entity, which, in many instances (although not currently), has resulted at various times in market valuations of public real estate companies in excess of the estimated net asset values of those companies. Therefore, the REIT Conversion offers Limited Partners the opportunity to obtain OP Units or Common Shares in exchange therefor in connection with the Mergers (and, for Limited Partners who retain OP Units, Common Shares upon the exercise of the Unit Redemption Right at any time commencing one year following the Mergers) whose public market valuation in the future may exceed the fair market value of the underlying assets of the Operating Partnership on a per OP Unit/Common Share basis. There can be no assurance, however, that the Common Shares of Host REIT will trade at a premium to the private market values of the Operating Partnership's assets or that they will not trade at a discount to private market values. Also, the benefit of Host's conversion to a REIT will not be shared by the Limited Partners if and to the extent that such benefit is reflected in the market valuation of Host's common stock prior to the REIT Conversion. COMPENSATION AND DISTRIBUTIONS TO THE GENERAL PARTNERS AND MARRIOTT INTERNATIONAL Under the partnership agreements of the Partnerships, the General Partners do not receive any fees or compensation for services rendered to the Partnerships as general partner but the General Partners and their affiliates are reimbursed for certain costs and expenses incurred on behalf of the Partnerships. In addition, each General Partner is entitled to distributions related to its respective interests in a Partnership. Host REIT, as general partner of the Operating Partnership, will be required to conduct all of its business through the Operating Partnership. Following the REIT Conversion, Host REIT will be entitled to receive cash distributions with respect to the OP Units that it owns and the Operating Partnership will pay (or reimburse Host REIT for) all expenses that Host REIT incurs, including taxes (subject to certain limited exceptions). Marriott International and its affiliates receive management fees and other reimbursements from the Partnerships under the Management Agreements. The following table sets forth the compensation, reimbursements and distributions paid by all of the Partnerships to the General Partners and their affiliates and the payments made to Marriott International and its affiliates on a combined basis for the last three fiscal years and the First Two Quarters 1998 ("Historical") and the estimated reimbursements and distributions that would have been paid by the Partnerships to the General Partners and their affiliates and payments made to Marriott International and its affiliates during the last three fiscal years and the First Two Quarters 1998 if the REIT Conversion had been in effect, assuming the Full Participation Scenario ("Pro Forma"). The Pro Forma estimates assume a distribution per OP Unit of $0.84 per year during 1997 and the First Two Quarters 1998 (based upon the preliminary estimated initial annual cash distributions per OP Unit during the twelve months ending December 31, 1999) and no distributions during 1996 and 1995 (based upon the assumption that the Operating Partnership and Host REIT would not have had any taxable income for such years because Host reported net operating losses of $10 million and $83 million, respectively, on its consolidated federal income tax returns for taxable years 1996 and 1995 and thus would not have made any distributions). 75 HISTORICAL AND PRO FORMA COMPENSATION, REIMBURSEMENTS AND DISTRIBUTIONS TO THE GENERAL PARTNERS AND THEIR AFFILIATES AND PAYMENTS MADE TO MARRIOTT INTERNATIONAL AND ITS AFFILIATES (IN THOUSANDS) - -------- (1) All expenses will be paid directly by the Operating Partnership; accordingly, there are no expected reimbursements on a pro forma basis. (2) The amount of distributions payable to the General Partners and their affiliates on a pro forma basis in 1997 and the First Two Quarters 1998 assumes payment of distributions at a rate of $0.84 per annum per OP Unit (which represents the preliminary estimated initial annual cash distributions per OP Unit during the twelve months ending December 31, 1999) with respect to the estimated minimum number of OP Units that the General Partners and their affiliates will receive with respect to their general and limited partner interests in the Partnerships, assuming all Partnerships participate in the Mergers and the maximum price of $15.50 per OP Unit. Such number does not reflect the aggregate number of OP Units Host REIT will receive in connection with the REIT Conversion. The amount of distributions payable to the General Partner and its affiliates on a pro forma basis in 1996 and 1995 are assumed to be zero (based upon the assumption that the Operating Partnership and Host REIT would not have had any taxable income for such years because Host reported net operating losses of $10 million and $83 million, respectively, on its consolidated federal income tax returns for taxable years 1996 and 1995 and thus would not have made any distributions). The pro forma distributions payable to the General Partner and its affiliates are not necessarily indicative of the amounts that would have been distributed per OP Unit in such periods if the REIT Conversion and the Mergers had been consummated as of the beginning of each period shown. ALTERNATIVES TO THE MERGERS In determining whether to propose the Mergers, the General Partners compared the benefits to the Limited Partners of continuing each Partnership with the benefits the Limited Partners could achieve by the participation of their Partnership in the REIT Conversion through a Merger. The General Partners considered the other principal alternative--liquidation of a Partnership--but do not believe that liquidation is appropriate at this time because the expected benefits of the proposed Mergers are greater. The following paragraphs discuss the advantages and disadvantages of continuing the Partnerships as standalone partnerships and, to assist Limited Partners in evaluating the Mergers, liquidating the Partnerships. CONTINUATION OF EACH PARTNERSHIP Benefits of Continuation. Continuing each Partnership without change, in accordance with its existing business plan and pursuant to its current partnership agreement, would have the following effects, some of which effects Limited Partners may perceive as benefits: . No Partnership would be subject to the risks associated with the Mergers and REIT Conversion, and instead each Partnership would remain a separate entity, with its own assets and liabilities and would 76
FISCAL YEAR FIRST TWO QUARTERS -------------------------------------------------------------- 1998 1997 1996 1995 -------------------- -------------------- -------------------- -------------------- HISTORICAL PRO FORMA HISTORICAL PRO FORMA HISTORICAL PRO FORMA HISTORICAL PRO FORMA ---------- --------- ---------- --------- ---------- --------- ---------- --------- Reimbursements to the General Partners and Affiliates/(1)/........ $ 1,799 $ -- $ 1,657 $ -- $ 1,168 $ -- $ 568 $ -- Distributions to the General Partners and Affiliates/(2)/........ 6,716 7,427 15,833 14,853 8,202 0 338 0 Payments to Marriott In- ternational and Affili- ates .................. 36,147 36,579 64,554 64,554 59,554 59,554 57,891 57,891 ------- ------- ------- ------- ------- ------- ------- ------- Total................. $44,662 $44,006 $22,044 $79,407 $68,924 $59,554 $58,797 $57,891 ======= ======= ======= ======= ======= ======= ======= ======= pursue its original investment objectives consistent with the guidelines, restrictions and safeguards contained in its partnership agreement; . No Partnership's performance would be affected by the performance of the other Hotel Partnerships or Host REIT, including the investment objectives, interests and intentions of the limited partners of the other Hotel Partnerships or the shareholders of Host REIT; . There would be no change in the nature of the Limited Partners' voting rights; and . There would be no change in the cash distribution policy of the Partnership. Disadvantages of Continuation. Maintaining the Partnerships as separate entities would have the following disadvantages, among others: . Continued illiquidity of a Limited Partner's investment due to the absence of an established market for interests in the Partnerships that provides full value for such interest; . The inability from time to time of the Partnerships to make regular distributions; . The inability of the Partnerships to take advantage of public market valuation of their assets, growth opportunities and other potential benefits of the Mergers; . Each Partnership will continue to have a leverage to value ratio exceeding 55% and typically averaging between 60% and 80% (calculated as a percentage of Exchange Value); . Limited Partners will continue to be subject to the risks inherent in the lack of broad diversity that any individual Partnership's assets represent; and . Any realization by the Limited Partners of the full value attributable to their Partnership Units likely would require a liquidation of the Partnership and the sale of its Hotel or Hotels which has the disadvantages set forth below (see "--Liquidation of Each Partnership"). LIQUIDATION OF EACH PARTNERSHIP Benefits of Liquidation. In lieu of participating in the Mergers and the REIT Conversion, each Partnership could sell its assets (subject to the existing Management Agreements), pay off its existing liabilities not assumed by the buyer and distribute the net sales proceeds to its partners in accordance with the distribution provisions of its partnership agreement. The primary advantage of this alternative would be to provide immediate liquidity to Limited Partners based upon the current market value of the Partnership's real estate assets. See "--Summary of Comparative Valuation Alternatives" for estimates of the net liquidation proceeds that might be available to the Limited Partners upon the liquidation of each Partnership. Disadvantages of Liquidation. The General Partners do not believe that this alternative would be as beneficial to Limited Partners as the Mergers, for the following reasons, among others: (i) certain existing Partnership debt cannot be defeased or prepaid at the present time (such as certain indebtedness of Atlanta Marquis and MHP2 and Desert Springs' Senior Notes) and when the existing debt can be defeased or prepaid, the costs of defeasance or prepayment (with the exception of Chicago Suites, MDAH and PHLP) would significantly decrease the sales proceeds available to Limited Partners of a Partnership and (ii) a sale and liquidation would be a taxable event for all Limited Partners, who would lose the ability to individually plan the timing of the recognition of their taxable gain. In addition, because of the tax consequences that the General Partners (and thus Host) would incur upon a Partnership's taxable sale of its Hotel or Hotels, this is not an alternative that the General Partners would favor, making it less likely that such an alternative could be implemented. SUMMARY OF COMPARATIVE VALUATION ALTERNATIVES To determine the Exchange Values and to assist Limited Partners in comparing alternatives to the Mergers, the General Partners, in conjunction with AAA, have computed for each Partnership the estimated Adjusted Appraised Value, the estimated Continuation Value and the estimated Liquidation Value of the Partnership 77 Interests of the Limited Partners. Estimated Exchange Value is equal to the greatest of estimated Adjusted Appraised Value, estimated Continuation Value and estimated Liquidation Value. In addition, the table below sets forth the minimum number of OP Units to be received by the Limited Partners in the Partnerships based upon the estimated Exchange Value and the maximum price per OP Unit of $15.50. For a detailed explanation of the calculation of each value, see "Determination of Exchange Values and Allocation of OP Units." (For the reasons described above in "--Background of the Mergers and the REIT Conversion," the General Partners did not attempt to estimate the value of reorganization of each Partnership as a separate REIT or merger with another REIT or UPREIT but they do not believe that either of these alternatives would result in a higher value for the Limited Partners than the Exchange Value to be received through the receipt of the OP Units in the Mergers.) The estimated values set forth below may increase or decrease as a result of various adjustments that will be finally calculated as of the Final Valuation Date, but such estimated Exchange Values will not change as a result of less than all of the Partnerships participating in the Mergers. The number of OP Units to be issued to the Limited Partners will not be determined until after the Effective Date. SUMMARY OF COMPARATIVE VALUATION ALTERNATIVES AND MINIMUM NUMBER OF OP UNITS (ALL AMOUNTS ON A PER PARTNERSHIP UNIT BASIS)(1) - -------- (1) A Partnership Unit in all of the Partnerships except Chicago Suites ($35,000) and PHLP ($10,000) represents an original investment of $100,000. (2) Estimated Exchange Value is equal to the greatest of estimated Adjusted Appraised Value, estimated Continuation Value and estimated Liquidation Value. (3) Assumes the price of an OP Unit is $15.50, which is the maximum price for purposes of the Mergers and thus results in the minimum number of OP Units that may be issued. (4) The estimated Adjusted Appraised Value and the estimated Liquidation Value for PHLP are zero because PHLP's outstanding debt is greater than the Appraised Value of the Hotels and the value of other assets, net of liabilities, owned by PHLP. RECOMMENDATION OF THE GENERAL PARTNERS FOR THE REASONS STATED HEREIN, THE GENERAL PARTNERS BELIEVE THAT THE MERGERS PROVIDE SUBSTANTIAL BENEFITS AND ARE FAIR TO THE LIMITED PARTNERS OF EACH PARTNERSHIP AND RECOMMEND THAT ALL LIMITED PARTNERS VOTE FOR THE MERGERS AND FOR THE RELATED AMENDMENTS TO THE PARTNERSHIP AGREEMENTS. SEE "FAIRNESS ANALYSIS AND OPINION--FAIRNESS ANALYSIS." 78
ESTIMATED ESTIMATED ADJUSTED ESTIMATED ESTIMATED ESTIMATED MINIMUM APPRAISED CONTINUATION LIQUIDATION EXCHANGE NUMBER OF PARTNERSHIP VALUE VALUE VALUE VALUE(2) OP UNITS(3) ----------- --------- ------------ ----------- --------- ----------- Atlanta Marquis.... $ 41,570 $ 45,425 $ 402 $ 45,425 2,931 Chicago Suites..... 33,133 24,184 31,149 33,133 2,138 Desert Springs..... 40,880 33,536 27,617 40,880 2,637 Hanover............ 123,202 98,090 88,474 123,202 7,949 MDAH............... 109,216 89,340 98,343 109,216 7,046 MHP................ 140,032 141,074 124,261 141,074 9,102 MHP2............... 237,334 211,263 205,140 237,334 15,312 PHLP............... 0(4) 5,040 0(4) 5,040 325 DETERMINATION OF EXCHANGE VALUES AND ALLOCATION OF OP UNITS OVERVIEW Following consummation of the REIT Conversion, OP Units are expected to be owned by the following groups: . Host REIT, which will own a number of OP Units equal to the number of outstanding Common Shares of Host REIT. These OP Units will consist of (i) the OP Units to be acquired in exchange for the contribution of Host's full-service hotel assets and other assets (excluding its senior living assets and the cash or other consideration to be distributed to shareholders of Host or Host REIT and certain other de minimis assets), subject to all liabilities of Host (including past and future contingent liabilities), other than liabilities of Crestline, (ii) the OP Units to be received by the General Partners and other Host subsidiaries with respect to their interests in the Partnerships and (iii) the OP Units to be acquired from Limited Partners who elect to receive Common Shares in connection with the Mergers. The OP Units received by the General Partners and other Host subsidiaries attributable to their interests in the Partnerships will be determined in the same manner as the number of OP Units to be received by Limited Partners and will be determined in accordance with the distribution provisions in the partnership agreements of the Partnerships. On a pro forma basis, as of June 19, 1998, Host REIT would have owned approximately 204 million OP Units, based upon the number of outstanding shares of Host common stock at that time, of which the General Partners and other Host subsidiaries would have owned approximately 17.7 million OP Units received with respect to their interests in the Partnerships. If Host issues any shares of preferred stock prior to the REIT Conversion, Host REIT also will own a number of preferred partnership interests in the Operating Partnership equal to the number of outstanding shares of preferred stock. . The Blackstone Entities, which will receive approximately 43.7 million OP Units and other consideration in exchange for the contribution of the Blackstone Hotels and certain other related assets, subject to certain liabilities. . Limited Partners of the Participating Partnerships, who will receive in the Mergers a number of OP Units based upon the Exchange Values of their respective Partnership Interests and the price per OP Unit (other than Limited Partners who elect to exchange such OP Units for Common Shares or Notes). . Partners unaffiliated with Host in four Private Partnerships, who have agreed to exchange their interests in their Private Partnerships for OP Units based upon the value of their interests in their Private Partnerships, as determined by negotiation with Host. METHODOLOGY FOR DETERMINING EXCHANGE VALUES SUMMARY. The Exchange Value of each Partnership will be equal to the greatest of its Adjusted Appraised Value, Continuation Value and Liquidation Value, each of which has been determined as follows: . Adjusted Appraised Value. The General Partners have retained AAA to determine the market value of each of the Hotels as of March 1, 1998 (the "Appraised Value"). The "Adjusted Appraised Value" of a Partnership equals the Appraised Value of its Hotels, adjusted as of the Final Valuation Date (as defined below) for lender reserves, capital expenditure reserves, existing indebtedness (including a "mark to market" adjustment to reflect the market value of such indebtedness), certain deferred maintenance costs, deferred management fees and transfer and recordation taxes and fees. . Continuation Value. The "Continuation Value" of a Partnership represents AAA's estimate, as adopted by the General Partners, of the discounted present value, as of January 1, 1998, of the limited partners' share of estimated future cash distributions and estimated net sales proceeds (plus lender reserves), assuming that the Partnership continues as an operating business for twelve years and its assets are sold on December 31, 2009 for their then estimated market value. 79 . Liquidation Value. The "Liquidation Value" of a Partnership represents the General Partners' estimate of the net proceeds to limited partners resulting from the assumed sale as of December 31, 1998 of the Hotel(s) of the Partnership, each at its Adjusted Appraised Value (after eliminating any "mark to market" adjustment and adding back the deduction for transfer and recordation taxes and fees, if any, made in deriving the Adjusted Appraised Value), less (i) estimated liquidation costs, expenses and contingencies equal to 2.5% of Appraised Value and (ii) prepayment penalties or defeasance costs, as applicable. Final determination of the Exchange Value of each Partnership will be made as of the end of the four week accounting period ending at least 20 days prior to the Effective Date (the "Final Valuation Date") and will be equal to the greatest of Adjusted Appraised Value, Continuation Value and Liquidation Value as of such date. Adjusted Appraised Value, Continuation Value and Liquidation Value will be adjusted as of the Final Valuation Date (i) to reflect the amount of lender and capital expenditure reserves and the amount of deferred management fees as of such date, (ii) to increase the Adjusted Appraised Value by any amounts actually expended by a Partnership after the Initial Valuation Date to perform deferred maintenance that were previously subtracted in determining the estimated Adjusted Appraised Value of such Partnership and (iii) to reflect any changes in the Partnership's other reserves, such as for litigation expenses and indemnification costs and any revised estimates of transfer and recordation taxes and fees. The General Partners do not believe that any adjustments to the Exchange Value will be material; however, if any such changes are deemed to be material, the General Partners will provide the Limited Partners in any Partnership so affected with an opportunity to change their vote on the Merger. APPRAISED VALUE. The Partnerships' Hotels were appraised as of March 1, 1998 by AAA, an independent, nationally recognized hotel valuation and financial advisory firm experienced in the appraisals of lodging properties such as the Partnerships' Hotels. Each appraisal (an "Appraisal") was reviewed by an MAI (Member Appraisal Institute) appraiser and certified by such MAI appraiser as having been prepared in accordance with the requirements of the Standards of Professional Practice of the Appraisal Institute and the Uniform Standards of Professional Appraisal Practice of the Appraisal Foundation. The purpose of each Appraisal is to provide an estimate of the "Market Value" of the related Hotel. "Market Value" means the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably and assuming the price is not affected by undue stimuli. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: (i) the buyer and seller are equally motivated; (ii) both parties are well informed or well advised, and each is acting in what he considers his own best interest; (iii) a reasonable time frame is allowed for exposure in the open market; (iv) payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and (v) the price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale. AAA made site visits at all of the Hotels except for three Hotels owned by MDAH and one Hotel owned by PHLP for purposes of the Appraisals. Neither AAA nor the General Partners believe that the lack of site visits to these Hotels affects the determination of market value because, as part of the Appraisals, AAA reviewed financial information of the Hotels as well as conducted extensive interviews with the managers of the Hotels. See "Fairness Analysis and Opinion--Fairness Opinion--Summary of Materials Considered and Investigation Undertaken." In preparing the Appraisals, AAA relied primarily on the income capitalization method of valuation, and then compared the value estimated by this method with recent sales of comparable properties, as a check on the reasonableness of the value determined through the income capitalization method. AAA employed the following procedures for determining the Appraised Value of each Hotel: . Historical 1997 and Projected Year's Earnings. AAA reviewed the historical 1997 net operating income (i.e., income before interest, taxes, depreciation and amortization) ("NOI") prior to incentive management fees and certain capital expenditures for the applicable Hotel. AAA also prepared a 80 projection of the net operating income prior to incentive management fees and certain capital expenditures for the applicable Hotel for the twelve month period ending February 28, 1999 (the "Projected Year"), using historical financial information for the Hotel, budget information, a survey with the manager of the Hotel addressing the physical condition of the Hotel, local market conditions (including business mix, demand generators, future trends and predictability of business), changes in the competitive environment, comparison with direct competitors of the Hotel and risk factors relating to the particular Hotel. The resulting gross margin (ratio of total revenues to net operating income prior to incentive management fees) was checked against AAA's database of the gross margins for similar hotels for reasonableness. . Impact of Incentive Management Fees. AAA estimated a normalized annual amount of incentive management fees payable under the applicable management agreement and subtracted this amount from the net operating income prior to incentive management fees and certain capital expenditures for 1997 and the Projected Year. . Impact of Owner Funded Capital Expenditures. AAA estimated normalized annual amounts of owner funded capital expenditures (over and above the FF&E reserve) based in part on projected owner funded capital expenditures estimated in the Engineering Study, including in the case of three Hotels (Atlanta Marquis, Desert Springs and Hanover) certain identified 1998 capital expenditures for which reserves have been set aside. The normalized amounts were then subtracted from the NOI prior to owner funded capital expenditures for 1997 and the Projected Year. . Capitalization of Adjusted NOI. AAA then capitalized the amount resulting from the foregoing adjustments ("Adjusted NOI") for 1997 and the Projected Year by dividing such amounts by capitalization rates that AAA determined to be appropriate. A capitalization rate represents the relationship between net operating income and sales prices of income producing property. AAA selected the capitalization rates based upon its review of current published surveys reflecting the opinions of investors and participants such as REITs, hotel acquisition/management companies and pension funds, lenders, brokers and consultants as to current capitalization rates, and its own database of capitalization rates reflected in recent transactions, adjusted for factors specific to the individual Hotel, such as location, physical condition, reserve policies, local market volatility and competition, guest mix, renovation influences and other income characteristics. AAA used separate capitalization rates that it deemed appropriate to capitalize 1997 historical Adjusted NOI and estimated Projected Year's Adjusted NOI. AAA then estimated the value of each Hotel based upon each of the values estimated by capitalizing 1997 and Projected Year's Adjusted NOI and its professional judgment. The following table sets forth the resulting Appraised Values of the Hotels of each Partnership, as estimated by AAA. APPRAISED VALUE OF EACH PARTNERSHIP'S HOTELS (IN THOUSANDS) - -------- (1) Excludes the 49.5% interest in the Harbor Beach Resort not owned by MHP. (2) Excludes the 50% interest in the Santa Clara Marriott not owned by MHP2. 81
PARTNERSHIP APPRAISED VALUE - ----------- --------------- Atlanta Marquis................................................ $ 255,000 Chicago Suites................................................. 34,300 Desert Springs................................................. 223,800 Hanover........................................................ 49,400 MDAH........................................................... 165,900 MHP............................................................ 354,261(1) MHP2........................................................... 463,300(2) PHLP........................................................... 265,800 ---------- Total.......................................................... $1,811,761 ========== The following table sets forth the effective capitalization rates for 1997 and Projected Year's Adjusted NOI resulting from AAA's estimated Appraised Values of the Hotels. RESULTING EFFECTIVE CAPITALIZATION RATES IN APPRAISALS . Comparison with Comparable Sales. AAA checked the Appraised Value of each Hotel derived by the foregoing procedures against its database of comparable sale transactions for reasonableness. In the case of a Hotel that is only partly owned by a Partnership, the Appraised Value of such Hotel was reduced proportionately to the amount attributable to such Partnership's ownership interest therein (but no adjustment was made to reflect the effect that the outside interest might have on decisions with respect to sales, refinancings or other major operational matters). With respect to the Partnerships' Hotels, eleven properties were encumbered by ground leases as of the date of the Appraisal: one owned by each of Chicago Suites, MDAH and MHP, three owned by MHP2 and five owned by PHLP. Accordingly, the Appraised Values of these Partnerships' Hotels have been decreased to reflect the encumbrance of the ground leases and the interest of the ground lessor in the operating cash flows of such Hotels. The Appraised Value of MHP's Orlando World Center Hotel also includes AAA's estimate of the present value of a planned expansion of the Hotel. The Appraised Values assume all contractual provisions for FF&E reserves are adequate and have not been reduced to reflect deferred maintenance or environmental remediation costs with respect to the Partnerships' Hotels (but estimated deferred maintenance costs have been deducted in estimating the Adjusted Appraised Value of each Hotel). The Appraised Values did not take into account the costs that might be incurred in selling a Hotel (but estimated costs for transfer and recordation taxes and fees have been deducted in estimating the Adjusted Appraised Value of each Hotel). The Appraisals are not guarantees of present or future values and no assurance can be given as to the actual value of the Partnerships' Hotels. The Appraisals should be read in conjunction with other information, such as, but not limited to, the audited financial statements of the Partnerships. The Appraised Values, and the assumptions underlying the projections on which the Appraised Values are based, are contingent upon a series of future events, the outcomes of which are not necessarily within the Operating Partnership's control and cannot be determined at this time. There can be no assurance that another appraiser would not have arrived at a different result. Some of the assumptions inevitably will not materialize and unanticipated events and circumstances will occur subsequent to the date of the Appraisals. Furthermore, the actual results achieved from the Hotels will vary from the results projected in the Appraisals and the variations may be material. ADJUSTED APPRAISED VALUE. The Adjusted Appraised Value of each Partnership was determined by totaling the Appraised Values of all of the Hotels of the Partnership and then making various adjustments to the aggregate Appraised Value, as described below. . Lender Reserves. For Atlanta Marquis, Desert Springs, MDAH, MHP and MHP2, debt service reserves are required to be held by third-party lenders. The amount of these lender reserves as of the 82
PROJECTED YEAR (ENDING PARTNERSHIP 1997 FEBRUARY 28, 1999) ----------- --------- ------------------ Atlanta Marquis................................ 9.3% 9.4% Chicago Suites................................. 9.4% 10.3% Desert Springs................................. 8.9% 9.3% Hanover........................................ 9.4% 10.1% MDAH........................................... 9.1 - 9.9% 10.1 - 10.6% MHP............................................ 8.8 - 9.4% 9.8 - 10.2% MHP2........................................... 9.1 - 9.6% 9.7 - 11.6% PHLP........................................... 9.2 - 9.8% 9.7 - 10.6% Initial Valuation Date was added to the Appraised Values of these Hotels. A final determination of the lender reserves of each of these Partnerships will be made on the Final Valuation Date and any changes in such reserves will be reflected in the Adjusted Appraised Value. . 1998 Capital Expenditure Reserves. For Atlanta Marquis, Desert Springs and Hanover, an amount equal to the capital expenditure reserves which were set aside as of March 1, 1998 for various identified capital improvements in 1998 (which amounts resulted in reductions in the Appraised Value as described above) was added back to the Appraised Value. . Mortgage and Other Debt. The estimated principal balance and accrued interest (including participating interest that would accrue as a result of the Mergers) as of the Effective Date (assumed to be December 31, 1998) of all mortgage and other debt of each Partnership has been subtracted from the Appraised Value. . Mark to Market Adjustments. The third-party loans of the Partnerships have various interest rates and terms to maturity. In order to reflect the market value of the third-party loans of each Partnership, the estimated Adjusted Appraised Value for each Partnership has been adjusted (increased or decreased) to "mark to market" the interest rate for such loans. This adjustment has been estimated by comparing the interest cost using the applicable interest rates on existing third- party loans over their remaining term to the interest cost using the interest rate that the Operating Partnership believes it would be able to obtain for unsecured debt in the market as of the Final Valuation Date (which would have been 8.0% per annum based on a 350 basis point (3.50%) spread over the yield on seven-year U.S. Treasury securities as of September 29, 1998). The mark to market adjustment for each loan was calculated by determining the difference between the present values, as of December 31, 1998, of the interest payments over the remaining term of the loan from January 1, 1999 to maturity using the actual interest rate as the discount rate as compared to using the assumed market rate as the discount rate. In the case of the mezzanine loan on Desert Springs, the adjustment reflects the prepayment penalty that would be payable because it is less than the mark to market adjustment. . Deferred Management Fees. The amount of deferred management fees (management fees earned by the manager pursuant to the Management Agreement and not paid currently) estimated to be payable under the Management Agreement(s) of each Partnership as of December 31, 1998 have been subtracted from the Appraised Value. The amount of such deferred management fees will be recalculated as of the Final Valuation Date. . Deferred Maintenance Costs. The estimated cost to complete any deferred maintenance items identified in the Engineering Study relating to the applicable Hotel or Hotels of each Partnership have been subtracted from the Appraised Value. The adjustments for this item will be reduced at the Final Valuation Date to reflect amounts expended after the Initial Valuation Date to perform such deferred maintenance. No adjustments have been made for previously budgeted capital expenditures or deferred maintenance costs estimated in the Engineering Study that are reflected in the cash flow projections used for purposes of estimating Appraised Values. . Transfer and Recordation Taxes and Fees. The estimated transfer and recordation taxes and fees required to be paid by each Partnership in connection with the Mergers have been subtracted from the Appraised Value. 83 The following table sets forth the adjustments to the aggregate Appraised Values made to derive the estimated Adjusted Appraised Value for each Partnership as of the Initial Valuation Date. CALCULATION OF ESTIMATED ADJUSTED APPRAISED VALUES AS OF THE INITIAL VALUATION DATE (IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNTS) - -------- (1) Excludes 49.5% of the $122,300,000 Appraised Value of the Harbor Beach Resort and the $82,266,000 in mortgage debt encumbering the Hotel. (2) Excludes 50% of the $126,200,000 Appraised Value of the Santa Clara Marriott Hotel but includes 100% of the $42,500,000 in mortgage debt encumbering the Hotel for which MHP2 is wholly responsible. (3) The estimated Adjusted Appraised Value for PHLP is zero because PHLP's outstanding debt is greater than the Appraised Value of the Hotels and the value of other assets, net of liabilities, owned by PHLP. (4) Excludes amounts attributable to limited partner interests of a General Partner, except as noted. (5) Includes Class B limited partner interests held by the General Partner. (6) Excludes $59.7 million attributable to the participating subordinated loan held by Host. (7) Includes limited partner interests held by a General Partner. (8) Includes estimated limited partner share of Host subsidiaries (except for Chicago Suites and Desert Springs in which no Host subsidiary owns any limited partner interest). (9) Including 1% owned by a limited partner who is not a holder of any of the 335 outstanding Partnership Units. CONTINUATION VALUE. AAA estimated the Continuation Value of each Partnership using the following methodology: . Estimated Future Cash Distributions. AAA prepared estimates of future partnership cash flow for the Partnership for the 12-year period from January 1, 1998 through December 31, 2009 based upon the estimated 1998 NOI before incentive management fees used in the Appraisals and for each subsequent year applying an assumed annual stabilized growth rate (ranging from 3.40% to 4.50%, depending upon the Partnership, as shown in the table below) developed by AAA for this analysis. For each year in the projection period, AAA estimated the amount of cash available for distribution to limited partners after payment of all management fees, debt service, owner funded capital expenditures based on the Engineering Study and other partnership expenses and after application of the applicable partnership agreement provisions. AAA assumed that each Partnership's FF&E reserves were adequate and understood that Host determined that there were no reserve shortfalls or surpluses. . Refinancing Assumptions. For debt that matures during the 12-year period, AAA assumed that the debt would be refinanced with interest rates ranging from 7.25% to 8.60% per annum and a 20 to 30-year amortization schedule, with estimated refinancing costs of 2% of the refinanced amount being paid from operating cash flow (or added to the principal balance of the loan, if cash flow was estimated to be insufficient). 84
ATLANTA CHICAGO DESERT MARQUIS SUITES SPRINGS HANOVER MDAH MHP MHP2 PHLP --------- -------- --------- -------- -------- --------- --------- --------- Appraised Value........ $ 255,000 $ 34,300 $ 223,800 $ 49,400 $165,900 $ 354,261(1) $ 463,300(2) $ 265,800 Lender reserves........ 3,600 0 6,173 0 3,000 1,800 6,800 0 Capital expenditure re- serve................. 16,750 0 1,500 1,690 0 0 0 0 Mortgage debt.......... (162,047) (22,284) (101,632) (29,394) (97,371) (192,137)(1) (259,945)(2) (161,136) Other debt............. (20,134) (464) (92,438) (10,398) (25,355) (722) 0 (128,102) Mark to market adjust- ment.................. 4,693 94 411 (435) 399 2,878 (2,154) 0 Deferred management fees.................. 0 0 0 0 0 0 (3,184) (34,151) Deferred maintenance costs................. (607) (46) (650) (72) (825) (245) (1,673) (5,212) Transfer taxes......... 0 (274) 0 0 0 0 0 (814) --------- -------- --------- -------- -------- --------- --------- --------- Estimated Adjusted Appraised Value....... $ 97,255 $ 11,326 $ 37,164 $ 10,791 $ 45,748 $ 165,835 $ 203,144 $ 0(3) ========= ======== ========= ======== ======== ========= ========= ========= Estimated General Part- ner's share(4)........ $ 75,223(5) $ 113 $ 372(6) $ 442 $ 533 $ 25,803 $ 26,330 $ 0 Estimated limited part- ner share of Host sub- sidiaries(7).......... $ 62 $ 0 $ 0 $ 4,928 $ 273 $ 67,670 $ 93,272 $ 0 Estimated total limited partners' share(8).... $ 22,032 $ 11,213(9) $ 36,792 $ 10,349 $ 45,215 $ 140,032 $ 176,814 $ 0 Per Partnership Unit... $ 41,570 $ 33,133 $ 40,880 $123,202 $109,216 $ 140,032 $ 237,334 $ 0 . Determination of Residual Value. To estimate the residual value of the limited partners' interest in the Partnership at the end of the 12-year period, AAA assumed that the Hotel(s) would be sold as of December 31, 2009 at their then market value. AAA estimated the market value of each Hotel as of such date by applying an exit capitalization rate that it deemed appropriate, using the factors described above in connection with the "--Appraised Value," which are set forth in the table below, to the estimated Adjusted NOI for 2009 (estimated as described above). AAA then subtracted estimated sales costs of 2% of the estimated market value, added lender reserves, and subtracted the estimated outstanding principal balance of debt as of December 31, 2009 and deferred management fees to arrive at net sales proceeds available for distribution to partners. AAA then determined what portion of such estimated net sales proceeds would be distributable to the Partnership's limited partners under the various partnership and debt agreements. . Discounting Distributions to Present Value. As a final step, AAA discounted the estimated future cash distributions to the limited partners from operations and estimated net sales proceeds (plus lender reserves) to their present value as of January 1, 1998, using a discount rate of 20% per annum. AAA believes that this discount rate reflects the return on investment that investors expect from leveraged investments of this nature. While the 12-year period used by AAA is somewhat arbitrary and other firms may have used a different time period, the 12-year period was selected by AAA because it corresponded to the time period used in the Engineering Study to estimate owner funded capital expenditures. AAA and the General Partners believe that such 12-year period is within the accepted range of time periods used in valuations similar to the Continuation Value. The growth rates and exit capitalization rates used to determine the estimated Continuation Value for each Partnership are as set forth below. GROWTH RATES, EXIT CAPITALIZATION RATES AND ESTIMATED CONTINUATION VALUE FOR EACH PARTNERSHIP (DOLLARS IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNTS) - -------- (1) Includes amounts attributable to interests of Host and its subsidiaries. (2) Reflects the average of the stabilized growth rates of Harbor Beach Resort (3.80% each year) and Orlando World Center (3.50% beginning in 2003 to reflect the effect of the planned expansion of the Hotel). (3) Includes Class B limited partner interests held by the General Partner. LIQUIDATION VALUE. The Liquidation Value of each Partnership was estimated by the General Partners and represents the estimated value of the Partnership if all of its assets were sold as of December 31, 1998. Such value was based upon the Adjusted Appraised Value of each Partnership, with the following adjustments: (i) the "mark to market" adjustment used to estimate the Adjusted Appraised Value was eliminated and instead prepayment or defeasance costs that would be payable under existing debt agreements (regardless of whether the debt in fact can be prepaid on December 31, 1998) were deducted from the Appraised Value; (ii) the deduction 85
ESTIMATED ESTIMATED ESTIMATED GENERAL LIMITED ESTIMATED EXIT CAPITALIZATION CONTINUATION PARTNER'S PARTNERS' CONTINUATION VALUE PARTNERSHIP GROWTH RATE RATE (2009) VALUE SHARE SHARE (PER PARTNERSHIP UNIT) - ----------- ----------- ------------------- ------------ --------- --------- ---------------------- Atlanta Marquis......... 4.40% 9.8% $ 88,662 $64,587(3) $ 24,075(1) $ 45,425 Chicago Suites.......... 3.70% 9.9% 8,962 558 8,404 24,184 Desert Springs.......... 4.50% 9.7% 31,007 824 30,183 33,536 Hanover................. 3.70% 9.9% 9,873 1,633 8,240(1) 98,090 MDAH.................... 3.40% 10.1% 40,245 3,258 36,987(1) 89,340 MHP..................... 3.65%(2) 9.9% 153,031 11,957 141,074(1) 141,074 MHP2.................... 3.40% 10.4% 167,776 10,385 157,391(1) 211,263 PHLP.................... 3.60% 10.1% 12,096 3,024 9,072(1) 5,040 for transfer and recordation taxes and fees used to estimate the Adjusted Appraised Value was eliminated and instead an amount equal to 2.5% of the Appraised Value of each Partnership's Hotel(s) was subtracted from the Appraised Value for estimated liquidation costs, expenses and contingencies; and (iii) the amount of participating interest payable on the Desert Springs subordinated loan held by Host was deducted from the Appraised Value to reflect the net proceeds available to partners of that Partnership. The General Partner then determined the portion of the estimated Liquidation Value that would be distributable to limited partners under the terms of the applicable partnership agreements and other contractual arrangements. The following table sets forth the adjustments made to Adjusted Appraised Value to estimate the Liquidation Value for each Partnership as of the Initial Valuation Date. CALCULATION OF ESTIMATED LIQUIDATION VALUES AS OF THE INITIAL VALUATION DATE (IN THOUSANDS, EXCEPT PER PARTNERSHIP UNIT AMOUNTS) - -------- (1) Excludes 49.5% of the $122,300,000 Appraised Value of the Harbor Beach Resort and the $82,266,000 in mortgage debt encumbering the Hotel. (2) Excludes 50% of the $126,200,000 Appraised Value of the Santa Clara Marriott Hotel but includes 100% of the $42,500,000 in mortgage debt encumbering the Hotel for which MHP2 is wholly responsible. (3) The estimated Liquidation Value for PHLP is zero because PHLP's outstanding debt is greater than the Appraised Value of the Hotels and the value of other assets, net of liabilities, owned by PHLP. (4) Excludes amounts attributable to limited partner interests of other Host subsidiaries. (5) Includes Class B limited partner interests held by the General Partner. (6) Excludes $59.7 million attributable to the participating subordinated loan held by Host. (7) Includes limited partner interests held by a General Partner, except as noted. (8) Includes estimated limited partner share of Host subsidiaries (except for Chicago Suites and Desert Springs in which no Host subsidiary owns any limited partner interest). (9) Includes 1% owned by a limited partner who is not a holder of any of the 335 outstanding Partnership Units. ESTIMATED EXCHANGE VALUES. The following table sets forth the estimated Exchange Value of each Partnership (based upon the greatest of its estimated Adjusted Appraised Value, estimated Continuation Value and estimated Liquidation Value), the estimated minimum number of OP Units to be received (based upon the maximum price of $15.50 per OP Unit) and the estimated Note Election Amount for each Partnership, all on a per Partnership Unit basis as of the Initial Valuation Date. The number of Common Shares received in exchange for OP Units will equal the number of OP Units exchanged. The estimated Note Election Amount for each Partnership (which will be received by Limited Partners electing to receive Notes in exchange for OP Units) is equal to the Liquidation Value (or, if greater, 80% of the Exchange Value) for that Partnership. The estimated values set forth below may increase or decrease as a result of various adjustments, which will be finally 86
ATLANTA CHICAGO DESERT MARQUIS SUITES SPRINGS HANOVER MDAH MHP MHP2 PHLP -------- -------- -------- -------- -------- -------- -------- -------- Appraised Value......... $255,000 $ 34,300 $223,800 $ 49,400 $165,900 $354,261(1) $463,300(2) $265,800 Lender reserves......... 3,600 0 6,173 0 3,000 1,800 6,800 0 Capital expenditure re- serve.................. 16,750 0 1,500 1,690 0 0 0 0 Mortgage debt........... (162,047) (22,284) (101,632) (29,394) (97,371) (192,137)(1) (259,945)(2) (161,136) Other debt.............. (20,134) (464) (89,669) (10,398) (25,355) (722) 0 (128,102) Prepayment/defeasance costs.................. (10,972) 0 (8,821) (2,168) 0 (10,794) (20,551) 0 Deferred management fees................... 0 0 0 0 0 0 (3,184) (34,151) Deferred maintenance costs.................. (607) (46) (650) (72) (825) (245) (1,673) (5,212) Sales costs............. (6,375) (858) (5,595) (1,235) (4,148) (8,857) (11,583) (6,645) -------- -------- -------- -------- -------- -------- -------- -------- Estimated Liquidation Value.................. $ 75,215 $ 10,648 $ 25,106 $ 7,823 $ 41,201 $143,306 $173,164 $ 0(3) ======== ======== ======== ======== ======== ======== ======== ======== Estimated General Part- ner's share(4)......... $ 75,002(5) $ 107 $ 251(6) $ 391 $ 487 $ 19,045 $ 20,335 $ 0 Estimated limited part- ner share of Host sub- sidiaries(7)........... $ 1 $ 0 $ 0 $ 3,539 $ 246 $ 60,049 $ 80,620 $ 0 Estimated total limited partners' share(8)..... $ 213 $ 10,541(9) $ 24,855 $ 7,432 $ 40,714 $124,261 $152,829 $ 0 Per Partnership Unit.... $ 402 $ 31,149 $ 27,617 $ 88,474 $ 98,343 $124,261 $205,140 $ 0 calculated as of the Final Valuation Date but will not change as a result of less than all of the Partnerships participating in the Mergers. The actual number of OP Units to be received by the Limited Partners will be based on the average closing price on the NYSE of a Host REIT Common Share for the 20 trading days after the Effective Date (but will not be less than $9.50 or greater than $15.50 per OP Unit) and will not be finally determined until such time. ESTIMATED EXCHANGE VALUES, MINIMUM NUMBER OF OP UNITS AND NOTE ELECTION AMOUNTS PER PARTNERSHIP UNIT(/1/) - -------- (1) A Partnership Unit in all of the Partnerships except for Chicago Suites ($35,000) and PHLP ($10,000) represents an original investment of $100,000. (2) The estimated Exchange Value is equal to the greatest of estimated Adjusted Appraised Value, estimated Continuation Value and estimated Liquidation Value. (3) Assumes the price of an OP Unit is $15.50, which is the maximum price used for purposes of the Mergers and thus results in the minimum number of OP Units that may be issued. (4) The principal amount of Notes is equal to the greater of (i) the Liquidation Value or (ii) 80% of the Exchange Value (the "Note Election Amount"). (5) The estimated Adjusted Appraised Value and the estimated Liquidation Value for PHLP are zero because PHLP's outstanding debt is greater than the Appraised Value of the Hotels and the value of other assets, net of liabilities, owned by PHLP. PRICE OF OP UNITS TO PAY EXCHANGE VALUES TO LIMITED PARTNERS Each Limited Partner of a Participating Partnership will receive in exchange for his Partnership Interests a number of OP Units with an aggregate deemed value equal to the Exchange Value of such Limited Partner's Partnership Interests. The price of an OP Unit for this purpose will be equal to the average closing price on the NYSE of a Host REIT Common Share for the 20 trading days after the Effective Date of the Mergers (but, subject to adjustment, will not be less than $9.50 or greater than $15.50 per OP Unit). Thus, if the 20-day average trading price is less than $9.50, the price per OP Unit in the Mergers would be $9.50; and if such average trading price is greater than $15.50, the price per OP Unit in the Mergers would be $15.50. The maximum and minimum prices per OP Unit will be reduced if the Blackstone Acquisition is not consummated and, as a result thereof, the Initial E&P Distribution exceeds $2.50 per Host or Host REIT common share. The OP Units will be issued to the Limited Partners promptly after the twentieth trading day following the Effective Date of the Mergers (which would be promptly after January 29, 1999 if the Effective Date of the Mergers is December 30, 1998). Limited Partners at the Effective Date of the Mergers who retain OP Units will receive cash distributions from their respective Partnerships for all of 1998 and, if the Mergers do not occur in 1998, any portion of 1999 prior to the Mergers for which period they do not receive a cash distribution from the Operating Partnership. Cash distributions will be made by each Partnership in accordance with its partnership agreement on or before June 1, 1999 in respect of 1998 operations and, if the Mergers do not occur prior to January 1, 1999, within 90 days after the Effective Date of the Mergers in respect of any 1999 operations. The General Partners of Chicago Suites, Hanover, MDAH and PHLP do not expect that these Partnerships will make any further distributions in respect of 1998 operations. Limited Partners at the Effective Date of the Mergers who receive Common Shares in exchange for OP Units pursuant to the Common Share Election will participate in the same distributions from the Partnerships as Limited Partners who retain OP Units and will receive distributions from Host REIT with respect to periods after their Common Shares are issued, which distributions are expected to equal the amount distributed with respect 87
ESTIMATED ESTIMATED ESTIMATED ESTIMATED ESTIMATED MINIMUM ESTIMATED ADJUSTED APPRAISED CONTINUATION LIQUIDATION EXCHANGE NUMBER OF NOTE ELECTION PARTNERSHIP VALUE VALUE VALUE VALUE(2) OP UNITS(3) AMOUNT(4) ----------- ------------------ ------------ ----------- --------- ----------- ------------- Atlanta Marquis......... $ 41,570 $ 45,425 $ 402 $ 45,425 2,931 $ 36,340 Chicago Suites.......... 33,133 24,184 31,149 33,133 2,138 31,149 Desert Springs.......... 40,880 33,536 27,617 40,880 2,637 32,704 Hanover................. 123,202 98,090 88,474 123,202 7,949 98,562 MDAH.................... 109,216 89,340 98,343 109,216 7,046 98,343 MHP..................... 140,032 141,074 124,261 141,074 9,102 124,261 MHP2.................... 237,334 211,263 205,140 237,334 15,312 205,140 PHLP.................... 0(5) 5,040 0(5) 5,040 325 4,032 to the OP Units for such periods (although Host REIT's distributions to shareholders would be lower than the Operating Partnership's distributions to holders of OP Units (by the amount of Host REIT's 1999 corporate income tax payments) if the REIT Conversion does not occur in 1998 and Host REIT is unable to elect REIT status effective January 1, 1999). Neither the Operating Partnership nor Host REIT anticipates making distributions after the Effective Date of the Mergers and prior to the issuance of Common Shares to those Limited Partners who elect to exchange their OP Units for Common Shares. Limited Partners at the Effective Date of the Mergers who receive Notes in exchange for OP Units pursuant to the Note Election will participate in the same distributions from the Partnerships as Limited Partners who retain OP Units but will not receive any distributions from the Operating Partnership with respect to periods after the Notes are issued. No fractional OP Units will be issued. Fractional amounts less than 0.50 of an OP Unit will be rounded down to the next whole number and fractional amounts greater than or equal to 0.50 will be rounded up to the next whole number of OP Units. DETERMINATION OF VALUE OF THE GENERAL PARTNERS' INTERESTS IN THE PARTNERSHIPS AND ALLOCATION OF OP UNITS TO THE GENERAL PARTNERS The value of each General Partner's interest will be determined in the same manner as the Exchange Value of the Limited Partners' Partnership Interests by the same methodologies set forth above and giving effect to the applicable distribution provisions in each partnership agreement. The number of OP Units that will be received by each General Partner will be equal to the value of its interest in the Partnership divided by the same price per OP Unit used to determine the number of OP Units to be received by the Limited Partners. The following table sets forth the estimated value of the interest of each General Partner and other Host subsidiaries in each Partnership based upon the estimated aggregate Exchange Value of the Limited Partners' Partnership Interests as of the Initial Valuation Date and the estimated minimum number of OP Units to be received by the General Partners and other Host subsidiaries in respect thereof. ESTIMATED VALUES OF THE GENERAL PARTNERS' AND OTHER HOST SUBSIDIARIES' INTERESTS AND MINIMUM NUMBER OF OP UNITS (IN THOUSANDS, EXCEPT NUMBER OF OP UNITS) - -------- (1) Excludes limited partner interests owned by a General Partner. (2) Excludes $59.7 million attributable to the participating subordinated loan held by Host. (3) Assumes the price of an OP Unit is $15.50, which is the maximum price for purposes of the Mergers and thus results in the minimum number of OP Units that may be issued. (4) Includes Class B limited partner interests held by the General Partner. 88
ATLANTA CHICAGO DESERT MARQUIS SUITES SPRINGS HANOVER MDAH MHP MHP2 PHLP -------- -------- -------- -------- -------- -------- -------- -------- Aggregate Estimated Exchange Value......... $ 88,662 $ 11,326 $ 37,164 $ 10,791 $ 45,748 $153,031 $203,144 $ 12,096 Limited partners' share of aggregate Estimated Exchange Value......... 24,075 11,213 36,792 10,349 45,215 141,074 176,814 9,072 -------- -------- -------- -------- -------- -------- -------- -------- Estimated value of the General Partner's interest(1)............ $ 64,587(4) $ 113 $ 372(2) $ 442 $ 533 $ 11,957 $ 26,330 $ 3,024 Estimated value of limited partner interest of Host and its subsidiaries ...... 68 0 0 4,928 273 68,174 93,272 5 -------- -------- -------- -------- -------- -------- -------- -------- Estimated total value of interests of the General Partner and other Host subsidiaries ....................... $ 64,655 $ 113 $ 372 $ 5,370 $ 806 $ 80,131 $119,602 $ 3,029 ======== ======== ======== ======== ======== ======== ======== ======== Estimated Minimum Number of OP Units(3)......... 4,171 7 24 346 52 5,170 7,716 195 FAIRNESS ANALYSIS AND OPINION FAIRNESS ANALYSIS The General Partners believe that the Mergers provide substantial benefits and are fair to the Limited Partners of each Partnership and recommend that all Limited Partners consent to the Mergers and the related amendments to the partnership agreements. The General Partners base this recommendation primarily on (i) their view that the expected benefits of the Mergers for the Limited Partners outweigh the risks and potential detriments of the Mergers to the Limited Partners (see "Background and Reasons for the Mergers and the REIT Conversion--Reasons for the Mergers" and "Risk Factors"), (ii) their view that the value of the OP Units allocable to the Limited Partners on the basis of the Exchange Value established for each Partnership represents fair consideration for the Partnership Interests held by the Limited Partners in each Partnership and is fair to the Limited Partners from a financial point of view and (iii) the Appraisals and Fairness Opinion of AAA. See "--Fairness Opinion." No Merger is conditioned upon the consummation of any other Merger. The General Partners have considered this fact in evaluating the fairness of the Mergers. The General Partners believe that the fairness of the Mergers will not be materially affected by the presence or absence of any individual Partnership or by any particular combination of Partnerships and that the Mergers will be fair to the Limited Partners, individually and as a whole, if they are consummated with any combination of Participating Partnerships. The General Partners base this belief primarily on the fact that the consideration to be paid to the Limited Partners in each individual Partnership has been established based upon such Partnership's Exchange Value, without regard to any possible combination of Partnerships. In reaching the conclusions implicit in the above recommendation, the General Partners have taken into account the following considerations, placing the greatest weight on the first two considerations: . The General Partners have concluded that the Exchange Value for each Partnership represents fair consideration for the Partnership Interests of the Limited Partners in the Mergers in relation to such Partnership because the Exchange Value is equal to the greatest of the Adjusted Appraised Value, Continuation Value and Liquidation Value, each of which is an acceptable method for determining the fair market value of a Partnership's assets. The General Partners also have concluded that the Exchange Value established for the Limited Partners in each Partnership fairly reflects the value of the assets held by such Partnership. . Individual Limited Partners who retain OP Units will be able to defer recognition of gain until such time as they choose to realize such gain based on their own personal circumstances. . The General Partners have concluded that the potential benefits of the Mergers to the Limited Partners, as described under "Background and Reasons for the Mergers and the REIT Conversion--Reasons for the Mergers," outweigh the potential risks and detriments of the Mergers for the Limited Partners, as described in "Risk Factors." . The General Partners considered the maximum and minimum deemed values of OP Units established for purposes of the Mergers. The General Partners noted that the maximum deemed value of the OP Units, which has the effect of establishing a minimum number of OP Units that Limited Partners will receive in any Merger, supports the fairness of the Mergers. With regard to the minimum deemed value of the OP Units, which has the effect of establishing a maximum number of OP Units that Limited Partners will receive in any Merger, the General Partners concluded that such a provision is customary when there is a maximum exchange price and that the levels established for the minimum and maximum deemed values of the OP Units represent a reasonable allocation of the risk of fluctuation in the trading price of Host REIT Common Shares immediately following the Mergers. The minimum value was set at a level that is less than the recent average trading price of Host common stock (after deducting an amount equal to the estimated per share Initial E&P Distribution to be made in connection with the REIT Conversion) and the maximum is higher than such adjusted trading price. The Merger Agreements limit the value of the distributions that Host and Host REIT can make to their shareholders 89 and to the Blackstone Entities (through the Operating Partnership) prior to consummation of the Mergers and provide that, if the Blackstone Acquisition is not consummated and as a result thereof the Initial E&P Distribution exceeds $2.50 per Host or Host REIT common share, then the maximum and minimum prices per OP Unit for purposes of the Mergers will be reduced by an amount equal to such excess distribution per share. Based upon these considerations and others, the General Partners concluded that the maximum and minimum deemed values of the OP Units support the fairness of the Mergers to the Limited Partners. . The General Partners considered the method of allocating the OP Units received by each Partnership in the Mergers between its General Partner and its Limited Partners. Because the OP Units are allocated in accordance with the distribution provisions in each Partnership's partnership agreement, the General Partners concluded that this method supports the fairness of the Mergers to the Limited Partners. . The General Partners considered the method of allocating the OP Units to be owned by Host REIT and its subsidiaries (including the General Partners) following the REIT Conversion (without taking into account any OP Units that may be acquired in connection with the Common Share Election). The number of OP Units to be owned by Host REIT and its subsidiaries will be equal to the number of shares of Host common stock outstanding at the time. Because the formation of the Operating Partnership is functionally equivalent to the formation of a wholly owned subsidiary and reflects the one-for-one economic equivalence between shares of Host common stock and OP Units, the General Partners concluded that this method supports the fairness of the Mergers to the Limited Partners. . The Fairness Opinion, in the view of the General Partners, supports the fairness of the Mergers, even though it includes qualifications, limitations and assumptions relating to its scope and other factors that Limited Partners should consider carefully and does not conclude that the Exchange Value is the best price that could be obtained. The availability of the Fairness Opinion is particularly significant in light of the absence of arm's length negotiations in establishing the terms of the Mergers. . The General Partners believe that the economic terms of the leases of the Hotels are fair and reasonable from the standpoint of the Operating Partnership. . Host REIT will benefit from the operations of the Operating Partnership only to the extent of the distributions received based upon its percentage interest in the Operating Partnership to the same extent as the other limited partners. The General Partners believe that this is a factor supporting the fairness of the Mergers to the Limited Partners. . The General Partners believe that the value of the consideration to be received by the Limited Partners of each Partnership in the Mergers is fair in relation to the value which would be derived by such Limited Partners under any of the alternatives described under "Background and Reasons for the Mergers and the REIT Conversion--Alternatives to the Mergers," especially since the Exchange Value of each Partnership is equal to the greatest of the Adjusted Appraised Value, the Continuation Value and the Liquidation Value and the historic prices paid for Partnership Units (except for Desert Springs). The General Partners do not believe that the sale of any Hotel(s) and liquidation of the associated Partnership would obtain for Limited Partners of such Partnership as much value as the value to be received by such Limited Partners following the Mergers. In addition, while the Continuation Values of three of the Partnerships (Atlanta Marquis, MHP and PHLP) are higher than the Adjusted Appraised Values of such Partnerships, the General Partners believe that the Mergers provide substantial benefits to such Limited Partners, including those benefits described under "Background and Reasons for the Mergers and the REIT Conversion--Reasons for the Mergers," especially with respect to liquidity and regular quarterly cash distributions. The General Partners believe that the following benefits are of the greatest value and importance to the Limited Partners of all of the Partnerships: . Liquidity. The Mergers and the REIT Conversion will offer Limited Partners liquidity with respect to their investments in the Partnerships because Limited Partners can elect to receive freely tradeable Host REIT Common Shares in connection with the Mergers. In addition, Limited Partners who elect to retain OP Units, at any time commencing one year following the Effective Date, will be able to exercise their Unit Redemption Right, subject to certain limited exceptions. 90 Host has approximately 204 million shares of common stock outstanding and is expected to have a total common equity market capitalization of approximately $3.4 billion after giving effect to the Initial E&P Distribution (based upon a price per Host REIT Common Share of $12.50). The election to exchange OP Units for Common Shares in connection with the Mergers or the exercise of the Unit Redemption Right, however, generally would result in recognition of taxable income or gain. . Regular Quarterly Cash Distributions. The General Partners expect that the Operating Partnership will make regular quarterly cash distributions to holders of OP Units and that Host REIT will make regular quarterly cash distributions to holders of Common Shares. Host expects that these distributions will be higher than the estimated cash distributions from operations during 1998 of all Partnerships except MHP and MHP2, and, in any event, the ability to receive distributions quarterly and in regular amounts would be enhanced. The ability to receive regular quarterly cash distributions on a pro rata basis also will mitigate the absence of any preferential distribution rights of the Limited Partners under the partnership agreements of Chicago Suites, Hanover and MHP2 and will further benefit the Limited Partners of Atlanta Marquis due to the absence of the General Partner's preferential distribution rights. . Risk Diversification. Upon consummation of the REIT Conversion, each Limited Partner's investment will be converted from an investment in an individual Partnership owning from one to eight hotels into an investment in an enterprise that is expected initially to own or control approximately 125 Hotels and will have a total market capitalization of approximately $3.4 billion, thereby reducing the dependence upon the performance of, and the exposure to the risks associated with, any particular Hotel or group of Hotels currently owned by an individual Partnership and spreading such risk over a broader and more varied portfolio, including more diverse geographic locations and multiple brands. . Reduction in Leverage and Interest Costs. It is expected that the Operating Partnership will have a leverage to value ratio (approximately 62%) that is lower than the leverage to value ratios for five of the Partnerships (Atlanta Marquis, Chicago Suites, Desert Springs, Hanover and PHLP) and that is not significantly different than the leverage ratios for MDAH, MHP and MHP2. . Substantial Tax Deferral. The General Partners expect that Limited Partners of the Participating Partnerships who do not elect to receive Common Shares or a Note in exchange for OP Units in connection with the Mergers generally should be able to obtain the benefits of the Mergers while continuing to defer recognition for federal income tax purposes of at least a substantial portion, if not all, of the gain with respect to their Partnership Interests that otherwise would be recognized in the event of a liquidation of the Partnership or a sale or other disposition of its assets in a taxable transaction (although Limited Partners in Atlanta Marquis, Desert Springs, MHP and PHLP may recognize a relatively modest amount of ordinary income as the result of required sales of personal property by each such Partnership to a Non-Controlled Subsidiary in order to facilitate Host REIT's qualification as a REIT). The General Partners considered the possibility that the REIT Conversion might not occur in time for Host REIT to elect REIT status effective January 1, 1999, in which event Host REIT's election to be taxed as a REIT could be delayed until January 1, 2000 (and the Blackstone Acquisition might not be consummated). The General Partners believe that the overall benefits of the Mergers and the REIT Conversion for the Limited Partners justify proceeding with the Mergers as promptly as practicable, even if Host REIT's election to be taxed as a REIT might not be effective until January 1, 2000. The General Partners took into account the complexity of the REIT Conversion, the number of transactions that must occur to complete the REIT Conversion and the benefits to the Limited Partners of positioning Host REIT to qualify as a REIT as soon as practicable. The General Partners also recognized that a delay in the election of REIT status until January 1, 2000 would not reduce the anticipated Operating Partnership cash distributions per OP Unit (but the Host REIT cash distributions per Common Share would be reduced by the amount of corporate income taxes that Host REIT would have to pay for 1999). 91 The General Partners believe that the factors described above, which support the fairness of the Mergers to the Limited Partners of the Partnerships, when weighed against the factors that may be disadvantageous, taken as a whole, indicate that the Mergers are fair to the Limited Partners of all of the Partnerships. FAIRNESS OPINION AAA, an independent financial advisory firm with substantial real estate and partnership transaction experience, was engaged by the General Partners to perform the Appraisals and to render the Fairness Opinion that (i) the Exchange Value and the methodologies and underlying assumptions used to determine the Exchange Value, the Adjusted Appraised Value, the Continuation Value and the Liquidation Value of each Partnership (including, without limitation, the assumptions used to determine the various adjustments to the Appraised Values of the Hotels) are fair and reasonable, from a financial point of view, to the Limited Partners of each Partnership and (ii) the methodologies used to determine the value of an OP Unit and the allocation of the equity interest in the Operating Partnership to be received by the Limited Partners of each Partnership are fair and reasonable to the Limited Partners of each Partnership. The Fairness Opinion is addressed to each Partnership and it may be relied upon by each of the Limited Partners of the Partnerships. The full text of the Fairness Opinion, which contains a description of the assumptions and qualifications applicable to the review and analysis by AAA, is set forth in Appendix B to this Consent Solicitation and should be read in its entirety. The material assumptions and qualifications to the Fairness Opinion are summarized below, although this summary does not purport to be a complete description of the various inquiries and analyses undertaken by AAA in rendering the Fairness Opinion. Arriving at a fairness opinion is a complex analytical process not necessarily susceptible to partial analysis or amenable to summary description. For a more complete description of the assumptions and qualifications that limit the scope of the Fairness Opinion, see "-- Qualifications to Fairness Opinion" and "--Assumptions" below. The Fairness Opinion is not limited to any particular combination of Partnerships participating in the Mergers because there is no combination of Partnerships required in order to complete the Mergers. No Merger is conditioned upon the consummation of any other Merger. The Fairness Opinion addresses the fairness of the Exchange Value for each Partnership to the Limited Partners of each Partnership, which Exchange Value has been established for each Partnership without regard to any possible combination of Partnerships. In light of the foregoing, the Fairness Opinion will not be revised to reflect the actual Partnerships which participate in the Mergers. Although the General Partners advised AAA that certain assumptions were appropriate in their view, the General Partners imposed no conditions or limitations on the scope of the investigation by AAA or the methods and procedures to be followed by AAA in rendering the Fairness Opinion. The fees and expenses of AAA will be treated as a Merger Expense and will be paid by the Operating Partnership. In addition, the General Partners have agreed to indemnify AAA against certain liabilities. See "--Compensation and Material Relationships." QUALIFICATIONS TO FAIRNESS OPINION. In the Fairness Opinion, AAA specifically states that it did not: (i) specifically consider other methodologies for allocation of the OP Units, (ii) address or conclude that other methodologies for allocation of the OP Units to the Partnerships might not have been more favorable to the Limited Partners in certain of the Partnerships, (iii) negotiate with the General Partners or Host, (iv) participate in establishing the terms of the Mergers, (v) provide an opinion as to the terms and conditions of the Mergers other than those explicitly stated in the Fairness Opinion, (vi) make any independent review of the capital expenditure estimates set forth in the Engineering Study or (vii) make any estimates of the Partnerships' contingent liabilities. In connection with preparing the Fairness Opinion, AAA was not engaged to, and consequently did not, prepare any written report or compendium of its analysis for internal or external use beyond the analysis set forth in Appendix B. AAA will not deliver any additional written opinion of the analysis, other than to update the written opinion if requested by the Operating Partnership. 92 EXPERIENCE OF AAA. AAA is the world's largest independent valuation consulting firm and is regularly and continually engaged in the valuation of commercial real estate and businesses and their securities in connection with tender offers, mergers and acquisitions, recapitalizations and reorganizations, divestitures, employee stock ownership plans, leveraged buyout plans, private placements, limited partnerships, estate and corporate matters, other financial advisory matters and other valuation purposes. AAA was selected because of its experience in the valuation of businesses and their securities in connection with tender offers, mergers and acquisitions, recapitalizations and reorganizations, including transactions involving hotel partnerships, and the price for its services. The General Partners did not solicit proposals from any other appraisal or investment banking firms for the Appraisals or the Fairness Opinion. Host and its affiliates have previously engaged AAA to provide appraisals and fairness opinions in connection with other transactions. SUMMARY OF MATERIALS CONSIDERED AND INVESTIGATION UNDERTAKEN. As a basis for rendering the Fairness Opinion, AAA has made such reviews, studies and analyses as it deemed necessary and pertinent in order to provide it with a reasonable basis for the Fairness Opinion, including, but not limited to, the following: (i) reviewed the transaction documents and SEC reporting and/or filing documents, including drafts of the Form S-4 for the Mergers; (ii) provided the Market Value of each Hotel owned by each Partnership in a separate short form appraisal report and each such report was reviewed and certified by an MAI appraiser as to its preparation in accordance with the requirements of the Standards of Professional Practice of the Appraisal Institute and the Uniform Standards of Professional Appraisal Practice of the Appraisal Foundation; as part of the Appraisals, AAA reviewed historical operating statements, 1998 budget and year-to-date results, and other financial information as it deemed necessary as a basis for the Fairness Opinion and the Appraisals also considered market transactions of similar lodging properties as appropriate as a basis for the Market Value of each Hotel; (iii) reviewed the methodologies used by each of the General Partners in their determination of the Exchange Value of each Partnership, including the nature and amount of all adjustments to the Appraised Values in determining such Exchange Values; AAA reviewed and tested for the fairness and reasonableness of all adjustments as well as for consideration of all adjustments deemed to be appropriate by AAA; (iv) reviewed the methodologies used by each of the General Partners in their determination of the value of an OP Unit and the allocation of the equity interest in the Operating Partnership to be received by the partners of each Partnership, and AAA reviewed and tested for the fairness and reasonableness of the methods and measurements made by the General Partners; (v) reviewed the General Partners' determination of the Liquidation Value of each Partnership, and AAA reviewed and tested for the fairness and reasonableness of all adjustments proposed by the General Partners, as well as for consideration of all adjustments deemed appropriate by AAA; (vi) provided an estimate of the Continuation Value of each Partnership based upon the estimated present value of expected benefits to be received by each limited partner interest as though the Mergers did not occur and each Partnership's assets were sold within a twelve year period; AAA, as part of its analysis and review, determined appropriate rates of growth in house profit or net operating income, as well as reviewed other key variables affecting partnership cash flows and other economic/financial factors affecting the Partnerships' expected operations and results; (vii) reviewed the terms of the ground leases of the Hotels and the partnership agreement of each Partnership; (viii) reviewed audited and unaudited historical income statements, balance sheets and statements of sources and uses of funds of each Partnership and Host and pro forma financial information for Host REIT; (ix) reviewed audited and unaudited historical operating statements of each Hotel, as well as current operating statements and budgets; (x) conducted real estate valuation and financial due diligence with respect to the Partnerships and their underlying assets, liabilities and equity; (xi) reviewed internal Marriott International, Host and Partnership financial analyses and other internally generated data for each Hotel; and (xii) discussed all of the foregoing information, where appropriate, with management of Marriott International, Host and the Partnerships and their respective employees. 93 ASSUMPTIONS. In rendering its opinion, AAA relied, without independent verification, on the accuracy and completeness in all material respects of certain relevant publicly available information and information provided to AAA by the Host and the Hotels. AAA assumed that all information furnished by Host, the Hotels and the Partnerships and their representatives, upon which AAA relied, presented an accurate description in all material respects of the current and prospective status of the Hotels and the Partnerships from an operational and financial point of view. AAA also noted that the Fairness Opinion was based upon financial, economic, market and other considerations as they existed as of March 1, 1998. AAA did not conduct any subsequent due diligence or valuation procedures, except that AAA reviewed year-to-date net house-profit results through September 11, 1998 as reflected on Marriott International's Format 90 reports for each Partnership and, based upon such review and upon current financial, economic and market conditions and indicated trends therein, AAA concluded that nothing came to AAA's attention that would cause it to be unable to render the Fairness Opinion as of such date. CONCLUSIONS. AAA concluded that, based upon and subject to its analysis and assumptions and limiting conditions, and as of October 8, 1998, the date of the Fairness Opinion: (i) the Exchange Value and the methodologies and underlying assumptions used to determine the Exchange Value, the Adjusted Appraised Value, the Continuation Value and the Liquidation Value of each Partnership (including, without limitation, the assumptions used to determine the various adjustments to the Appraised Values of the Hotels) are fair and reasonable, from a financial point of view, to the Limited Partners of each Partnership and (ii) the methodologies used to determine the value of an OP Unit and the allocation of the equity interest in the Operating Partnership to be received by the limited partners of each Partnership are fair and reasonable to the Limited Partners of each Partnership. In connection with rendering the Fairness Opinion, AAA considered the possibility that the REIT Conversion would not occur in time for Host REIT to elect REIT status effective January 1, 1999. In concluding that such failure would not affect the conclusions in the Fairness Opinion, AAA noted that (i) Host REIT would be structured and would operate as if it were a REIT for the period following the REIT Conversion and until such time as it could elect REIT status and (ii) the methodologies used to determine the value of an OP Unit and the allocation of the equity interest in the Operating Partnership would not be affected by the inability of Host REIT to elect REIT status as of January 1, 1999 because the market price of the Host REIT Common Shares during the 20-trading day period after the Mergers should reflect, among other things, the inability of Host REIT to elect REIT status. SUMMARY OF METHODOLOGY. AAA evaluated each Partnership's Hotel(s) based upon the income capitalization approach and broadly applied the sales comparison approach. Appraisers typically use up to three approaches in valuing real property: the cost approach, the income capitalization approach and the sales comparison approach. The type and age of a property, market conditions and the quantity and quality of data affect the applicability of each approach in a specific appraisal situation. Since the Hotels are viable, existing, ongoing enterprises with an established market presence, work force and management team, the cost approach was not considered by AAA in the Appraisals. The income capitalization approach estimates a Hotel's capacity to produce income through an analysis of the market, operating expenses and net income. Net income may then be processed into a value through either (or a combination of) two methods: direct capitalization or discounted cash flow analysis. The sales comparison approach looks at similar properties which have recently sold or are currently offered for sale in the market and are analyzed and compared with the Hotel being valued. For further description of the methodology employed by AAA in the Appraisals, see "Determination of Exchange Values and Allocation of OP Units." COMPENSATION AND MATERIAL RELATIONSHIPS. AAA has been paid a fee of $335,000 for its services as described herein, including the Appraisals and preparing to deliver the Fairness Opinion. In addition, AAA will be reimbursed for all reasonable out-of-pocket expenses, including legal fees, and will be indemnified against certain liabilities, including certain liabilities under the securities laws. The fee was negotiated between Host, the General Partners and AAA. Payment of the fee to AAA is not dependent upon completion of the Mergers. AAA has been previously engaged by Host and its affiliates to provide appraisals, fairness opinions and solvency opinions in connection with other transactions. 94 THE MERGERS AND THE REIT CONVERSION GENERAL Limited Partners of each Partnership are being asked to approve the acquisition of their Partnership by the Operating Partnership through the merger of their Partnership with a Merger Partnership as part of the REIT Conversion. In each Merger, the Participating Partnership will survive, and each Limited Partner thereof will receive OP Units with a deemed value equal to the Exchange Value of his Partnership Interests (or, if the Limited Partner elects to tender such OP Units to Host REIT, an equal number of Common Shares or, if the Limited Partner elects to tender such OP Units to the Operating Partnership, a Note in a principal amount equal to the Note Election Amount of his Partnership Interests). If the REIT Conversion, including the Mergers and the Blackstone Acquisition, is consummated as contemplated, the Operating Partnership is expected to acquire and initially own, or have controlling interests in, approximately 125 full-service Hotels located throughout the United States and Canada, containing approximately 58,500 rooms and operating primarily under the Marriott, Ritz-Carlton, Four Seasons, Swissotel and Hyatt brand names. THE REIT CONVERSION The transactions summarized below collectively constitute the REIT Conversion. If the required corporate (Board and shareholder) and partnership approvals for the various transactions are obtained and other conditions to the different steps in the REIT Conversion are satisfied or waived, these transactions are expected to occur at various times prior to the end of 1998 (or as soon thereafter as practicable). The Mergers of the Participating Partnerships are expected to occur at the final stage of the REIT Conversion. The Operating Partnership and the General Partners are seeking the approval of the Mergers and the related partnership agreement amendments at this time, in advance of satisfaction of all other contingencies, in order to determine how the Partnerships will fit into the UPREIT structure following the REIT Conversion, which Host desires to implement during 1998 in order to permit Host REIT to qualify as a REIT for its 1999 taxable year. Consummation of the Mergers is not conditioned on the REIT Conversion being completed in time for Host REIT to elect REIT status effective January 1, 1999. If the REIT Conversion does not occur in time for Host REIT to elect REIT status effective January 1, 1999, the effectiveness of Host REIT's election could be delayed until January 1, 2000, which would result in Host REIT continuing to pay substantial corporate-level income taxes in 1999 (which would reduce Host REIT's cash distributions per Common Share but not the Operating Partnership's cash distributions per OP Unit) and could cause the Blackstone Acquisition not to be consummated. In view of the complexity of the REIT Conversion and the number of transactions that must occur to complete the REIT Conversion, Host and the General Partners believe that it is beneficial both to the Limited Partners and the shareholders of Host to complete the REIT Conversion as soon as practicable, even if the REIT Conversion cannot be completed prior to January 1, 1999. If Host REIT's election to be taxed as a REIT is not effective on January 1, 1999, Host REIT intends to operate following the REIT Conversion in a manner that would permit it to qualify as a REIT at the earliest time practicable, and it might pursue a merger with another entity or other transaction that would permit it to commence a new taxable year and elect REIT status prior to January 1, 2000. Host REIT in any event would elect to be treated as a REIT for federal income tax purposes not later than its taxable year commencing January 1, 2000. It is a condition to the Mergers that they be completed by June 30, 1999, unless the General Partners and the Operating Partnership mutually agree to extend that deadline to a date no later than December 31, 1999. . Contribution of Host's Lodging Assets to the Operating Partnership. As a preliminary step, at various times during 1998, Host will contribute its wholly owned full-service hotel assets, its interests in the Hotel Partnerships (other than its interests in the General Partners, who will remain in existence as subsidiaries of Host REIT and will receive OP Units in the Mergers) and its other assets (excluding its senior living assets and cash or other consideration to be distributed in connection with the Initial E&P Distribution and certain other de minimis assets that cannot be contributed to the Operating Partnership) to the Operating Partnership in exchange for (i) a number of OP Units equal to the number of outstanding shares of common stock of Host at the time of the REIT Conversion (reduced by the number of OP Units to be received by the General Partners and other subsidiaries of Host in the Mergers), (ii) preferred partnership interests in the Operating Partnership corresponding to any shares of Host preferred stock outstanding at the time of the REIT Conversion and (iii) the assumption by the Operating Partnership of all liabilities of Host (including past and future contingent liabilities and 95 liabilities for the Plans in accordance with the 1998 Employee Benefits Allocation Agreement), other than liabilities of Crestline. Following these contributions, the Operating Partnership and its subsidiaries will directly or indirectly own all of Host's wholly owned hotels, substantially all of Host's interests in the Hotel Partnerships and all of Host's other assets (excluding its senior living assets and the cash or other consideration to be distributed in connection with the Initial E&P Distribution and certain other de minimis assets that cannot be contributed to the Operating Partnership). . Debt Refinancing. In August 1998, Host refinanced $1.55 billion of outstanding public bonds through offers to purchase such debt securities for cash and a concurrent solicitation of consents to amend the terms of the debt securities to facilitate the transactions constituting the REIT Conversion. Host obtained the funds for this Bond Refinancing primarily from the issuance of new debt securities and the New Credit Facility. See "Business and Properties--Indebtedness." . Treatment of Convertible Preferred Securities. In the REIT Conversion, the Operating Partnership will assume primary liability for repayment of the $567 million of convertible subordinated debentures of Host underlying the $550 million of Convertible Preferred Securities. As the successor to Host, Host REIT also will be liable on the debentures and the debentures will become convertible into Common Shares, but the Operating Partnership will have primary responsibility for payment of the debentures, including all costs of conversion. Upon conversion by a Convertible Preferred Securities holder, the Operating Partnership will acquire Common Shares from Host REIT in exchange for an equal number of OP Units and distribute the Common Shares to the Convertible Preferred Securities holder. As a result of the distribution of Crestline common stock and any cash and other consideration to Host or Host REIT shareholders in connection with the Initial E&P Distribution, the conversion ratio of the Convertible Preferred Securities will be adjusted to take into account certain effects of the REIT Conversion. See "Business and Properties--Indebtedness." . The Mergers. On the Effective Date, each Participating Partnership will merge with a Merger Partnership. The Participating Partnerships will be the surviving entities of the Mergers and will continue in existence as indirect subsidiaries of the Operating Partnership. In the Mergers, each Limited Partner will receive a number of OP Units with a deemed value equal to the Exchange Value of his respective Partnership Interests. If a Limited Partner elects to receive Common Shares or a Note in exchange for OP Units in connection with the Mergers, such Limited Partner will, upon receipt of his OP Units, tender (or be deemed to tender) all of such OP Units to Host REIT for an equal number of Common Shares or to the Operating Partnership in exchange for a Note with a principal amount equal to the Note Election Amount of his Partnership Interests. The General Partners and other subsidiaries of Host will also receive OP Units in exchange for their interests in the Partnerships and the General Partners will continue as wholly owned direct or indirect subsidiaries of Host REIT. Any Partnership that does not participate in a Merger will continue as a separate partnership with its own assets and liabilities and with its current Limited Partners. There will be no change in its investment objectives, policies or restrictions or the fees or distributions payable to the applicable General Partner or Manager. Each Partnership that does not participate in a Merger will remain subject to the terms of its current partnership agreement. The Operating Partnership would contribute some or all of the interests in certain of these Partnerships (such as Atlanta Marquis, Desert Springs, Hanover, MHP and MHP2) that it receives from Host and its subsidiaries to a Non-Controlled Subsidiary. . Restructuring of the Private Partnerships. The Operating Partnership will acquire the partnership interests from unaffiliated partners of four Private Partnerships in exchange for OP Units and, accordingly, will own all of the interests in those Private Partnerships. For the remaining Private Partnerships, (i) the Operating Partnership will be a partner in the partnership if the unaffiliated partners consent to a lease of the partnership's Hotel(s) to a Lessee or (ii) if the requisite consents to enter into a lease are not obtained, the Operating Partnership may transfer its interest in such partnership to a Non- Controlled Subsidiary. The determination of the action to be taken with respect to the Operating Partnership's interest in these Private Partnerships will be based primarily upon the character of the income therefrom under the REIT tax rules. 96 The partners in the following Private Partnerships will receive the estimated number of OP Units set forth below in connection with the REIT Conversion (assuming a price of $15.50 per OP Unit): . The Blackstone Acquisition. Subject to various terms and conditions, the Operating Partnership expects to acquire from the Blackstone Entities ownership of, or controlling interests in, twelve hotels and two mortgage loans, one secured by one of the acquired hotels and one secured by an additional hotel. In addition, Host REIT will acquire a 25% interest in the Swissotel management company from the Blackstone Entities, which Host REIT will transfer to Crestline. If the Blackstone Acquisition is consummated, the Operating Partnership expects to issue approximately 43.7 million OP Units (based upon a negotiated value of $20.00 per OP Unit), assume debt and make cash payments totaling approximately $862 million and distribute up to 18% of the shares of Crestline common stock and other consideration to the Blackstone Entities. Fifty percent of the OP Units issued in the Blackstone Acquisition will become redeemable on July 1, 1999, an additional 25% will become redeemable on October 1, 1999 and the balance will become redeemable on January 1, 2000. Holders of OP Units issuable in the Blackstone Acquisition will have registration rights under a shelf registration statement with respect to Host REIT Common Shares received in connection with the exercise of their redemption rights. In connection with the Blackstone Acquisition, Host agreed to cause a person designated by Blackstone Real Estate Acquisitions L.L.C. ("Blackstone") to be appointed to serve as a director of Host (or a director of Host REIT following the REIT Conversion) and to continue to include a person designated by Blackstone in the slate of directors nominated by the board of directors for so long as Blackstone and its affiliates own at least 5% of the outstanding OP Units. Mr. Schreiber has been appointed to be the initial Blackstone designee. If the Blackstone Acquisition does not close, the Blackstone designee will resign. Host also agreed that, if more than two directors of Crestline also are directors of Host REIT, Blackstone will be entitled to designate a director of Crestline. The Operating Partnership does not expect that there will be any common directors of Crestline and Host REIT. Host also agreed to certain limitations on sales of the properties acquired in the Blackstone Acquisition lasting for five years after the REIT Conversion for 50% of the properties and for an additional five years for the remaining properties. Each Blackstone Entity has agreed that, until the earlier of the fifth anniversary of the closing of the Blackstone Acquisition and the date on which the Blackstone Entities do not own, in the aggregate, more than 5% of the outstanding OP Units and Common Shares, such Blackstone Entity will not, and will use its best efforts to cause its affiliates to not, directly or indirectly (i) subject to certain exceptions, acquire or agree to acquire beneficial ownership of any securities or partnership interests of Host REIT, the Operating Partnership or Crestline, if after giving effect thereto, such Blackstone Entity and its affiliates (together with the other members of any group (as defined in Section 13d-1 of the Exchange Act) of which any of them is a part) would (A) directly or indirectly own more than 9.8% of any class of voting securities of such entity or more than 19.9% of the aggregate value of all outstanding voting securities of Host REIT and OP Units or (B) violate the ownership limitations or transfer restrictions set forth in the Charter, the Partnership Agreement of the Operating Partnership or the Articles of Incorporation of Crestline, (ii) sell, transfer, pledge or otherwise dispose of any OP Units or any voting securities of Host REIT or Crestline in violation of such ownership limitations or transfer restrictions, (iii) participate in any proxy contest in opposition to the position taken by the directors or general partner, as applicable, of Host REIT, the Operating Partnership or Crestline, (iv) seek to cause a disposition (by way of merger, business combination, sale or otherwise) of a 97
NEGOTIATED VALUE OF NUMBER OF PARTNERSHIP OP UNITS OP UNITS ----------- ------------------- --------- HMC BN Limited Partnership................... $20,600,000 1,329,032 Ivy Street Hotel Limited Partnership......... 4,050,000 261,290 Times Square Marquis Hotel, L.P. ............ 7,499,000 483,806 HMC/RGI Hartford Limited Partnership......... 10,500,000 677,419 material portion of the assets or securities or partnership interests, or a change in the composition of the directors or management, of Host REIT, the Operating Partnership or Crestline or (v) initiate or propose to the holders of securities or partnership interests, as applicable, of Host REIT, the Operating Partnership or Crestline, or otherwise solicit their approval of, any proposal to be voted by such holders. . Contribution of Assets to Non-Controlled Subsidiaries. The Operating Partnership will organize the Non-Controlled Subsidiaries to hold various assets (not exceeding, in the aggregate, 20% by value of the assets of the Operating Partnership) contributed by Host and its subsidiaries to the Operating Partnership. The direct ownership of most of these assets by the Operating Partnership could jeopardize Host REIT's status as a REIT. These assets primarily will consist of partnership or other interests in hotels which are not leased, certain furniture, fixtures and equipment used in the Hotels and certain international hotels in which Host owns interests. In exchange for the contribution of these assets to the Non-Controlled Subsidiaries, the Operating Partnership will receive nonvoting common stock representing 95% of the total economic interests of the Non-Controlled Subsidiaries. In addition, the Operating Partnership and, prior to the Mergers, Atlanta Marquis, Desert Springs, Hanover, MHP and PHLP (assuming they participate in the Mergers) will sell to a Non-Controlled Subsidiary an estimated $200 million in value of personal property associated with certain Hotels for notes or cash that has been contributed or loaned to the Non-Controlled Subsidiary by the Operating Partnership, or a combination thereof. The Operating Partnership could not lease this personal property to the Lessees without potentially jeopardizing Host REIT's qualification as a REIT. The Non-Controlled Subsidiary will lease such personal property to the applicable Lessees. The Host Employee Trust, a Delaware statutory business trust, and possibly certain other investors will acquire all of the voting common stock representing the remaining 5% of the total economic interests, and 100% of the control, of each Non-Controlled Subsidiary. The income beneficiaries of the Host Employee Trust will be employees of Host REIT eligible to participate in the Comprehensive Stock Incentive Plan (excluding directors of Host REIT and certain other highly compensated employees). Upon termination of the Host Employee Trust, the residual assets, if any, are to be distributed to a charitable organization designated in its declaration of trust. . Leases of Hotels. The Operating Partnership, its subsidiaries and its controlled partnerships, including the Participating Partnerships, will lease virtually all of their Hotels to the Lessees pursuant to the Leases. See "Business and Properties--The Leases." The leased Hotels will be operated by the Lessees under their existing brand names pursuant to their existing long-term Management Agreements, which will be assigned to the Lessees for the terms of the applicable Leases, but under which the Operating Partnership will remain obligated. See "Business and Properties--The Management Agreements." . Host REIT Merger and Initial E&P Distribution. Host will merge into Host REIT upon obtaining shareholder approval of the merger. Pursuant to the merger agreement, Host shareholders will receive, for each share of Host common stock, one Host REIT Common Share. In connection with the REIT Conversion, Host or Host REIT will make the Initial E&P Distribution. The aggregate value of the Crestline common stock and the cash or other consideration to be distributed to Host or Host REIT shareholders and the Blackstone Entities as the Initial E&P Distribution is currently estimated to be approximately $525 million to $625 million (approximately $2.10 to $2.50 per share to the Host or Host REIT shareholders). The actual amount of the distribution will be based in part upon the estimated amount of accumulated earnings and profits of Host as of the last day of its taxable year in which the Host merger into Host REIT is consummated. To the extent that the distributions made in connection with the Initial E&P Distribution are not sufficient to eliminate Host's estimated accumulated earnings and profits, Host REIT will make one or more additional taxable distributions to its shareholders (in the form of cash or securities) prior to the last day of its first full taxable year as a REIT (currently expected to be December 31, 1999) in an amount intended to be sufficient to eliminate such earnings and profits, and the Operating Partnership will make corresponding distributions to all holders of OP Units (including Host REIT) in an amount sufficient 98 to permit Host REIT to make such additional distributions. Limited Partners who elect to receive Common Shares in connection with the Mergers will not receive the Crestline common stock or any other portion of the Initial E&P Distribution, which will have been distributed before they become shareholders of Host REIT (approximately 25 trading days after the Effective Date of the Mergers). In addition, under the terms of the Blackstone Acquisition, the Blackstone Entities are entitled to receive a pro rata portion of the same consideration received by Host REIT's shareholders in connection with the Initial E&P Distribution except to the extent the Blackstone Entities elected to receive additional OP Units in lieu thereof. The payment to the Blackstone Entities of Crestline common stock and other consideration is expected to be approximately $90 million to $110 million if the REIT Conversion and the Blackstone Acquisition are consummated. Following the distribution, Crestline's principal assets will include the senior living assets of Host, which are expected to consist of 31 senior living communities, a 25% interest in the Swissotel management company acquired from the Blackstone Entities and the Lessees. Certain REITs have spun-off public operating companies to conduct certain activities which REITs are prohibited from conducting and have described such structure as a "paper-clip" structure. There is no established definition of a "paper-clip" structure. While the Operating Partnership and Crestline clearly expect to have a mutually beneficial, long-term relationship, they do not believe that their relationship should be characterized as a "paper-clip" structure because they will operate as separate public companies with independent business plans, there will be no overlap between officers and directors of the two companies (other than one officer of Host who will be a director but not an officer of Crestline), there are no rights of first refusal or other similar arrangements (other than the noncompetition arrangements) with respect to future acquisitions between Host REIT and Crestline and they expect the shareholders of the two companies to diverge over time. Crestline also will be engaged in the businesses of owning senior living communities and asset management of hotels, neither of which will be conducted by Host REIT. Crestline further intends to pursue leasing opportunities for both full-service and limited-service hotels with majority owners other than Host REIT. 99 Following the REIT Conversion, assuming the Full Participation Scenario, the organizational structure of Host REIT is expected to be as follows: [FLOW CHART APPEARS HERE] - -------- (1) Represents Limited Partners and others who retain OP Units and do not elect to receive Common Shares or Notes; excludes Host and its subsidiaries. Percentage ownership in the Operating Partnership assumes all Limited Partners elect to retain OP Units. (2) Also will include Limited Partners who elect to receive Common Shares in exchange for the OP Units received in the Mergers. Immediately following the merger of Host into Host REIT and the distribution by Host or Host REIT of Crestline common stock to its shareholders and the Blackstone Entities, the shareholders of Crestline will consist of the shareholders of Host REIT (other than Limited Partners who elect to receive Common Shares in connection with the Mergers) and the Blackstone Entities. The common ownership of the two public companies, however, will diverge over time. (3) Percentage ownership in the Operating Partnership assumes no Limited Partners elect to receive either Common Shares or Notes in connection with the Mergers and that the price per Common Share is $15.50, which is the maximum price per OP Unit for purposes of the Mergers. (4) The Operating Partnership will own all or substantially all of the equity interests in the Participating Partnerships, certain Private Partnerships and other Host subsidiaries that own Hotels, both directly and through other direct or indirect, wholly owned subsidiaries of the Operating Partnership or Host REIT. Host will contribute its partial equity interests in the Non-Participating Partnerships and those Private Partnerships whose partners have not elected to exchange their interests for OP Units to the Operating Partnership, and the Operating Partnership will either hold such partial interests or contribute them to the Non-Controlled Subsidiaries. 100 Ownership Interests in the Operating Partnership Following the Mergers and the REIT Conversion. Following the Mergers and the REIT Conversion, the Operating Partnership is expected to be owned as set forth below: OWNERSHIP OF THE OPERATING PARTNERSHIP - -------- (1) Assumes that all Partnerships participate in the Mergers, that the Blackstone Acquisition is consummated, that all Limited Partners elect to retain OP Units, and that the price of an OP Unit is $15.50, which is the maximum price for purposes of the Mergers. The percentage interest of Host REIT will increase, and the percentage interest of Limited Partners will decrease, if Limited Partners elect to receive Common Shares or Notes in exchange for their OP Units in connection with the Mergers. THE MERGERS Issuance of OP Units. If Limited Partners holding the requisite percentage of outstanding Partnership Interests in a Partnership vote to approve a Merger and certain related amendments to the partnership agreements, then such Participating Partnership will merge with a Merger Partnership, with the Participating Partnership being the surviving entity. Each Limited Partner of the Participating Partnership will receive OP Units with a deemed value equal to the Exchange Value of such Limited Partner's Partnership Interests. Limited Partners who retain OP Units will be issued such OP Units promptly following the twentieth trading day following the Effective Date. The General Partners and other Host subsidiaries that own limited partner interests in the Partnerships also will receive OP Units in exchange for their general and limited partner interests in the Partnerships, respectively. The price attributed to an OP Unit, the Exchange Value of each Partnership and the allocation of OP Units will be established in the manner described in detail under "Determination of Exchange Values and Allocation of OP Units." Unit Redemption Right. Beginning one year after the Mergers, Limited Partners who retain OP Units will have the right to redeem their OP Units at any time, upon ten business days' notice to the Operating Partnership, and receive, at the election of Host REIT, either Common Shares of Host REIT on a one-for-one basis (subject to adjustment) or cash in an amount equal to the market value of such shares. Limited Partners must redeem at least 1,000 OP Units (or all remaining OP Units owned by the holder of OP Units if less than 1,000 OP Units) each time the Unit Redemption Right is exercised. See "Description of OP Units--Unit Redemption Right." Right to Exchange OP Units for Common Shares. At any time during the Election Period, Limited Partners can elect (or revoke any such election previously made) to tender all of the OP Units they will receive in a Merger (if their Partnership approves the Merger) to Host REIT in exchange for an equal number of Common Shares. The Common Shares, which will be issued promptly following the twentieth trading day after the Effective Date of the Mergers, will be freely tradeable and listed on the NYSE. A Limited Partner who makes the Common Share Election will be treated as having made a taxable disposition of his OP Units, which likely would be deemed to occur at the time his right to receive the Common Shares becomes fixed (which would be January 22, 1999 if the Effective Date of the Mergers is December 30, 1998). See "Description of Capital Stock--Common Shares" and "Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Exercise Their Right to Make the Common Share Election or the Note Election." Right to Exchange OP Units for Notes. At any time during the Election Period, Limited Partners can elect (or revoke any such election previously made) to tender all of the OP Units they will receive in a Merger (if their Partnership approves the Merger) to the Operating Partnership in exchange for a Note. The principal amount 101
ENTITY PERCENTAGE INTEREST(1) ------ ---------------------- Host REIT............................................. 75.8% Limited Partners of the Partnerships.................. 6.9 Private Partnerships.................................. 1.1 Blackstone Entities................................... 16.2 ----- Total............................................... 100.0% ===== of the Note received by a Limited Partner will be equal to the Note Election Amount of his Partnership Interest, which will be less than the value of the OP Units that such Limited Partner otherwise would have received (because the Note Election Amount will be less than the Exchange Value for each Partnership). The Notes will be issued promptly following the twentieth trading day after the Effective Date of the Mergers. Holders of Notes will receive interest payments on a semi-annual basis on June 15 and December 15 of each year at the rate of 6.56% per annum from and after the Effective Date of the Mergers. A Limited Partner who makes the Note Election will be treated as having made a taxable disposition of his OP Units, which likely would be deemed to occur on the Effective Date of the Mergers (which currently is expected to occur on December 30, 1998). See "Description of the Notes" and "Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Exercise Their Right to Make the Common Share Election or the Note Election." No fractional OP Units will be issued by the Operating Partnership in the Mergers. In lieu thereof, fractional amounts less than 0.50 of an OP Unit will be rounded down to the next whole number of OP Units and fractional amounts greater than or equal to 0.50 will be rounded up to the next whole number of OP Units. For a description of the OP Units, including restrictions on transfer and the Unit Redemption Right, see "Description of OP Units." 1998 Partnership Distributions. Limited Partners at the Effective Date of the Mergers who retain OP Units will receive cash distributions from their respective Partnerships for all of 1998 and, if the Mergers do not occur in 1998, any portion of 1999 prior to the Mergers for which they do not receive a cash distribution from the Operating Partnership. Cash distributions will be made by each Partnership in accordance with its partnership agreement on or before June 1, 1999 in respect of 1998 operations and, if the Mergers do not occur prior to January 1, 1999, within 90 days after the Effective Date of the Mergers in respect of any 1999 operations. The General Partners of Chicago Suites, Hanover, MDAH and PHLP do not expect that these Partnerships will make any distributions in respect of 1998 operations. Limited Partners at the Effective Date of the Mergers who receive Common Shares in exchange for OP Units pursuant to the Common Share Election will participate in the same distributions from the Partnerships as Limited Partners who retain OP Units and will receive distributions from Host REIT with respect to periods after their Common Shares are issued, which distributions are expected to equal the amount distributed with respect to the OP Units for such periods (although Host REIT's distributions to shareholders would be lower than the Operating Partnership's distributions to holders of OP Units (by the amount of Host REIT's 1999 corporate income tax payments) if the REIT Conversion does not occur in 1998 and Host REIT is unable to elect REIT status effective January 1, 1999). Neither the Operating Partnership nor Host REIT anticipates making distributions after the Effective Date of the Mergers and prior to the issuance of Common Shares to those Limited Partners who elect to exchange their OP Units for Common Shares. Limited Partners at the Effective Date of the Mergers who receive a Note in exchange for OP Units pursuant to the Note Election will participate in the same distributions from the Partnerships as Limited Partners who retain OP Units but will not receive any distributions from the Operating Partnership with respect to periods after the Notes are issued. Ownership Interest of Host in the Partnerships. The table below sets forth the current ownership interests of Host in the Partnerships. Following the REIT Conversion, assuming all of the Partnerships participate in the Mergers, the Partnerships will be owned by the Operating Partnership. 102
PARTNERSHIP LIMITED PARTNER INTERESTS GENERAL PARTNER INTERESTS - ----------- ------------------------- ------------------------- Atlanta Marquis............. Class A 0.28% 1.00% Class B 100.00 Chicago Suites.............. 0.00 1.00 Desert Springs.............. 0.00 1.00 Hanover..................... 47.62 5.00 MDAH........................ 0.60 1.00 MHP......................... 48.33 1.00 MHP2........................ 52.75 1.00 PHLP........................ 0.06 1.00 Amendments to the Partnership Agreements. In order to consummate each Merger as currently proposed, there are a number of amendments required to be made to the partnership agreements of the Partnerships. Limited Partners must vote separately on the Merger and the amendments to the partnership agreement, but the Merger will not be consummated unless both the Merger and the amendments to the partnership agreement are approved. The effectiveness of such amendments will be conditioned upon the Partnership's participation in a Merger. The required amendments generally include (i) permitting the Partnership to enter into the Leases with the Lessees; (ii) reducing to one the number of appraisals of the fair market value of a Partnership's Hotel(s) that the Partnership must obtain before the General Partner can cause a Partnership to sell its assets to the General Partner or an affiliate; and (iii) other amendments required to allow the transactions constituting the Mergers or otherwise necessary or desirable to consummate the Mergers or the REIT Conversion. No Partner Liability. Each Partnership will make certain representations and warranties to the Operating Partnership regarding itself and its Hotels in connection with its Merger. The merger agreements in which such representations and warranties are contained will provide that the Operating Partnership will have no recourse against any of the partners in the Participating Partnerships in the event the Operating Partnership suffers a loss as a result of any inaccuracies in such representations and warranties. Closing Adjustments. The General Partners currently expect that the Adjusted Appraised Value of each Partnership will be greater than either the Continuation Value or Liquidation Value of each Partnership (except for Atlanta Marquis, MHP and PHLP, where the Continuation Value is expected to be the greatest of the three values), which means that the Exchange Values of such Partnerships (other than Atlanta Marquis, MHP and PHLP) will be equal to their Adjusted Appraised Values. The Adjusted Appraised Values of the Partnerships may increase or decrease as a result of adjustments made prior to the Effective Date to reflect (i) the amount of lender and capital expenditure reserves and the amount of deferred management fees, (ii) any amounts actually expended by a Partnership after the Initial Valuation Date to perform deferred maintenance previously used in determining the estimated Exchange Value of such Partnership and (iii) any changes in the Partnership's other reserves, such as for litigation expenses and indemnification costs and for any revised estimates of transfer and recordation taxes and fees. See "Determination of Exchange Values and Allocation of OP Units." Effective Time of the Mergers. The Effective Time will be after the merger of Host into Host REIT becomes effective and the shares of Crestline common stock and cash or other consideration are distributed to Host or Host REIT's shareholders in connection with the Initial E&P Distribution, which is expected to occur during the final stage of the REIT Conversion. The Effective Time currently is expected to occur on or about December 30, 1998, subject to satisfaction or waiver of the conditions to the Mergers. There is no assurance that the Effective Time will occur before January 1, 1999, and if the Effective Time occurs on or after January 1, 1999, the effectiveness of Host REIT's election of REIT status could be delayed until January 1, 2000, which would result in Host REIT continuing to pay significant corporate-level income taxes in 1999 and could cause the Blackstone Acquisition not to be consummated. CONDITIONS TO CONSUMMATION OF THE MERGERS Participation by each Partnership in a Merger is subject to the satisfaction or waiver of certain conditions, including, among others: . Limited Partner Approvals. Limited Partners holding the requisite percentage of Partnership Interests in such Partnership shall have approved the Merger and the amendments to the partnership agreement (as described above). . Host Shareholder Approval. Shareholders owning 66 2/3% of the outstanding shares of Host's common stock shall have approved the merger of Host into Host REIT and such merger shall have been consummated. . REIT Qualification. Host's Board of Directors shall have determined, based upon the advice of counsel, that Host REIT can elect to be treated as a REIT for federal income tax purposes effective no later than the first full taxable year commencing after the REIT Conversion is completed (which might not be until 103 the year commencing January 1, 2000 if the REIT Conversion is not completed until after December 31, 1998), and Host REIT shall have received an opinion of counsel substantially to such effect. . NYSE Listing. The Common Shares shall have been listed on the NYSE. . Third-Party Consents. All required governmental and other third-party consents to the Mergers and the REIT Conversion, including consents of lenders, Marriott International and certain of its subsidiaries and ground lessors and consents to transfer material operating licenses and permits and the Management Agreements, shall have been received, except for such consents as would not reasonably be expected to have a material adverse effect on the business, financial condition or results of operations of Host REIT, the Operating Partnership and their subsidiaries taken as a whole. . No Adverse Tax Legislation. The United States Congress shall not have enacted legislation, or proposed legislation with a reasonable possibility of being enacted, that would have the effect of (i) substantially impairing the ability of Host REIT to qualify as a REIT or the Operating Partnership to qualify as a partnership, (ii) substantially increasing the federal tax liabilities of Host REIT resulting from the REIT Conversion or (iii) substantially reducing the expected benefits to Host REIT resulting from the REIT Conversion. The determination that this condition has been satisfied will be made by Host, in its discretion. . Completion of Mergers by June 30, 1999. The Mergers must have been completed by June 30, 1999, unless the Operating Partnership and the General Partners have mutually agreed to extend the deadline to a date no later than December 31, 1999. The obligation of the Operating Partnership to consummate a Merger is subject to satisfaction or waiver of the same or similar conditions. EXTENSION, AMENDMENT AND TERMINATION OF THE MERGERS The Operating Partnership, Host REIT and the General Partners reserve the right, subject to limitations under applicable law, to (i) amend the terms of any Merger or the REIT Conversion by giving written notice of such amendment to the Limited Partners, (ii) extend the Solicitation Period or delay consummation of any Merger, (iii) terminate the solicitation of consents pursuant to this Consent Solicitation as to any or all of the Partnerships and (iv) terminate the REIT Conversion or any Merger whether or not all of the conditions thereto have been satisfied or waived. If the terms of any Merger or the REIT Conversion are amended in a manner determined by the Operating Partnership, Host REIT and the General Partners to constitute a material adverse change with respect to any Limited Partner, they will promptly disclose such amendment in a manner reasonably calculated to inform the applicable Limited Partners of such amendment and will extend the Solicitation Period for an appropriate time period if the Solicitation Period would otherwise expire during such extension period. If an event occurs or any matter is brought to the attention of the Operating Partnership or Host REIT that, in its judgment, materially adversely affects one or more of the Partnerships, any Merger or the REIT Conversion, the Operating Partnership and Host REIT reserve the right (but does not have the obligation) to terminate the solicitation of consents with respect to the Merger of any Partnership, decide not to consummate the REIT Conversion, modify the terms of the REIT Conversion or any Merger or take such other actions as may be in their best interests. EFFECT OF REIT CONVERSION ON NON-PARTICIPATING PARTNERSHIPS Each Non-Participating Partnership will continue to operate as a separate legal entity with its own assets and liabilities and with its current Limited Partners. There will be no change in its investment objectives, policies or restrictions or the fees or distributions payable to the applicable General Partner or Manager. Each Non-Participating Partnership will remain subject to the terms of its current partnership agreement. Host may contribute some or all of its ownership interest in a Non-Participating Partnership to a Non- Controlled Subsidiary. 104 EXPENSES The Operating Partnership, Host REIT and the Partnerships will incur substantial costs and expenses in connection with structuring and consummating the Mergers, including legal fees, accounting fees and other costs and expenses associated with these transactions. The Merger Expenses, whether or not the Mergers are approved by the Partnerships, will be borne as follows: If some or all of the Mergers are consummated, the Merger Expenses of the Participating Partnerships would be borne by the Operating Partnership. Transfer and recordation taxes and fees will be taken into account in determining the Exchange Value for the applicable Partnership whose Exchange Value is based upon Adjusted Appraised Value. Those Partnerships which have an Exchange Value equal to their respective estimated Continuation Values, Atlanta Marquis, MHP and PHLP, will have their transfer and recordation taxes and fees paid by the Operating Partnership. If a Merger is rejected, then the General Partner of such Partnership would pay such Partnership's share of the Merger Expenses. The REIT Conversion Expenses, other than the Merger Expenses, will be borne by Host and the Operating Partnership. Assuming the Full Participation Scenario, the expenses of the Mergers are estimated to be as follows: MERGER EXPENSES ACCOUNTING TREATMENT The contribution by Host of its assets (other than its senior living assets and cash or other consideration to be distributed to its shareholders and certain other assets) to the Operating Partnership in exchange for OP Units and the subsequent contributions by the Operating Partnership of certain of such assets to the Non-Controlled Subsidiaries will be accounted for at Host's historical (carryover) basis. The acquisition of the Hotel Partnerships in exchange for OP Units and the Blackstone Acquisition will be accounted for as purchases. 105
Information and Tabulation Agents................................... $ 200,000 Printing, postage and brochures..................................... 2,500,000 Travel, public relations, graphics, etc............................. 200,000 Transfer fees, taxes and title...................................... 1,500,000 Legal fees and expenses............................................. 2,500,000 Appraisals and Fairness Opinion (including fees and expenses)....... 465,000 Accounting fees and expenses........................................ 600,000 Miscellaneous....................................................... 250,000 ---------- Total Merger expenses............................................. $8,215,000 ========== BUSINESS AND PROPERTIES BUSINESS OF THE OPERATING PARTNERSHIP Host REIT and the Operating Partnership have been formed primarily to continue, in an UPREIT structure, the full-service hotel ownership business currently conducted by Host. The primary business objectives of Host REIT and the Operating Partnership will be to (i) achieve long-term sustainable growth in Funds From Operations and cash flow per OP Unit or Common Share, (ii) increase asset values by improving and expanding the initial Hotels, as appropriate, (iii) acquire additional existing and newly developed upscale and luxury full-service hotels in targeted markets (primarily focusing on downtown hotels in core business districts in major metropolitan markets and select airport and resort /convention locations), (iv) develop and construct upscale and luxury full-service hotels and (v) potentially pursue other real estate investments. Host REIT will operate as a self-managed and self-administered REIT and its operations will be conducted solely through the Operating Partnership and its subsidiaries. Following the REIT Conversion, the Hotels are expected to consist of approximately 125 hotels, representing approximately 58,500 rooms, located throughout the United States and Canada. The Hotels will be generally operated under the Marriott, Ritz-Carlton, Four Seasons, Swissotel and Hyatt brand names and managed by subsidiaries of Marriott International and other companies. These brand names are among the most respected and widely recognized brand names in the lodging industry. Subsequent to the REIT Conversion, the Hotels will be leased by the Operating Partnership to the Lessees and will be managed on behalf of the Lessees by subsidiaries of Marriott International and other companies (the "Managers"). Host REIT will be the sole general partner of the Operating Partnership and will manage all aspects of the business of the Operating Partnership. This will include decisions with respect to (i) sales and purchases of hotels, (ii) the financing of the hotels, (iii) the leasing of the hotels and (iv) capital expenditures for the hotels (subject to the terms of the leases and the Management Agreements). Host REIT will be managed by its Board of Directors and will have no employees who are not also employees of the Operating Partnership. Under current federal income tax law, REITs are not permitted to derive revenues directly from the operations of hotels. Therefore, the Operating Partnership will lease the Hotels, through its subsidiaries, to the Lessees under the Leases. See "--The Leases" below. The Lessees will pay rent to the Operating Partnership generally equal to a specified Minimum Rent plus, to the extent it would exceed Minimum Rent, Percentage Rent. The Lessees will operate the Hotels pursuant to the Management Agreements with the Managers. Each of the Management Agreements provides for certain base and incentive management fees, plus reimbursement of certain costs, as further described below. See "-- The Management Agreements." Such fees and cost reimbursements will be the obligation of the Lessees and not the Operating Partnership (although the obligation to pay such fees could adversely affect the ability of the Lessees to pay the required rent to the Operating Partnership). The Leases, through the Percentage Rent provisions, are designed to allow the Operating Partnership to participate in any growth in room sales at the Hotels above specified levels, which management expects can be achieved through increases in room rates and occupancies. Although the economic trends affecting the hotel industry will be the major factor in generating growth in lease revenues, the abilities of the Lessees and the Managers will also have a material impact on future sales growth. In addition to external growth generated by new acquisitions, the Operating Partnership intends to carefully and periodically review its portfolio to identify opportunities to selectively enhance existing assets to improve operating performance through major capital improvements. The Operating Partnership's Leases will provide the Operating Partnership with the right to approve and finance major capital improvements. GENERAL The Company's primary focus is on the acquisition of upscale and luxury full-service hotel lodging properties. Since the beginning of 1994 through the date hereof, the Company has acquired 79 full-service hotels 106 representing more than 36,000 rooms for an aggregate purchase price of approximately $3.9 billion. Based upon data provided by Smith Travel Research, the Company believes that its full-service hotels outperform the industry's average occupancy rate by a significant margin and averaged 78.4% occupancy for 1997 compared to a 71.1% average occupancy for competing hotels in the upscale and luxury full-service segment of the lodging industry, the segment which is most representative of the Company's full-service hotels. The upscale and luxury full-service segments of the lodging industry are benefiting from a favorable supply and demand relationship in the United States, especially in the principal sub-markets in which the Company operates, considering hotels of similar size and quality. Management believes that demand increases have primarily resulted from a strong domestic economic environment and a corresponding increase in business travel. In spite of increased demand for rooms, the room supply growth rate in the full-service segment has not similarly increased. Management believes that this slower increase in the supply growth rate in the full-service segment is attributable to many factors, including (i) the limited availability of attractive building sites for full-service hotels, (ii) the lack of available financing for new full-service hotel construction and (iii) the availability of existing full- service properties for sale at a discount to their replacement cost. The relatively high occupancy rates of the Company's hotels, along with increased demand for full-service hotel rooms, have allowed the Managers of the Company's hotels to increase average daily room rates by selectively raising room rates and by replacing certain discounted group business with higher-rate group and transient business. As a result, on a comparable basis, room revenue per available room ("REVPAR") for the Company's full-service properties increased approximately 12.6% in 1997. The Company expects this supply/demand imbalance in the upscale and luxury full-service segments to continue, which should result in improved REVPAR at its hotel properties in the near term; however, there can be no assurance that such supply/demand imbalance will continue or that REVPAR will continue to improve. BUSINESS OBJECTIVES The Operating Partnership's primary business objective is to increase its "Funds from Operations" (defined as net income (or loss) computed in accordance with generally accepted accounting principles ("GAAP"), excluding gains (or losses) from debt restructuring and sales of properties, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures) per OP Unit and cash flow and enhance its value by: . Acquiring additional existing upscale and luxury full-service hotels, including Marriott and Ritz-Carlton hotels and other hotels operated by leading management companies such as Four Seasons, Hyatt and Swissotel, which satisfy the Operating Partnership's investment criteria, including entering into joint ventures when the Operating Partnership believes its return on investment will be maximized by doing so. . Developing new upscale and luxury full-service hotels, including Marriott and Ritz-Carlton hotels and other hotels operated by leading management companies such as Four Seasons, Hyatt and Swissotel, which satisfy the Operating Partnership's investment criteria, employing transaction structures which mitigate risk to the Operating Partnership. . Participating in the growth in sales for each of the hotels through leases which provide for the payment of rent based upon the lessees' gross hotel sales in excess of specified thresholds. . Enhancing existing hotel operations by completing selective capital improvements which are designed to increase gross hotel sales. BUSINESS STRATEGY The Company's primary business strategy is to continue to focus on maximizing the profitability of its existing full-service hotel portfolio and acquiring and, in limited cases, constructing, additional high quality, full- service hotel properties, including controlling interests in joint ventures, partnerships or other entities holding such hotel properties. Although competition for acquisitions has increased, the Company believes that the upscale and luxury full-service segments of the market offer opportunities to acquire assets at attractive multiples of cash flow and at discounts to replacement value, including underperforming hotels which can be improved by 107 conversion to the Marriott or Ritz-Carlton brands. The Company believes that the upscale and luxury full-service segments are very promising because: . There is a limited supply of new upscale and luxury full-service hotel rooms currently under construction in the sub-markets in which the Company operates. According to Smith Travel Research, from 1988 to 1991, upscale and luxury full-service room supply for the Company's competitive set increased an average of approximately 4% annually which resulted in an oversupply of rooms in the industry. However, this growth slowed to an average of approximately 1% from 1992 through 1997. Furthermore, the lead time from conception to completion of construction of a full-service hotel is generally three to five years or more in the markets in which the Company is principally pursuing acquisitions, which management believes will contribute to the continued low growth of room supply relative to the growth of room demand in the upscale and luxury full-service segments through 2000. . Many desirable hotel properties continue to be held by inadvertent owners such as banks, insurance companies and other financial institutions, both domestic and international, which are motivated and willing sellers. In recent years, the Company has acquired a number of properties from inadvertent owners at significant discounts to replacement cost, including luxury hotels operating under the Ritz- Carlton brand. While in the Company's experience to date, these sellers have been primarily U.S. financial organizations, the Company believes that numerous international financial institutions are also inadvertent owners of U.S. lodging properties and have only recently begun to dispose of such properties. The Company expects that there will be increased opportunities to acquire lodging properties from international financial institutions and expects to dedicate significant resources to aggressively pursue these opportunities. . The Company believes that there are numerous opportunities to improve the performance of acquired hotels by replacing the existing hotel manager with Marriott International and converting the hotel to the Marriott brand. Based upon data provided by Smith Travel Research, the Company believes that Marriott-flagged properties have consistently outperformed the industry. Demonstrating the strength of the Marriott brand name, the average occupancy rate for the Company's comparable full-service properties was 79.4%, compared to the average occupancy rate of 71.1% for competing upscale and luxury full-service hotels. In addition, the Company's comparable properties generated a 29% REVPAR premium over its competitive set. Accordingly, management anticipates that any additional full-service properties acquired by the Company in the future and converted from other brands to the Marriott brand should achieve higher occupancy rates and average room rates than has previously been the case for those properties as the properties begin to benefit from Marriott's brand name recognition, reservation system and group sales organization. The Company intends to pursue additional full- service hotel acquisitions, some of which may be conversion opportunities. Sixteen of the Company's 79 acquired full-service hotels from the beginning of 1994 through the date hereof were converted to the Marriott brand following their acquisition. . The Company intends to increase its pool of potential acquisition candidates by considering acquisitions of select non-Marriott and non- Ritz-Carlton hotels that offer long-term growth potential and are consistent with the overall quality of its current portfolio. The Company will focus on upscale and luxury full-service properties in difficult to duplicate locations with high barriers to entry, such as hotels located in downtown, airport and resort/convention locations, which are operated by quality managers. In April 1998, the Company reached a definitive agreement with the Blackstone Entities to acquire interests in twelve upscale and luxury full-service hotels and a mortgage loan secured by a thirteenth hotel in the U.S. and certain other assets in a transaction valued at the time of the agreement, including the assumption of debt. The Company expects to pay approximately $862 million in cash and assumed debt, issue approximately 43.7 million OP Units (based upon a negotiated value of $20.00 per OP Unit) and distribute up to 18% of the shares of Crestline common stock to the Blackstone Entities in exchange for the assets received from the Blackstone Entities. The Blackstone portfolio consists of two Ritz- Carltons, three Four Seasons (including one in which the Operating Partnership's only interest will be a mortgage loan), one Grand Hyatt, three Hyatt Regencies and four Swissotel properties. See "--Blackstone Acquisition." 108 The Company believes it is well qualified to pursue its acquisition and development strategy. Management has extensive experience in acquiring and financing lodging properties and believes its industry knowledge, relationships and access to market information provide a competitive advantage with respect to identifying, evaluating and acquiring hotel assets. During 1997, the Company acquired, or purchased controlling interests in, 17 full-service hotels, containing 8,624 rooms, for an aggregate purchase price of approximately $765 million (including the assumption of approximately $418 million of debt). The Company also completed the acquisition of the 504-room New York Marriott Financial Center, following the acquisition of the mortgage on the hotel for $101 million in late 1996. The Company holds minority interests and serves as a general partner or limited partner in various partnerships that own, as of the date hereof, an aggregate of 240 hotel properties, 20 of which are full-service properties, managed or franchised by Marriott International. In 1997, the Company acquired, or obtained controlling interests in, five affiliated partnerships, adding 10 hotels to its portfolio. In January, the Company acquired a controlling interest in MHP. MHP owns the 1,503-room Marriott Orlando World Center and a 50.5% interest in the 624-room Marriott Harbor Beach Resort. In April, the Company acquired a controlling interest in the 353-room Hanover Marriott. In the fourth quarter, the Company acquired the Chesapeake Hotel Limited Partnership ("CHLP"). CHLP owns the 430-room Boston Marriott Newton; the 681-room Chicago Marriott O'Hare; the 595-room Denver Marriott Southeast; the 588-room Key Bridge Marriott in Virginia; the 479-room Minnesota Airport Marriott; and the 221-room Saddle Brook Marriott in New Jersey. In December 1997, the Company obtained a controlling interest in the partnership that owns the 884-room Marriott's Desert Springs Resort and Spa in California. In 1998, the Company acquired a controlling interest in the partnership that owns the Atlanta Marriott Marquis, containing 1,671 rooms, for approximately $239 million, including the assumption of approximately $164 million of mortgage debt. The Company also acquired a controlling interest in a partnership that owns three full-service hotels, containing a total of 1,029 rooms, for approximately $50 million and the outstanding interest in the 289- room Park Ridge Marriott in New Jersey for $24 million. More recently, the Company acquired the 281-room Ritz-Carlton, Phoenix for $75 million, the 397- room Ritz-Carlton in Tysons Corner, Virginia for $96 million and the 487-room Torrance Marriott for $52 million. In the third quarter of 1998, the Company acquired the 308-room Ritz-Carlton, Dearborn for approximately $65 million, the 336-room Ritz-Carlton, San Francisco for approximately $161 million and the 404-room Memphis Marriott (which was converted to the Marriott brand upon acquisition) for approximately $16 million. The Company is continually engaged in discussions with respect to other potential acquisition properties. In addition to investments in partnerships in which it already held minority interests, the Company has been successful in adding properties to its portfolio through partnership arrangements with either the seller of the property or the incoming managers (typically Marriott International or a Marriott franchisee). During 1997, the Company acquired interests in five such partnerships which owned five full-service hotels, including the 197-room Waterford Hotel in Oklahoma City, Oklahoma; the 404-room Norfolk Waterside Marriott in Norfolk, Virginia; the 380-room Hartford/Farmington Marriott near Farmington, Connecticut; the 380-room former Manhattan Beach Radisson Plaza in Manhattan Beach, California; and the 299-room Ontario Airport Marriott in Ontario, California. The Waterford Hotel and the Manhattan Beach Radisson Plaza have been converted to the Marriott brand. As discussed above, in 1998, the Company acquired a controlling interest in a partnership that owns three hotels: the 359-room Albany Marriott in New York; the 350-room San Diego Marriott Mission Valley in California; and the 320-room Minneapolis Marriott Southwest in Minnesota. The Company has the financial flexibility and, due to its existing partnership investment portfolio, the administrative infrastructure in place to accommodate such arrangements. The Company views this ability as a competitive advantage and expects to enter into similar arrangements to acquire additional properties in the future. The Company believes there is a significant opportunity to acquire additional Ritz-Carlton hotels due to the Company's relationship with Marriott International and due to the number of Ritz-Carlton brand hotels currently owned by inadvertent owners. The Company also intends to purchase upscale and luxury full-service hotels with the intention of converting them to the Ritz- Carlton brand. 109 The Company currently owns six international properties, with 2,550 rooms, located in Canada and Mexico. The overbuilding and economic stress currently being experienced in some European and Pacific Rim countries may eventually lead to additional international acquisition opportunities. The Company will acquire international properties only when such acquisitions achieve satisfactory returns after adjustments for currency and country risks. In addition to acquisitions, the Company plans to selectively develop new upscale and luxury full-service hotels in major urban markets and convention/resort locations with strong growth prospects, unique or difficult to duplicate sites, high barriers to entry for other new hotels and limited new supply. The Company intends to target only development projects that show promise of providing financial returns that represent a premium to acquisitions. In 1997, the Company announced that it will develop the 717-room Tampa Convention Center Marriott for $104 million, including a $16 million subsidy provided by the City of Tampa. The Company may also expand certain existing hotel properties where strong performance and market demand exists. Expansions to existing properties creates a lower risk to the Company as the success of the market is generally known and development time is significantly shorter than new construction. The Company recently committed to add approximately 500 rooms and an additional 15,000 square feet of meeting space to the 1,503-room Marriott Orlando World Center. HOTEL LODGING INDUSTRY The upscale and luxury full-service segments of the lodging industry continue to benefit from a favorable cyclical imbalance in the supply/demand relationship in which room demand growth has exceeded supply growth, which has remained fairly limited. The lodging industry posted strong gains in revenues and profits in 1997, as demand growth continued to outpace additions to supply. The Company believes that upscale and luxury full-service hotel room supply growth will remain limited through at least 1998. Accordingly, the Company believes this supply/demand imbalance will result in improving occupancy and room rates which should result in improved REVPAR and operating profit. Following a period of significant overbuilding in the mid-to-late 1980s, the lodging industry experienced a severe downturn. Since 1991, new hotel construction, excluding casino-related construction, has been modest and largely offset by the number of rooms taken out of service each year. Due to an increase in travel and an improving economy, hotel occupancy has grown steadily over the past several years and room rates have improved. The Company believes that room demand for upscale and luxury full-service properties will continue to grow at approximately the rate of inflation. Increased room demand should result in increased hotel occupancy and room rates. According to Smith Travel Research, upscale and luxury full-service occupancy for the Company and its competitive set grew in 1997 to 72.5%, while room rate growth continued to exceed inflation. While room demand has been rising, new hotel supply growth has been minimal. Smith Travel Research data shows that upscale and luxury full-service room supply increased an average of only 1% annually from 1991 through 1997. According to Coopers & Lybrand, L.L.P., hotel supply in the upscale and luxury full-service segment is expected to grow annually at 1.8% to 1.9% through 1998. The increase in room demand and minimal growth in new hotel supply has also led to increased room rates. The Company believes that these recent trends will continue, with overall occupancy increasing slightly and room rates increasing at more than one and one-half times the rate of inflation in 1998. As a result of the overbuilding in the mid-to-late 1980s, many full-service hotels have not performed as originally planned. Cash flow has often not covered debt service requirements, causing lenders (e.g., banks, insurance companies and savings and loans) to foreclose and become "inadvertent owners" who are motivated to sell these assets. In the Company's experience to date, these sellers have been primarily U.S. financial organizations. The Company believes that numerous international financial institutions are also inadvertent owners of lodging properties and expects there will be increased opportunities to acquire lodging properties from international financial institutions. While the interest of inadvertent owners to sell has created attractive acquisition opportunities with strong current yields, the lack of supply growth and increasing room night demand should contribute to higher long-term returns on invested capital. Given the relatively long lead time to develop urban, convention and resort hotels, as well as the lack of project financing, management believes the growth in room supply in this segment will be limited, at least until the year 2000. 110 HOTEL LODGING PROPERTIES The Company's lodging portfolio consists of 104 upscale and luxury full- service hotels with over 50,000 rooms. The Company's hotel lodging properties represent quality assets in the upscale and luxury full-service lodging segments. All but three of the Company's hotel properties are currently operated under the Marriott or Ritz-Carlton brand names. The following tables set forth certain information with respect to the operations of the Hotels to be owned by the Operating Partnership following the REIT Conversion on a historical and pro forma basis for fiscal year 1997 and for the First Two Quarters 1998.
FISCAL YEAR 1997 ------------------------------------------- AVERAGE PARTNERSHIP NO. OF HOTELS NO. OF ROOMS HOTEL REVENUES OCCUPANCY DAILY RATE REVPAR ----------- ------------- ------------ -------------- --------- ---------- ------- (IN THOUSANDS) Atlanta Marquis(1)...... 1 1,671 $ 85,397 69.8% $127.36 $ 88.95 Chicago Suites.......... 1 256 6,568 83.2 146.83 122.14 Desert Springs(2)....... 1 884 33,369 73.0 169.55 123.77 Hanover................. 1 353 6,735 80.8 123.55 99.82 MDAH.................... 6 1,692 26,699 76.4 102.97 78.63 MHP(3).................. 2 2,127 75,211 80.3 155.44 124.84 MHP2(4)................. 4 3,411 69,014 80.7 133.75 107.91 PHLP(5)................. 8 3,181 50,323 78.5 105.21 82.63 Blackstone Hotels....... 12 5,520 147,524 72.8 166.72 121.33 Host (historical)(6).... 95 45,718 946,726 78.4 133.74 104.84 Host (pro forma)(6)(7) ....................... 126 58,603 1,324,601 77.7 133.01 103.30 - -------- (1) Atlanta Marquis has an 80% residual interest in the Atlanta Marriott Marquis Hotel. Revenues represents sales generated by the Hotel. (2) Subsequent to November 25, 1997, revenues reflect gross hotel sales. Prior to that date, revenues reflected hotel rental income. (3) Includes Marriott's Harbor Beach Resort, in which MHP owns a 50.5% interest. (4) Includes the Santa Clara Marriott, in which MHP2 owns a 50% interest and Host owns the remaining 50% interest. (5) Includes the Tampa Westshore Marriott and the Raleigh Crabtree Marriott, which are currently consolidated by Host. A subsidiary of Host provided 100% nonrecourse financing totaling approximately $35 million to PHLP, in which Host owns the sole general partner interest, for the acquisition of these two hotels. (6) Includes the hotels owned by Desert Springs, Hanover, MHP and MHP2 for both fiscal year 1997 and First Two Quarters 1998 and Atlanta Marquis for First Two Quarters 1998. (7) Includes the hotels owned by all Hotel Partnerships and the Blackstone Hotels, assuming the Full Participation Scenario. 111
FIRST TWO QUARTERS 1998 ------------------------------------------- AVERAGE PARTNERSHIP NO. OF HOTELS NO. OF ROOMS HOTEL REVENUES OCCUPANCY DAILY RATE REVPAR ----------- ------------- ------------ -------------- --------- ---------- ------- (IN THOUSANDS) Atlanta Marquis(1)...... 1 1,671 $ 41,957 69.1% $138.66 $ 95.81 Chicago Suites.......... 1 256 3,358 82.0 159.98 131.18 Desert Springs(2)....... 1 884 65,051 79.7 214.47 170.93 Hanover................. 1 353 3,391 71.5 142.62 101.97 MDAH.................... 6 1,692 14,521 77.0 114.66 88.29 MHP(3).................. 2 2,127 47,968 85.0 176.75 150.24 MHP2(4)................. 4 3,411 37,946 80.4 152.56 122.66 PHLP(5)................. 8 3,181 29,480 81.1 117.81 95.54 Blackstone Hotels....... 12 5,520 79,346 72.0 175.53 126.41 Host (historical)(6).... 101 49,019 577,472 78.6 145.04 114.02 Host (pro forma)(6)(7) ....................... 126 58,603 715,360 77.8 146.18 113.67 One commonly used indicator of market performance for hotels is room revenue per available room, or REVPAR, which measures daily room revenues generated on a per room basis. This does not include food and beverage or other ancillary revenues generated by the property. REVPAR represents the combination of the average daily room rate charged and the average daily occupancy achieved. The Company has reported annual increases in REVPAR since 1993. To maintain the overall quality of the Company's lodging properties, each property undergoes refurbishments and capital improvements on a regularly scheduled basis. Typically, refurbishing has been provided at intervals of five years, based on an annual review of the condition of each property. For the First Two Quarters 1998, First Two Quarters 1997, fiscal years 1997, 1996 and 1995, the Company spent $79 million, $60 million, $131 million, $87 million and $56 million, respectively, on capital improvements to existing properties. As a result of these expenditures, the Company will be able to maintain high quality rooms at its properties. The Company's hotels average nearly 500 rooms. Twelve of the Company's hotels have more than 750 rooms. Hotel facilities typically include meeting and banquet facilities, a variety of restaurants and lounges, swimming pools, gift shops and parking facilities. The Company's hotels primarily serve business and pleasure travelers and group meetings at locations in downtown and suburban areas, near airports and at resort convention locations throughout the United States. The properties are generally well situated in locations where there are significant barriers to entry by competitors including downtown areas of major metropolitan cities at airports and resort/convention locations where there are limited or no development sites. Marriott International serves as the manager for 88 of the 104 hotels owned by the Company and all but three are part of Marriott International's full- service hotel system. The average age of the properties is 15 years, although several of the properties have had substantial, more recent renovations or major additions. In 1997, for example, the Company substantially completed a two-year $30 million capital improvement program at the New York Marriott Marquis which included renovations to all guestrooms, refurbishment of ballrooms, restaurant updates and retail additions. In early 1998, the Company completed a $15 million capital improvement program at the Denver Marriott Tech Center. The program included replacement of guestroom interiors, remodeling of the lobby, ballroom, meeting rooms and corridors, as well as renovations to the exterior of the building. The chart below sets forth performance information for the Company's comparable hotels: - -------- (1) Consists of the 78 properties owned by the Company for the entire First Two Quarters 1998 and First Two Quarters 1997, respectively, and the 54 properties owned by the Company for the entire 1997 and 1996 fiscal years, respectively, except for the 85-room Sacramento property, which is operated as an independent hotel. These properties, for the respective periods, represent the "comparable properties." Properties held for less than all of the periods discussed above, respectively, are not considered comparable. 112
FIRST TWO QUARTERS FISCAL YEAR -------------------- ---------------- 1998 1997 1997 1996 --------- --------- ------- ------- COMPARABLE FULL-SERVICE HOTELS(1) --------------------------------- Number of properties................ 78 78 54 54 Number of rooms..................... 38,589 38,589 27,074 27,044 Average daily rate.................. $ 146.64 $ 135.21 $134.49 $121.58 Occupancy percentage................ 79.6% 79.8% 79.4% 78.0% REVPAR.............................. $ 116.66 $ 107.85 $106.76 $ 94.84 REVPAR % change..................... 8.2% -- 12.6% -- The chart below sets forth certain performance information for the Company's hotels: - -------- (1) Excludes the information related to the 85-room Sacramento property, which is operated as an independent hotel. Revenues in 1997 for nearly all of the Company's hotels were improved or comparable to 1996. This improvement was achieved through steady increases in customer demand, as well as yield management techniques applied by the manager to maximize REVPAR on a property-by-property basis. REVPAR for comparable properties increased 12.6% for fiscal year 1997 as average room rates increased almost 11% and average occupancy increased over one percentage point. Overall, this resulted in outstanding sales growth. Sales expanded at a 9% rate for comparable hotels and house profit margins increased by over two percentage points. REVPAR in 1997 for all of the Company's properties (including both comparable and non-comparable properties) increased 12.9% as average room rates increased over 11% and average occupancy increased over one percentage point. For the First Two Quarters 1998, REVPAR for comparable properties increased 8.2% as average room rates increased 8.5% and average occupancy decreased slightly. Sales for the First Two Quarters 1998 expanded at 9% rate for comparable hotels and the house profit margin increased by one percentage point. REVPAR for the First Two Quarters 1998 for all of the Company's properties increased 5.4% as average room rates increased nearly 7% and average occupancy decreased over one percentage point. The Company believes that its hotels consistently outperform the industry's average REVPAR growth rates. The relatively high occupancy rates of the Company's hotels, along with increased demand for upscale and luxury full-service hotel rooms, allowed the managers of the Company's hotels to increase average room rates by selectively raising room rates and replacing certain discounted group business with higher-rate group and transient business. The Company believes that these favorable REVPAR growth trends should continue due to the limited new construction of full-service properties and the expected improvements from the conversion of seven properties to the Marriott brand in 1996 and 1997. A number of the Company's full-service hotel acquisitions were converted to the Marriott brand upon acquisition--most recently the Coronado Island Marriott Resort and the Manhattan Beach Marriott were converted in the second half of 1997. The conversion of these properties to the Marriott brand is intended to increase occupancy and room rates as a result of Marriott International's nationwide marketing and reservation systems, its Marriott Rewards program, group sales force, as well as customer recognition of the Marriott brand name. The Marriott brand name has consistently delivered occupancy and REVPAR premiums over other brands. Based upon data provided by Smith Travel Research, the Company's comparable properties have an eight percentage point occupancy premium and a 29% REVPAR premium over its competitive set for 1997. The Company actively manages the conversions and, in many cases, has worked closely with the manager to selectively invest in enhancements to the physical product to make the property more attractive to guests or more efficient to operate. The invested capital with respect to these properties is primarily used for the improvement of common areas, as well as upgrading soft and hard goods (i.e., carpets, drapes, paint, furniture and additional amenities). The conversion process typically causes periods of disruption to these properties as selected rooms and common areas are temporarily taken out of service. Historically, the conversion properties have shown improvements as the benefits of Marriott International's marketing and reservation programs, group sales force and customer service initiatives take hold. In addition, these properties have generally been integrated into Marriott International's systems covering purchasing and distribution, insurance, telecommunications and payroll processing. 113
FIRST TWO QUARTERS FISCAL YEAR -------------------- ------------------------- 1998 1997 1997 1996 1995 --------- --------- ------- ------- ------- Number of properties........... 101 86 95 79 55 Number of rooms................ 49,019 40,387 45,718 37,210 25,932 Average daily rate(1).......... $145.04 $135.74 $133.74 $119.94 $110.30 Occupancy percentage(1)........ 78.6% 79.7% 78.4% 77.3% 75.5% REVPAR(1)...................... $114.02 $108.15 $104.84 $ 92.71 $ 83.32 Following the REIT Conversion, the Lessees and the Managers will continue to focus on cost control in an attempt to ensure that hotel sales increases serve to maximize house and operating profit. While control of fixed costs serves to improve profit margins as hotel sales increase, it also results in more properties reaching financial performance levels that allow the Managers to share in the growth of profits in the form of incentive management fees. The Company believes this is a positive development as it strengthens the alignment of the Company's, the Lessees' and the Managers' interests. During 1996, the Company completed its divestiture of limited service properties through the sale and leaseback of 16 Courtyard and 18 Residence Inn properties. These properties, along with 37 Courtyard properties sold and leased back during 1995, continue to be reflected in the Company's revenues and are managed by Marriott International under long-term management agreements. Following the REIT Conversion, these properties will be subleased to a subsidiary of Crestline. During 1997, limited service properties represented 2% of the Company's hotel EBITDA, compared to 5% in 1996, and the Company expects this percentage to continue to decrease as the Company continues to acquire primarily full-service properties. The following table presents full-service hotel information by geographic region for fiscal year 1997: 114
AGGREGATE AVERAGE COMPLETED NUMBER AVERAGE RENOVATION NUMBER OF GUEST AVERAGE DAILY EXPENDITURES GEOGRAPHIC REGION OF HOTELS ROOMS OCCUPANCY RATE REVPAR (IN THOUSANDS) - ----------------- --------- -------- --------- ------- ------- -------------- Atlanta................. 7 441 76.5% $131.69 $100.74 $ 4,115 Florida................. 11 511 80.9 131.78 106.64 14,007 Mid-Atlantic............ 12 364 76.1 111.71 85.00 3,477 Midwest................. 10 418 74.3 107.65 79.99 2,751 New York................ 10 708 84.7 173.85 147.22 15,232 Northeast............... 7 367 75.2 96.75 72.72 9,260 South Central........... 15 525 76.5 120.81 92.39 15,190 Western................. 21 519 79.5 140.07 111.39 19,806 Latin America........... 2 436 62.7 129.54 81.17 290 Average-all regions... -- 485 78.4 133.74 104.84 -- HOTEL PROPERTIES The following table sets forth, as of September 28, 1998, the location and number of rooms relating to each of the Company's hotels. All of the properties are operated under Marriott brands by Marriott International, unless otherwise indicated. 115
LOCATION ROOMS - -------- ----- Alabama Grand Hotel Resort and Golf Club......................................... 306 Arizona Scottsdale Suites........................................................ 251 The Ritz-Carlton, Phoenix (1)............................................ 281 California Coronado Island Resort (2)(6)............................................ 300 Costa Mesa Suites........................................................ 253 Desert Springs Resort and Spa (3)(4)..................................... 884 Manhattan Beach (5)(6)................................................... 380 Marina Beach (6)......................................................... 368 Newport Beach............................................................ 570 Newport Beach Suites..................................................... 250 Ontario Airport (7)...................................................... 299 Sacramento Airport (6)(8)................................................ 85 San Diego Marriott Hotel and Marina (6).................................. 1,355 San Diego Mission Valley (9)............................................. 350 San Francisco Airport.................................................... 684 San Francisco Fisherman's Wharf (10)..................................... 285 San Francisco Moscone Center (6)......................................... 1,498 San Ramon (6)............................................................ 368 Santa Clara (6).......................................................... 754 The Ritz-Carlton, Marina del Rey (1)(6)(11).............................. 306 The Ritz-Carlton, San Francisco (1)...................................... 336 Torrance................................................................. 487 Colorado Denver Southeast (6)(12)................................................. 595 Denver Tech Center....................................................... 625 Denver West (6).......................................................... 307 Marriott's Mountain Resort at Vail....................................... 349 Connecticut Hartford/Farmington (7).................................................. 380 Hartford/Rocky Hill (6).................................................. 251 Florida Fort Lauderdale Marina................................................... 580 Harbor Beach Resort (3)(4)(6)............................................ 624 Jacksonville (6)(9)...................................................... 256 Miami Airport (6)........................................................ 782 Orlando World Center (3)(4).............................................. 1,503 Palm Beach Gardens (6)(10)............................................... 279 Singer Island (Holiday Inn) (8).......................................... 222 Tampa Airport (6)........................................................ 295 Tampa Westshore (6)(13).................................................. 309 The Ritz-Carlton, Naples (1)............................................. 463 Georgia Atlanta Marriott Marquis (3)(4).......................................... 1,671 Atlanta Midtown Suites (6)............................................... 254 Atlanta Norcross......................................................... 222 Atlanta Northwest........................................................ 400 Atlanta Perimeter (6).................................................... 400 JW Marriott Hotel at Lenox (6)........................................... 371 The Ritz-Carlton, Atlanta (1)............................................ 447 The Ritz-Carlton, Buckhead (1)........................................... 553 Illinois Chicago/Deerfield Suites................................................. 248 Chicago/Downers Grove Suites............................................. 254 Chicago/Downtown Courtyard............................................... 334 Chicago O'Hare (6)(12)................................................... 681 Indiana South Bend (6)........................................................... 300 Louisiana New Orleans (4).......................................................... 1,290 Maryland Bethesda (6)............................................................. 407 Gaithersburg/Washingtonian Center........................................ 284 Massachusetts Boston/Newton (3)........................................................ 430 Michigan Detroit Romulus.......................................................... 245 The Ritz-Carlton, Dearborn (1)........................................... 306 Minnesota Minneapolis/Bloomington (12)............................................. 479 Minneapolis City Center (6).............................................. 583 Minneapolis Southwest (9)................................................ 320 Missouri Kansas City Airport (6).................................................. 382 St. Louis Pavilion (6)................................................... 672 New Hampshire Nashua................................................................... 251 New Jersey Hanover (3)(4)........................................................... 353 Newark Airport (6)....................................................... 590 Park Ridge (6)........................................................... 289 Saddle Brook (6)(12)..................................................... 221 New York Albany (9)............................................................... 359 New York Marriott Financial Center (14).................................. 504 New York Marriott Marquis (6)............................................ 1,911 Marriott World Trade Center (6).......................................... 820 North Carolina Charlotte Executive Park (10)............................................ 298 Raleigh Crabtree Valley (13)............................................. 375 Oklahoma Oklahoma City............................................................ 354 Oklahoma City Waterford (5).............................................. 197 Oregon Portland................................................................. 503 Pennsylvania Philadelphia (Convention Center) (6)..................................... 1,200 Philadelphia Airport (6)................................................. 419 Pittsburgh City Center (6)(10)........................................... 400 Tennesee Memphis (2)(6)........................................................... 404 Texas Dallas/Fort Worth........................................................ 492 Dallas Quorum (6)........................................................ 547 El Paso (6).............................................................. 296 Houston Airport (6)...................................................... 566 JW Marriott Houston (6).................................................. 503 Plaza San Antonio (6)(10)................................................ 252 San Antonio Rivercenter (4)(6)........................................... 999 San Antonio Riverwalk (6)................................................ 500 HOTEL PROPERTIES (CONTINUED) Properties that are currently not consolidated by Host and are subject to the Mergers:
LOCATION ROOMS - -------- ------ Utah Salt Lake City (6)..................................................... 510 Virginia Dulles Airport (6)..................................................... 370 Key Bridge (6)(12)..................................................... 588 Norfolk Waterside (6)(7)............................................... 404 Pentagon City Residence Inn............................................ 300 The Ritz-Carlton, Tysons Corner (6).................................... 397 Washington Dulles Suites............................................... 254 Westfields............................................................. 335 Williamsburg........................................................... 295 Washington, D.C. Washington Metro Center................................................ 456 Canada Calgary................................................................ 380 Toronto Airport (15)................................................... 423 Toronto Eaton Centre (6)............................................... 459 Toronto Delta Meadowvale (8)........................................... 374 Mexico Mexico City Airport (15)............................................... 600 JW Marriott Hotel, Mexico City (15).................................... 314 ------ TOTAL.................................................................. 50,067 ====== Properties that are included in the Blackstone portfolio are as follows:
HOTEL STATE ROOMS - ----- ----- ----- MDAH Fairview Park (6)......................................... Virginia 395 Dayton.................................................... Ohio 399 Research Triangle Park.................................... North Carolina 224 Detroit Marriott Southfield............................... Michigan 226 Detroit Marriott Livonia.................................. Michigan 224 Fullerton (6)............................................. California 224 ----- 1,692 ----- HOTEL STATE ROOMS - ----- ----- ----- Chicago Suites Marriott O'Hare Suites (6)................................ Illinois 256 ----- PHLP Albuquerque (6)........................................... New Mexico 411 Greensboro-High Point (6)................................. North Carolina 299 Houston Medical Center (6)................................ Texas 386 Miami Biscayne Bay (6).................................... Florida 605 Marriott Mountain Shadows Resort.......................... Arizona 337 Seattle SeaTac Airport.................................... Washington 459 ----- 2,497 ----- TOTAL.................................................................... 4,445 ===== - -------- (1) Property is operated as a Ritz-Carlton. The Ritz-Carlton Hotel Company, L.L.C. manages the property and is wholly owned by Marriott International. (2) This property was acquired by the Company and converted to the Marriott brand in 1997 or 1998. (3) The Company acquired a controlling interest in the partnership that owns this property in 1997 or 1998. The Company previously owned a general partner interest in the partnership. (4) Property is held within a partnership and is currently consolidated by Host. (5) The Company acquired a controlling interest in the newly-formed partnership that owns this property in 1997. The property was converted to the Marriott brand and is operated as a Marriott franchised property. (6) The land on which the hotel is built is leased under one or more long- term lease agreements. (7) The Company acquired a controlling interest in the newly-formed partnership that owns this property in 1997. The property is operated as a Marriott franchised property. (8) Property is not operated under the Marriott brand and is not managed by Marriott International. (9) The Company acquired a controlling interest in the partnership that owns this property in 1998. The property will be operated as a Marriott franchised property. (10) Property is operated as a Marriott franchised property. (11) Property was acquired by the Company in 1997. (12) The Company acquired the partnership that owns this property in 1997. The Company previously owned a general partner interest in the partnership. (13) Property is owned by PHLP. A subsidiary of the Company provided 100% nonrecourse financing totaling approximately $35 million to PHLP, in which the Company owns the sole general partner interest, for the acquisition of these two hotels. The Company consolidates these properties in the accompanying financial statements. (14) The Company completed the acquisition of this property in early 1997. The Company previously had purchased the mortgage loan secured by the hotel in late 1996. (15) Property will be transferred to the Non-Controlled Subsidiary in conjunction with the REIT Conversion and no longer consolidated by the Company. 116
HOTEL STATE ROOMS - ----- ----- ----- Four Seasons, Atlanta...................................... Georgia 246 Four Seasons, Philadelphia................................. Pennsylvania 365 Grand Hyatt, Atlanta....................................... Georgia 439 Hyatt Regency, Burlingame.................................. California 793 Hyatt Regency, Cambridge................................... Massachusetts 469 Hyatt Regency, Reston...................................... Virginia 514 Swissotel, Atlanta......................................... Georgia 348 Swissotel, Boston.......................................... Massachusetts 498 Swissotel, Chicago......................................... Illinois 630 The Drake (Swissotel), New York............................ New York 494 The Ritz-Carlton, Amelia Island............................ Florida 449 The Ritz-Carlton, Boston (1)............................... Massachusetts 275 ----- TOTAL................................................................... 5,520 ===== 1998 ACQUISITIONS In January 1998, the Company acquired an additional interest in Atlanta Marquis, which owns an interest in the 1,671-room Atlanta Marriott Marquis Hotel, for approximately $239 million, including the assumption of approximately $164 million of mortgage debt. The Company previously owned a 1.3% general and limited partnership interest. In March 1998, the Company acquired a controlling interest in the partnership that owns three hotels: the 359-room Albany Marriott, the 350-room San Diego Marriott Mission Valley and the 320-room Minneapolis Marriott Southwest for approximately $50 million. In the second quarter of 1998, the Company acquired the partnership that owns the 289-room Park Ridge Marriott in Park Ridge, New Jersey for $24 million. The Company previously owned a 1% managing general partner interest and a note receivable interest in such partnership. In addition, the Company acquired the 281-room Ritz-Carlton, Phoenix for $75 million, the 397-room Ritz-Carlton in Tysons Corner, Virginia for $96 million and the 487-room Torrance Marriott near Los Angeles, California for $52 million. In the third quarter of 1998, the Company acquired the 308-room Ritz-Carlton, Dearborn for approximately $65 million, the 336-room Ritz-Carlton, San Francisco for approximately $161 million and the 404-room Memphis Crowne Plaza (which was converted to the Marriott brand upon acquisition) for approximately $16 million. In April 1998, the Company, through the Operating Partnership, entered into an agreement to acquire certain assets from various affiliates of The Blackstone Group. See "--Blackstone Acquisition." BLACKSTONE ACQUISITION In April 1998, the Company reached a definitive agreement with the Blackstone Entities to acquire ownership of, or controlling interests in, twelve hotels and two mortgage loans, one secured by one of the acquired hotels and one secured by an additional hotel. In addition, the Company will acquire a 25% interest in the Swissotel management company from the Blackstone Entities, which the Company will transfer to Crestline in connection with the distribution of Crestline common stock to the Company's shareholders and the Blackstone Entities. If the Blackstone Acquisition is consummated, the Operating Partnership expects to issue approximately 43.7 million OP Units (based upon a negotiated value of $20.00 per OP Unit), assume debt and make cash payments totaling approximately $862 million and distribute up to 18% of the shares of Crestline common stock and other consideration to the Blackstone Entities. The consideration received by the Blackstone Entities was determined through negotiations between the Company and Blackstone because the transaction could be negotiated privately and was not based upon appraisals of the assets. Each OP Unit will be exchangeable for one Common Share (or its cash equivalent, at the Company's election). Upon completion of the Blackstone Acquisition and the REIT Conversion, the Blackstone Entities will own approximately 16% of the outstanding OP Units. John G. Schreiber, co-chairman of the Blackstone Real Estate Partners' investment committee, has joined the Board of Directors of the Company. The Blackstone portfolio is one of the premier collections of hotel real estate properties. It includes: The Ritz-Carlton, Amelia Island (449 rooms); The Ritz-Carlton, Boston (275 rooms); Hyatt Regency Burlingame at San Francisco Airport (793 rooms); Hyatt Regency Cambridge, Boston (469 rooms); Hyatt Regency Reston, Virginia (514 rooms); Grand Hyatt Atlanta (439 rooms); Four Seasons Philadelphia (365 rooms); Four Seasons Atlanta (246 rooms); The Drake (Swissotel) New York (494 rooms); Swissotel Chicago (630 rooms); Swissotel Boston (498 rooms) and Swissotel Atlanta (348 rooms). Additionally, the transaction includes: the first mortgage loan on the Four Seasons Beverly Hills (285 rooms); two office buildings in Atlanta--the offices at The Grand (97,879 sq. ft.) and the offices at the Swissotel (67,110 sq. ft.); and a 25% interest in the Swissotel U.S. management company (which will be transferred to Crestline). At the closing of the Blackstone Acquisition, the Blackstone portfolio will be contributed to the Operating Partnership and its hotels will be leased to subsidiaries of Crestline and will continue to be managed on behalf of the Lessees under their existing management agreements. The Operating Partnership's acquisition of the Blackstone portfolio is subject to certain conditions, including the REIT Conversion being consummated by March 31, 1999 and Host REIT qualifying as a REIT for 1999 (which condition may not be satisfied if the REIT Conversion is not completed prior to January 1, 1999). 117 INVESTMENTS IN AFFILIATED PARTNERSHIPS The Company and certain of its subsidiaries also manage the Company's partnership investments and conduct the partnership services business. As such, as of the date hereof, the Company and/or its subsidiaries own an investment in, and generally serve as a general partner or managing general partner for, 18 unconsolidated partnerships which collectively own 20 Marriott full-service hotels, 120 Courtyard hotels, 50 Residence Inns and 50 Fairfield Inns. In addition, the Company holds notes receivable (net of reserves) from partnerships totaling approximately $23 million at January 2, 1998. Thirteen of the 20 full-service hotels owned by the unconsolidated partnerships will be acquired by the Operating Partnership in connection with the REIT Conversion. As the managing general partner of these partnerships, the Company and its subsidiaries are responsible for the day-to-day management of partnership operations, which includes payment of partnership obligations from partnership funds, preparation of financial reports and tax returns and communications with lenders, limited partners and regulatory bodies. The Company or its subsidiaries are usually reimbursed for the cost of providing these services. Hotel properties owned by the unconsolidated partnerships generally were acquired from the Company or its subsidiaries in connection with limited partnership offerings. These hotel properties are currently operated under management agreements with Marriott International. As the managing general partner of such partnerships, the Company or its subsidiaries oversee and monitor Marriott International's performance pursuant to these agreements. The Company's interests in these partnerships range from 1% to 50%. Cash distributions provided from these partnerships are tied to the overall performance of the underlying properties and the overall level of debt owed by the partnership. Partnership distributions to the Company were $1 million for the First Two Quarters 1998, $4 million for the First Two Quarters 1997, $5 million in each of 1997 and 1996 and $3 million in 1995. All partnership debt is nonrecourse to the Company and its subsidiaries, except that the Company is contingently liable under various guarantees of debt obligations of certain of these partnerships. Such commitments are limited in the aggregate to $60 million at January 2, 1998. Subsequent to year-end, such maximum commitments were reduced to $20 million in connection with the refinancing and acquisition of a controlling interest in the Atlanta Marriott Marquis. In most cases, fundings of such guarantees represent loans to the respective partnerships. MARKETING As of September 28, 1998, 88 of the Company's 104 hotel properties are managed or franchised by Marriott International as Marriott or Ritz-Carlton brand hotels. Thirteen of the 16 remaining hotels are operated as Marriott brand hotels under franchise agreements with Marriott International. The Company believes that these Marriott-managed and franchised properties will continue to enjoy competitive advantages arising from their participation in the Marriott International hotel system. Marriott International's nationwide marketing programs and reservation systems as well as the advantage of the strong customer preference for Marriott brands should also help these properties to maintain or increase their premium over competitors in both occupancy and room rates. Repeat guest business in the Marriott hotel system is enhanced by the Marriott Rewards program, which expanded the previous Marriott Honored Guest Awards program. Marriott Rewards membership includes more than 7.5 million members. The Marriott reservation system provides Marriott reservation agents complete descriptions of the rooms available for sale and up-to-date rate information from the properties. The reservation system also features connectivity to airline reservation systems, providing travel agents with access to available rooms inventory for all Marriott and Ritz-Carlton lodging properties. In addition, software at Marriott's centralized reservations centers enables agents to immediately identify the nearest Marriott or Ritz- Carlton brand property with available rooms when a caller's first choice is fully occupied. 118 COMPETITION The Company's hotels compete with several other major lodging brands in each segment in which they operate. Competition in the industry is based primarily on the level of service, quality of accommodations, convenience of locations and room rates. Although the competitive position of each of the Company's hotel properties differs from market to market, the Company believes that its properties compare favorably to their competitive set in the markets in which they operate on the basis of these factors. The following table presents key participants in segments of the lodging industry in which the Company competes: RELATIONSHIP WITH HM SERVICES On December 29, 1995, the Company distributed to its shareholders through a special dividend (the "Special Dividend") all of the outstanding shares of common stock of Host Marriott Services Corporation ("HM Services"), formerly a direct, wholly owned subsidiary of the Company which, as of the date of the Special Dividend, owned and operated the food, beverage and merchandise concessions at airports, on tollroads and at stadiums and arenas and other tourist attractions. The Special Dividend provided Company shareholders with one share of common stock of HM Services for every five shares of Company common stock held by such shareholders on the record date of December 22, 1995. For the purpose of governing certain of the ongoing relationships between the Company and HM Services after the Special Dividend, and to provide an orderly transition, the Company and HM Services have entered into various agreements, including agreements to (i) allocate certain responsibilities with respect to employee compensation, benefit and labor matters; (ii) define the respective parties' rights and obligations with respect to deficiencies and refunds of federal, state and other income or franchise taxes relating to the Company's businesses for tax years prior to the Special Dividend and with respect to certain tax attributes of the Company after the Special Dividend; (iii) provide certain administrative and other support services to each other for a transitional period on an as-needed basis; and (iv) to provide for the issuance of HM Services common stock in connection with the exercise of certain outstanding warrants to purchase shares of Company common stock. RELATIONSHIP WITH MARRIOTT INTERNATIONAL; MARRIOTT INTERNATIONAL DISTRIBUTION Prior to October 8, 1993, the Company was named "Marriott Corporation." In addition to conducting its existing hotel ownership business and the business of HM Services (prior to its distribution to shareholders through the Special Dividend), Marriott Corporation engaged in lodging and senior living services management, timeshare resort development and operation, food service and facilities management and other contract services businesses (the "Management Business"). On October 8, 1993, the Company completed the Marriott International Distribution (as defined herein). Marriott International conducts the Management Business as a separate publicly traded company. The Company and Marriott International have entered into agreements which provide, among other things, for Marriott International to (i) manage or franchise various hotel properties owned or leased by the Company, (ii) advance up to $225 million to the Company under the Marriott International line of credit, which was terminated in 1997, (iii) provide first mortgage financing of $109 million for the Philadelphia Marriott Hotel, which was repaid in December 1996, (iv) provide financing for certain Company acquisitions, (v) guarantee the Company's performance in connection with certain loans or other obligations and (vi) provide certain limited administrative services. The Company views its relationship with Marriott International as providing various advantages, including access to high quality management services, strong brand names and superior marketing and reservation systems. 119
SEGMENT REPRESENTATIVE PARTICIPANTS - ------- --------------------------- Luxury Full-Service..... Ritz-Carlton; Four Seasons Upscale Full-Service.... Crowne Plaza; Doubletree; Hyatt; Hilton; Marriott Hotels, Resorts and Suites; Radisson; Red Lion; Sheraton; Swissotel; Westin; Wyndham Marriott International has the right to purchase up to 20% of the voting stock of the Company if certain events involving a change of control (or potential change of control) of the Company occur, subject to certain limitations (including a limitation effective after the REIT Conversion intended to help protect the qualification of Host REIT as a REIT). See "Certain Relationships and Related Transactions--Relationship Between Host and Marriott International." EMPLOYEES Currently, the Company and its subsidiaries collectively have approximately 225 corporate employees, and approximately 300 other employees (primarily employed at one of its non-U.S. hotels) which are covered by collective bargaining agreements that are subject to review and renewal on a regular basis. The Company believes that it has good relations with its labor unions and has not experienced any material business interruptions as a result of labor disputes. Following the REIT Conversion, the Operating Partnership expects to have approximately 175 employees. The balance of the Company's current employees are expected to become employees of Crestline following the REIT Conversion. ENVIRONMENTAL AND REGULATORY MATTERS Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the costs of removal or remediation of hazardous or toxic substances on, under or in such property. Such laws may impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. In addition, certain environmental laws and common law principles could be used to impose liability for release of asbestos-containing materials ("ACMs"), and third parties may seek recovery from owners or operators of real properties for personal injury associated with exposure to released ACMs. Environmental laws also may impose restrictions on the manner in which property may be used or business may be operated, and these restrictions may require expenditures. In connection with its current or prior ownership or operation of hotels, the Company may be potentially liable for any such costs or liabilities. Although the Company is currently not aware of any material environmental claims pending or threatened against it, no assurance can be given that a material environmental claim will not be asserted against the Company. LEGAL PROCEEDINGS Following the Mergers and the REIT Conversion, the Operating Partnership will assume all liability arising under legal proceedings filed against Host and will indemnify Host REIT as to all such matters. Host and the other defendants believe all of the lawsuits in which Host is a defendant, including the following lawsuits, are without merit and the defendants intend to defend vigorously against such claims. However, no assurance can be given as to the outcome of any of the lawsuits. Texas Multi-Partnership Lawsuit. On March 16, 1998, limited partners in several limited partnerships sponsored by Host filed a lawsuit, Robert M. Haas, Sr. and Irwin Randolph Joint Tenants, et al. v. Marriott International, Inc., et al., Case No. 98-CI-04092, in the 57th Judicial District Court of Bexar County, Texas, alleging that the defendants conspired to sell hotels to the partnerships for inflated prices and that they charged the partnerships excessive management fees to operate the partnerships' hotels. The plaintiffs further allege that the defendants committed fraud, breached fiduciary duties and violated the provisions of various contracts. The plaintiffs are seeking unspecified damages. Although the partnerships have not been named as defendants, their partnership agreements include provisions which require the partnerships to indemnify the general partners against losses, expenses and fees. The defendants filed answers and defenses to the petition. Limited Service Transaction. On February 11, 1998, a group of four individuals, all of whom are limited partners in partnerships sponsored by Host, filed a putative class action lawsuit, Ruben, et al. v. Host Marriott Corporation, et al., Civil Action No. 16186, in Delaware State Chancery Court, alleging that the proposed merger of the partnerships (the "Consolidation") into an UPREIT structure constitutes a breach of the fiduciary duties 120 owed to the limited partners of the partnerships by Host and the general partners of the partnerships. In addition, the plaintiffs allege that the Consolidation breaches various agreements relating to the partnerships. The plaintiffs are seeking, among other things, certification of a class, injunctive relief to prohibit the consummation of the Consolidation or, in the alternative, rescission of the merger and damages. Although the partnerships have not been named as defendants, their partnership agreements include provisions which require the partnerships to indemnify the general partners against losses, expenses and fees. The defendants have filed a motion to dismiss. Atlanta Marquis. Certain limited partners of Atlanta Marriott Marquis Limited Partnership ("AMMLP"), filed a putative class action lawsuit, Hiram and Ruth Sturm v. Marriott Marquis Corporation, et al., Case No. 97-CV-3706, in the U.S. District Court for the Northern District of Georgia, on December 12, 1997 against AMMLP's general partner, its directors and Host, regarding the merger of AMMLP into a new partnership (the "AMMLP Merger") as part of a refinancing of the partnership's debt. The plaintiffs allege that the defendants misled the limited partners in order to induce them to approve the AMMLP Merger, violated securities regulations and federal roll-up regulations and breached their fiduciary duties to the partners. The plaintiffs sought to enjoin, or in the alternative, rescind, the AMMLP Merger and damages. The partnership agreement includes provisions which require the partnership to indemnify the general partners against losses, expenses and fees. The defendants have filed a motion to dismiss. Another limited partner of AAMLP sought similar relief and filed a separate lawsuit, styled Poorvu v. Marriott Marquis Corporation, et al., Civil Action No. 16095-NC, on December 19, 1997, in Delaware State Chancery Court. The defendants have filed an answer to the complaint. Courtyard II. A group of partners in Courtyard by Marriott II Limited Partnership ("CBM II") filed a lawsuit, Whitey Ford, et al. v. Host Marriott Corporation, et al., Case No. 96-CI-08327, on June 7, 1996, in the 285th Judicial District Court of Bexar County, Texas, against Host, Marriott International and others alleging breach of fiduciary duty, breach of contract, fraud, negligent misrepresentation, tortious interference, violation of the Texas Free Enterprise and Antitrust Act of 1983 and conspiracy in connection with the formation, operation and management of CBM II and its hotels. The plaintiffs are seeking unspecified damages. On January 29, 1998, two other limited partners filed a petition in intervention seeking to convert the lawsuit into a class action. The defendants have filed an answer, the class has been certified, class counsel has been appointed and discovery is underway. Trial is presently scheduled for May 1999. MHP2. Two groups of limited partners of Marriott Hotel Properties II Limited Partnership ("MHP2") are each asserting putative class claims in lawsuits filed in the United States District Court for the Southern District of Florida on May 10, 1996, Leonard Rosenblum, as Trustee of the Sylvia Bernice Rosenblum Trust, et al. v. Marriott MHP Two Corporation, et al., Case No. 96-8377-CIV-HURLEY, and, on December 18, 1997, Mackenzie Patterson Special Fund 2, L.P. et al. v. Marriott MHP Two Corporation, et al., Case No. 97-8989- CIV-HURLEY respectively, against Host and certain of its affiliates alleging that the defendants violated their fiduciary duties and engaged in fraud and coercion in connection with a tender offer for MHP2 units. The District Court dismissed the Mackenzie Patterson case on August 4, 1998 and remanded the Rosenblum case to Palm Beach County Circuit Court on July 25, 1998. The defendants have moved to dismiss Rosenblum's fifth amended complaint in the case now styled Leonard Rosenblum, as Trustee of the Sylvia Bernice Rosenblum Trust, et al. v. Marriott MHP Two Corporation, et al., Case No. CL-96-4087-AD, or, in the alternative, to deny class certification. PHLP. On July 15, 1998, one limited partner in PHLP filed a class action lawsuit styled Michael C. deBerardinis v. Host Marriott Corporation, Civil Action No. WMN 98-2263, in the United States District Court for the District of Maryland. The plaintiff alleges that Host misled the limited partners in order to induce them into approving the sale of one of the Partnership's hotels, violated the securities regulations by issuing a false and misleading consent solicitation and breached fiduciary duties and the partnership agreement. The complaint seeks unspecified damages. Host intends to vigorously defend against the claims asserted in the lawsuit. 121 THE LEASES In order for Host REIT to qualify as a REIT, neither Host REIT nor the Operating Partnership may operate the Hotels or related properties. Accordingly, the Operating Partnership will lease the Hotels to the Lessees, which will be wholly owned indirect subsidiaries of Crestline. The following summary of the principal terms of the Leases is qualified in its entirety by reference to the Leases, a form of which has been filed as an exhibit to the Registration Statement of which this Consent Solicitation is a part. Lessees. There generally will be a separate Lessee for each Hotel or group of Hotels that is owned by a separate subsidiary of Host REIT. Each Lessee will be a Delaware limited liability company, whose purpose will be limited to acting as lessee under the applicable Lease(s). For those Hotels where it is the Manager, Marriott International or a subsidiary will have a noneconomic membership interest in the Lessee entitling it to certain voting rights but no economic rights. The operating agreements for such Lessees will provide that the Crestline member of the Lessee will have full control over the management of the business of the Lessee, except with respect to certain decisions for which the consent of both members will be required. These decisions are (i) dissolving, liquidating, consolidating, merging, selling or leasing all or substantially all of the assets of the Lessee; (ii) engaging in any other business or acquiring any assets or incurring any liabilities not reasonably related to the conduct of the Lessee's business; (iii) instituting voluntary bankruptcy or similar proceedings or consenting to involuntary bankruptcy or similar proceedings; (iv) terminating the Management Agreement relating to the Lessee's hotel, other than by reason of a breach by the Manager or upon exercise of express termination rights in the Management Agreement; (v) challenging the status or rights of the Manager or the enforceability of the membership rights; or (vi) incurring debt in excess of certain limits. Upon any termination of the applicable Management Agreement, these special voting rights of Marriott International (or its subsidiary) will cease. Lease Terms. Each Lease will have a fixed term ranging generally from seven to ten years (depending upon the Lease), subject to earlier termination upon the occurrence of certain contingencies described in the Leases (including, particularly, the provisions described herein under "Damage or Destruction," "Termination of the Leases upon Disposition of Hotels" and "Termination of the Leases upon Changes in Tax Laws"). Minimum Rent; Percentage Rent; Additional Charges. Each Lease will require the Lessee to pay (i) Minimum Rent (as defined below) in a fixed dollar amount per annum plus (ii) to the extent it exceeds Minimum Rent, Percentage Rent based upon specified percentages of aggregate sales from the applicable Hotel, including room sales, food and beverage sales and other income ("Gross Revenues"), in excess of specified thresholds. "Minimum Rent" will be a fixed dollar amount specified in each Lease less the FF&E Adjustment (which is described under "Personal Property Limitation" below). Any amounts other than Minimum Rent and Percentage Rent due to the Lessor under the Leases are referred to as "Additional Charges." The amount of Minimum Rent and the Percentage Rent thresholds will be adjusted each year (the "Annual Adjustment"). The Annual Adjustment with respect to Minimum Rent shall equal a percentage of any increase in the Consumer Price Index ("CPI") during the previous twelve months. The Annual Adjustment with respect to Percentage Rent thresholds shall be a specified percentage equal to the weighted average of a percentage of any increase in CPI plus a specified percentage of any increase in a regional labor cost index agreed upon by the Lessor and the Lessee during the previous twelve months. Neither Minimum Rent nor Percentage Rent thresholds will be decreased because of the Annual Adjustment. Rental payments will be made on a Fiscal Year basis. The "Fiscal Year" shall mean the fiscal year used by the Manager. Payments of Rent (defined herein) will be made within two business days after the required payment date under the Management Agreement for each Accounting Period. "Accounting Period" shall mean for those Hotels where Marriott International is the Manager, any of the thirteen four-week accounting periods which are used in the Manager's accounting system. Rent payable for each Accounting Period will be the sum 122 of (i) the excess (if any) of (x) the greater of cumulative Minimum Rent year- to-date or cumulative Percentage Rent year-to-date over (y) the total amount of Minimum Rent and Percentage Rent paid year-to-date plus (ii) any Additional Charges due ("Rent"). If the total amount of Minimum Rent and Percentage Rent paid year-to-date, as of any rent payment date, is greater than both cumulative Minimum Rent year-to-date and cumulative Percentage Rent year-to- date, then the Lessor will remit the difference to the Lessee. The Leases will generally provide for a Rent adjustment in the event of damage, destruction, partial taking, certain capital expenditures or an FF&E Adjustment. Lessee Expenses. Each Lessee will be responsible for paying all of the expenses of operating the applicable Hotel(s), including all personnel costs, utility costs and general repair and maintenance of the Hotel(s). The Lessee also will be responsible for all fees payable to the applicable Manager, including base and incentive management fees, chain services payments and franchise or system fees, with respect to periods covered by the term of the Lease. The Lessee will not be obligated to bear the cost of any capital improvements or capital repairs to the Hotels or the other expenses borne by the Lessor, as described below. Lessor Expenses. The Lessor will be responsible for the following expenses: real estate taxes, personal property taxes (to the extent the Lessor owns the personal property), casualty insurance on the structures, ground lease rent payments, required expenditures for FF&E (including maintaining the FF&E reserve, to the extent such is required by the applicable Management Agreement) and capital expenditures. The consent of the Lessor will be required for any capital expenditures funded by the Lessor (except in an emergency or where the Owner's consent is not required under the Management Agreement) or a change in the amount of the FF&E Reserve payment. Crestline Guarantee. Crestline and certain of its subsidiaries will enter into a limited guarantee of the Lease and Management Agreement obligations of each Lessee. For each of four identified "pools" of Hotels, the cumulative limit of the guarantee at any time will be 10% of the aggregate rents under all Leases in such pool paid with respect to the preceding thirteen full Accounting Periods (with an annualized amount based upon the Minimum Rent for those Leases that have not been in effect for thirteen full Accounting Periods). In the event of a payment default under any Lease or failure of Crestline to maintain certain minimum net worth or debt service coverage ratios, the obligations under the guarantees of Leases in each pool will be secured by excess cash flow of each Lessee in such pool, which will be collected, held in a cash collateral account, and disbursed in accordance with agreed cash management procedures. Security. The obligations of the Lessee will be secured by a pledge of all personal property (tangible and intangible) of the Lessee related to or used in connection with the operation of the Hotels (including any cash and receivables from the Manager or others held by the Lessee as part of "working capital"). Working Capital. Each Lessor will sell the existing working capital (including Inventory and Fixed Asset Supplies (as defined in the Uniform System of Accounts for Hotels) and receivables due from the Manager, net of accounts payable and accrued expenses) to the applicable Lessee upon the commencement of the Lease at a price equal to the fair market value of such assets. The purchase price will be represented by a note evidencing a loan that bears interest at a rate per annum equal to the "long-term applicable federal rate" in effect on the commencement of the Lease. Interest owed on the working capital loan will be due simultaneously with each periodic Rent payment and the amount of each payment of interest will be credited against such Rent payment. The principal amount of the working capital loan will be payable upon termination of the Lease. At the termination or expiration of the Lease, the Lessee will sell to the Lessor the then existing working capital at a price equal to the value of such assets at that time. The Lessor will pay the purchase price of the working capital by offsetting the purchase price against the outstanding principal balance of the working capital loan. To the 123 extent that the value of the working capital delivered to the Lessor exceeds the value of the working capital delivered by the Lessor to the Lessee at the commencement of the Lease, the Lessor shall pay to the Lessee an amount equal to the difference in cash. To the extent that the value of the working capital delivered to the Lessor is less than the value of the working capital delivered by the Lessor to the Lessee at the commencement of the Lease, the Lessee shall pay to the Lessor an amount equal to the difference in cash. Termination of Leases upon Disposition of Full-Service Hotels. In the event the applicable Lessor enters into an agreement to sell or otherwise transfer any full-service Hotel free and clear of the applicable Lease, the Lessor must pay the Lessee a termination fee equal to the fair market value of the Lessee's leasehold interest in the remaining term of the Lease. For purposes of determining the fair market value, a discount rate of 12% will be assumed, and the annual income for each remaining year of the Lease will be assumed to be the average annual income generated by the Lessee during the three fiscal years preceding the termination date or if the Hotel has not been in operation for at least three fiscal years, then the average during the preceding fiscal years that have elapsed, and if the Hotel has not been in operation for at least twelve months, then the assumed annual income shall be determined on a pro forma basis. Alternatively, the Lessor will be entitled to (i) substitute a comparable Hotel or Hotels (in terms of economics and quality for the Lessor and the Lessee as agreed to by the Lessee) for any Hotel that is sold or (ii) sell the Hotel subject to the Lease (subject to the Lessee's reasonable approval if the sale is to an entity that does not have sufficient financial resources and liquidity to fulfill the "owner's" obligations under the Management Agreement and the Lessor's obligations under the Lease, or does not satisfy specified character standards) without being required to pay a termination fee. In addition, the Lessors collectively and the Lessees collectively will each have the right to terminate up to twelve Leases without being required to pay any fee or other compensation as a result of such termination, but the Lessors will be permitted to exercise such right only in connection with sales of Hotels to an unrelated third party or the transfer of a Hotel to a joint venture in which the Operating Partnership does not have a two-thirds or greater interest. Termination of the Leases upon Changes in Tax Laws. In the event that changes in the federal income tax laws allow the Lessors, or subsidiaries or affiliates of the Lessors, to directly operate the Hotels without jeopardizing Host REIT's status as a REIT, the Lessors will have the right to terminate all, but not less than all, of the Leases (excluding Leases of Hotels that must still be leased following the tax law change) in return for paying the Lessees the fair market value of the remaining terms of the Leases, valued in the same manner as provided above under "Termination of Leases upon Disposition of Hotels." The payment will be payable in cash or, subject to certain conditions, Common Shares, at the election of the Lessor and Host REIT. Damage or Destruction. If a Hotel is partially or totally destroyed and is no longer suitable for use as a hotel (as reasonably determined by the Lessor), the Lease of such Hotel shall automatically terminate and the insurance proceeds shall be retained by the Lessor, except for any proceeds attributable to personal property owned by the Lessee or business interruption insurance. In this event, no termination fee shall be owed to the Lessee. If a Hotel is partially destroyed, but is still suitable for use as a hotel (as reasonably determined by the Lessor), the Lessee, subject to the Lessor agreeing to release the insurance proceeds to fund any shortfall in the insurance proceeds, shall apply the insurance proceeds to restore the Hotel to its preexisting condition. The Lessor shall fund any shortfall in insurance proceeds less than or equal to five percent of the estimated cost of repair. The Lessor may fund, in its sole discretion, any shortfall in insurance proceeds greater than five percent of the estimated cost of the repair, provided that if the Lessor elects not to fund such shortfall, the Lessee may terminate the Lease and the Lessor shall pay to the Lessee a termination fee equal to the Lessee's Operating Profit for the immediately preceding Fiscal Year. The term "Lessee's Operating Profit" shall mean for any Fiscal Year an amount equal to revenues due to the Lessee from the leased property after the payment of all expenses relating to the operation of leasing of the leased property less rent paid to the Lessor. If and to the extent any damage or destruction results in a reduction of Gross Revenues which would otherwise be realizable from the operation of the Hotel, the Lessor shall receive all loss of income insurance and the Lessee shall have no obligation to pay rent, for any Accounting Period until the effects of the damage are restored, in excess of the greater of (i) one-thirteenth of the total Rent paid in the fiscal year prior to the casualty or (ii) Percentage Rent calculated for the current Accounting Period. 124 Events of Default. Except as otherwise provided below, and subject to the notice and, in some cases, cure periods in the Lease, the Lease may be terminated without penalty by the applicable Lessor if any of the following Events of Default (among others) occur: . Failure to pay Rent within ten days after the due date; . Failure to comply with, or observe any of, the terms of the Lease (other than the failure to pay Rent) for 30 days after notice from the Lessor, including failure to properly maintain the Hotel (other than by reason of the failure of the Lessor to perform its obligations under the Lease), such period to be extended for up to an additional 90 days if such default cannot be cured with due diligence within 30 days; . Acceleration of maturity of certain indebtedness of the Lessee with a principal amount in excess of $1,000,000; . Failure of Crestline to maintain minimum net worth or debt service coverage ratio requirements; . Filing of any petition for relief, bankruptcy or liquidation by or against the Lessee or any parent company of the Lessee; . The Lessee voluntarily ceases to operate the Hotel for 30 consecutive days, except as a result of a casualty, condemnation or emergency situation; . A change in control of Crestline, the Lessee or any subsidiary of Crestline that is a direct or undirect parent of the Lessee. Unless the change in control involves an "adverse party" which would include a competitor in the hotel business, a party without adequate financial resources, a party that has been convicted of a felony (or controlled by such a person), or a party who would jeopardize Host REIT's qualification as a REIT, the Lessor must pay a termination fee equal to the Lessee's Operating Profit from the Hotel for the immediately preceding Fiscal Year); or . The Lessee, or Crestline or Lessee's direct parent defaults under the assignment of Management Agreement, the guarantees described above, the noncompetition agreement described below and certain other related agreements between the parties or their affiliates. Assignment of Lease. A Lessee will be permitted to sublet all or part of the Hotel or assign its interest under its Lease, without the consent of the Lessor, to any wholly owned and controlled single purpose subsidiary of Crestline, provided that Crestline continues to meet the minimum net worth test and all other requirements of the Lease. Transfers to other parties will be permitted if approved by the Lessor. Subordination to Qualifying Mortgage Debt. The rights of each Lessee will be expressly subordinate to qualifying mortgage debt and any refinancing thereof. A default under the loan documents may result in the termination of the Lease by the lender. The lender will not be required to provide a non-disturbance agreement to the Lessee. The Lessor will be obligated to compensate the Lessee, on a basis equal to the lease termination provision described in "Termination of Leases upon Disposition of Hotels" above, if the Lease is terminated because of a non- monetary default under the terms of a loan that occurs because of an action or omission by the Lessor (or its affiliates) or a monetary default where there is not an uncured monetary Event of Default of the Lessee. In addition, if any loan is not refinanced in a timely manner, and the loan amortization schedule is converted to a cash flow sweep structure, the Lessee has the right to terminate the Lease after a twelve-month cure period and the Lessor will owe a termination fee as provided above. During any period of time that a cash flow sweep structure is in effect, the Lessor will compensate the Lessee for any lost revenue resulting from such cash flow sweep. The Operating Partnership will guarantee these obligations. 125 Personal Property Limitation. If a Lessor reasonably anticipates that the average tax basis of the items of the Lessor's FF&E and other personal property that are leased to the applicable Lessee will exceed 15% of the aggregate average tax basis of the real and personal property subject to the applicable Lease, the following procedures will apply, subject to obtaining lender consent where required: . The Lessor will acquire any replacement FF&E that would cause the applicable limits to be exceeded (the "Excess FF&E"), and immediately thereafter the Lessee would be obligated either to acquire such Excess FF&E from the Lessor or to cause a third party to purchase such FF&E. . The Lessee would agree to give a right of first opportunity to a Non- Controlled Subsidiary to acquire the Excess FF&E and to lease the Excess FF&E to the Lessee at an annual rental equal to the Market Leasing Factor (as defined below) times the cost of the Excess FF&E. If such Non-Controlled Subsidiary does not agree to acquire the Excess FF&E and to enter into such lease, then the Lessee may either acquire the Excess FF&E itself or arrange for another third party to acquire such Excess FF&E and to lease the same to Lessee. . The annual Rent under the applicable Lease would be reduced in accordance with a formula based on Market Recovery rates. Certain Actions under the Leases. The Leases prohibit the Lessee from taking the following actions with respect to the Management Agreement without notice to the Lessor and, if the action would have a material adverse effect on the Lessor, the consent of the Lessor: (i) terminate the Management Agreement prior to the expiration of the term thereof; (ii) amend, modify or assign the Management Agreement; (iii) waive (or fail to enforce) any right of the "Owner" under the Management Agreement; (iv) waive any breach or default by the Manager under the Management Agreement (or fail to enforce any right of the "Owner" in connection therewith); (v) agree to any change in the Manager or consent to any assignment by the Manager; or (vi) take any other action which reasonably would be expected to materially adversely affect the Lessor's rights or obligations under the Management Agreement for periods following the termination of the Lease (whether upon the expiration of its term or upon earlier termination as provided for therein). Change in Manager. A Lessee will be permitted to change the Manager or the brand affiliation of a Hotel only with the approval of the applicable Lessor, which approval may not be unreasonably withheld. Any replacement manager must be a nationally recognized manager with substantial experience in managing hotels of comparable quality. No such replacement can extend beyond the term of the Lease without the consent of the Lessor, which consent may be withheld in the Lessor's sole discretion. THE MANAGEMENT AGREEMENTS General The Lessees will lease the Hotels from the Hotel Partnerships under the Management Agreements between the Hotel Partnerships and the subsidiaries of Marriott International and other companies that currently manage the Hotels. Following the REIT Conversion and as a result of their assumptions of obligations under the Management Agreements, the Lessees will have substantially all of the rights and obligations of the "Owners" of the Hotels under the Management Agreements for the period during which the Leases are in effect (including the obligation to pay the management and other certain fees thereunder) and will hold the Operating Partnership harmless with respect thereto. See "--Management Services Provided by Marriott International and Affiliates--Assignment of Management Agreements." Relationship with Marriott International Subsidiaries of Marriott International will serve as Managers for a substantial majority of the Operating Partnership's Hotels which will be leased to the Lessees, pursuant to the Management Agreements. Marriott International and its subsidiaries also provide various other services to Host REIT and its affiliates and to Crestline and its affiliates. With respect to these contractual arrangements, the potential exists for disagreement 126 as to contract compliance. Additionally, the possible desire of Host REIT and the Operating Partnership to finance, refinance or effect a sale of any of the Hotels leased to the Lessees and managed by subsidiaries of Marriott International may, depending upon the structure of such transactions, result in a need to modify the Management Agreements with respect to such Hotel. Any such modification proposed by Host REIT or the Operating Partnership may not be acceptable to Marriott International or the applicable Lessee, and the lack of consent from either Marriott International or the applicable Lessee that has assumed the Management Agreement could adversely affect the Operating Partnership's ability to consummate such financing or sale. In addition, certain situations could arise where actions taken by Marriott International in its capacity as manager of competing lodging properties would not necessarily be in the best interests of the Operating Partnership, Host REIT or the Lessees. Nevertheless, the Operating Partnership believes that there is sufficient mutuality of interest between the Operating Partnership, the Lessees and Marriott International to result in a mutually productive relationship. Management Services Provided by Marriott International and Affiliates General. Under each Management Agreement related to a Marriott International- managed Hotel, the Manager will provide complete management services to the applicable Lessees in connection with its management of such Lessee's Hotels following the REIT Conversion. Except where specifically noted, these relationships are substantially identical to those that exist between the applicable Manager and Host or the applicable Hotel Partnership currently, and that would exist between the Operating Partnership's subsidiaries and the Manager in the event the Leases expire or otherwise terminate while the Management Agreements remain in effect. The services provided by each Manager to each Lessee will include the following: Assignment of Management Agreements. The Management Agreements applicable to each Hotel will be assigned to the applicable Lessee for the term of the Lease of such Hotel. The Lessee will be obligated to perform all of the obligations of the Lessor under the Management Agreement during the term of its Lease, other than certain retained obligations including, without limitation, payment of property taxes, property casualty insurance and ground rent, and maintaining a reserve fund for FF&E replacements and capital expenditures, for which the Lessor will retain responsibility. Although the Lessee will assume obligations of the Lessor under the Management Agreement, the Lessor will not be released from its obligations and, if the Lessee fails to perform any obligations, the Manager will be entitled to seek performance by or damages from the Lessor. If the Lease is terminated for any reason, any new or successor Lessee must meet certain requirements for an "Approved Lessee" or otherwise be acceptable to Marriott International. The requirements for an "Approved Lessee" includes that the entity (i) has sufficient financial resources and liquidity to fill the obligations under the Management Agreement, (ii) is not in control of or controlled by persons who have been convicted of felonies, (iii) is not engaged, or affiliated with any person or entity engaged in the business of operating a branded hotel chain having 5,000 or more guest rooms in competition with Marriott International, and (iv) must be a single purpose entity in which Marriott International has a noneconomic membership interest with the same rights as it has in Lessee. Any new lease must be in substantially the same form as the Lease or otherwise be acceptable to Marriott International. Operational Services. The Managers will have sole responsibility and exclusive authority for all activities necessary for the day-to-day operation of the Hotels, including establishment of all room rates, the processing of reservations, procurement of inventories, supplies and services, periodic inspection and consultation visits to the Hotels by the Managers' technical and operational experts and promotion and publicity of the Hotels. The Manager will receive compensation from the Lessee in the form of a base management fee and an Incentive Management Fee, which are normally calculated as percentages of gross revenues and operating profits, respectively. Executive Supervision and Management Services. The Managers will provide all managerial and other employees for the Hotels; review the operation and maintenance of the Hotels; prepare reports, budgets and projections; provide other administrative and accounting support services, such as planning and policy services, financial planning, divisional financial services, risk planning services, product planning and development, 127 employee planning, corporate executive management, legislative and governmental representation and certain in-house legal services; and protect the "Marriott" trademark and other tradenames and service marks. The Manager also will provide a national reservations system. Chain Services. The Management Agreements will require the Manager to furnish certain services (the "Chain Services") that are furnished generally on a central or regional basis to hotels in the Marriott hotel system. Such services will include the following: (i) the development and operation of computer systems and reservation services, (ii) regional management and administrative services, regional marketing and sales services, regional training services, manpower development and relocation costs of regional personnel and (iii) such additional central or regional services as may from time to time be more efficiently performed on a regional or group level. Costs and expenses incurred in providing such services are allocated among all hotels in the Marriott hotel system managed by the Manager or its affiliates and each applicable Lessee will be required to reimburse the Manager for its allocable share of such costs and expenses. Working Capital and Fixed Asset Supplies. The Lessee will be required to maintain working capital for each Hotel and fund the cost of fixed asset supplies, which principally consist of linen and similar items. The applicable Lessee will also be responsible for providing funds to meet the cash needs for the operations of the Hotels if at any time the funds available from operations are insufficient to meet the financial requirements of the Hotels. Use of Affiliates. The Manager employs the services of its affiliates to provide certain services under the Management Agreements. Certain of the Management Agreements provide that the terms of any such employment must be no less favorable to the applicable Lessee, in the reasonable judgment of the Manager, than those that would be available from the Manager. FF&E Replacements. The Management Agreements generally provide that once each year the Manager will prepare a list of FF&E to be acquired and certain routine repairs that are normally capitalized to be performed in the next year ("FF&E Replacements") and an estimate of the funds necessary therefor. Under the terms of the Leases, the Operating Partnership, as lessor, is required to provide to the applicable Lessee, all necessary FF&E for the operation of the Hotels (including funding any required FF&E Replacements). For purposes of funding the FF&E Replacements, a specified percentage (generally 5%) of the gross revenues of the Hotel will be deposited by the Manager into a book entry account (the "FF&E Reserve Account"). These amounts will be treated under the Leases as paid by the Lessees to the Operating Partnership and will be credited against their rental payments. If the Manager determines that more than 5% of the gross revenues of the Hotel will be required to fund repairs for a certain period, the Manager may increase the percentage of gross revenues to be deposited into the FF&E Reserve Account for such periods. In such event, the Operating Partnership may elect to fund such increases through annual increases in the amount deposited by the Manager in the FF&E Reserve Account or to make a lump- sum contribution to the FF&E Reserve Account of the additional amounts required. If the Operating Partnership adopts the first election, the deductions will be credited against the rental obligations of the Lessee. If the Operating Partnership fails to elect either option within thirty days of the request for additional funds or fails to pay the lump-sum within 60 days of its election to do so, the Manager may terminate the Management Agreement. Under certain circumstances, the Manager may make repairs in addition to those set forth on its list, but in no event may it expend more than the amount in the FF&E Reserve Account without the consent of the Operating Partnership and the Lessee. Under certain of the Management Agreements, the Operating Partnership must approve the FF&E Replacements, including any FF&E Replacements proposed by the Manager that are not contained on the annual list which was approved by the Operating Partnership and the Lessee. If the Manager and the Operating Partnership agree, the Operating Partnership will acquire or otherwise provide the FF&E Replacements set forth on the approved list. If the Operating Partnership and the Manager are unable to agree on the list within 60 days of its submission, the Operating Partnership will be required to make only those FF&E Replacements specified on such list that are no more extensive than the system standards for FF&E Replacements that the Manager requires for Marriott hotels. For purposes of funding the FF&E Replacements required to be paid for by the 128 Operating Partnership, each Management Agreement and the Operating Partnership's loan agreements require the Operating Partnership to deposit a designated amount into the FF&E Reserve Account periodically. The Lessees will have no obligation to fund the FF&E Reserve Accounts (and any amounts deposited therein by the Manager from funds otherwise due the Lessee under the Management Agreement will be credited against the Lessee's rental obligation). Under each Lease, the Operating Partnership will be responsible for the costs of FF&E Replacements and for decisions with respect thereto (subject to its obligations to the Lessee under the Lease). Building Alterations, Improvements and Renewals. The Management Agreements require the Manager to prepare an annual estimate of the expenditures necessary for major repairs, alterations, improvements, renewals and replacements to the structural, mechanical, electrical, heating, ventilating, air conditioning, plumbing and vertical transportation elements of each Hotel. Such estimate will be submitted to the Operating Partnership and the Lessee for their approval. In addition to the foregoing, the Management Agreements generally provide that the Manager may propose such changes, alterations and improvements to the Hotel as are required, in the Manager's reasonable judgment, to keep the Hotel in a competitive, efficient and economical operating condition or in accordance with Marriott standards. The cost of the foregoing shall be paid from the FF&E Reserve Account; to the extent that there are insufficient funds in such account, the Operating Partnership is required to pay any shortfall. Under the Management Agreements (and the Leases), neither the Operating Partnership nor the Lessee may unreasonably withhold consent to repairs and other changes which are required under applicable law or any of the Manager's "life-safety" standards and, if the Operating Partnership and the Lessee fail to approve any of the other proposed repairs or other changes within 60 days of the request therefor, the Manager may terminate the Management Agreement. Under certain other of the Management Agreements, if the Operating Partnership and the Manager are unable to agree on the estimate within 60 days of its submission, the Operating Partnership will be required to make only those expenditures that are no more extensive than the Manager requires for Marriott hotels generally, as the case may be. Under the terms of the Leases, the Operating Partnership will be responsible for the costs of the foregoing items and for decisions with respect thereto (subject to its obligations to the Lessees under the Leases). Service Marks. During the term of the Management Agreements, the service mark "Marriott" and other symbols, logos and service marks currently used by the Manager and its affiliates may be used in the operation of the Hotels. Marriott International (or its applicable affiliates) intends to retain its legal ownership of these marks. Any right to use the service marks, logo and symbols and related trademarks at a Hotel will terminate with respect to that Hotel upon termination of the Management Agreement with respect to such Hotel. Termination Fee. Certain of the Management Agreements provide that if the Management Agreement is terminated prior to its full term due to casualty, condemnation or the sale of the Hotel, the Manager will receive a termination fee as specified in the specific Management Agreement. Under the Leases, the responsibility for the payment of any such termination fee as between the Lessee and the Operating Partnership will depend upon the cause for such termination. Termination for Failure to Perform. Substantially all of the Management Agreements may be terminated based upon a failure to meet certain financial performance criteria, subject to the Manager's right to prevent such termination by making certain payments to the Lessee based upon the shortfall in such criteria. Events of Default. Events of default under the Management Agreements include, among others, the following: (i) the failure of either party to make payments pursuant to the Management Agreement within ten days after written notice of such nonpayment has been made, (ii) the failure of either party to perform, keep or fulfill any of the covenants, undertakings, obligations or conditions set forth in the Management Agreement and the continuance of such default for a period of 30 days after notice of said failure or, if such default is not susceptible of being cured within 30 days, the failure to commence said cure within 30 days or thereafter fails to diligently pursue such efforts to completion, (iii) if either party files a voluntary petition in bankruptcy or insolvency or a petition for reorganization under any bankruptcy law or admits that it is unable to pay its debts 129 as they become due, (iv) if either party consents to an involuntary petition in bankruptcy or fails to vacate, within 90 days from the date of entry thereof, any order approving an involuntary petition by such party; or (v) if an order, judgment or decree by any court of competent jurisdiction, on the application of a creditor, adjudicating either party as bankrupt or insolvent or approving a petition seeking reorganization or appointing a receiver, trustee, or liquidator or all or a substantial part of such party's assets is entered, and such order, judgment or decree continues unstayed and in effect for any period of 90 days. As described above, all fees payable under the Management Agreements will become obligations of the Lessees, to be paid by the Lessees, as modified prior to the consummation of the REIT Conversion, for so long as the Leases remain in effect. The Lessees' obligations to pay these fees, however, could adversely affect the ability of one or more Lessees to pay Base Rent or Percentage Rent payable under the Leases, even though such amounts otherwise are due and owing to the Operating Partnership. Moreover, the Operating Partnership remains obligated to the Manager to the extent the Lessee fails to pay these fees. NONCOMPETITION AGREEMENT Crestline, Host and the Non-Controlled Subsidiary which will lease to Crestline any Excess FF&E existing as the commencement of the Leases (the "Initial FF&E Lessor") will enter into a noncompetition agreement in connection with the Initial E&P Distribution. Pursuant to this non-competition agreement, Crestline will agree, among other things, that until the earlier of December 31, 2008 and the date on which it is no longer a Lessee for more than 25% of the hotels owned by Host at the time of the Initial E&P Distribution, it will not (i) own, operate or otherwise control (as owner or franchisor) any full-service hotel brand or franchise, or purchase, finance or otherwise invest in full-service hotels, or act as an agent or consultant with respect to any of the foregoing activities, except for acquisitions of property used in hotels as to which Crestline is the Lessee, investments in full-service hotels which represent an immaterial portion of a merger or similar transaction or a minimal portfolio investment in another entity, limited investments (whether debt or equity) in full-service hotels as to which Crestline is the Lessee or activities undertaken with respect to its business of providing asset management services to hotel owners, or (ii) without the consent of Host, manage any of the hotels owned by Host, other than to provide asset management services as described in "Certain Relationships and Related Transactions--Relationship between Host REIT and Crestline Capital Corporation After the Initial E&P Distribution--Asset Management Agreement." Host and the Initial FF&E Lessor will agree, among other things, that, (i) until December 31, 2003, neither of them will purchase, finance or otherwise invest in senior living communities, or act as an agent or consultant with respect to any of the foregoing activities (except for acquisitions of communities which represent an immaterial portion of a merger or similar transaction or for minimal portfolio investments in other entities) and (ii) until the earlier of December 31, 2008 and the date on which Crestline is no longer a Lessee for more than 25% of the hotels owned by Host at the time of the Initial E&P Distribution, neither of them will lease, as tenant or subtenant, limited- or full-service hotel properties and act as operator or franchisee thereof or provide asset management services to owners of hotels, or purchase, finance or otherwise invest in persons or entities which engage in any of the foregoing activities, or act as an agent or consultant with respect to any of the foregoing activities (except for acquisitions of entities which engage in any of the foregoing activities where the prohibited activities represent an immaterial portion of a merger or similar transaction, or minimal portfolio investments in other entities which engage in any of the foregoing activities, or certain leasing arrangements existing at the time of the Initial E&P Distribution or entered into in the future between Host and the Initial FF&E Lessor or Host and certain other related parties, or the management by Host of any hotels in which Host or the Initial FF&E Lessor has an equity interest). In addition, both Crestline and Host will agree not to hire or attempt to hire any of the other company's senior employees at any time prior to December 31, 2000. 130 INDEBTEDNESS As of June 19, 1998, the Company had the following debt outstanding: - -------- (1) Includes consolidated mortgage indebtedness of Atlanta Marquis, Desert Springs, Hanover, MHP and MHP2, which, on an individual Partnership basis, is as follows:
OUTSTANDING PRINCIPAL BALANCE AT JUNE 19, 1998 ------------------ (IN MILLIONS) Properties Notes, with a rate of 9 1/2% due May 2005....... $ 600 New Properties Notes, with a rate of 8 7/8% due July 2007.. 600 Acquisitions Notes, with a rate of 9% due December 2007.... 350 Senior Notes, with an average rate of 9 3/4% at June 19, 1998, maturing through 2012............................... 35 ------- Total Notes.............................................. 1,585 ------- Mortgage debt (nonrecourse) secured by $2.6 billion of real estate assets, with an average rate of 8.5% at June 19, 1998, maturing through 2022.............................................. 1,868(1) Line of Credit, secured by $500 million of real estate as- sets, with a variable rate of Eurodollar plus 1.7% or Base Rate (as defined) plus 0.7% at the option of the Operating Partnership (7.4% at June 19, 1998) due June 2004 ........ 22 ------- Total Mortgage Debt...................................... 1,890 ------- Other notes, with an average rate of 7.4% at June 19, 1998, maturing through 2017..................................... 87 Capital lease obligations.................................. 8 ------- Total Other Debt......................................... 95 ------- Total Debt............................................... $ 3,570(2) ======= 131
OUTSTANDING PRINCIPAL BALANCE AT MATURITY INTEREST 1998 JUNE 19, 1998 DATE RATE DEBT SERVICE -------------------- --------- --------- ------------- (IN MILLIONS) (IN MILLIONS) Atlanta Marquis First mortgage debt... $163 02/11/10 7.4% $14.1 ---- ----- Desert Springs First mortgage debt... 102 12/11/22 7.8% 9.4 Mezzanine debt........ 20 12/12/10 10.365% 2.8 ---- ----- Total Desert Springs debt............... 122 12.2 ---- ----- Hanover Mortgage debt......... 30 08/01/04 8.58% 3.0 ---- ----- MHP First mortgage debt... 151 01/01/08 7.48% 12.7 Second mortgage debt.. 83 05/01/00 9.125% 9.2 Construction loan..... 3 01/01/08 7.48% -- ---- ----- Total MHP debt...... 237 21.9 ---- ----- MHP2 Mortgage debt......... 220 10/11/07 8.22% 22.6 ---- ----- Total consolidated debt included above.............. $772 $73.8 ==== ===== (2) The consolidated Company debt of $3,570 million does not include indebtedness of Chicago Suites, MDAH and PHLP, which, on an individual Partnership basis, is as follows, and would increase the Operating Partnership's total indebtedness to $3,873 million at June 19, 1998. -------- (a) Scheduled principal and interest payments are forecast at $2.5 million for 1998. In June 1998, $766,000 in principal was repaid from 1997 excess cash. A principal payment will be made in June 1999 from 1998 excess cash. (b) Scheduled principal and interest payments are forecast at $5.9 million for Note A and $1.6 million for Note B. Additionally, in June 1998, $2.9 million in principal was repaid on Note A and $8.5 million was repaid on Note B from 1997 excess cash. A principal payment will be made in May 1999 from 1998 excess cash. (c) Interest expense is forecast at $14.2 million for 1998. Minimum principal payments are $6.0 million. On February 23, 1998, $3.8 million was repaid in principal from 1997 excess cash. A principal payment will be made in February 1999 from 1998 excess cash. Aggregate debt maturities at June 19, 1998, excluding capital lease obligations, are (in millions):
OUTSTANDING PRINCIPAL BALANCE AT MATURITY 1998 JUNE 19, 1998 DATE INTEREST RATE DEBT SERVICE -------------------- -------- ------------------ ------------- (IN MILLIONS) (IN MILLIONS) Chicago Suites Mortgage debt......... $ 24.3 06/12/01 3 month LIBOR + 2% $ 2.5(a) ------ MDAH Note A................ 73.1 12/15/99 LIBOR + 1% 5.9 Note B................ 27.8 12/15/99 LIBOR 1.6 Note C................ 9.3 12/15/10 No interest -- ------ ----- 110.2 7.5(b) ------ PHLP Mortgage debt......... 168.9 12/22/99 LIBOR + 1.5% 20.2(c) ------ Total unconsolidated debt............... $303.4 ====== Bond Refinancing. On August 5, 1998, HMH Properties, Inc. ("HMH Properties"), a subsidiary of Host that will merge into the Operating Partnership prior to the Effective Date, issued $1.7 billion of 7 7/8% senior notes issued in two series, consisting of $500 million due 2005 and $1.2 billion due 2008 (the "New Senior Notes"). The New Senior Notes are guaranteed by Host, Host Marriott Hospitality, Inc. and certain subsidiaries of HMH Properties and are secured by pledges of equity interests in certain subsidiaries of HMH Properties. The Operating Partnership will assume the New Senior Notes in connection with the REIT Conversion and the guarantee by Host is expected to terminate on the Effective Date. The indenture under which the New Senior Notes were issued contains covenants restricting the ability of HMH Properties and certain of its subsidiaries to incur indebtedness, acquire or sell assets or make investments in other entities, and make distributions to equityholders of HMH Properties and (following the REIT Conversion) the Operating Partnership. Following the REIT Conversion, the indenture permits the Operating 132
1998.................................................................. $ 302 1999.................................................................. 29 2000.................................................................. 133 2001.................................................................. 76 2002.................................................................. 150 Thereafter............................................................ 2,872 ------ $3,562 ====== Partnership to make distributions to holders of OP Units, including Host REIT, in amounts equal to the greater of (i) 95% of FFO plus net proceeds of equity offerings (provided that no event of default under the indenture has occurred and is continuing and the Operating Partnership is able to incur debt under the applicable indenture covenants) or (ii) an amount sufficient to permit Host REIT to maintain its status as a REIT and satisfy certain other requirements (provided that no event of default under the indenture has occurred and is continuing and the Operating Partnership has a consolidated debt to adjusted total assets ratio that is less than a specified level). The indenture also permits the Operating Partnership to make distributions to Host REIT sufficient to enable Host REIT to make the E&P Distribution. The New Senior Notes also contain a financial covenant requiring the maintenance of a specified ratio of unencumbered assets to unsecured debt. New Credit Facility. On August 5, 1998, HMH Properties entered into a $1.25 billion credit facility (the "New Credit Facility") provided by a syndicate of financial institutions (the "Lenders") led by Bankers Trust Company. The New Credit Facility provides the Company with (i) a $350 million term loan facility (subject to increases as provided in the succeeding paragraph) and (ii) a $900 million revolving credit facility. The New Credit Facility will have an initial term of three years with two one-year options to extend. The proceeds of the New Credit Facility, along with the proceeds from the New Senior Notes, were used to fund the purchase of $1.55 billion of senior notes of HMH Properties at the initial closing on August 5, 1998, and repay $22 million of outstanding borrowings under a line of credit provided by the Lenders to certain subsidiaries of Host and will be used (i) to acquire full- service hotels and other real estate assets including, under certain circumstances, senior living properties, (ii) under certain circumstances, to develop new full-service hotels and (iii) for general working capital purposes. The term loan facility was funded on the closing date of the New Credit Facility. The $350 million term loan facility may be increased by up to $250 million after the initial closing and will be available, subject to terms and conditions thereof and to the commitment of sufficient Lenders, in up to two drawings to be made on or prior to the second anniversary of the closing of the New Credit Facility. The Lenders will advance funds under the revolving credit facility as requested by the Company with minimum borrowing amounts and frequency limitations to be agreed upon, subject to customary conditions including, but not limited to, (i) no existing or resulting default or event of default under the New Credit Facility and (ii) continued accuracy of representations and warranties in all material respects. As of September 28, 1998, approximately $350 million was outstanding under the New Credit Facility. The interest rate applicable to the New Credit Facility and the unused commitment fee applicable to the revolving portion of the New Credit Facility are calculated based on a spread over LIBOR that will fluctuate based on the quarterly recalculation of a leverage ratio set forth in the New Credit Facility. The New Credit Facility provides that in the event that the Company achieves one of several investment grade long-term unsecured indebtedness ratings, the spread over LIBOR applicable to the New Credit Facility will be fixed based on the particular rating achieved. If the Company elects to exercise its one-year extensions, the Company will be required to amortize approximately 22.5% per annum of the principal amount outstanding under the New Credit Facility at the end of the initial three-year term. The Company's obligations under the New Credit Facility are guaranteed, subject to certain conditions, on a senior basis by Host, Host Marriott Hospitality, Inc. and certain of HMH Properties' existing and future subsidiaries. The New Credit Facility will be assumed by the Operating Partnership in connection with the REIT Conversion and the guarantee of Host is expected to terminate on the Effective Date. In addition, certain subsidiaries of Host Marriott other than HMH Properties and its subsidiaries may, under certain circumstances, guarantee the obligations under the New Credit Facility in the future. Borrowings under the New Credit Facility will rank pari passu with the New Senior Notes and other existing and future senior indebtedness of the Company. The New Credit Facility is secured, on an equal and ratable basis, with the New Senior Notes by a pledge of the capital stock of certain direct and indirect subsidiaries of HMH Properties. In addition, the New Credit Facility may, under certain circumstances in the future, be secured by a pledge of capital stock of certain subsidiaries of Host other than HMH Properties and its subsidiaries. 133 The New Credit Facility includes financial and other covenants that require the maintenance of certain ratios with respect to, among other things, maximum leverage, limitations on indebtedness, minimum net worth and interest and fixed charge coverage and that restrict payment of distributions and investments, acquisitions and sales of assets by the Company. Following the REIT Conversion, the New Credit Facility permits the Operating Partnership to make distributions to holders of OP Units, including Host REIT, in an aggregate amount for every four fiscal quarters equal to the greater of (i) 85% of adjusted funds from operations plus the net proceeds of equity offerings and (ii) the minimum amount necessary to permit Host REIT to maintain its status as a REIT and to satisfy certain other requirements, provided that no specified default or event of default has occurred under the New Credit Facility and is continuing. The New Credit Facility also permits the Operating Partnership to make distributions to Host REIT sufficient to enable Host REIT to make the E&P Distribution. 134 DISTRIBUTION AND OTHER POLICIES The following is a discussion of the anticipated policies with respect to distributions, investments, financing, lending, conflicts of interest and certain other activities of the Operating Partnership and Host REIT. Upon consummation of the REIT Conversion, the Operating Partnership's policies with respect to these activities will be determined by the Board of Directors of Host REIT and may be amended or revised from time to time at the discretion of the Board of Directors without notice to, or a vote of, the shareholders of Host REIT or the limited partners of the Operating Partnership, except that changes in certain policies with respect to conflicts of interest must be consistent with legal and contractual requirements. DISTRIBUTION POLICY Host REIT and the Operating Partnership intend to pay regular quarterly distributions to holders of Common Shares and OP Units. Host REIT and the Operating Partnership anticipate that distributions will be paid during January, April, July and October of each year, except that the first distribution in 1999 is expected to be paid at the end of February if the REIT Conversion is completed in 1998. The following discussion and the information set forth in the table and footnotes below should be read in conjunction with the Pro Forma Statements of Operations and notes thereto, "Summary--Forward Looking Statements," "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." Although the Code generally requires a REIT to distribute 95% of its taxable income for each year (within a certain period after the end of such year), the Operating Partnership will establish its initial distribution at a level that will enable Host REIT to distribute to its shareholders an amount equal to 100% of its taxable income (other than capital gains, which will be addressed on a case-by-case basis) for each year no later than the end of January of the following year. The Operating Partnership anticipates that distributions generally will be paid from cash available for distribution, but to the extent that cash available for distribution is insufficient, the Operating Partnership intends to borrow funds in order to make distributions consistent with such distribution policy. Based upon Host's preliminary estimate of Host REIT's taxable income for the twelve months ending December 31, 1999, Host and the Operating Partnership currently estimate that this policy will result in an initial annual distribution by the Operating Partnership of approximately $0.84 per OP Unit ($0.21 per quarter) during the twelve months ending December 31, 1999. The Operating Partnership has estimated its cash available for distribution during the twelve months ending December 31, 1999 based upon the Operating Partnership's pro forma cash from operations during the fifty-two weeks ended June 19, 1998 (the "Last Twelve Months"), adjusted for certain known material events and/or contractual commitments that either have occurred or will occur prior to December 31, 1999. No effect was given to any changes in working capital resulting from changes in current assets and liabilities (which changes are not expected to be material) or to any immaterial changes in the net amount of cash estimated to be used for (or provided by) investing activities or financing activities. Rental income is recognized only for leases to be executed at or prior to completion of the REIT Conversion. The estimates of cash available for distribution are not intended to be a projection or forecast of the Operating Partnership's results of operations or its liquidity. The following table describes the calculation of the Operating Partnership's pro forma cash from operations during the Last Twelve Months and its estimated cash available for distribution, cash from contingent rents and borrowings to make estimated distributions during the twelve months ending December 31, 1999: 135 - -------- (1) Represents loss on sale of real estate for the last two quarters 1997 of $15 million. (2) Represents pro forma real estate related depreciation and amortization for the fiscal year ended January 2, 1998 of $339 million minus pro forma real estate related depreciation and amortization for the First Two Quarters 1997 of $153 million plus pro forma real estate related depreciation and amortization for the First Two Quarters 1998 of $151 million. (3) Represents pro forma portion of cash from operations of unconsolidated equity investments, net of pro forma equity in earnings of affiliates, for the fiscal year ended January 2, 1998 of $39 million minus pro forma portion of cash from operations of unconsolidated equity investments, net of pro forma equity in earnings of affiliates, for the First Two Quarters 1997 of $15 million plus pro forma portion of cash from operations of unconsolidated equity investments, net of pro forma equity in earnings of affiliates, for the First Two Quarters 1998 of $16 million. (4) Represents pro forma one-time gain for the last two quarters 1997 of $10 million. (5) Represents pro forma portion of cash from operations relating to minority owners, net of pro forma portion of minority interest relating to OP Units, for the fiscal year ended January 2, 1998 of $10 million minus pro forma portion of cash from operations relating to minority owners, net of pro forma portion of minority interest relating to OP Units, for the First Two Quarters 1997 of $5 million plus pro forma portion of cash from operations relating to minority owners, net of pro forma portion of minority interest relating to OP Units, for the First Two Quarters 1998 of $3 million. (6) Represents FF&E reserves for the year ending December 31, 1999 of $178 million based on pro forma FF&E for the Last Twelve Months. Any differences between such estimated amount and the Last Twelve Month pro forma amount are not expected to be material. (7) Represents principal repayments required for the year ending December 31, 1999 of $64 million based on the terms of the pro forma indebtedness at June 19, 1998. (8) The amount of contingent rent received but deferred pursuant to EITF 98- 9, "Accounting for Contingent Rents in Interim Financial Periods," at June 19, 1998 and June 20, 1997 was $261 million and $207 million, respectively. The difference of $54 million represents the elimination of the net effect of these two deferred items, which has the effect of applying the applicable lease rental terms to the historical gross sales from the leased Hotels for the last Twelve Months to estimate rental revenues for the calendar year 1999. Interim and annual revenues will be impacted to the extent percentage rent threshold's under the leases are not met or exceeded. If the rental revenues represented by this 136
(DOLLARS IN MILLIONS, EXCEPT PER OP UNIT AMOUNTS) ------------- Pro forma income before extraordinary items for the fiscal year ended January 2, 1998........................................... $ 24 Plus: Pro forma income (loss) before extraordinary items for the First Two Quarters 1997................................... 161 Less: Pro forma income (loss) before extraordinary items for the First Two Quarters 1998................................ (151) ----- Pro forma income before extraordinary items for the Last Twelve Months.......................................................... 34 Plus: Pro forma loss on sale of real estate for the Last Twelve Months(1).................................................. 15 Plus: Pro forma real estate related depreciation and amortization for the Last Twelve Months(2).................................................. 337 Plus: Pro forma portion of cash from operations of unconsolidated equity investments for the Last Twelve Months, net of pro forma equity in earnings of affiliates for the Last Twelve Months(3).............................. 37 Less: One-time gain for the Last Twelve Months(4).............. (10) Less: Pro forma portion of cash from operations relating to minority owners for the Last Twelve Months, net of pro forma portion of minority interest relating to OP Units for the Last Twelve Months(5).................................. (8) ----- Pro forma cash from operations during the Last Twelve Months..... 405 Adjustments: FF&E reserves(6)............................................... (178) Principal repayments(7)........................................ (64) ----- Estimated cash available for distribution during the twelve months ending December 31, 1999................................. 163 ----- Adjustments: Estimated cash from contingent rents(8)........................ 54 Estimated borrowings to make estimated initial annual cash distributions ................................................ $ 9 ----- Total estimated initial annual cash distributions during the twelve months ending December 31, 1999(9)....................... $ 226 ===== Estimated initial annual cash distributions per OP Unit during the twelve months ending December 31, 1999(10).................. $0.84 ===== adjustment were not realized for the twelve months ending December 31, 1999, then the Operating Partnership would be required to borrow the amount of the shortfall under the New Credit Facility or from other sources to make estimated initial annual cash distributions during 1999. (9) Based on a total of 269.4 million OP Units outstanding on a pro forma basis after the Mergers (based upon the maximum price of $15.50 per OP Unit) and the preliminary estimated cash distributions during the twelve months ending December 31, 1999 of $0.84 per OP Unit. (10) Based on a total of 269.4 million OP Units outstanding on a pro forma basis after the Mergers (based upon the maximum price of $15.50 per OP Unit). If Host's preliminary estimate of $226 million of cash distributions by the Operating Partnership during the twelve months ending December 31, 1999 proves accurate but the Operating Partnership's aggregate estimated cash available for distribution and estimated cash from contingent rents during the twelve months ending December 31, 1999 were only $217 million, then the Operating Partnership would be required to borrow approximately $9 million (or $0.04 per OP Unit) to make such distributions to enable Host REIT to distribute 100% of its estimated taxable income in accordance with its distribution policy. Moreover, if estimated cash from contingent rents were less than $54 million, then the Operating Partnership also would be required to borrow any such shortfall in order to make such distributions. While the Operating Partnership does not believe this will be necessary, it believes it would be able to borrow the necessary amounts under the New Credit Facility or from other sources (see "Business and Properties--Indebtedness") and that any such borrowing would not have a material adverse effect on its financial condition or results of operations. The distributions to shareholders per Common Share are expected to be equal to the amount distributed by the Operating Partnership per OP Unit. However, if the REIT Conversion is not completed until after January 1, 1999, then Host REIT's distributions to shareholders in 1999 would be lower than the Operating Partnership's distributions per OP Unit (by the amount of Host REIT's 1999 corporate income tax payments) until its REIT election becomes effective, which would be no later than January 1, 2000. The Operating Partnership intends to make distributions during 1999 at the estimated level described below even if the REIT election of Host REIT were not effective until January 1, 2000. The following table describes the calculation of Host REIT's estimated initial cash distributions and estimated cash distributions per Common Share for the twelve months ending December 31, 1999, based on the Operating Partnership's estimated cash distributions of $0.84 per OP Unit, if the REIT Conversion were to occur on January 1, 1999 but Host REIT's REIT election were not effective until January 1, 2000: - ------- (1) Estimated cash tax payments based on applying Host REIT's blended statutory tax rate (assumed to be a federal rate of 35%, plus a blended state rate of 5% net of the federal benefit), taking into account utilization of Host REIT's estimated alternative minimum tax ("AMT") credit carryforwards (approximately $21 million) and estimated AMT preferences (approximately $55 million), and applying the resulting effective rate (25%) to estimated taxable income for the year. (2) Based on a total of 204.2 million Common Shares outstanding. Investors are cautioned that Host expects that its preliminary estimate of 1999 taxable income (and the resulting estimated distributions during 1999) may materially change as a result of issuances of additional 137
Estimated cash distributions by the Operating Partnership for the twelve months ending December 31, 1999................................ $ 226 Less: Estimated cash distributions to OP Unitholders (other than Host REIT)............................................................... (55) ------ Host REIT's share of estimated cash distributions by the Operating Partnership for the twelve months ending December 31, 1999............ 171 Less: Estimated cash payments for federal and state income taxes (if Host REIT has not yet made REIT election)(1)........................ (64.5) ------ Estimated cash distributions by Host REIT (if Host REIT has not yet made a REIT election) for the twelve months ending December 31, 1999.. $106.5 ====== Estimated cash distributions per Common Share (if Host REIT has not yet made a REIT election) for the twelve months ending December 31, 1999(2)............................................................... $ 0.52 ====== common or preferred stock by Host either prior to or following the Mergers (which could reduce the distribution per OP Unit in accordance with its distribution policy), changes in operations, acquisitions or dispositions of assets, changes in the preliminary estimate of taxable income for 1999 and various other factors (some of which may be beyond the control of Host REIT and the Operating Partnership). Distributions will be made in the discretion of Host REIT's Board of Directors and will be affected by a number of factors, including the rental payments received by the Operating Partnership from the Lessees with respect to the Leases of the Hotels, the operating expenses of the Operating Partnership, the level of borrowings and interest expense incurred in borrowing, the Operating Partnership's financial condition and cash available for distribution, the taxable income of Host REIT and the Operating Partnership, the effects of acquisitions and dispositions of assets, unanticipated capital expenditures and distributions required to be made on any preferred units issued by the Operating Partnership. Actual results may vary substantially from the estimates and no assurance can be given that the Operating Partnership's estimates will prove accurate or that any level of distributions will be made or sustained. For a discussion of the tax treatment of distributions to holders of OP Units, see "Federal Income Tax Consequences--Tax Treatment of Holders of OP Units--Treatment of Operating Partnership Distributions." For a discussion of the annual distribution requirements applicable to REITs, see "Federal Income Tax Consequences--Taxation of Host REIT Following the REIT Conversion--Annual Distribution Requirements Applicable to REITs." For a discussion of the tax treatment of distributions to the holders of Common Shares, see "Federal Income Tax Consequences--Taxation of Taxable U.S. Shareholders of Host REIT Generally," "--Taxation of Tax-Exempt Shareholders of Host REIT" and "-- Taxation of Non-U.S. Shareholders of Host REIT." INVESTMENT POLICIES Investments in Real Estate or Interests in Real Estate. Host REIT is required to conduct all of its investment activities through the Operating Partnership. The Operating Partnership's investment objectives are to (i) achieve long-term sustainable growth in Funds From Operations per OP Unit or Common Share, (ii) increase asset values by improving and expanding the initial Hotels, as appropriate, (iii) acquire additional existing and newly developed upscale and luxury full-service hotels in targeted markets, (iv) develop and construct upscale and luxury full-service hotels and (v) potentially pursue other real estate investments. The Operating Partnership's business will be primarily focused on upscale and luxury full-service hotels. Where appropriate, and subject to REIT qualification rules and limitations contained in the Partnership Agreement, the Operating Partnership may sell certain of its hotels. The Operating Partnership also may participate with other entities in property ownership through joint ventures or other types of co-ownership. Equity investments may be subject to existing mortgage financing and other indebtedness or such financing or indebtedness may be incurred in connection with acquiring investments. Any such financing or indebtedness will have priority over the Operating Partnership's equity interest in such property. Investments in Real Estate Mortgages. While the Operating Partnership will emphasize equity real estate investments, it may, in its discretion, invest in mortgages and other similar interests. The Operating Partnership does not intend to invest to a significant extent in mortgages or deeds of trust, but may acquire mortgages as a strategy for acquiring ownership of a property or the economic equivalent thereof, subject to the investment restrictions applicable to REITs. See "Business and Properties--Blackstone Acquisition," "Federal Income Tax Consequences--Federal Income Taxation of Host REIT Following the Mergers--Income Tests Applicable to REITs" and "--Asset Tests Applicable to REITs." As of June 19, 1998, the Operating Partnership held two mortgages secured by hotels. In addition, the Operating Partnership may invest in mortgage-related securities and/or may seek to issue securities representing interests in such mortgage-related securities as a method of raising additional funds. Securities of or Interests in Persons Primarily Engaged in Real Estate Activities and Other Issuers. Subject to the percentage ownership limitations and gross and asset income tests necessary for REIT qualification, the Operating Partnership also may invest in securities of other entities engaged in real estate 138 activities or invest in securities of other issuers, including for the purpose of exercising control over such entities. The Operating Partnership may acquire all or substantially all of the securities or assets of other REITs or similar entities where such investments would be consistent with the Operating Partnership's investment policies. No such investments will be made, however, unless the Board of Directors determines that the proposed investment would not cause either Host REIT or the Operating Partnership to be an "investment company" within the meaning of the Investment Company Act of 1940, as amended. FINANCING POLICIES The Operating Partnership's and Host REIT's organizational documents currently contain no restrictions on incurring debt. Host REIT and the Operating Partnership, however, will have a policy of incurring debt only if upon such incurrence the debt-to-total market capitalization of Host REIT and the Operating Partnership would be 60% or less. In addition, the New Senior Notes indenture and the New Credit Facility impose limitations on the incurrence of indebtedness. The Indenture for the Notes also limits the amount of Debt (as defined in the Indenture, see "Description of the Notes-- Limitations on Incurrence of Debt") that the Operating Partnership may incur if, immediately after giving effect to the incurrence of such additional Debt, the aggregate principal amount of all outstanding Debt of the Operating Partnership and its Subsidiaries (as defined in the Indenture) on a consolidated basis is greater than 75% of the Operating Partnership's undepreciated total assets on the date of such incurrence. Indentures for debt issued to replace the public bonds may contain other restrictions. The Operating Partnership may, from time to time, reduce its outstanding indebtedness by repurchasing a portion of such outstanding indebtedness, subject to certain restrictions contained in the Partnership Agreement and the terms of its outstanding indebtedness. The Operating Partnership will from time to time reevaluate its borrowing policies in light of then current economic conditions, relative costs of debt and equity capital, market conditions, market values of properties, growth and acquisition opportunities and other factors. Consequently, the Operating Partnership's financing policy is subject to modification and change. The Operating Partnership may waive or modify its borrowing policy without any vote of the shareholders of Host REIT or the limited partners of the Operating Partnership. To the extent that the Board of Directors determines to seek additional capital, Host REIT or the Operating Partnership may raise such capital through equity offerings, debt financing or retention of cash flow or a combination of these methods. As long as the Operating Partnership is in existence, the net proceeds of all equity capital raised by Host REIT will be contributed to the Operating Partnership in exchange for OP Units in the Operating Partnership, which will dilute the ownership interest of limited partners of the Operating Partnership. In the future, the Operating Partnership may seek to extend, expand, reduce or renew its New Credit Facility, or obtain new credit facilities or lines of credit, subject to its general policy relating to the ratio of debt-to-total market capitalization, for the purpose of making acquisitions or capital improvements or providing working capital or meeting the taxable income distribution requirements for REITs under the Code. In the future, Host REIT and the Operating Partnership also may determine to issue securities senior to the Common Shares or OP Units, including preferred shares and debt securities (either of which may be convertible into Common Shares or OP Units or may be accompanied by warrants to purchase Common Shares or OP Units). The Operating Partnership has not established any limit on the number or amount of mortgages that may be placed on any single hotel or on its portfolio as a whole, although the Operating Partnership's objective is to reduce its reliance on secured indebtedness. LENDING POLICIES The Operating Partnership may consider offering purchase money financing in connection with the sale of a hotel where the provision of such financing will increase the value received by the Operating Partnership for the hotel sold. CONFLICTS OF INTEREST POLICIES Under the MGCL, no contract or transaction between a Maryland corporation and any of its directors or between a Maryland corporation and any other corporation, firm, or other entity in which any of its directors is a 139 director, or has a material financial interest, shall be void or voidable solely for this reason, or solely because the director is present at the meeting of the board or committee of the board which authorizes, approves, or ratifies the contract or transaction, or solely because such director's or directors' votes are counted for such purpose, if (i) the fact of common directorship or interest is disclosed or known to the board of directors or the committee, and the board or committee authorizes, approves, or ratifies the contract or transaction by the affirmative vote of a majority of disinterested directors, even if the disinterested directors constitute less than a quorum, (ii) the fact of common directorship or interest is disclosed or known to the stockholders entitled to vote, and the contract or transaction is authorized, approved, or ratified by a majority of the votes cast by the stockholders entitled to vote other than the votes of shares owned of record or beneficially by the interested corporation, firm or other entity, or (iii) the contract or transaction is fair and reasonable to the corporation. Common or interested directors or the stock owned by them or by an interested corporation, firm, or other entity may be counted in determining the presence of a quorum at a meeting of the board of directors or a committee of the board or at a meeting of the stockholders, as the case may be, at which the contract or transaction is authorized, approved or ratified. Host REIT's Board of Directors has also adopted a policy to address conflicts of interest. In addition, Maryland and Delaware law impose certain duties on the Board of Directors and Host REIT, as general partner of the Operating Partnership (to the extent such duties have not been eliminated pursuant to the Charter or the Partnership Agreement). There can be no assurance, however, that these policies always will be successful in eliminating the influence of such conflicts. If they are not successful, decisions could be made that may fail to reflect fully the interests of all limited partners of the Operating Partnership. Host REIT has adopted a policy which would require that all material contracts and transactions between Host REIT, the Operating Partnership or any of its subsidiaries, on the one hand, and a director or executive officer of Host REIT or any entity in which such director or executive officer is a director or has a material financial interest, on the other hand, must be approved by the affirmative vote of a majority of the disinterested directors. Where appropriate in the judgment of the disinterested directors, the Board of Directors may obtain a fairness opinion or engage independent counsel to represent the interests of nonaffiliated security holders, although the Board of Directors will have no obligation to do so. In addition, under Delaware law (where the Operating Partnership is formed), Host REIT, as general partner, has a fiduciary duty to the Operating Partnership and, consequently, such transactions are subject to the duties of care and loyalty that Host REIT, as general partner, owes to limited partners of the Operating Partnership (to the extent such duties have not been eliminated pursuant to the terms of the Partnership Agreement). The Partnership Agreement provides that (i) in considering to dispose of any of the assets of the Operating Partnership, Host REIT shall take into account the tax consequences to it of any such disposition and shall have no liability to the Operating Partnership or the limited partners for decisions based upon or influenced by such tax consequences (and the Operating Partnership generally is obligated to pay any taxes Host REIT incurs as result of such transactions), (ii) Host REIT, as general partner, is under no obligation to consider the separate interests of the limited partners (including, without limitation, tax consequences) in deciding whether to cause the Operating Partnership to take, or decline to take, any action and (iii) any act or omission by Host REIT, as a general partner, undertaken in the good faith belief that such action is necessary or desirable to protect the ability of Host REIT to continue to qualify as a REIT or to allow Host REIT to avoid incurring liability for taxes under Section 857 or 4981 of the Code (relating to required distributions) is deemed approved by all limited partners. POLICIES WITH RESPECT TO OTHER ACTIVITIES The Operating Partnership may, but does not presently intend to, make investments other than as previously described. Host REIT will make investments only through the Operating Partnership. Host REIT and the Operating Partnership will have authority to offer their securities and to repurchase or otherwise reacquire their securities and may engage in such activities in the future. Host REIT and the Operating Partnership also may make loans to joint ventures in which they may participate in the future to meet working capital needs. Neither Host REIT nor the Operating Partnership will engage in trading, underwriting, agency distribution or sale of securities of other issuers. Host REIT's policies with respect to such activities may be reviewed and modified from time to time by Host REIT's directors without notice to, or the vote of, its shareholders. 140 SELECTED FINANCIAL DATA The following table presents certain selected historical financial data of Host which has been derived from Host's audited Consolidated Financial Statements for the five most recent fiscal years ended January 2, 1998 and the unaudited condensed consolidated financial statements for the First Two Quarters 1998 and First Two Quarters 1997. The income statement data for fiscal year 1993 does not reflect the Marriott International Distribution and related transactions and, accordingly, the table presents data for Host for 1993 that includes amounts attributable to Marriott International. As a result of the Marriott International Distribution and related transactions, the assets, liabilities and businesses of Host have changed substantially. The information contained in the following table is not comparable to the operations of Host or the Operating Partnership on a going-forward basis because the historical information relates to an operating entity which owns and operates its hotels, while the Company will own the Hotels but will lease them to the Lessees and receive rental payments in connection therewith. - -------- (1) In the First Two Quarters 1997 and fiscal year 1997, Host recognized a $5 million and a $3 million, respectively, extraordinary gain, net of taxes, on the extinguishment of certain debt. In 1994, Host recognized a $6 million extraordinary loss, net of taxes, on the required redemption of senior notes. In 1993, Host recognized a $4 million extraordinary loss, net of taxes, on the completion of an exchange offer for its then outstanding bonds. (2) Fiscal year 1996 includes 53 weeks. (3) Operating results for 1995 include a $10 million pre-tax charge to write down the carrying value of five limited service properties to their net realizable value and a $60 million pre-tax charge to write down an undeveloped land parcel to its estimated sales value. In 1995, Host recognized a $20 million extraordinary loss, net of taxes, on the extinguishment of debt. (4) Operating results for 1993 include the operations of Marriott International through the Marriott International Distribution date of October 8, 1993. These operations had a net pre-tax effect on income of $211 million for the year ended December 31, 1993 and are recorded as "Profit from operations distributed to Marriott International" on Host's 141
FIRST TWO QUARTERS FISCAL YEAR -------------- ---------------------------------------------- 1998 1997 1997(1) 1996(2) 1995(3) 1994(1) 1993(1)(4) ------ ------ ------- ------- ------- ------- ---------- (UNAUDITED) (IN MILLIONS) INCOME STATEMENT DATA: Revenues.............. $ 747 $ 522 $1,147 $ 732 $ 484 $ 380 $ 659 Operating profit...... 374 215 449 233 114 152 92 Interest expense...... 162 122 302 237 178 165 164 Income (loss) from continuing operations........... 96 32 47 (13) (62) (13) 56 Net income (loss)(5).. 96 37 50 (13) (143) (25) 50 OTHER OPERATING DATA: Cash from operations.. 206 193 464 201 142 146 415 Cash provided by (used in) investing activities........... 11 (200) (1,046) (504) (208) (178) (262) Cash provided by (used in) financing activities........... (213) (188) 389 806 200 26 (389) Comparative FFO(6) (unaudited).......... 206 145 295 164 136 N/A N/A Depreciation and amortization......... 125 102 240 168 122 113 N/A RATIO DATA (UNAUDITED): Ratio of earnings to fixed charges(7)..... 2.0x 1.5x 1.3x 1.0x -- -- N/A Deficiency of earnings to fixed charges(7).. -- -- -- -- 70 12 N/A BALANCE SHEET DATA: Cash, cash equivalents and short-term marketable securities........... $ 561 $ 509 $ 865 $ 704 $ 201 $ 67 $ 73 Total assets.......... 6,765 5,324 6,526 5,152 3,557 3,366 3,362 Debt.................. 3,784 2,715 3,783 2,647 2,178 1,871 2,113 consolidated statements of operations and are, therefore, not included in sales, operating profit before corporate expenses and interest, interest expense and interest income for the same period. The net pre-tax effect of these operations is, however, included in income before income taxes, extraordinary item and cumulative effect of changes in accounting principles and in net income for the same periods. Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," was adopted in the first quarter of 1993. In the second quarter of 1993, Host changed its accounting method for assets held for sale. During 1993, Host recorded a $34 million credit to reflect the adoption of SFAS No. 109 and a $32 million charge, net of taxes, to reflect the change in its accounting method for assets held for sale. Operating results in 1993 included pre-tax expenses related to the Marriott International Distribution totaling $13 million. (5) Host recorded a loss from discontinued operations, net of taxes, as a result of the Special Dividend (as defined herein) of $61 million in 1995, $6 million in 1994, and $4 million in 1993. The 1995 loss from discontinued operations includes a pre-tax charge of $47 million for the adoption of SFAS No. 121, "Accounting For the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of," a pre-tax $15 million restructuring charge and an extraordinary loss of $10 million, net of taxes, on the extinguishment of debt. (6) Host considers Comparative Funds From Operations ("Comparative FFO," which represents Funds From Operations, as defined by the National Association of Real Estate Investment Trusts, Inc. ("NAREIT"), plus deferred tax expense) a meaningful disclosure that will help the investment community to better understand the financial performance of Host, including enabling its shareholders and analysts to more easily compare Host's performance to REITs. FFO is defined by NAREIT as net income computed in accordance with GAAP, excluding gains or losses from debt restructurings and sales of properties, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. FFO should not be considered as an alternative to net income, operating profit, cash flows from operations or any other operating or liquidity performance measure prescribed by GAAP. FFO is also not an indicator of funds available to fund the Host's cash needs, including its ability to make distributions. Host's method of calculating FFO may be different from methods used by other REITs and, accordingly, may not be comparable to such other REITs. (7) The ratio of earnings to fixed charges is computed by dividing net income before interest expense and other fixed charges by total fixed charges, including interest expense, amortization of debt issuance costs and the portion of rent expense that is deemed to represent interest. The deficiency of earnings to fixed charges is largely the result of depreciation and amortization of $122 million and $113 million in 1995 and 1994, respectively. 142 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION LACK OF COMPARABILITY FOLLOWING THE MERGERS AND THE REIT CONVERSION Because substantially all of the Company's Hotels will be leased following the Mergers and the REIT Conversion, the Company does not believe that the historical results of operations of Host will be comparable to the results of operations of the Company following the Mergers and the REIT Conversion. For pro forma information giving effect to the Mergers and the REIT Conversion (including the Leases), see "Unaudited Pro Forma Financial Information." HISTORICAL RESULTS OF OPERATIONS Revenues primarily represent house profit from hotel properties and senior living communities, net gains (losses) on property transactions and equity in the earnings (losses) of affiliates. House profit reflects the net revenues flowing to Host as property owner and represents gross hotel sales less property-level expenses (excluding depreciation, management fees, property taxes, ground and equipment rent, insurance and certain other costs which are classified as operating costs and expenses included in the accompanying financial statements). Other operating costs and expenses include idle land carrying costs and certain other costs. Host's hotel operating costs and expenses are, to a great extent, fixed. Therefore, Host derives substantial operating leverage from increases in revenue. This operating leverage is somewhat diluted, however, by the impact of base management fees which are calculated as a percentage of sales, variable lease payments and incentive management fees tied to operating performance above certain established levels. Successful hotel performance resulted in certain of Host's properties reaching levels which allowed the manager to share in the growth of profits in the form of higher management fees. Host expects that this trend will continue in 1998 as the upscale and luxury full-service segments continue to strengthen. At these higher operating levels, Host's and the managers' interests are closely aligned, which helps to drive further increases in profitability, but moderates operating leverage. For the periods discussed herein, Host's hotel properties have experienced substantial increases in room revenues generated per available room ("REVPAR"). REVPAR is a commonly used indicator of market performance for hotels which represents the combination of the average daily room rate charged and the average occupancy achieved. REVPAR does not include food and beverage or other ancillary revenues generated by the property. The REVPAR increase primarily represents strong percentage increases in room rates, while occupancy increases have been more moderate. Increases in average room rates have generally been achieved by the managers through shifting occupancies away from discounted group business to higher-rated group and transient business and by selectively increasing room rates. This has been made possible by increased travel due to improved economic conditions and by the favorable supply/demand characteristics existing in the upscale and luxury full-service segments of the lodging industry. Host expects this favorable relationship between supply growth and demand growth to continue in the upscale and luxury markets in which it operates, which should result in improved REVPAR and operating profits at its hotel properties in the near term. However, there can be no assurance that REVPAR will continue to increase in the future. FIRST TWO QUARTERS 1998 COMPARED TO FIRST TWO QUARTERS 1997 (HISTORICAL) Revenues. Revenues primarily represent house profit from Host's hotel properties, net gains (losses) on property transactions and equity in earnings (losses) of affiliates. Revenues increased $225 million, or 43%, to $747 million for the twenty-four weeks ended June 19, 1998 ("First Two Quarters 1998") from $522 million for the twenty-four weeks ended June 20, 1997 ("First Two Quarters 1997"). Host's revenue and operating profit were impacted by improved lodging results for comparable full-service hotel properties, the addition of 18 full-service hotel properties during 1997 and eight full- service properties during the First Two Quarters 1998, the acquisition of 30 senior living communities in 1997 and one senior living community in 1998 and the gain on the sale of two hotel properties in the First Two Quarters 1998. 143 Hotel sales (gross hotel sales, including room sales, food and beverage sales, and other ancillary sales such as telephone sales) increased $317 million, or 25%, to $1,574 million in the First Two Quarters 1998, reflecting the REVPAR increases for comparable units and the addition of full-service properties in 1997 and 1998. Improved results for Host's full-service hotels were driven by strong increases in REVPAR for comparable units of 8.2% to $116.66 for the First Two Quarters 1998. Results were further enhanced by a one percentage point increase in the house profit margin for comparable full- service properties. On a comparable basis for Host's full-service hotel properties, average room rates increased over eight percent, while average occupancy decreased slightly. Revenues generated from Host's 31 senior living communities totaled $39 million for the First Two Quarters 1998. For the First Two Quarters 1998, average occupancy was almost 92% and the average per diem rate was almost $88, which resulted in revenue per available unit ("REVPAU") of $80.65. Senior living communities' sales totaled $110 million for the First Two Quarters 1998. Revenues were also impacted by the gains on the sales of two hotel properties. The New York East Side Marriott was sold for $191 million resulting in a pre-tax gain of approximately $40 million. The Napa Valley Marriott was sold for $21 million resulting in a pre-tax gain of approximately $10 million. Operating Costs and Expenses. Operating costs and expenses principally consist of depreciation, management fees, property taxes, ground, building and equipment rent, insurance and certain other costs. Operating costs and expenses increased $66 million to $373 million in the First Two Quarters 1998 from $307 million for the First Two Quarters 1997, primarily representing increased hotel and senior living communities' operating costs, including depreciation and management fees. Hotel operating costs increased $52 million to $343 million for the First Two Quarters 1998 primarily due to the addition of 26 full-service properties during 1997 and the First Two Quarters 1998 and increased management fees and rentals tied to improved property results. As a percentage of hotel revenues, hotel operating costs and expenses decreased to 53% of revenues in the First Two Quarters 1998 from 57% of revenues in the First Two Quarters 1997 due to the significant increases in REVPAR discussed above, as well as the operating leverage as a result of a significant portion of Host's hotel operating costs and expenses being fixed. Host's senior living communities' operating costs and expenses were $20 million for the First Two Quarters 1998. Operating Profit. As a result of the changes in revenues and operating costs and expenses discussed above, Host's operating profit increased $159 million, or 74%, to $374 million for the First Two Quarters 1998. Hotel operating profit increased $88 million, or 40%, to $309 million, or 47% of hotel revenues, for the First Two Quarters 1998 from $221 million, or 43% of hotel revenues, for the First Two Quarters 1997. Specifically, hotels in New York City and Toronto reported significant improvements for the First Two Quarters 1998. Results in Mexico City have also improved as the Mexican economy continues to strengthen. Properties in Florida reported some minor softness in results due to exceptionally poor weather in 1998. Host's senior living communities generated $19 million of operating profit for the First Two Quarters 1998. Minority Interest. Minority interest expense increased $6 million to $30 million for the First Two Quarters 1998, primarily reflecting the impact of the consolidation of affiliated partnerships and the acquisition of controlling interests in newly-formed partnerships during 1997 and the First Two Quarters 1998. Corporate Expenses. Corporate expenses increased $3 million to $21 million for the First Two Quarters 1998. As a percentage of revenues, corporate expenses decreased to 2.8% of revenues for the First Two Quarters 1998 from 3.4% in the First Two Quarters 1997, reflecting Host's efforts to control its corporate expenses in spite of the substantial growth in revenues. REIT Conversion Expenses. REIT Conversion Expenses reflect the professional fees and other expenses associated with the Company's conversion to a REIT. Interest Expense. Interest expense increased 33% to $162 million in the First Two Quarters 1998, primarily due to additional debt of approximately $580 million assumed in connection with the 1997 and 1998 144 full-service hotel additions, approximately $300 million assumed in connection with the acquisition of senior living communities, as well as the issuance of $600 million of 8 7/8% senior notes in July 1997. Dividends on Convertible Preferred Securities. The dividends on Convertible Preferred Securities reflect the dividends accrued on the $550 million in 6.75% Convertible Preferred Securities issued by Host in December 1996. Interest Income. Interest income increased $3 million to $25 million for the First Two Quarters 1998, primarily reflecting interest earned on cash held for future hotel investments. Income before Extraordinary Item. Income before extraordinary item for the First Two Quarters 1998 was $96 million, compared to $32 million for the First Two Quarters 1997. Extraordinary Gain. In March 1997, Host purchased 100% of the outstanding bonds secured by a first mortgage on the San Francisco Marriott Hotel. Host purchased the bonds for $219 million, which was an $11 million discount to the face value of $230 million. In connection with the redemption and defeasance of the bonds, Host recognized an extraordinary gain of $5 million, which represents the $11 million discount and the write-off of deferred financing fees, net of taxes. Net Income. Host's net income for the First Two Quarters 1998 was $96 million compared to $37 million for the First Two Quarters 1997. For the First Two Quarters 1998 and 1997, basic earnings per common share were $.47 and $.18, respectively and diluted earnings per common share were $.45 and $.18, respectively. 1997 COMPARED TO 1996 (HISTORICAL) Revenues. Revenues increased $415 million, or 57%, to $1.1 billion for 1997. Host's revenue and operating profit were impacted by: -- improved lodging results for comparable full-service hotel properties; -- the addition of 23 full-service hotel properties during 1996 and 18 full-service properties during 1997; -- the addition of 30 senior living communities in 1997; -- the 1996 sale and leaseback of 16 Courtyard properties and 18 Residence Inns; and -- the 1997 results including 52 weeks versus 53 weeks in 1996. Hotel revenues increased $376 million, or 52%, to $1.1 billion in 1997, as all three of the Company's lodging concepts reported growth in REVPAR. Hotel sales increased $864 million, or 44%, to over $2.8 billion in 1997, reflecting the REVPAR increases for comparable units and the addition of full-service properties during 1996 and 1997. Improved results for the Company's full- service hotels were driven by strong increases in REVPAR for comparable units of 12.6% in 1997. Results were further enhanced by a more than two percentage point increase in the house profit margin for comparable full-service properties. On a comparable basis for Host's full-service properties, average room rates increased almost 11%, while average occupancy increased over one percentage point. Revenues generated from Host's 1997 third quarter acquisition of 29 senior living communities totaled $37 million. During 1997, average occupancy of the communities was 92% and the average per diem rate was $84, which resulted in 1997 REVPAR of $77. Overall occupancies for 1997 were lower than the historical and anticipated future occupancies due to the significant number of expansion units added during the year, the overall disruption to the communities as a result of the construction and the time required to fill the expansion units. Senior living communities' sales totaled $111 million for 1997. Operating Costs and Expenses. Operating costs and expenses increased $199 million to $698 million for 1997, primarily representing increased hotel and senior living communities' operating costs, including depreciation and management fees. Hotel operating costs increased $188 million to $649 million, primarily due 145 to the addition of 41 full-service properties during 1996 and 1997, and increased management fees and rentals tied to improved property results. As a percentage of hotel revenues, hotel operating costs and expenses decreased to 59% of revenues for 1997, from 64% of revenues for 1996, reflecting the impact of increased 1997 revenues on relatively fixed operating costs and expenses. Host's senior living communities operating costs and expenses were $20 million (54% of revenues) for 1997. Operating Profit. As a result of the changes in revenues and operating costs and expenses discussed above, Host's operating profit increased $216 million, or 93%, to $449 million in 1997. Hotel operating profit increased $188 million, or 73%, to $444 million, or 41% of hotel revenues, for 1997 compared to $256 million, or 36% of hotel revenues, for 1996. In nearly all markets, Host's hotels recorded improvements in comparable operating results. In particular, Host's hotels in the Northeast, Mid-Atlantic and Pacific coast regions benefited from the upscale and luxury full-service room supply and demand imbalance. Hotels in New York City, Philadelphia, San Francisco/Silicon Valley and in Southern California performed particularly well. In 1998, Host expects results to be strong in these markets and other gateway cities in which the Company owns hotels. In 1997, Host's suburban Atlanta properties (three properties totaling 1,022 rooms) generally reported decreased results due to higher activity in 1996 related to the Summer Olympics and the impact of the additional supply added to the suburban areas. However, the majority of Host's hotel rooms in Atlanta are in the core business districts in downtown and Buckhead where they realized strong year-over-year results and were only marginally impacted by the additional supply. Host's senior living communities generated $17 million (46% of revenues) of operating profit. Minority Interest. Minority interest expense increased $26 million to $32 million for 1997, primarily reflecting the impact of the consolidation of affiliated partnerships and the acquisition of controlling interests in newly- formed partnerships during 1996 and 1997. Corporate Expenses. Corporate expenses increased $4 million to $47 million in 1997. As a percentage of revenues, corporate expenses decreased to 4.1% of revenues in 1997 from 5.9% of revenues in 1996. This reflects Host's efforts to carefully control its corporate expenses in spite of the substantial growth in revenues. Interest Expense. Interest expense increased $65 million to $302 million in 1997, primarily due to the additional mortgage debt of approximately $1.1 billion assumed in connection with the 1996 and 1997 full-service hotel additions, approximately $315 million in debt incurred in conjunction with the acquisition of senior living communities, as well as the issuance of $600 million of 8 7/8% senior notes in July 1997. Dividends on Convertible Preferred Securities of Subsidiary Trust. The dividends on the Convertible Preferred Securities reflect the dividends on the $550 million in 6.75% Convertible Preferred Securities issued by Host in December 1996. Interest Income. Interest income increased $4 million to $52 million for 1997, primarily reflecting the interest income on the available proceeds generated by the December 1996 offering of Convertible Preferred Securities and the proceeds generated by the issuance of the 8 7/8% senior notes in July 1997. Income (Loss) Before Extraordinary Items. Income before extraordinary items for 1997 was $47 million, compared to a $13 million loss before extraordinary items for 1996 as a result of the items discussed above. Extraordinary Gain (Loss). In March 1997, Host purchased 100% of the outstanding bonds secured by a first mortgage on the San Francisco Marriott Hotel. Host purchased the bonds for $219 million, which was an $11 million discount to the face value of $230 million. In connection with the redemption and defeasance of the bonds, Host recognized an extraordinary gain of $5 million, which represents the $11 million discount less the write-off of unamortized deferred financing fees, net of taxes. In December 1997, Host refinanced the mortgage debt secured by the Marriott's Orlando World Center. In connection with the refinancing, Host recognized an extraordinary loss of $2 million, which represents payment of a prepayment penalty and the write-off of unamortized deferred financing fees, net of taxes. 146 Net Income (Loss). Host's net income in 1997 was $50 million, compared to a net loss of $13 million in 1996. Basic earnings per common share was $.25 for 1997, compared to a basic loss per common share of $.07 in 1996. Diluted earnings per common share was $.24 for 1997 compared to a diluted loss per common share of $.07 in 1996. 1996 COMPARED TO 1995 (HISTORICAL) Revenues. Revenues increased $248 million, or 51%, to $732 million in 1996. Host's revenue and operating profit were impacted by: -- improved lodging results for comparable full-service hotel properties; -- the addition of nine full-service hotel properties during 1995 and 23 full-service properties during 1996; -- the 1996 and 1995 sale and leaseback of 53 of Host's Courtyard properties and 18 of Host's Residence Inns; -- the 1996 change in the estimated depreciable lives and salvage values for certain hotel properties which resulted in additional depreciation expense of $15 million; -- the 1996 results including 53 weeks versus 52 weeks in 1995; -- the $60 million pre-tax charge in 1995 to write down the carrying value of one undeveloped land parcel to its estimated sales value; -- a $10 million pre-tax charge in 1995 to write down the carrying value of certain Courtyard and Residence Inn properties held for sale to their net realizable values included in "Net gains (losses) on property transactions"; and -- the 1995 sale of four Fairfield Inns. Hotel revenues increased $243 million, or 51%, to $717 million in 1996, as all three of Host's lodging concepts reported growth in REVPAR. Hotel sales increased $590 million, or 44%, to $1.9 billion in 1996, reflecting the REVPAR increases for comparable units and the addition of full-service properties during 1995 and 1996. Improved results for Host's full-service hotels were driven by strong increases in REVPAR for comparable units of 11% in 1996. Results were further enhanced by an almost two percentage point increase in the house profit margin for comparable full-service properties. On a comparable basis for Host's full- service properties, average room rates increased 8%, while average occupancy increased over two percentage points. Operating Costs and Expenses. Operating costs and expenses increased $129 million to $499 million for 1996, primarily representing increased hotel operating costs, including depreciation, partially offset by the $60 million pre-tax charge in 1995 to write down the carrying value of one undeveloped land parcel to its estimated sales value. Hotel operating costs increased $180 million to $461 million, primarily due to the addition of 32 full-service properties during 1995 and 1996, increased management fees and rentals tied to improved property results and a change in the depreciable lives and salvage values of certain large hotel properties ($15 million). As a percentage of hotel revenues, hotel operating costs and expenses increased to 64% of revenues for 1996, from 59% of revenues for 1995, reflecting the impact of the lease payments on the Courtyard and Residence Inn properties which have been sold and leased back, and the change in depreciable lives and salvage values for certain large hotel properties discussed above, as well as the shifting emphasis to full-service properties. Full-service hotel rooms accounted for 100% of Host's total hotel rooms on January 3, 1997, versus 84% on December 29, 1995. Operating Profit. As a result of the changes in revenues and operating costs and expenses discussed above, Host's operating profit increased $119 million, or 104%, to $233 million in 1996. Hotel operating profit increased $63 million, or 33%, to $256 million, or 36% of hotel revenues, for 1996 compared to $193 million, or 41% of 147 hotel revenues, for 1995. Across the board, the Company's hotels recorded substantial improvements in comparable operating results. In addition, several hotels, including the New York Marriott Marquis, the New York Marriott East Side, the Philadelphia Marriott, the San Francisco Marriott and the Miami Airport Marriott posted particularly significant improvements in operating profit for the year. Host's Atlanta properties also posted outstanding results, primarily due to the 1996 Summer Olympics. Additionally, several hotels which recently converted to the Marriott brand, including the Denver Marriott Tech Center, the Marriott's Mountain Resort at Vail and the Williamsburg Marriott, recorded strong results compared to the prior year as they completed renovations and began to realize the benefit of their conversions. Corporate Expenses. Corporate expenses increased $7 million to $43 million in 1996. As a percentage of revenues, corporate expenses decreased to 5.9% of revenues in 1996 from 7.4% of revenues in 1995. This reflects Host's efforts to carefully control its corporate administrative expenses in spite of the substantial growth in revenues. Interest Expense. Interest expense increased 33% to $237 million in 1996, primarily due to the additional mortgage debt of approximately $696 million incurred in connection with the 1996 full-service hotel additions and the issuance of $350 million of notes issued by HMC Acquisition Properties, Inc., a wholly-owned subsidiary of Host, in December 1995, partially offset by the net impact of the 1995 redemptions of Host Marriott Hospitality, Inc. notes ("Hospitality Notes"). Loss from Continuing Operations. The loss from continuing operations for 1996 decreased $49 million to $13 million, as a result of the changes discussed above. Net Loss. Host's net loss in 1996 was $13 million, compared to a net loss of $143 million in 1995, which included a $61 million loss from discontinued operations and a $20 million extraordinary loss primarily representing premiums paid on bond redemptions and the write-off of deferred financing fees and discounts on the debt. The basic and diluted loss per common share was $.07 for 1996 and $.90 for 1995. PRO FORMA RESULTS OF OPERATIONS Because substantially all of the Company's Hotels will be leased to the Lessees following the REIT Conversion, the Company does not believe that Host's historical results of operations will be comparable to the results of operations of the Company following the REIT Conversion. Accordingly, a comparison of the Company's pro forma results of operations for the First Two Quarters 1998 to the First Two Quarters 1997 and fiscal year 1997 to fiscal year 1996 have been included below. The following discussion and analysis should be read in conjunction with the Company's combined consolidated financial statements and the Company's unaudited pro forma financial statements and related notes thereto included elsewhere in this Consent Solicitation. The following discussion and analysis has been prepared assuming the following two scenarios: . All Partnerships participate and no Notes are issued ("100% Participation with No Notes Issued"). . All Partnerships participate and Notes are issued with respect to 100% of the OP Units allocable to each Partnership ("100% Participation with Notes Issued"). These presentations do not purport to represent what combination will result from the Mergers and the REIT Conversion, but instead are designed to illustrate what the composition of the Company would have been like under the above scenarios. Furthermore, the unaudited pro forma financial statements do not purport to represent what the Company's results of operations or cash flows would actually have been if the Mergers and REIT Conversion had in fact occurred on such date or at the beginning of such period or to project the Company's results of operations or cash flows for any future date or period. 148 100% PARTICIPATION WITH NO NOTES ISSUED--FIRST TWO QUARTERS 1998 COMPARED TO FIRST TWO QUARTERS 1997 (PRO FORMA) The following table presents the results of operations for the First Two Quarters 1998 and the First Two Quarters 1997 on a pro forma basis under the scenarios discussed above: Revenues. Revenues primarily represent lease revenues, net gains (losses) on property transactions and equity in earnings (losses) of affiliates, including the Non-Controlled Subsidiaries. Revenues increased $8 million, or 2%, to $345 million for the First Two Quarters 1998 from $337 million for the First Two Quarters 1997. EITF 98-9, "Accounting for Contingent Rents in Interim Financial Periods," requires a lessor to defer recognition of contingent rental income in interim periods until the specified target that triggers the contingent rental income is achieved. Based on the structure of the Company's leases, only minimum rent was recorded in the First Two Quarters 1998 and First Two Quarters 1997. On a pro forma basis, the Company would have received rental payments of $603 million and $543 million, respectively, resulting in deferred revenue of $261 million and $207 million, respectively, for the First Two Quarters 1998 and First Two Quarters 1997. Hotel sales (gross hotel sales, including room sales, food and beverage sales, and other ancillary sales such as telephone sales) increased $136 million, or 8.1%, to over $1.9 billion in the First Two Quarters 1998, reflecting the REVPAR increases for the Company's hotels. Improved results for the Company's hotels were driven by strong increases in REVPAR of 8.3% to $113.67 for the First Two Quarters 1998. Average room rates increased 9%, while average occupancy decreased slightly to 77.8%. Operating Costs and Expenses. Operating costs and expenses principally consist of depreciation, property taxes, ground, rent, insurance and certain other costs. Operating costs and expenses decreased $2 million to $270 million in the First Two Quarters 1998. As a percentage of rental revenues, hotel operating costs and expenses decreased to 77% of rental revenues in the First Two Quarters 1998 from 79% of rental revenues in the First Two Quarters 1997 due to the increase in minimum rent under the Company's leases. Operating Profit. As a result of the changes in rental revenues and operating costs and expenses discussed above, the Company's operating profit increased $10 million, or 15%,to $75 million for the First Two Quarters 1998. Hotel operating profit increased $7 million, or 10%, to $77 million, or 23% of rental revenues, for the First Two Quarters 1998 from $70 million, or 21% of rental revenues, for the First Two Quarters 1997. The Company's hotels recorded significant improvements in comparable operating results, however, due to EITF 98-9, only minimum rent could be recorded. Specifically, hotels in New York City, Boston, Toronto and Atlanta 149
100% PARTICIPATION 100% PARTICIPATION WITH NO NOTES ISSUED WITH NOTES ISSUED ---------------------- -------------------- FIRST TWO QUARTERS FIRST TWO QUARTERS ---------------------- -------------------- 1998 1997 1998 1997 ---------- ---------- --------- --------- (IN MILLIONS) Rental revenues.................. $ 342 $ 336 $ 342 $ 336 Total revenues................... 345 337 345 337 Operating costs and expenses..... 270 272 269 271 Operating profit before minority interest, corporate expenses and interest expense................ 75 65 76 66 Minority interest................ (11) (7) (11) (7) Corporate expenses............... (20) (18) (20) (18) Interest expense................. (216) (221) (224) (229) Interest income.................. 13 13 13 13 ---------- ---------- --------- --------- Income (loss) before income taxes........................... (159) (168) (166) (175) Benefit (provision) for income taxes........................... 8 7 8 8 ---------- ---------- --------- --------- Income (loss) before extraordinary items............. $ (151) $ (161) $ (158) $ (167) ========== ========== ========= ========= reported significant improvements for the First Two Quarters 1998. Properties in Florida reported some temporary declines in operating results due to exceptionally poor weather in 1998. Minority Interest. Minority interest expense increased $4 million to $11 million for the First Two Quarters 1998, primarily reflecting improved lodging results. Corporate Expenses. Corporate expenses increased $2 million to $20 million for the First Two Quarters 1998 due to increased staffing levels and the impact of inflation. Interest Expense. Interest expense decreased $5 million to $216 million in the First Two Quarters 1998, primarily due to the impact of principal amortization on the Company's mortgage debt. Interest Income. Interest income was unchanged at $13 million for the First Two Quarters 1998 and 1997, respectively. Loss before Extraordinary Items. The loss before extraordinary items for the First Two Quarters 1998 was $151 million, compared to $161 million for the First Two Quarters 1997. 100% PARTICIPATION WITH NOTES ISSUED--FIRST TWO QUARTERS 1998 COMPARED TO FIRST TWO QUARTERS 1997 (PRO FORMA) Revenues. Revenues increased $8 million, or 2%,to $345 million for the First Two Quarters 1998 from $337 million for the First Two Quarters 1997. Based on the structure of the Company's leases, only minimum rent was recorded in the First Two Quarters 1998 and First Two Quarters 1997. On a pro forma basis, the Company would have received rental payments of $603 million and $543 million, respectively, resulting in deferred revenue of $261 million and $207 million, respectively, for the First Two Quarters 1998 and First Two Quarters 1997. Hotel sales (gross hotel sales, including room sales, food and beverage sales, and other ancillary sales such as telephone sales) increased $136 million, or 8.1%, to over $1.9 billion in the First Two Quarters 1998, reflecting the REVPAR increases for the Company's hotels. Improved results for the Company's hotels were driven by strong increases in REVPAR of 8.3% to $113.67 for the First Two Quarters 1998. Average room rates increased 9%, while average occupancy decreased slightly to 77.8%. Operating Costs and Expenses. Operating costs and expenses decreased $2 million to $269 million in the First Two Quarters 1998. As a percentage of rental revenues, hotel operating costs and expenses decreased to 77% of revenues in the First Two Quarters 1998 from 79% of rental revenues in the First Two Quarters 1997 due to the increase in minimum rent under the Company's leases. Operating Profit. As a result of the changes in rental revenues and operating costs and expenses discussed above, the Company's operating profit increased $10 million, or 15%,to $76 million for the First Two Quarters 1998. Hotel operating profit increased $7 million, or 10%,to $78 million, or 23% of rental revenues, for the First Two Quarters 1998 from $71 million, or 21% of rental revenues, for the First Two Quarters 1997. Once again, the Company's hotels recorded significant improvements in comparable operating results; however, due to EITF 98-9, only minimum rent could be recorded. Specifically, hotels in New York City, Boston, Toronto and Atlanta reported significant improvements for the First Two Quarters 1998. Properties in Florida reported some temporary declines in operating results due to exceptionally poor weather in 1998. Minority Interest. Minority interest expense increased $4 million to $11 million for the First Two Quarters 1998, primarily reflecting improved lodging results. Corporate Expenses. Corporate expenses increased $2 million to $20 million for the First Two Quarters 1998 due to increased staffing levels and the impact of inflation. 150 Interest Expense. Interest expense decreased $5 million to $224 million in the First Two Quarters 1998, primarily due to the impact of principal amortization on the Company's mortgage debt. Interest Income. Interest income remained unchanged at $13 million for the First Two Quarters 1998 and 1997, respectively. Loss before Extraordinary Items. The loss before extraordinary items for the First Two Quarters 1998 was $158 million, compared to $167 million for the First Two Quarters 1997. 100% PARTICIPATION WITH NO NOTES ISSUED--1997 COMPARED TO 1996 (PRO FORMA) The following table presents the results of operations for the Company for 1997 and 1996 on a pro forma basis under the two pro forma scenarios: Revenues. Revenues increased $90 million, or 8.7%, to $1,120 million for 1997. The Company's revenue and operating profit were principally impacted by improved lodging results for its hotel properties, which led to a substantial increase in rental revenues. The 1997 results also included 52 weeks versus 53 weeks in 1996. Hotel sales increased $264 million, or 7.3%, to nearly $3.9 billion in 1997, reflecting the increases in REVPAR. Improved results for the Company's full- service hotels were driven by strong increases in REVPAR of 9.8% to $103.30 in 1997. Average room rates increased nearly 9%, while average occupancy increased slightly to 77.7%. Operating Costs and Expenses. Operating costs and expenses increased $11 million to $600 million for 1997. As a percentage of rental revenues, hotel operating costs and expenses decreased to 53% of rental revenues for 1997, from 56% of rental revenues for 1996, reflecting the impact of increased 1997 rental revenues on relatively fixed operating costs and expenses. Operating Profit. As a result of the changes in rental revenues and operating costs and expenses discussed above, the Company's operating profit increased $79 million, or 18%,to $520 million in 1997. Hotel operating profit increased $71 million, or 15%, to $530 million, or 47% of rental revenues, for 1997 compared to $459 million, or 44% of rental revenues, for 1996. In nearly all markets, the Company's hotels recorded improvements in comparable operating results. In particular, the Company's hotels in the Northeast, Mid- Atlantic and Pacific coast regions benefited from the upscale and luxury full- service room supply and demand imbalance. Hotels in New York City, Philadelphia, San Francisco/Silicon Valley and in Southern California performed particularly 151
100% PARTICIPATION WITH 100% PARTICIPATION WITH NO NOTES ISSUED NOTES ISSUED ------------------------ ------------------------ FISCAL YEAR FISCAL YEAR ------------------------ ------------------------ 1997 1996 1997 1996 ----------- ----------- ----------- ----------- (IN MILLIONS) Rental revenues........... $ 1,119 $ 1,036 $ 1,119 $ 1,036 Total revenues............ 1,120 1,030 1,120 1,030 Operating costs and expenses................. 600 589 598 587 Operating profit before minority interest, corporate expenses and interest expense......... 520 441 522 443 Minority interest......... (10) (9) (10) (9) Corporate expenses........ (44) (39) (44) (39) Interest expense.......... (468) (481) (485) (498) Interest income........... 27 27 27 27 ----------- ----------- ----------- ----------- Income (loss) before income taxes............. 25 (61) 10 (76) Benefit (provision) for income taxes............. (1) 3 (1) 4 ----------- ----------- ----------- ----------- Income (loss) before extraordinary items...... $ 24 $ (58) $ 9 $ (72) =========== =========== =========== =========== well. In 1998, the Company expects results to be strong in these markets and other gateway cities in which the Company owns hotels. In 1997, the Company's suburban Atlanta properties (three properties totaling 1,022 rooms) generally reported decreased results due to higher activity in 1996 related to the Summer Olympics and the impact of the additional supply added to the suburban areas. However, the majority of the Company's hotel rooms in Atlanta are in the core business districts in downtown and Buckhead where they realized strong year-over-year results and were only marginally impacted by the additional supply. Minority Interest. Minority interest expense increased $1 million to $10 million in 1997. Corporate Expenses. Corporate expenses increased $5 million to $44 million in 1997 due to increased staffing levels and the impact of inflation. Interest Expense. Interest expense decreased $13 million to $468 million in 1997, primarily due to the impact of principal amortization on the Company's mortgage debt. Interest Income. Interest income remained the same at $27 million for 1997, reflecting the interest income earned on the loan to the Non-Controlled Subsidiary for its acquisition of furniture and equipment, the working capital loan to Crestline, and a mortgage note on one property. Income (Loss) Before Extraordinary Items. Income before extraordinary items for 1997 was $24 million, compared to a $58 million loss before extraordinary items for 1996 as a result of the items discussed above. 100% PARTICIPATION WITH NOTES ISSUED--1997 COMPARED TO 1996 (PRO FORMA) Revenues. Revenues increased $90 million, or 8.7%, to $1,120 million for 1997. The Company's revenue and operating profit were principally impacted by improved lodging results for the Company's hotel properties, which led to a substantial increase in rental revenues. The 1997 results also included 52 weeks versus 53 weeks in 1996. Hotel sales increased $264 million, or 7.3%, to nearly $3.9 billion in 1997, reflecting increases in REVPAR. Improved results for the Company's full- service hotels were driven by strong increases in REVPAR of 9.8% to $103.30 in 1997. Average room rates increased nearly 9%, while average occupancy increased slightly to 77.7%. Operating Costs and Expenses. Operating costs and expenses increased $11 million to $598 million for 1997. As a percentage of rental revenues, hotel operating costs and expenses decreased to 52% of rental revenues for 1997, from 56% of rental revenues for 1996, reflecting the impact of increased 1997 rental revenues on relatively fixed operating costs and expenses. Operating Profit. As a result of the changes in rental revenues and operating costs and expenses discussed above, the Company's operating profit increased $79 million, or 18%, to $522 million in 1997. Hotel operating profit increased $71 million, or 15%, to $532 million, or 48% of rental revenues, for 1997 compared to $461 million, or 44% of rental revenues, for 1996. In nearly all markets, the Company's hotels recorded improvements in comparable operating results. In particular, the Company's hotels in the Northeast, Mid-Atlantic and Pacific coast regions benefited from the upscale and luxury full-service room supply and demand imbalance. Hotels in New York City, Philadelphia, San Francisco/Silicon Valley and in Southern California performed particularly well. In 1998, the Company expects results to be strong in these markets and other gateway cities in which the Company owns hotels. In 1997, the Company's suburban Atlanta properties (three properties totaling 1,022 rooms) generally reported decreased results due to higher activity in 1996 related to the Summer Olympics and the impact of the additional supply added to the suburban areas. However, the majority of the Company's hotel rooms in Atlanta are in the core business districts in downtown and Buckhead where they realized strong year-over-year results and were only marginally impacted by the additional supply. Minority Interest. Minority interest increased $1 million to $10 million for 1997. 152 Corporate Expenses. Corporate expenses increased $5 million to $44 million in 1997 due to increased staffing levels and the impact of inflation. Interest Expense. Interest expense decreased $13 million to $485 million in 1997, reflecting the impact of principal amortization on the Company's mortgage debt. Interest Income. Interest income remained unchanged at $27 million for 1997. Interest income includes the interest income earned on the loan to the Non- Controlled Subsidiary for its acquisition of furniture and equipment, the working capital loan to Crestline, and a mortgage note on one property. Income (Loss) Before Extraordinary Items. Income before extraordinary items for 1997 was $9 million, compared to a $72 million loss before extraordinary items for 1996 as a result of the items discussed above. LIQUIDITY AND CAPITAL RESOURCES Host funds its capital requirements with a combination of operating cash flow, debt and equity financing and proceeds from sales of selected properties and other assets. Host utilizes these sources of capital to acquire new properties, fund capital additions and improvements and make principal payments on debt. Capital Transactions. Host has recently substantially changed its debt financing through the following series of transactions which were intended to facilitate the consummation of the REIT Conversion. On April 20, 1998, Host and certain of its subsidiaries filed a shelf registration statement on Form S-3 (the "Shelf Registration") with the Securities and Exchange Commission for $2.5 billion in securities, which may include debt, equity or any combination thereof. Host anticipates that any net proceeds from the sale of offered securities will be used for refinancing of Host's indebtedness, for acquisitions and general corporate purposes. On August 5, 1998, HMH Properties, an indirect wholly owned subsidiary of Host, which owns 61 of Host's hotels, purchased substantially all of its (i) $600 million in 9 1/2% senior notes due 2005, (ii) $350 million in 9% senior notes due 2007 and (iii) $600 million in 8 7/8% senior notes due 2007 (collectively, the "Old Senior Notes"). Concurrently with each offer to purchase, HMH Properties solicited consents (the "1998 Consent Solicitations") from registered holders of the Old Senior Notes to certain amendments to eliminate or modify substantially all of the restrictive covenants and certain other provisions contained in the indentures pursuant to which the Old Senior Notes were issued. HMH Properties simultaneously utilized the Shelf Registration to issue an aggregate of $1.7 billion in New Senior Notes. The New Senior Notes were issued in two series, $500 million of 7 7/8% Series A notes due in 2005 and $1.2 billion of 7 7/8% Series B notes due in 2008. The 1998 Consent Solicitations facilitated the merger of HMC Capital Resources Holdings Corporation ("Capital Resources"), a wholly owned subsidiary of Host, with and into HMH Properties. Capital Resources, the owner of eight of Host's hotel properties, was the obligor under the $500 million revolving credit facility (the "Old Credit Facility"). The Operating Partnership will assume the New Senior Notes in connection with the REIT Conversion and the guarantee of Host is expected to terminate on the Effective Date. In conjunction with the issuance of the New Senior Notes, HMH Properties entered into the $1.25 billion New Credit Facility with a group of commercial banks. The New Credit Facility has an initial three-year term with two one- year extension options. Borrowings under the New Credit Facility generally bear interest at the Eurodollar rate plus 1.75%. The interest rate and commitment fee (currently 0.35%) on the unused portion of the New Credit Facility fluctuate based on certain financial ratios. The New Senior Notes and the New Credit Facility are guaranteed by Host and its wholly owned subsidiary, Host Marriott Hospitality, Inc., and certain subsidiaries of HMH Properties and are secured by pledges of equity interests in certain subsidiaries of HMH Properties. The New Credit Facility will be assumed by the Operating Partnership in connection with the REIT Conversion and the guarantee of Host is expected to terminate on the Effective Date. As of September 28, 1998, approximately $350 million was outstanding under the New Credit Facility. 153 The New Credit Facility and the indenture under which the New Senior Notes were issued contain covenants restricting the ability of HMH Properties and certain of its subsidiaries to incur indebtedness, grant liens on their assets, acquire or sell assets or make investments in other entities, and make distributions to equityholders of HMH Properties, Host, and (following the REIT Conversion) the Operating Partnership and Host REIT. The New Credit Facility and the New Senior Notes also contain certain financial covenants relating to, among other things, maintaining certain levels of tangible net worth and certain ratios of EBITDA to interest and fixed charges, total debt to EBITDA, unencumbered assets to unsecured debt, and secured debt to total debt. The New Credit Facility replaces Host's Old Credit Facility. The net proceeds from the offering and borrowings under the New Credit Facility were used by Host to purchase substantially all of the Existing Senior Notes, to repay amounts outstanding under the Existing Credit Facility and to make bond premium and consent payments totaling $178 million. These costs, along with the write-off of deferred financing fees of approximately $55 million related to the Existing Senior Notes and the Existing Credit Facility, will be recorded as a pre-tax extraordinary loss on the extinguishment of debt in the third quarter of 1998. In June 1997, HMC Capital Resources Corporation ("Capital Resources"), a wholly owned subsidiary of Host, entered into the Old Credit Facility with a group of commercial banks under which it may borrow up to $500 million for certain permitted uses. As a result of this transaction, Host terminated its line of credit with Marriott International. In July 1997, HMH Properties and HMC Acquisition Properties, Inc. ("Acquisitions"), indirect, wholly owned subsidiaries of Host, completed consent solicitations with holders of their senior notes (the "1997 Consent Solicitations") to amend certain provisions of their senior notes indentures. The 1997 Consent Solicitations facilitated the merger of Acquisitions with and into HMH Properties (the "HMH Properties Merger"). The amendments to the indentures also increased the ability of HMH Properties to acquire, through certain subsidiaries, additional properties subject to nonrecourse indebtedness and controlling interests in corporations, partnerships and other entities holding attractive properties and increased the threshold for distributions to affiliates to the excess of HMH Properties' earnings before interest expense, income taxes, depreciation and amortization and other non- cash items subsequent to the 1997 Consent Solicitations over 220% of HMH Properties' interest expense. HMH Properties paid dividends to Host of $54 million, $29 million and $36 million in 1997, 1996 and 1995, respectively, as permitted under the indentures. Concurrent with the 1997 Consent Solicitations and the HMH Properties Merger, HMH Properties issued an aggregate of $600 million of 8 7/8% senior notes at par with a maturity of July 2007. HMH Properties received net proceeds of approximately $570 million, net of the costs of the 1997 Consent Solicitations and the offering. In addition to the capital resources provided by its new debt financings, Host Marriott Financial Trust (the "Issuer"), a wholly owned subsidiary trust of Host, has outstanding 11 million shares of 6 3/4% convertible quarterly income preferred securities (the "Convertible Preferred Securities"), with a liquidation preference of $50 per share (for a total liquidation amount of $550 million) issued in December 1996. The Convertible Preferred Securities represent an undivided beneficial interest in the assets of the Issuer and, pursuant to various agreements entered into in connection with the transaction, are fully, irrevocably and unconditionally guaranteed by Host. Proceeds from the issuance of the Convertible Preferred Securities were invested in 6 3/4% Convertible Subordinated Debentures (the "Debentures") due December 2, 2026 issued by Host. The Issuer exists solely to issue the Convertible Preferred Securities and its own common securities (the "Common Securities") and invest the proceeds therefrom in the Debentures, which are its sole assets. Each of the Convertible Preferred Securities is convertible at the option of the holder into shares of Host common stock at the rate of 2.6876 shares per Convertible Preferred Security (equivalent to a conversion price of $18.604 per share of Host common stock). The Debentures are convertible at the option of the holders into shares of Company common stock at a conversion rate of 2.6876 shares for each $50 in principal amount of Debentures. The conversion rate is subject to adjustments in certain events, including (i) payment of dividends (and other distributions) on Host common stock by Host in shares of Host common stock; (ii) distributions to all holders of Host common stock of rights or warrants entitling such holders (for a period not to exceed 45 days) to subscribe for or purchase Host common 154 stock at an exercise price less than the market price of Host common stock; (iii) subdivisions and combinations of Host common stock; (iv) payment of dividends (and other distributions) on Host common stock consisting of indebtedness of Host, capital stock or other securities, assets or cash (other than certain cash dividends at an annualized rate of up to 12.5% of the market price of Host common stock); (v) payments for Host common stock by Host or any of its subsidiaries in respect of a tender or exchange offer (other than an odd-lot offer) at a price per share in excess of 110% of the market price of Host common stock; (vi) consummation by Host of certain mergers, a consolidation, a sale of all or substantially all of its assets, a recapitalization or certain reclassifications of Host common stock. The distribution of the capital stock of Crestline to all holders of Host REIT common stock would, and certain other elements of the REIT Conversion (such as other distributions of Host's accumulated earnings and profits) may, result in an adjustment to the conversion price of the Debentures. The Issuer will only convert Debentures pursuant to a notice of conversion by a holder of Convertible Preferred Securities. During 1997 and 1996, no shares were converted into common stock. Holders of the Convertible Preferred Securities are entitled to receive preferential cumulative cash distributions at an annual rate of 6 3/4% accruing from the original issue date, commencing March 1, 1997, and payable quarterly in arrears thereafter. The distribution rate and the distribution and other payment dates for the Convertible Preferred Securities will correspond to the interest rate and interest and other payment dates on the Debentures. Host may defer interest payments on the Debentures for a period not to exceed 20 consecutive quarters. If interest payments on the Debentures are deferred, so too are payments on the Convertible Preferred Securities. Under this circumstance, Host will not be permitted to declare or pay any cash distributions with respect to its capital stock or debt securities that rank pari passu with or junior to the Debentures. Subject to certain restrictions, the Convertible Preferred Securities are redeemable at the Issuer's option upon any redemption by Host of the Debentures after December 2, 1999. Upon repayment at maturity or as a result of the acceleration of the Debentures upon the occurrence of a default, the Debentures shall be subject to mandatory redemption, from which the proceeds will be applied to redeem Convertible Preferred Securities and Common Securities, together with accrued and unpaid distributions. In connection with consummation of the REIT Conversion, the Company will assume primary liability for repayment of the convertible debentures of Host underlying the Convertible Preferred Securities. Upon conversion by a Convertible Preferred Securities holder, the Company will purchase Common Shares from Host REIT in exchange for a like number of OP Units and distribute the Common Shares to the Convertible Preferred Securities holder. In March 1996, Host completed the issuance of 31.6 million shares of common stock for net proceeds of nearly $400 million. In December 1995, Acquisitions issued $350 million of 9% senior notes (the "Acquisitions Notes"). The Acquisitions Notes were issued at par and have a final maturity of December 2007. The net proceeds totaled $340 million and were utilized to repay in full the outstanding borrowings of $210 million under Acquisitions' $230 million revolving credit facility (the "Revolver"), which was then terminated to acquire three full-service properties and to finance future acquisitions of full-service hotel properties with the remaining proceeds. In May 1995, two wholly owned subsidiaries of Host Marriott Hospitality, Inc. ("Hospitality"), a wholly owned subsidiary of Host, issued an aggregate of $1 billion of 9.5% senior secured notes in two concurrent offerings. HMH Properties and Host Marriott Travel Plazas, Inc. ("HMTP"), the operator/manager of HM Services' food, beverage and merchandise concessions business, issued $600 million and $400 million, respectively, of senior notes. The net proceeds of approximately $971 million were used to defease, and subsequently redeem, all of Hospitality's remaining bonds and to repay borrowings under the line of credit with Marriott International. The HMTP senior notes were included in the HM Services' special dividend. During 1995, Host replaced its line of credit with a line of credit from Marriott International pursuant to which Host had the right to borrow up to $225 million. The line of credit with Marriott International was terminated as a result of the Capital Resources transaction discussed above. 155 Asset Dispositions. Host historically has sold, and may from time to time in the future consider opportunities to sell, certain of its real estate properties at attractive prices when the proceeds could be redeployed into investments with more favorable returns. During the second quarter of 1998, Host sold the 662-room New York Marriott East Side for proceeds of $191 million and recorded a pre-tax gain of approximately $40 million and the Napa Valley Marriott for proceeds of $21 million and recorded a pre-tax gain of approximately $10 million. During 1997, Host sold the 255-room Sheraton Elk Grove Suites for proceeds of approximately $16 million. Host also sold 90% of its 174-acre parcel of undeveloped land in Germantown, Maryland, for approximately $11 million, which approximated its carrying value. During the first and second quarters of 1996, 16 of the Host's Courtyard properties and 18 of the Host's Residence Inn properties were sold (subject to a leaseback) to Hospitality Properties Trust for approximately $314 million and Host will receive approximately $35 million upon expiration of the leases. A gain on the transactions of approximately $46 million was deferred and is being amortized over the initial term of the leases. During the first and third quarters of 1995, 37 of Host's Courtyard properties were sold to and leased back from Hospitality Properties Trust for approximately $330 million. Host received net proceeds from the two 1995 transactions of approximately $297 million and will receive approximately $33 million upon expiration of the leases. A deferred gain of $14 million on the sale/leaseback transactions is being amortized over the initial term of the leases. In 1995, Host also sold its four remaining Fairfield Inns for net cash proceeds of approximately $6 million, which approximated their carrying value. In cases where Host has made a decision to dispose of particular properties, Host assesses impairment of each individual property to be sold on the basis of expected sales price less estimated costs of disposal. Otherwise, Host assesses impairment of its real estate properties based on whether it is probable that undiscounted future cash flows from such properties will be less than their net book value. If a property is impaired, its basis is adjusted to its fair market value. In the second quarter of 1995, Host made a determination that its owned Courtyard and Residence Inn properties were held for sale and recorded a $10 million charge to write down the carrying value of five individual Courtyard and Residence Inn properties to their estimated net sales values. Capital Acquisitions, Additions and Improvements. Host seeks to grow primarily through opportunistic acquisitions of full-service hotels. Host believes that the upscale and luxury full-service hotel segments of the market offer opportunities to acquire assets at attractive multiples of cash flow and at discounts to replacement value, including under performing hotels which can be improved by conversion to the Marriott or Ritz-Carlton brands. During 1997, Host acquired eight full-service hotels (3,600 rooms) and controlling interests in nine additional full-service hotels (5,024 rooms) for an aggregate purchase price of approximately $766 million (including the assumption of approximately $418 million of debt). Host also completed the acquisition of the 504-room New York Marriott Financial Center, after acquiring the mortgage on the hotel for $101 million in late 1996. During 1996, Host acquired six full-service hotels (1,964 rooms) for an aggregate purchase price of $189 million and controlling interests in 17 additional full-service properties (8,917 rooms) for an aggregate purchase price of approximately $1.1 billion (including the assumption of $696 million of debt). During 1995, Host acquired nine hotels totaling approximately 3,900 rooms in separate transactions for approximately $390 million ($141 million of which was financed through first mortgage financing on four of the hotels). In the first quarter of 1998, Host acquired a controlling interest in the partnership that owns the 1,671-room Atlanta Marriott Marquis Hotel for $239 million, including the assumption of $164 million of mortgage debt. Host also acquired a controlling interest in the partnership that owns the 359-room Albany Marriott, the 350-room San Diego Marriott Mission Valley and the 320- room Minneapolis Marriott Southwest for approximately $50 million. In the second quarter of 1998, the Company acquired the 289-room Park Ridge Marriott for $24 million and acquired the 281-room Ritz-Carlton, Phoenix for $75 million. Host is continually engaged in discussions with respect to other potential acquisition properties. In addition, Host acquired the 397-room Ritz-Carlton, Tysons Corner, Virginia and the 487-room Torrance Marriott near Los Angeles, California. In the third quarter of 1998, Host acquired the 308- room Ritz-Carlton, Dearborn for approximately $65 million, the 156 336-room Ritz-Carlton, San Francisco for approximately $161 million and the 404-room Memphis Marriott (which was converted to the Marriott brand upon acquisition) for approximately $16 million. On April 17, 1998, Host announced that it had reached a definitive agreement with the Blackstone Entities to acquire interests in twelve world-class luxury hotels and certain other assets. If the Blackstone Acquisition is consummated, the Operating Partnership expects to pay approximately $862 million in cash and assumed debt and to issue approximately 43.7 million OP Units (based upon a negotiated value of $20.00 per OP Unit) and other consideration. The Blackstone portfolio consists of two Ritz-Carltons, two Four Seasons, one Grand Hyatt, three Hyatt Regencies and four Swissotel properties and the mortgage on a third Four Seasons. These hotels are located in major urban and convention/resort markets with significant barriers to new competition. The Blackstone Acquisition is expected to close as part of, and is contingent upon, the REIT Conversion. At that time, the Blackstone hotels and other assets will be acquired by the Company. The hotels will be leased to Lessees and will be managed on behalf of the Lessees under their existing management contracts. Under the terms of its hotel management agreements, Host is generally required to spend approximately 5% of gross hotel sales to cover the capital needs of the properties, including major guest room and common area renovations which occur every five to six years. Host completed the construction of the 1,200-room Philadelphia Marriott, which opened on January 27, 1995. The construction costs of this hotel were funded 60% through a loan from Marriott International which was repaid in the fourth quarter of 1996. In March 1997, Host obtained a $90 million mortgage which bears interest at a fixed rate of 8.49% and matures in 2009. Construction of a second hotel in Philadelphia, the 419-room Philadelphia Airport Marriott (the "Airport Hotel"), was completed and opened on November 1, 1995. The Airport Hotel was financed principally with $40 million of proceeds from an industrial development bond financing. Host also completed construction of a 300-room Residence Inn in Arlington, Virginia, which opened in March 1996. Capital expenditures for these three hotels totaled $11 million in 1996 and $64 million in 1995. In November 1997, Host announced that it had committed to develop and construct the 717-room Tampa Convention Center Marriott for a cost estimated at approximately $88 million, net of an approximate $16 million subsidy provided by the City of Tampa. Host may also expand certain existing hotel properties where strong performance and market demand exists. Expansions to existing properties creates a lower risk to Host as the success of the market is generally known and development time is significantly shorter than new construction. Host recently committed to add approximately 500 rooms and an additional 15,000 square feet of meeting space to the 1,503-room Marriott's Orlando World Center. In 1997, Host acquired the outstanding common stock of the Forum Group from Marriott Senior Living Services, Inc. ("MSLS"), a subsidiary of Marriott International. Host purchased the Forum Group portfolio of 29 senior living communities for approximately $460 million, including approximately $270 million in debt. The properties will continue to be operated by MSLS. In addition, Host plans to add approximately 1,060 units to these communities for approximately $107 million through a expansion plan which will be completed in 1999. In 1997, approximately $56 million (549 units) of the expansion plan had been completed (including $33 million of debt financing provided by Marriott International). Host also acquired 49% of the remaining 50% interest in the venture which owned the 418-unit Leisure Park senior living community from Marriott International for approximately $23 million, including approximately $15 million of debt. During the first quarter of 1998, Host acquired the Gables at Winchester in suburban Boston, a 124-unit senior living community, for $21 million and entered into conditional purchase agreements to acquire two Marriott Brighton Gardens assisted living communities from the Summit Companies of Denver, Colorado. After the anticipated completion of construction in the first quarter of 1999, Host may acquire these two 160-unit properties located in Denver and Colorado Springs, Colorado, for $35 million, if they achieve certain operating 157 performance criteria. All three of these communities will be operated by MSLS under long-term operating agreements. Under the terms of its senior living communities' management agreements, Host is generally required to spend an amount of gross revenues to cover certain routine repairs and maintenance and replacements and renewals to the communities' property and improvements. The amount Host is required to spend will be 2.65% through fiscal year 2002, 2.85% for fiscal years 2003 through 2007, and 3.5% thereafter. Host anticipates spending approximately $6 million in 1998. As part of the Initial E&P Distribution, Host REIT and the Operating Partnership will distribute shares of Crestline common stock (which will own the Forum Group portfolio and other senior living communities described above) to Host REIT's shareholders and the Blackstone Entities. Debt Payments. At January 2, 1998, Host and its subsidiaries had $1,585 million of senior notes, approximately $2.0 billion of non-recourse mortgage debt secured by real estate assets and approximately $219 million of unsecured and other debt. Scheduled maturities over the next five years were $942 million as of January 2, 1998, a significant portion of which represents the maturity of the mortgage on the New York Marriott Marquis of approximately $270 million in December 1998. Management anticipates that the mortgage will be refinanced by the end of 1998 on comparable terms. Host's interest coverage, defined as EBITDA divided by cash interest expense, improved to nearly 2.5 times in 1997 from 2.0 times in 1996. At January 2, 1998, Host was party to an interest rate exchange agreement with a financial institution (the contracting party) with an aggregate notional amount of $100 million. Under this agreement, Host collects interest based on specified floating interest rates of one month LIBOR (rate of 6% at January 2, 1998) and pays interest at fixed rates (rate of 7.99% at January 2, 1998). This agreement expires in 1998, in conjunction with the maturity of the mortgage on the New York Marriott Marquis. Also in 1997, Host was party to two additional interest rate swap agreements with an aggregate notional amount of $400 million. These agreements expired in May 1997. Host realized a net reduction of interest expense of $1 million in 1997, $6 million in 1996 and $5 million in 1995 related to interest rate exchange agreements. Host monitors the creditworthiness of its contracting parties by evaluating credit exposure and referring to the ratings of widely accepted credit rating services. The Standard and Poors' long-term debt ratings for the contracting party is A- for its sole outstanding interest rate exchange agreement. Host is exposed to credit loss in the event of non-performance by the contracting party to the interest rate swap agreement; however, Host does not anticipate non- performance by the contracting party. Cash Flows. Host's cash flow from continuing operations in 1997, 1996 and 1995 totaled $464 million, $205 million and $110 million, respectively. Cash flow from operations in the First Two Quarters 1998 and First Two Quarters 1997 totaled $206 million and $193 million, respectively. Cash flow from operations increased principally due to improved lodging results and the significant acquisitions of hotels. Host's cash used in investing activities from continuing operations in 1997, 1996 and 1995 totaled $1,046 million, $504 million and $156 million, respectively. Cash used in investing activities was $49 million and $200 million for the First Two Quarters 1998 and the First Two Quarters 1997, respectively. Cash from investing activities primarily consists of net proceeds from the sales of certain assets, offset by the acquisition of hotels and other capital expenditures previously discussed, as well as the purchases and sales of short-term marketable securities. Cash used in investing activities was significantly impacted by the purchase of $354 million of short-term marketable securities in 1997 and the net sale of $308 million of short-term marketable securities in the First Two Quarters 1998. Host's cash from financing activities from continuing operations was $389 million for 1997, $806 million for 1996 and $204 million for 1995. Cash used in financing activities was $213 million and $188 million, respectively, for the First Two Quarters 1998 and First Two Quarters 1997. Host's cash from financing activities 158 primarily consists of the proceeds from debt and equity offerings, the issuance of the Convertible Preferred Securities, mortgage financing on certain acquired hotels and borrowings under the Line of Credit, offset by redemptions and payments on senior notes, prepayments on certain hotel mortgages and other scheduled principal payments. The ratio of earnings to fixed charges was 2.0 to 1.0, 1.5 to 1.0, 1.3 to 1.0, 1.0 to 1.0 and .7 to 1.0 for the First Two Quarters 1998, the First Two Quarters 1997, 1997, 1996 and 1995, respectively. The deficiency of earnings to fixed charges of $70 million for 1995 is largely the result of depreciation and amortization of $122 million. In addition, the deficiency for 1995 was impacted by the $60 million pre-tax charge to write down the carrying value of one undeveloped land parcel to its estimated sales value. Comparative FFO. Host believes that Comparative Funds From Operations ("Comparative FFO," which represents Funds From Operations, as defined by NAREIT, plus deferred tax expense) is a meaningful disclosure that will help the investment community to better understand the financial performance of Host, including enabling its shareholders and analysts to more easily compare Host's performance to REITs. FFO is defined by NAREIT as net income computed in accordance with GAAP, excluding gains or losses from debt restructurings and sales of properties, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. FFO should not be considered as an alternative to net income, operating profit, cash flows from operations or any other operating or liquidity performance measure prescribed by GAAP. FFO is also not an indicator of funds available to fund Host's cash needs, including its ability to make distributions. Host's method of calculating FFO may be different from methods used by other REITs and, accordingly, is not comparable to such other REITs. Comparative FFO increased $61 million, or 42%, to $206 million in the First Two Quarters 1998. Comparative FFO increased $131 million, or 80%, to $295 million in 1997. The following is a reconciliation of Host's income (loss) before extraordinary items to Comparative FFO (in millions): The Company considers Comparative FFO to be an indicative measure of Host's operating performance due to the significance of Host's long-lived assets and because such data is considered useful by the investment community to better understand Host's results, and can be used to measure Host's ability to service debt, fund capital expenditures and expand its business; however, such information should not be considered as an alternative to net income, operating profit, cash from operations or any other operating or liquidity performance measure prescribed by generally accepted accounting principles. Cash expenditures for various long-term assets and income taxes have been, and will be, incurred which are not reflected in the Comparative FFO presentation. Partnership Activities. Host has general and limited partner interests in numerous limited partnerships which own 240 hotels (including 20 full-service hotels) as of the date hereof, managed by Marriott International. Debt of the hotel limited partnerships is typically secured by first mortgages on the properties and is generally nonrecourse to the partnership and the partners. However, Host has committed to advance amounts to certain affiliated limited partnerships, if necessary, to cover certain future debt service requirements. Such commitments were limited, in the aggregate, to an additional $60 million at January 2, 1998. Subsequent to year-end, this amount was reduced to $20 million in connection with the refinancing and acquisition of a controlling interest in 159
FIRST TWO QUARTERS FISCAL YEAR -------------- ------------ 1998 1997 1997 1996 ------ ------ ----- ----- Income (loss) before extraordinary items...... $ 96 $ 32 $ 47 $ (13) Real estate related depreciation and amortization................................. 125 101 240 168 Other real estate activities.................. (52) 2 6 7 Partnership adjustments....................... (8) -- (13) 1 REIT Conversion expenses...................... 6 -- -- -- Deferred taxes................................ 39 10 15 1 ------ ------ ----- ----- Comparative FFO............................. $ 206 $ 145 $ 295 $ 164 ====== ====== ===== ===== the partnership which owns the Atlanta Marriott Marquis. Amounts repaid to the Company under these guarantees totaled $2 million and $13 million in 1997 and 1996, respectively. Fundings by Host under these guarantees amounted to $10 million in 1997 and $8 million in 1995. Leases. Host leases certain property and equipment under noncancelable operating leases, including the long-term ground leases for certain hotels, generally with multiple renewal options. The leases related to the 53 Courtyard properties and 18 Residence Inn properties sold during 1995 and 1996 are nonrecourse to Host and contain provisions for the payment of contingent rentals based on a percentage of sales in excess of stipulated amounts. Host remains contingently liable on certain leases related to divested non-lodging properties. Such contingent liabilities aggregated $110 million at January 2, 1998. However, management considers the likelihood of any substantial funding related to these divested properties' leases to be remote. Inflation. Host's hotel lodging properties are impacted by inflation through its effect on increasing costs and on the managers' ability to increase room rates. Unlike other real estate, hotels have the ability to change room rates on a daily basis, so the impact of higher inflation generally can be passed on to customers. A substantial portion of Host's debt bears interest at fixed rates. This debt structure largely mitigates the impact of changes in the rate of inflation on future interest costs. However, Host currently is exposed to variable interest rates through an interest rate exchange agreement with a financial institution with an aggregate notional amount of $100 million. Under this agreement, Host collects interest based on the specified floating rates of one month LIBOR (rate of 6% at January 2, 1998) and pays interest at fixed rates (rate of 7.99% at January 2, 1998). This agreement expires in 1998 in conjunction with the maturity of the mortgage on the New York Marriott Marquis. Host's Line of Credit and the mortgage on the San Diego Marriott Hotel and Marina ($199 million at January 2, 1998) bears interest based on variable rates. Accordingly, the amount of Host's interest expense under the interest rate swap agreements and the floating rate debt for a particular year will be affected by changes in short-term interest rates. Year 2000 Issues. Over the last few years, Host has invested in implementing new accounting systems which are Year 2000 compliant. Accordingly, Host believes that future costs associated with Year 2000 issues will be minimal and not material to Host's consolidated financial statements. However, Host does rely upon accounting software used by the managers and operators of its properties to obtain financial information. Management believes that the managers and operators have begun to implement changes to the property specific software to ensure that software will function properly in the Year 2000 and does not expect to incur significant costs related to these modifications. Accounting Standards. Host adopted Statements of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan" and SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" during 1995. Adoption of these statements did not have a material effect on Host's continuing operations. See the discussion below for a discussion of the impact of the adoption of SFAS No. 121 on discontinued operations. SFAS No. 121 requires that an impairment loss be recognized when the carrying amount of an asset exceeds the sum of the undiscounted estimated future cash flows associated with the asset. Under SFAS No. 121, Host reviewed the impairment of its assets employed in its operating group business lines (airport, toll plaza and sports and entertainment) on an individual operating unit basis. For each individual operating unit determined to be impaired, an impairment loss equal to the difference between the carrying value and the fair market value of the unit's assets was recognized. Fair market value was estimated to be the present value of expected future cash flows of the individual operating unit, as determined by management, after considering such factors as future air travel and toll-pay vehicle data and inflation. As a result of the adoption of SFAS No. 121, Host recognized a non-cash, pre-tax charge against earnings during the fourth quarter of 1995 of $47 million, which was reflected in discontinued operations. 160 In the fourth quarter of 1996, the Company adopted SFAS No. 123, "Accounting for Stock Based Compensation." The adoption of SFAS No. 123 did not have a material effect on Host's financial statements. During 1997, Host adopted SFAS No. 128, "Earnings Per Share," SFAS No. 129, "Disclosure of Information About Capital Structure" and SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." The adoption of these statements did not have a material effect on Host's consolidated financial statements and the appropriate disclosures required by these statements have been incorporated herein. In the First Quarter 1998, Host adopted SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in financial statements. The objective of SFAS No. 130 is to report a measure of all changes in equity of an enterprise that result from transactions and other economic events of the period other than transactions with owners. Comprehensive income is the total of net income and all other nonowner changes in equity. Host's only component of other comprehensive income is the right to receive up to 1.4 million shares of Host Marriott Services Corporation's common stock or an equivalent cash value subsequent to exercise of the options held by certain former and current employees of Marriott International. For the First Two Quarters 1998 and First Two Quarters 1997, Host's other comprehensive income was $1 million and $3 million, respectively. As of June 19, 1998 and January 2, 1998, Host's accumulated other comprehensive income was approximately $11 million and $10 million, respectively. On November 20, 1997, the Emerging Issues Task Force ("EITF") of the Financial Accounting Standards Board reached a consensus on EITF 97-2, "Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician Practice Management Entities and Certain Other Entities with Contractual Management Arrangements." EITF 97-2 addresses the circumstances in which a management entity may include the revenues and expenses of a managed entity in its financial statements. Host has considered the impact of EITF 97-2 on its financial statements and has determined that EITF 97-2 requires the Company to include property-level sales and operating expenses of its hotels and senior living communities in its statements of operations. Host will adopt EITF 97-2 in the fourth quarter of 1998, with retroactive effect in prior periods to conform to the new presentation. Application of EITF 97-2 to the consolidated financial statements for the First Two Quarters 1998, First Two Quarters 1997 and Fiscal Years 1997, 1996 and 1995 would have increased both revenues and operating expenses by approximately $922 million, $745 million, $1,713 million, $1,225 million and $878 million, respectively, and would have had no impact on operating profit, net income or earnings per share. EITF 98-9, "Accounting for Contingent Rent in Interim Financial Periods", was issued on May 21, 1998. EITF 98-9 requires a lessor to defer recognition of contingent rental income in interim periods until the specified target that triggers the contingent rental income is achieved. EITF 98-9 has no impact on Host prior to the REIT Conversion, but will impact the revenue recognized under the Leases on a quarterly basis following the REIT Conversion. 161 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS OF HOST REIT The following table sets forth certain information with respect to persons who will be Directors immediately after the completion of the REIT Conversion, and the executive officers of Host REIT (or the Operating Partnership), all of whom are currently directors, executive officers or key employees of Host. - -------- (1) Richard E. Marriott and J.W. Marriott, Jr. are brothers. The following is a biographical summary of the experience of the persons who will be Directors and executive officers of Host REIT after the REIT Conversion: Richard E. Marriott. Mr. Richard E. Marriott has been a Director of Host since 1979 and is a Director of Marriott International, Inc., Host Marriott Services Corporation, Potomac Electric Power Company and the Polynesian Cultural Center, and he is Chairman of the Board of First Media Corporation. He also serves as a Director of certain subsidiaries of Host and is a past President of the National Restaurant Association. In addition, Mr. Marriott is the President and a Trustee of the Marriott Foundation for People with Disabilities. Mr. Marriott's term as a Director of Host REIT will commence at or prior to the REIT Conversion and will expire at the 2001 annual meeting of shareholders. Mr. Marriott joined Host in 1965 and has served in various executive capacities. In 1984, he was elected Executive Vice President, and in 1986, he was elected Vice Chairman of the Board of Directors. In 1993, Mr. Marriott was elected Chairman of the Board. Mr. Marriott also has been responsible for management of Host's government affairs functions. J.W. Marriott, Jr. Mr. J.W. Marriott, Jr. has been a Director of Host since 1964 and is Chairman of the Board and Chief Executive Officer of Marriott International, Inc., and a Director of Host Marriott Services Corporation, General Motors Corporation and the U.S.-Russia Business Council. He also serves on the Boards of Trustees of the Mayo Foundation, Georgetown University and the National Geographic Society. He is on the President's Advisory Committee of the American Red Cross, the Executive Committee of the World Travel & Tourism Council and is a member of the Business Council and the Business Roundtable. Mr. Marriott's term as a Director of Host REIT will commence at or prior to the REIT Conversion and will expire at the 1999 annual meeting of shareholders. R. Theodore Ammon. Mr. Ammon has been a Director of Host since 1992 and is a private investor and Chairman of Big Flower Holdings, Inc. He was formerly a General Partner of Kohlberg Kravis Roberts & Company (a New York and San Francisco-based investment firm) from 1990 to 1992, and was an executive of such firm prior to 1990. Mr. Ammon is also a member of the Board of Directors of Samsonite Corporation and Culligan Water Technologies, Inc. In addition, he serves on the Board of Directors of the New York YMCA, Jazz @ Lincoln Center and the Institute of International Education and on the Board of Trustees of Bucknell University. Mr. Ammon's term as a Director of Host REIT will commence at or prior to the REIT Conversion and will expire at the 2001 annual meeting of shareholders. 162
NAME AGE POSITION WITH HOST REIT (OR THE OPERATING PARTNERSHIP) ---- --- ------------------------------------------------------ Richard E. Marriott(1).. 59 Chairman of the Board of Directors J.W. Marriott, Jr.(1)... 66 Director R. Theodore Ammon....... 48 Director Robert M. Baylis........ 59 Director Ann Dore McLaughlin..... 56 Director Harry L. Vincent, Jr.... 78 Director John G. Schreiber....... 51 Director Terence C. Golden....... 53 Director, President and Chief Executive Officer Robert E. Parsons, Jr. ................... 42 Executive Vice President and Chief Financial Officer Christopher J. Nassetta............... 36 Executive Vice President and Chief Operating Officer Christopher G. Townsend............... 50 Senior Vice President, General Counsel and Corporate Secretary Donald D. Olinger....... 39 Senior Vice President and Corporate Controller Robert M. Baylis. Mr. Baylis has been a Director of Host since 1996 and is a Director of The International Forum, an executive education program of the Wharton School of the University of Pennsylvania. He was formerly Vice Chairman of CS First Boston. Mr. Baylis also serves as a Director of New York Life Insurance Company, Covance, Inc. and Gryphon Holdings, Inc. In addition, he is an overseer of the University of Pennsylvania Museum of Archeology and Anthropology. Mr. Baylis's term as a Director of Host REIT will commence at or prior to the REIT Conversion and will expire at the 2000 annual meeting of shareholders. Ann Dore McLaughlin. Ms. McLaughlin has been a Director of Host since 1993 and currently is Chairman of the Aspen Institute. She formerly served as President of the Federal City Council from 1990 until 1995. Ms. McLaughlin has served with distinction in several U.S. Administrations in such positions as Secretary of Labor and Under Secretary of the Department of the Interior. She also serves as a Director of AMR Corporation, Fannie Mae, General Motors Corporation, Kellogg Company, Nordstrom, Potomac Electric Power Company, Union Camp Corporation, Donna Karan International, Inc., Vulcan Materials Company, Harman International Industries, Inc. and Sedgwick Group plc. Ms. McLaughlin's term as a Director of Host REIT will commence at or prior to the REIT Conversion and will expire at the 2000 annual meeting of shareholders. Harry L. Vincent, Jr. Mr. Vincent has been a Director of Host since 1969 and is a retired Vice Chairman of Booz-Allen & Hamilton, Inc. He also served as a Director of Signet Banking Corporation from 1973 until 1989. Mr. Vincent's term as a Director of Host REIT will commence at or prior to the REIT Conversion and will expire at the 1999 annual meeting of shareholders. John G. Schreiber. Mr. Schreiber has been a Director of Host since 1998 and is President of Schreiber Investments, Inc. and a Senior Advisor and Partner of Blackstone Real Estate Advisors, L.P. Mr. Schreiber serves as a Trustee of AMLI Residential Properties Trust and as a Director of Urban Shopping Centers, Inc., JMB Realty Corporation and a number of mutual funds advised by T. Rowe Price Associates, Inc. Prior to his retirement as an officer of JMB Realty Corporation in 1990, Mr. Schreiber was Chairman and CEO of JMB/Urban Development Company and an Executive Vice President of JMB Realty Corporation. Mr. Schreiber's term as a Director of Host REIT will commence at or prior to the REIT Conversion and will expire at the 1999 annual meeting of shareholders. Terence C. Golden. Mr. Golden has been a Director of Host since 1995 and was named President and Chief Executive Officer of Host in 1995. Mr. Golden also serves as a Director of certain subsidiaries of Host. He also serves as Chairman of Bailey Realty Corporation and Bailey Capital Corporation and various affiliated companies. In addition, Mr. Golden is Chairman of the Washington Convention Center and a Director of Prime Retail, Inc., Cousins Properties, Inc., The Morris and Gwendolyn Cafritz Foundation and the District of Columbia Early Childhood Collaborative. He is also a member of the Executive Committee of the Federal City Council. Mr. Golden will be President and Chief Executive Officer of Host REIT commencing at or prior to the REIT Conversion and his term as a Director of Host REIT will commence at or prior to the REIT Conversion and will expire at the 2000 annual meeting of shareholders. Prior to joining Host, Mr. Golden was Chairman of Bailey Realty Corporation and prior to that had served as Chief Financial Officer of The Oliver Carr Company. Before joining The Oliver Carr Company, he served as Administrator of the General Services Administration and as Assistant Secretary of Treasury, and he was co-founder and national managing partner of Trammel Crow Residential Companies. Robert E. Parsons, Jr. Mr. Parsons joined Host's Corporate Financial Planning staff in 1981 and was made Assistant Treasurer in 1988. In 1993, Mr. Parsons was elected Senior Vice President and Treasurer of Host, and in 1995, he was elected Executive Vice President and Chief Financial Officer of Host. Since September 1998, Mr. Parsons has been President and an initial Director of Host REIT but he will resign from such positions upon or prior to the REIT Conversion. Mr. Parsons will be Executive Vice President and Chief Financial Officer of Host REIT commencing at or prior to the REIT Conversion. Christopher J. Nassetta. Mr. Nassetta joined Host in October 1995 as Executive Vice President and was elected Chief Operating Officer of Host in 1997. Mr. Nassetta will be Executive Vice President and Chief 163 Operating Officer of Host REIT commencing at or prior to the REIT Conversion. Prior to joining Host, Mr. Nassetta served as President of Bailey Realty Corporation from 1991 until 1995. He had previously served as Chief Development Officer and in various other positions with The Oliver Carr Company from 1984 through 1991. Christopher G. Townsend. Mr. Townsend joined Host's Law Department in 1982 as a Senior Attorney. In 1984, Mr. Townsend was made Assistant Secretary of Host, and in 1986, he was made Assistant General Counsel. In 1993, Mr. Townsend was elected Senior Vice President, Corporate Secretary and Deputy General Counsel. In January 1997, he was elected General Counsel. Since September 1998, Mr. Townsend has been Vice President and an initial Director of Host REIT but he will resign from such positions upon or prior to the REIT Conversion. Mr. Townsend will be Senior Vice President, General Counsel and Secretary of Host REIT commencing at or prior to the REIT Conversion. Donald D. Olinger. Mr. Olinger joined Host in 1993 as Director--Corporate Accounting. Later in 1993, Mr. Olinger was promoted to Senior Director and Assistant Controller. He was promoted to Vice President-- Corporate Accounting in 1995. In 1996, he was elected Senior Vice President and Corporate Controller. Since September 1998, Mr. Olinger has been Vice President of Host REIT but he will resign from such position at or prior to the REIT Conversion. Mr. Olinger will be Senior Vice President and Corporate Controller of Host REIT commencing at or prior to the REIT Conversion. Prior to joining Host, Mr. Olinger was with the public accounting firm of Deloitte & Touche. COMMITTEES OF THE BOARD OF DIRECTORS Promptly following the consummation of the REIT Conversion, the Board of Directors of Host REIT will establish the following committees: Audit Committee. The Audit Committee will be comprised of five Directors who are not employees of Host REIT, namely, R. Theodore Ammon (Chair), Harry L. Vincent, Jr., Ann Dore McLaughlin, John G. Schreiber and Robert M. Baylis. The Audit Committee will meet at least three times a year with the independent auditors, management representatives and internal auditors; recommend to the Board of Directors appointment of independent auditors; approve the scope of audits and other services to be performed by the independent and internal auditors; consider whether the performance of any professional service by the auditors other than services provided in connection with the audit function could impair the independence of the outside auditors; and review the results of internal and external audits, the accounting principles applied in financial reporting, and financial and operational controls. Compensation Policy Committee. The Compensation Policy Committee will be comprised of six Directors who are not employees of Host REIT, namely, Harry L. Vincent, Jr. (Chair), R. Theodore Ammon, John G. Schreiber, Robert M. Baylis, J.W. Marriott, Jr. and Ann Dore McLaughlin. The Compensation Policy Committee's functions will include recommendations on policies and procedures relating to senior officers' compensation and various employee stock plans, and approval of individual salary adjustments and stock awards in those areas. Nominating and Corporate Governance Committee. The Nominating and Corporate Governance Committee will be comprised of six Directors who are not employees of Host REIT, namely, Ann Dore McLaughlin (Chair), Harry L. Vincent, Jr., John G. Schreiber, R. Theodore Ammon, J.W. Marriott, Jr. and Robert M. Baylis. It will consider candidates for election as Directors and will be responsible for keeping abreast of and making recommendations with regard to corporate governance in general. In addition, the Nominating and Corporate Governance Committee will fulfill an advisory function with respect to a range of matters affecting the Board of Directors and its Committees, including the making of recommendations with respect to qualifications of Director candidates, compensation of Directors, the selection of committee chairs, committee assignments and related matters affecting the functioning of the Board. 164 Host REIT may from time to time form other committees as circumstances warrant. Such committees will have authority and responsibility as delegated by the Board of Directors. COMPENSATION OF DIRECTORS Directors who are also officers of Host REIT will receive no additional compensation for their services as Directors. Directors elected by the holders of Common Shares and who are not officers will receive an annual retainer fee of $25,000 as well as an attendance fee of $1,250 for each shareholders' meeting, meeting of the Board of Directors or meeting of a committee of the Board of Directors, regardless of the number of meetings held on a given day. The chair of each committee of the Board of Directors will receive an additional annual retainer fee of $1,000, except for the chair of the Compensation Policy Committee, Mr. Vincent, who will receive an annual retainer fee of $6,000. (The higher annual retainer fee paid to the chair of the Compensation Policy Committee relates to his additional duties which include, among other things, the annual performance appraisal of the chief executive officer on behalf of the Board, although the final appraisal is determined by the Board.) Any individual Director receiving these fees may elect to defer payment of all such fees or any portion thereof pursuant to Host REIT's Executive Deferred Compensation Plan and/or Host REIT's Non- Employee Directors' Deferred Stock Compensation Plan. Directors will also be reimbursed for travel expenses and other out-of-pocket costs incurred in attending meetings or in visiting hotels or other properties controlled by Host REIT or by Marriott International. In 1997, the following Directors of the Company received special one-time awards of Company common stock in the amounts indicated: Mr. Ammon, 4,000 shares; Mr. Baylis, 7,000 shares; Ms. McLaughlin, 7,000 shares and Mr. Vincent, 7,000 shares. The special one-time awards of Company common stock vest at the rate of 10% per year of a Director's service on the Board, with credit given for each year of service already completed, and will also become fully vested upon the death or disability of the Directors. EXECUTIVE COMPENSATION The table below sets forth a summary of the compensation paid by Host for the last three fiscal years to the Chief Executive Officer and the four additional most highly compensated executive officers of Host for Host's fiscal year 1997 (the "Named Executive Officers"). 165
LONG-TERM COMPENSATION -------------------- ANNUAL COMPENSATION AWARDS PAYOUTS ---------------------------------- ------------ ------- RESTRICTED NAME AND FISCAL OTHER ANNUAL STOCK LTIP ALL OTHER PRINCIPAL POSITION YEAR SALARY(1)(2) BONUS(3) COMPENSATION AWARDS(4)(5) PAYOUTS COMPENSATION(6) - ------------------ ------ ------------ -------- ------------ ------------ ------- --------------- Richard E. Marriott..... 1997 $271,449 $108,580 $110,789(7) $ 0 $ 0 $ 22,668(8) Chairman of the 1996 262,951 105,180 114,969(7) 0 0 21,439(8) Board 1995 250,554 100,000 107,463(7) 0 0 12,634 Terence C. Golden(9).... 1997 619,045 557,141 58,783(10) 354,693 0 66,105 President and Chief 1996 600,017 480,013 0 10,476,603 0 560,827(11) Executive Officer 1995 190,656 152,152 0 0 0 0 Robert E. Parsons, Jr... 1997 338,889 254,167 0 0 0 36,231 Executive Vice 1996 328,447 263,490 0 3,658,277 0 26,273 President and Chief 1995 213,767 123,649 0 0 0 10,951 Financial Officer Christopher J. Nassetta(9)............ 1997 338,889 254,167 0 0 0 36,231 Executive Vice 1996 328,447 263,490 0 3,647,513 0 119,168(11) President and Chief 1995 78,000 50,700 0 0 0 0 Operating Officer Christopher G. Townsend............... 1997 202,962 111,629 0 1,015,800 0 18,405 Senior Vice President, 1996 186,232 102,428 0 0 0 15,891 General Counsel 1995 156,375 93,825 0 0 0 7,658 - -------- (1) Fiscal year 1996 base salary earnings were for 53 weeks. (2) Salary amounts include base salary earned and paid in cash during the fiscal year, the amount of base salary deferred at the election of the executive officer under the Host Marriott Corporation Executive Deferred Compensation Plan and the increase in base salary for the period October 1, 1997 through the end of the fiscal year which was paid in 1998. (3) Bonus includes the amount of cash bonus earned pursuant to Host's Performance-Based Annual Incentive Bonus Plan (which was approved by the shareholders in 1996) and to the named individual's performance-based bonus plan during the fiscal year, which is either paid subsequent to the end of each fiscal year or deferred under the Deferred Compensation Plan. (4) During 1997, the Compensation Policy Committee (the "Committee") of the Board of Directors approved the grant of restricted stock to certain key employees of Host, including Mr. Townsend. In 1996, the Committee approved similar grants of restricted stock to certain key employees of Host, including Messrs. Golden, Parsons and Nassetta. Mr. Golden also received grants of restricted stock on November 6, 1997 and on August 1, 1996 which were pursuant to the terms of his restricted stock agreement with Host. Messrs. Golden, Parsons and Nassetta each received awards which vest over a five-year period, and Mr. Townsend received an award which vests over a three-year period. All such awards consist of shares subject to restrictions relating primarily to continued employment ("General Restrictions") and shares subject to annual performance objectives such as financial performance of Host ("Performance Restrictions"). Performance objectives are established by the Committee and are subject to annual review and revision. Sixty percent of the shares awarded to each executive officer have annual Performance Restrictions, and forty percent of the shares awarded have General Restrictions conditioned upon continued employment. In addition, Messrs. Parsons and Nassetta each received an award of restricted stock which vests sixty percent on December 31, 1998 and forty percent on December 31, 2000, subject to the attainment of certain performance criteria and to the named individual's continued employment ("Special Team Awards"). All Special Team Awards are presented above as "Restricted Stock Awards," and the value stated above is the fair market value on the date of the grant. At Mr. Golden's request and in order to motivate the management team to enhance shareholder value, the Committee issued these Special Team Awards of the shares of restricted stock to key executives of Host in connection with Mr. Golden's joining Host. The dollar value of those awards has been reflected in the Restricted Stock Awards column of the table for the Named Executive Officers. In the event that the executives to whom restricted stock was granted do not continue in the employ of Host or do not meet the performance criteria set by the Committee, those shares will be forfeited, and the Committee has retained the right to grant any forfeited restricted shares to Mr. Golden. (5) The aggregate number and value of shares of deferred stock and restricted stock subject to "General Restrictions" and "Performance Restrictions" (see footnote 4 above) held by each Named Executive Officer as of the end of fiscal year 1997 are as follows: Mr. R.E. Marriott, 264,000 shares valued at $5,071,440; Mr. Golden, 655,231 shares valued at $12,586,987; Mr. Nassetta, 240,267 shares valued at $4,615,529; Mr. Parsons, 261,531 shares valued at $5,073,335; and Mr. Townsend, 56,321 shares valued at $1,078,485. During the period in which any restrictions apply, holders of restricted stock are entitled to receive all dividends or other distributions paid with respect to such stock. Under the terms of certain restricted stock award agreements granted under the long-term incentive plan, each share of restricted stock vests upon a change in control of Host. The stock bonus awards granted by Host are generally derived based on dividing 20% of each individual's annual cash bonus award by the average of the high and low trading prices for a share of common stock on the last trading day of the fiscal year. No voting rights or dividends are attributed to award shares until such award shares are distributed. Stock bonus awards may be denominated as current awards or deferred awards. A current award is distributed in 10 annual installments commencing one year after the award is granted. A deferred award is distributed in a lump sum or in up to 10 annual installments following termination of employment. Deferred award shares contingently vest pro rata in annual installments commencing one year after the stock bonus award is granted to the employee. Awards are not subject to forfeiture once the employee reaches age 55 with 10 years of service with Host or upon (i) retirement after 20 years of service, (ii) disability or (iii) death. (6) Amounts included in "All Other Compensation" represent total matching Host contribution amounts received under the Retirement and Savings Plan and the Deferred Compensation Plan. In 1997, the amounts attributable to the Retirement and Savings Plan account for each Named Executive Officer were as follows: Mr. R.E. Marriott, $9,024; Mr. Golden, $7,939; Mr. Nassetta, $9,024; Mr. Parsons, $9,500; and Mr. Townsend, $8,448. The amounts attributable to the Deferred Compensation Plan for each named executive officer were as follows: Mr. R.E. Marriott, $13,644; Mr. Golden, $58,166; Mr. Nassetta, $27,207; Mr. Parsons, $26,731; and Mr. Townsend, $9,957. (7) Amount includes $92,000 in 1997, $86,700 in 1996, and $86,200 in 1995 for the allocation of Host personnel for non-Host business. (8) Effective beginning in 1996, Mr. R.E. Marriott waived (i) payments due to be made to him under the Deferred Compensation Plan following his retirement and (ii) common stock due to be distributed to him under Host's 1997 Comprehensive Stock Incentive Plan following his retirement. In connection with this waiver, Host entered into an 166 arrangement to purchase life insurance policies for the benefit of a trust established by Mr. R.E. Marriott. The cost of the life insurance policies to Host has been actuarially determined and will not exceed the projected after-tax cost Host expected to incur in connection with the payments under the Deferred Compensation Plan and the stock distributions under Host's 1997 Comprehensive Stock Incentive Plan that were waived by Mr. R.E. Marriott. (9) Mr. Golden joined Host as President and Chief Executive Officer on September 1, 1995. Mr. Nassetta joined Host as Executive Vice President on October 1, 1995. (10) Amount represents reimbursement of travel expenses of Mr. Golden's spouse when she accompanies him on Host business trips. (11) As part of their restricted stock agreements with Host, Messrs. Golden and Nassetta were awarded 44,910 and 8,421 shares of Host common stock, respectively, on February 1, 1996. The value of the shares was $516,465 for Mr. Golden and $96,842 for Mr. Nassetta. For a comparison of the reimbursements and distributions currently payable to the General Partners and their affiliates and the reimbursements and distributions to be paid by Host REIT, on a pro forma basis, to the General Partners following the Mergers and the REIT Conversion, see "Background and Reasons for the Mergers and the REIT Conversion-- Reimbursements and Distributions to the General Partners and Marriott International." AGGREGATED STOCK OPTION EXERCISES AND YEAR-END VALUE The table below sets forth, on an aggregated basis, (i) information regarding the exercise during fiscal year 1997 of options to purchase Host common stock (and shares of the common stock of other companies which Host has previously spun off) by each of the executive officers listed on the Executive Compensation table above, and (ii) the value on January 2, 1998 of all unexercised options held by such individuals. Host did not grant any options to the executive officers listed on the preceding table in fiscal year 1997. Terence C. Golden and Christopher J. Nassetta do not have any options to purchase stock in any of the companies listed in the following table. AGGREGATED STOCK OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES - -------- (1) "HM" represents options to purchase Host common stock ("Host Options"). "HMS" represents options to purchase HM Services common stock. "MI" represents options to purchase Marriott International common stock. In connection with Host's issuance on December 29, 1995 of a special dividend (the "HMS Special Dividend") of HM Services common stock to Host's stockholders, and pursuant to the Host Marriott Corporation 1993 Comprehensive Stock Incentive Plan, all Host Options held by employees of Host were adjusted to reflect the HMS Special Dividend by providing each option holder with the option to purchase one share of HM Services common stock for every option to purchase five shares of Host Common Stock held as of the close of business on December 29, 1995. The exercise price of the HM Services options was set, and the price of Host Options was adjusted, so that the economic value of Host Options prior to the HMS Special Dividend was preserved and not increased or decreased as a result of the HMS Special Dividend. In addition, in connection with Host's issuance on October 8, 1993 of a special dividend (the "MI Special Dividend") of Marriott International common stock to Host's stockholders, and pursuant to the Host Marriott Corporation 1993 Comprehensive Stock Incentive 167
VALUE OF UNEXERCISED IN- NUMBER OF SHARES THE UNDERLYING UNEXERCISED MONEY OPTIONS AT OPTIONS AT FISCAL YEAR END FISCAL YEAR END (2) (#) (#) -------------------------------- ------------------------- SHARES ACQUIRED ON VALUE EXERCISE REALIZED NAME COMPANY(1) (#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- ---------- ----------- -------- --------------- -------------- ----------- ------------- R. E. Marriott.......... HM 35,000 421,379 55,700 0 944,307 0 HMS 0 0 11,140 0 145,741 0 MI 0 0 55,700 0 3,198,557 0 TOTAL 35,000 421,379 122,540 0 4,288,605 0 R. E. Parsons, Jr....... HM 2,500 40,825 20,225 0 311,837 0 HMS 500 5,993 4,045 0 49,212 0 MI 0 0 1,625 0 85,423 0 TOTAL 3,000 46,819 25,895 0 446,472 0 C. G. Townsend.......... HM 0 0 6,975 0 110,745 0 HMS 0 0 1,395 0 17,354 0 MI 0 0 0 0 0 0 TOTAL 0 0 8,370 0 128,100 0 Plan, all Host Options held by employees of Host were adjusted to reflect the MI Special Dividend by providing each option holder with the option to purchase one share of Marriott International common stock for every option to purchase one share of Host Common Stock held as of the close of business on October 8, 1993. The exercise price of the Marriott International options was set, and the price of Host Options was adjusted, so that the economic value of Host Options prior to the MI Special Dividend was preserved and not increased or decreased as a result of the MI Special Dividend. (2) Based on a per share price for Host common stock of $19.21, a per share price for HM Services common stock of $14.43, and a per share price for Marriott International common stock of $68.56. These prices reflect the average of the high and low trading prices on the New York Stock Exchange on January 2, 1998. LONG-TERM INCENTIVE PLAN The table below sets forth the number of shares of Host common stock awarded under a long-term incentive plan on February 1, 1996 to Messrs. Parsons and Nassetta and on January 22, 1997 to Mr. Townsend. Richard E. Marriott and Terence C. Golden did not receive any of the type of awards reported in the following table. These awards represent the number of restricted shares of Host common stock that may vest during or at the end of a three-year period, subject to the satisfaction of certain time and performance restrictions established by the Compensation Policy Committee of the Board of Directors. The vesting provisions governing these awards are subject to review and revision by the Compensation Policy Committee. The performance criteria are set in advance of the completion of the performance year, and if the time and performance criteria are not achieved, the full number of shares will be forfeited. The shares may be paid in full if either of the following two formulas is met: . Prior to November 1, 1998, the average price of Host common stock traded on the NYSE during any consecutive 60-day period shall increase to 172.8% of the price of Host common stock on November 2, 1995; or . The average of the high and low prices of Host common stock traded on the NYSE for each of the first five days of trading prior to November 1, 1998 is 172.8% of the price of Host common stock on November 2, 1995. The price of Host common stock on November 2, 1995 was determined to be $11.08 (which reflects an adjustment for the distribution of the common stock of Host Marriott Services Corporation to Host's stockholders on December 29, 1995), and therefore the target price under the two formulas is $19.146 (i.e., 172.8% of $11.08). This increase represents a 20% compounded annual growth rate in the price of Host common stock. LONG-TERM INCENTIVE PLAN AWARDS IN LAST FISCAL YEAR EMPLOYMENT AGREEMENTS The Operating Partnership expects to have employment agreements with certain of its executive officers but there is no assurance that this will be the case. The terms of such agreements currently are under negotiation and are not expected to be finalized until the Effective Date. 1998 EMPLOYEE BENEFITS ALLOCATION AGREEMENT As part of the REIT Conversion, Host, the Operating Partnership and Crestline expect to enter into an Employee Benefits and Other Employment Matters Allocation Agreement ("1998 Employee Benefits Allocation 168
PERFORMANCE OR OTHER PERIOD NAME NUMBER OF SHARES UNTIL MATURITY OR PAYOUT - ---- ---------------- --------------------------- Robert E. Parsons, Jr. ............ 84,206 3 years Christopher J. Nassetta............ 84,206 3 years Christopher G. Townsend............ 20,000 3 years Agreement"). The 1998 Employee Benefits Allocation Agreement is expected to govern the allocation of responsibilities with respect to various compensation, benefits and labor matters. Under the 1998 Employee Benefits Allocation Agreement, Crestline is expected to assume from Host REIT certain liabilities relating to covered benefits and labor matters with respect to individuals who are employed by Host REIT or its affiliates before the Effective Date who will be employed by Crestline or its affiliates ("Transferred Employees") and the Operating Partnership is expected to assume from Host certain other liabilities relating to employee benefits and labor matters. The 1998 Employee Benefits Allocation Agreement is also expected to govern the treatment of awards under the Host Marriott Corporation 1997 Comprehensive Stock Incentive Plan, formerly called the Host Marriott Corporation 1993 Comprehensive Stock Incentive Plan (the "Comprehensive Stock Incentive Plan"), as part of the REIT Conversion. The 1998 Employee Benefits Allocation Agreement is expected to require Crestline to establish the Crestline Capital Corporation 1998 Comprehensive Stock Incentive Plan to grant awards of Crestline common stock. Additionally, the 1998 Employee Benefits Allocation Agreement is expected to provide that the Operating Partnership will adopt the Comprehensive Stock Incentive Plan. COMPREHENSIVE STOCK INCENTIVE PLAN Host sponsors the Comprehensive Stock Incentive Plan for purposes of attracting and retaining highly qualified employees. Host has reserved 44,442,911 shares of Host common stock for issuance pursuant to the Comprehensive Stock Incentive Plan. As part of the REIT Conversion, the Comprehensive Stock Incentive Plan is expected to be adopted by the Operating Partnership. Shares of Host common stock issued or reserved under the Comprehensive Stock Incentive Plan are expected to be exchanged for Host REIT Common Shares and Crestline common stock, according to the terms of the 1998 Employee Benefits Allocation Agreement. Under the terms of the Comprehensive Stock Incentive Plan, Host may award eligible full-time employees (i) options to purchase Host common stock, (ii) deferred shares of Host common stock, (iii) restricted shares of Host common stock, (iv) stock appreciation rights, (v) special recognition awards or (vi) other equity-based awards, including but not limited to, phantom shares of Host common stock, performance shares of Host common stock, bonus shares of Host common stock, dividend equivalent units or similar securities or rights. After the REIT Conversion, all grants under the Comprehensive Stock Incentive Plan will be for Host REIT Common Shares. The Company intends to continue to award options to purchase Host common stock under the Comprehensive Stock Incentive Plan after the REIT Conversion. Options granted to officers and key employees of the Company will have an exercise price of not less than the fair market value on the date of grant. Incentive stock options granted under the Comprehensive Stock Incentive Plan expire no later than 10 years after the date of grant and non-qualified stock options expire up to 15 years after the date of grant. Under the terms of the Comprehensive Stock Incentive Plan, Host may award deferred shares of Host common stock to eligible full-time employees. Deferred shares may be granted as part of a bonus award or deferred stock agreement. After the REIT Conversion, the Company intends to award deferred shares of Host REIT Common Shares under the Comprehensive Stock Incentive Plan. Deferred shares generally vest over ten years in annual installments commencing one year after the date of grant. The Comprehensive Stock Incentive Plan also provides for the issuance of restricted shares of Host common stock to officers and key executives to be distributed over the next three or five years in annual installments based on continued employment and the attainment of certain performance criteria. The Company intends to award restricted shares of Host REIT Common Shares after the REIT Conversion. Under the terms of the Comprehensive Stock Incentive Plan, Host may grant bonus awards to eligible full-time employees. Bonus awards may be part of a management incentive program which pays part of the annual performance bonus awarded to managers and other key employees in shares of Host common stock. A bonus award entitles the holder to receive a distribution of Host's common stock in accordance with the underlying 169 agreement. Holders of bonus awards vest in the shares covered by their award over ten years in annual installments commencing one year after grant. Unless the holder of a bonus award elects otherwise, vested shares are distributed in 10 consecutive, approximately equal, annual installments. After the REIT Conversion, the Company intends to award bonus awards for shares of Host REIT Common Shares. The Comprehensive Stock Incentive Plan authorizes Host to grant stock appreciation rights ("SAR") to eligible full-time employees. SARs awarded under the Comprehensive Stock Incentive Plan give the holder the right to an amount equal to the appreciation in the value of the Host common stock over a specified price. SARs may be paid in the Host common stock, cash or other form or combination form of payout. After the REIT Conversion, the Company intends to award SARs on Host REIT Common Shares. Under the Comprehensive Stock Incentive Plan, Host may award an eligible full-time employee or officer a Special Recognition Award. Special Recognition Awards may be paid in the form of Host common stock or an option to purchase Host common stock at an amount not less than fair market value on the date of grant. After the REIT Conversion, the Company intends to award Special Recognition Awards or Host REIT Common Shares to eligible full-time employees or officers. STOCK PURCHASE PLAN Host sponsors the Host Marriott Corporation Employee Stock Purchase Plan (the "Stock Purchase Plan"). Under the terms of the Stock Purchase Plan, an individual who is: (i) an active eligible employee on the last day of the prior plan year, (ii) working more than 20 hours per week and (iii) customarily employed more than five months in a calendar year may, on the first day of the plan year, purchase Host common stock through contributions or payroll deductions at the lower of the fair market value on the first or last day of such plan year. The Company expects to continue the Stock Purchase Plan after the REIT Conversion. 401(K) PLAN Host sponsors the Host Marriott Corporation Retirement and Saving Plan (the "401(k) Plan"). The 401(k) Plan has received a favorable ruling from the IRS as to its tax-qualified status. The 401(k) Plan is expected to be adopted by the Operating Partnership as part of the REIT Conversion. The 401(k) Plan is available to all eligible employees immediately upon their date of hire. A participant may elect to contribute from 1% to 15% of his compensation to the 401(k) Plan. Each year, Host makes a fixed matching contribution equal to 50% of the first 6% of the compensation contributed to the 401(k) Plan by employees. In addition, Host may make a discretionary contribution, in an amount, if any, determined annually by the Board, to the 401(k) Plan for the benefit of eligible employees. Under the terms of the 401(k) Plan, participants may elect to invest part or all of their plan benefits in Host common stock. As part of the REIT Conversion, all shares of Host common stock held under the 401(k) Plan are expected to be converted to Host REIT Common Shares and Crestline common stock. After the REIT Conversion, the Company expects to allow the 401(k) Plan's participants to elect to invest all or part of their plan benefits in Host REIT Common Shares. DEFERRED COMPENSATION PLAN Host sponsors the Host Marriott Corporation Non-Employee Director's Deferred Stock Compensation Plan (the "Deferred Compensation Plan") for purposes for attracting and retaining qualified non-employee Directors. Under the terms of the Deferred Compensation Plan, a non-employee Director may elect to defer payment of part or all of his Directors' fees from Host until such individual is no longer a member of the Board. In addition, the Deferred Compensation Plan provides for: (i) a special one time grant of Host common stock to participants who were directors of Host on May 1, 1997; and (ii) annual grants of 750 shares of Host common stock effective on May 14, 1997 and at each annual meeting thereafter. Currently, fees that are deferred under the Deferred Compensation Plan are converted into shares of Host common stock using the fair market value of such shares on the date of deferral. After the REIT Conversion, Host REIT intends to invest Directors' fees deferred under the Deferred Compensation Plan in Host REIT Common Shares. 170 Non-Employee Directors may elect to receive payment of their benefits under the Deferred Compensation Plan in cash or Host common stock. After the REIT Conversion, Host REIT expects to allow participants of the Deferred Compensation Plan to elect to receive their benefits in cash or Host REIT Common Shares. LIMITATION OF LIABILITY AND INDEMNIFICATION The MGCL permits a Maryland corporation to include in its Charter a provision limiting the liability of its directors and officers to the corporation and its shareholders for money damages except for liability resulting from (a) actual receipt of an improper benefit or profit in money, property or services or (b) acts committed in bad faith or active and deliberate dishonesty established by a final judgment as being material to the cause of action. The Charter of Host REIT contains such a provision which eliminates such liability to the maximum extent permitted by Maryland law. The Charter of Host REIT authorizes it, to the maximum extent permitted by Maryland law, to obligate itself to indemnify and to pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (i) any present or former director or officer or (ii) any individual who, while a director of Host REIT and at the request of Host REIT, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or any other enterprise from and against any claim or liability to which such person may become subject or which such person may incur by reason of his or her status as a present or former Director or officer of Host REIT. The Bylaws of Host REIT obligate it, to the maximum extent permitted by Maryland law, to indemnify and to pay or reimburse reasonable expenses in advance of final disposition of a proceeding to (a) any present or former director or officer who is made party to the proceeding by reason of his service in that capacity or (b) any individual who, while a director or officer of Host REIT and at the request of Host REIT, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or any other enterprise as a trustee, director, officer or partner of such corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise and who is made a party to the proceeding by reason of his service in that capacity, against any claim or liability to which he may become subject by reason of such status. The Charter and Bylaws also permit Host REIT to indemnify and advance expenses to any person who served as a predecessor of Host REIT in any of the capacities described above and to any employee or agent of Host REIT or a predecessor of Host REIT. The Bylaws require Host REIT to indemnify a director or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he is made a party by reason of his service in that capacity. The MGCL permits a Maryland corporation to indemnify and advance expenses to its directors, officers, employees and agents. The MGCL permits a corporation to indemnify its present and former directors and officers, among others, against judgments, penalties, fines, settlements and reasonable expenses actually incurred by them in connection with any proceeding to which they may be made a party by reason of their service in those or other capacities unless it is established that (a) the act or omission of the director or officer was material to the matter giving rise to the proceeding and (i) was committed in bad faith or (ii) was the result of active and deliberate dishonesty, (b) the director or officer actually received an improper personal benefit in money, property or services or (c) in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. However, under the MGCL, a Maryland corporation may not indemnify for an adverse judgment in a suit by or in the right of the corporation. In accordance with the MGCL, the Bylaws of Host REIT require it, as a condition to advancing expenses, to obtain (1) a written affirmation by the director or officer of his good faith belief that he has met the standard of conduct necessary for indemnification by Host REIT as authorized by the Bylaws and (2) a written statement by or on his behalf to repay the amount paid or reimbursed by Host REIT if it shall ultimately be determined that the standard of conduct was not met. The Partnership Agreement also provides for indemnification of Host REIT and its officers and trustees to the same extent that indemnification is provided to officers and directors of Host REIT in its Charter, and limits the liability of Host REIT and its officers and directors to the Operating Partnership and its respective partners to the same extent that the liability of the officers and directors of Host REIT to Host REIT and its shareholders is limited under Host REIT's Charter. 171 Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or persons controlling the registrant pursuant to the foregoing provisions, Host REIT has been informed that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. INDEMNIFICATION AGREEMENTS Host REIT intends to enter into indemnification agreements with each of its directors and officers. The indemnification agreement will require, among other things, that Host REIT indemnify its directors and officers to the fullest extent permitted by law and advance to its directors and officers all related expenses, subject to reimbursement if it is subsequently determined that indemnification is not permitted. 172 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS RELATIONSHIP BETWEEN HOST AND MARRIOTT INTERNATIONAL Host and Marriott International, prior to October 8, 1993, were operated as a single consolidated company. On October 8, 1993 in connection with the issuance of a special dividend (the "Marriott International Distribution"), the consolidated company's businesses were split between Host and Marriott International. Thereafter, Host retained the capital intensive lodging real estate business (the "Ownership Business") and the airport/tollroad concessions business (the "Host/Travel Plazas Business"), while Marriott International took over the management of the lodging and service management businesses (the "Management Business"). (On December 29, 1995, Host distributed the Host/Travel Plazas Business to the shareholders of Host Marriott Services Corporation; see "--Relationship between Host and Host Marriott Services Corporation" below.) On the date of the Marriott International Distribution, Host and its subsidiaries and Marriott International and its subsidiaries entered into certain contractual arrangements governing their relationship following the Marriott International Distribution. J.W. Marriott, Jr. and Richard E. Marriott beneficially own approximately 10.6%, and 10.2%, respectively, of the outstanding shares of common stock of Marriott International. By reason of their ownership of such shares of common stock of Marriott International and their positions as Chairman and a Director, respectively, of Marriott International, J.W. Marriott, Jr. and Richard E. Marriott, who will also be a Director and Chairman, respectively, of Host REIT, could be deemed in control of Marriott International within the meaning of the federal securities laws. Other members of the Marriott family might also be deemed control persons of Marriott International by reason of their ownership of shares of Marriott International and/or their relationship to other family members. Prior to the Marriott International Distribution, Host and Marriott International entered into a Distribution Agreement (the "Marriott International Distribution Agreement"), which provided for, among other things, (i) the division between Host and Marriott International of certain liabilities and (ii) certain other agreements governing the relationship between Host and Marriott International following the Marriott International Distribution. Subject to certain exceptions, the Marriott International Distribution Agreement provided for, among other things, assumptions of liabilities and cross-indemnities designed to allocate, effective as of the Marriott International Distribution, financial responsibility for the liabilities arising out of or in connection with the Management Business to Marriott International and its subsidiaries, and financial responsibility for the liabilities arising out of or in connection with the Ownership Business and Host/Travel Plazas Business, along with the consolidated company's liabilities under a substantial portion of its pre-existing financing and long-term debt obligations, to Host and its retained subsidiaries. The agreements executed in connection with the Marriott International Distribution Agreement also set forth certain specific allocations of liabilities between Host and Marriott International. Under the Marriott International Distribution Agreement, Marriott International obtained the Marriott International Purchase Right, which provided Marriott International with the right, until June 2017, to purchase up to 20% of each class of Host's voting stock (determined after assuming full exercise of the right) at its then fair market value (based on an average of trading prices during a specified period), upon the occurrence of certain specified events generally involving a change in control of Host. The Marriott International Purchase Right may be exercised for a 30-day period following the date a person or group of affiliated persons has (i) become the beneficial owner of 20% or more of the total voting power of the then outstanding shares of Host's voting stock or (ii) announced a tender offer for 30% more of the total voting power of the then outstanding shares of Host's common stock. The purchase price for the common stock to be purchased upon the exercise of the Marriott International Purchase Right is determined by taking the average of the closing sale price of the common stock during the 30 consecutive trading days preceding the date the Marriott International Purchase Right becomes exercisable.The Marriott International Purchase Right will continue in effect with respect to Host REIT after the Mergers, subject to the following limitations intended to protect 173 the REIT status of Host REIT. The Marriott International Purchase Right will be exercisable only to the extent that neither (i) Marriott International or any entity in which it has a direct or indirect interest and which would be deemed, under the applicable attribution rules, to own the shares of Host REIT owned by Marriott International or which would be deemed to own, taking into account the applicable attribution rules, more than 9.8% of Crestline, any subsidiary of Crestline or any other tenant of Host REIT nor (ii) any owners of direct or indirect interests in Marriott International would, as a result of such exercise, own, taking into account the applicable attribution rules, more than 9.8% of both Host REIT and Crestline, any subsidiary of Crestline or any other tenant of Host REIT. In addition to the foregoing limitation, the Marriott International Purchase Right will be exercisable only if such acquisition and ownership of Host REIT Common Shares would not cause the Operating Partnership to be considered to own, directly or by attribution, 10% or more of Crestline, any subsidiary of Crestline or any other tenant of Host REIT. The Marriott International Purchase Right will have an antitakeover effect to the extent that any person considering acquiring a substantial or controlling block of Host REIT's Common Shares will face the possibility that its ability to exercise control would be impaired by the exercise of Marriott International's Purchase Right. In addition, the exercise price of the Marriott International Purchase Right could be lower than the price at which a potential acquiror might be willing to purchase a 20% block of Common Shares because the purchase price for the Marriott International Purchase Right is based on the average trading price during a 30-day period which may be prior to the announcement of a takeover event. This potential price differential might have a further antitakeover effect by discouraging potential acquirors of Host REIT. For the purpose of governing certain of the ongoing relationships between Host and Marriott International after the Marriott International Distribution, Host and Marriott International have entered into other agreements. Host believes that the agreements are fair to both parties and contain terms which are generally comparable to those which would have been reached in arm's- length negotiations with unaffiliated parties. Among such other agreements between Host and Marriott International are: (i) Lodging Management and Franchise Agreements. Marriott International and certain of its subsidiaries have entered into management agreements with Host and certain of its subsidiaries to manage for fees the Marriott Hotels, Resorts and Suites, Ritz-Carlton hotels, Courtyard hotels and Residence Inns owned or leased by Host and its subsidiaries. Marriott International has also entered into franchise agreements with Host and certain of its subsidiaries to allow Host to use the Marriott brand, associated trademarks, reservation systems and other related items in connection with Host's operation of ten Marriott hotels not managed by Marriott International. Each of those management and franchise agreements reflects market terms and conditions and is substantially similar to the terms of management and franchise agreements with other third-party owners regarding lodging facilities of a similar type. In 1997, Host paid to Marriott International fees of $166 million from the managed and franchised lodging properties owned or leased by Host. In addition, Host or one of its subsidiaries is a partner in several unconsolidated partnerships (some of which will be consolidated in connection with the REIT Conversion) that, at the end of 1997, owned 241 lodging properties operated by Marriott International or certain of its subsidiaries under long-term agreements. In such cases, Host or its subsidiary typically serves as the general partner. In 1997, these unconsolidated partnerships paid to Marriott International fees of $119 million pursuant to such agreements. The partnerships also paid $23 million in rent to Marriott International in 1997 for land leased from Marriott International upon which certain of the limited service partnerships' hotels are located. In connection with the REIT Conversion, these management and franchise agreements will be assigned to the Lessees for the term of the applicable Leases (but the Operating Partnership will remain obligated in the event the Lessees fail to perform their obligations). (ii) Credit Agreement. In 1995, Marriott International and a subsidiary of Host entered into a Credit Agreement pursuant to which the subsidiary had the right to borrow up to $225 million from Marriott International. In 1997, however, Host entered into a revolving line of credit agreement with third parties, and as a result, Host terminated the revolving line of credit under the Credit Agreement with Marriott 174 International. Host remains subject to various covenants and guaranty reimbursement obligations under the Credit Agreement. (iii) Tax Sharing Agreement. Host and Marriott International have entered into a tax sharing agreement that defines the parties' rights and obligations with respect to deficiencies and refunds of federal, state and other income or franchise taxes relating to Host's businesses for tax years prior to the Marriott International Distribution and with respect to certain tax attributes of Host after the Marriott International Distribution. Host and Marriott International have agreed to cooperate with each other and to share information in preparing tax returns and in dealing with other tax matters. (iv) Noncompetition Agreement. Host and Marriott International entered into a noncompetition agreement that defines the parties' rights and obligations with respect to certain businesses operated by Marriott International and Host. In general, under the noncompetition agreement, Host and its subsidiaries are prohibited from entering into or acquiring any business that competes with the hotel management business as conducted by Marriott International until October 8, 2000. See "--Senior Living Communities Acquisitions." (v) Administrative Services Agreements. Marriott International and Host have entered into a number of agreements pursuant to which Marriott International has agreed to provide certain continuing administrative services to Host and its subsidiaries. Such services are provided on market terms and conditions. In general, the administrative services agreements can be kept in place at least through the end of 1998. (vi) Marriott International Guarantees. In connection with the Marriott International Distribution, Host and Marriott International entered into agreements pursuant to which Marriott International has agreed to guarantee Host's performance in connection with certain partnership, real estate and project loans and other Host obligations. Such guarantees are limited in an aggregate principal amount of up to $107 million at June 19, 1998. Marriott International has not been required to make any payments pursuant to the guarantees. In addition to the foregoing agreements, Host and Marriott International have had occasion to enter into other agreements in the ordinary course of business. Host believes that such agreements are fair to both parties and contain terms which are generally comparable to those which would have been reached in arm's-length negotiations with unaffiliated parties. Among such other agreements between Host and Marriott International are: (a) Hotel Acquisitions. Marriott International has provided, and Host expects that Marriott International in the future will provide, financing to Host for a portion of the cost of acquiring properties to be operated or franchised by Marriott International. In 1997, Marriott International did not provide any new acquisition financing, although Host remained indebted to Marriott International for acquisition financing from prior years. Marriott International provided Host with $70 million of mortgage financing in 1995 for the acquisition of three full-service hotels at an average interest rate of 8.5%. Marriott International subsequently sold one of the loans in 1996. In 1996, Marriott International and Host formed a joint venture (which will be owned by a Non-Controlled Subsidiary) and Marriott International provided Host with $29 million in debt financing at an average interest rate of 12.7% and with $28 million in preferred equity, for the acquisition of two full-service hotels in Mexico City. (b) Senior Living Communities Acquisitions. On June 21, 1997, Host acquired the outstanding common stock of Forum Group, Inc. (the "Forum Group") from Marriott Senior Living Services, Inc., a subsidiary of Marriott International. Host purchased the Forum Group portfolio of 29 premier senior living communities for approximately $460 million, including approximately $270 million in debt ($59 million of which was provided by Marriott International). In 1997, Host had completed $56 million of the approximately $107 million expansion plan to add approximately 1,060 units to these communities. As a result, an additional $33 million of debt financing has been provided by Marriott International and Marriott International may provide additional financing as the expansion plan is completed. The properties will continue to be managed by Marriott International. From the date of acquisition through the end of 1997, Host paid to Marriott International management fees of $6 million from the senior living properties owned 175 by Host. In connection with the acquisition, Host and Marriott International entered into a noncompetition agreement that defines the parties' rights and obligations with respect to the operation of senior living services by Marriott International and Host. In general, under the noncompetition agreement, Host and its subsidiaries are prohibited from entering into or acquiring any business that competes with the senior living management business as conducted by Marriott International until 2017. In 1997, Host also acquired all but 1% of the remaining 50% interest in the joint venture which owned the 418-unit Leisure Park senior living community from Marriott International for approximately $23 million, including approximately $15 million of mortgage debt assumed by Host. As part of the REIT Conversion, the senior living communities business will be distributed to Host's shareholders; thus, the Limited Partners whose Partnership participates in a Merger will not own an interest in this business. (c) 1993 Employee Benefits Allocation Agreement. Host and Marriott International have entered into an Employee Benefits and Other Employment Matters Allocation Agreement ("1993 Employee Benefits Allocation Agreement") that provides for the allocation of certain responsibilities with respect to employment compensation, benefit and labor matters. The 1993 Employee Benefits Allocation Agreement was amended as of March 27, 1998 to: (i) reflect various conversions and redenominations that were necessary as a result of the spin-off and acquisitions described in Marriott International's February 12, 1998 Proxy, and to add New Marriott MI, Inc. (renamed Marriott International, Inc.) as a party to the 1993 Employee Benefits Allocation Agreement. In general, the 1993 Employee Benefits Allocation Agreement provides that Host retained all employee liabilities for employees who on or after the Marriott International Distribution were employees of Host, and that old Marriott International, Inc., which was renamed Sodexo Marriott Services, Inc. in 1998, retained all liabilities for employees who on or after the Marriott Distribution were employees of Marriott International. Pursuant to the 1993 Employee Benefits Allocation Agreement, and in connection with the Marriott Distribution, Host also adjusted outstanding awards under the Host employee benefit plans. The 1993 Employee Benefits Allocation Agreement is expected to be amended as part of the REIT Conversion to add the Operating Partnership and Crestline as parties to the agreement and to reflect the 1998 Employee Benefits Allocation Agreement. RELATIONSHIP BETWEEN HOST AND HOST MARRIOTT SERVICES CORPORATION On December 29, 1995, Host issued a special dividend (the "HMSC Distribution") which split Host's businesses between Host and Host Marriott Services Corporation ("HM Services"). Prior to December 29, 1995, HM Services was a wholly owned subsidiary of Host. Thereafter, Host retained the capital intensive lodging real estate business (the "Ownership Business"), while HM Services took over the airport/tollroad concessions business (the "Host/Travel Plazas Business"). Host and its subsidiaries and HM Services and its subsidiaries have entered into certain relationships following the HMSC Distribution. Richard E. Marriott and J.W. Marriott, Jr. beneficially own approximately 6.75% and 6.88%, respectively, of the outstanding shares of common stock of HM Services. By reason of their ownership of such shares of common stock of HM Services and their positions as Directors of HM Services, Richard E. Marriott and J.W. Marriott, Jr., who are also Chairman and a Director, respectively, of Host, could be deemed in control of HM Services within the meaning of the federal securities laws. Other members of the Marriott family might also be deemed control persons of HM Services by reason of their ownership of shares of HM Services and/or their relationship to other family members. Prior to the HMSC Distribution, Host and HM Services entered into a Distribution Agreement (the "HMSC Distribution Agreement"), which provided for, among other things, (i) certain asset transfers to occur prior to the HMSC Distribution, (ii) the HMSC Distribution, (iii) the division between Host and HM Services of certain liabilities and (iv) certain other agreements governing the relationship between Host and HM Services following the HMSC Distribution. Subject to certain exceptions, the HMSC Distribution Agreement provides for, among other things, assumptions of liabilities and cross-indemnities designed to allocate, effective as of the HMSC Distribution, 176 financial responsibility for the liabilities arising out of or in connection with the Host/Travel Plazas Business to HM Services and its subsidiaries and financial responsibility for the liabilities arising out of or in connection with the Ownership Business to Host and its retained subsidiaries. The agreements executed in connection with the HMSC Distribution Agreement also set forth certain specific allocations of liabilities between Host and HM Services. The HMSC Distribution Agreement also provides that HM Services will assume its proportionate share of Host's current obligation for certain employee benefit awards denominated in Host common stock currently held by employees of Marriott International. For the purpose of governing certain of the ongoing relationships between Host and HM Services after the HMSC Distribution, Host and HM Services have entered into other agreements. Host believes that the agreements are fair to both parties and contain terms which are generally comparable to those which would have been reached in arm's-length negotiations with unaffiliated parties. Among such other agreements between Host and HM Services are: (i) Tax Sharing Agreement. Host and HM Services have entered into a tax sharing agreement that defines the parties' rights and obligations with respect to deficiencies and refunds of federal, state and other income or franchise taxes relating to Host's businesses for tax years prior to the HMSC Distribution and with respect to certain tax attributes of Host after the HMSC Distribution. Host and HM Services have agreed to cooperate with each other and to share information in preparing tax returns and in dealing with other tax matters. (ii) Guarantees of Concession Agreements. Host and HM Services have entered into agreements pursuant to which Host has agreed to guarantee HM Services' performance in connection with certain tollroad concessions operated by HM Services. Host has not been required to make any payment pursuant to the guarantees and does not anticipate making any such payment in 1998. (iii) 1995 Employee Benefits Allocation Agreement. Host and HM Services have entered into an Employee Benefits and Other Employment Matters Allocation Agreement (the "1995 Employee Benefits Allocation Agreement") that provides for the allocation of certain responsibilities with respect to employee compensation, benefits and labor matters. In general, the 1995 Employee Benefits Allocation Agreement provides that Host retain all employee liabilities for employees who on or after the HMSC Distribution were employees of Host, and that HM Services retain all employee liabilities for employees who on or after the HMSC Distribution were employees of HM Services. Pursuant to the 1995 Employee Benefits Allocation Agreement, and in connection with the HMSC Distribution, Host also adjusted outstanding awards under Host employee benefit plans. The 1995 Employee Benefits Allocation Agreement is expected to be amended as part of the REIT Conversion to add the Operating Partnership and Crestline as parties to the agreement and to reflect the 1998 Employee Benefits Allocation Agreement. RELATIONSHIP BETWEEN HOST AND CRESTLINE CAPITAL CORPORATION AFTER THE INITIAL E&P DISTRIBUTION For the purposes of governing certain of the ongoing relationships between Crestline and Host after the Initial E&P Distribution and to provide mechanisms for an orderly transition, Crestline and Host will enter into, in addition to the Leases, various agreements, as described below. Distribution Agreement Prior to the Initial E&P Distribution, Crestline and Host will enter into a distribution agreement (the "Distribution Agreement"), which will provide for, among other things, (i) the distribution of shares of Crestline in connection with the Initial E&P Distribution; (ii) the division between Crestline and Host of certain assets and liabilities; (iii) the contribution to Crestline of Host's 3% general partnership interest in Boynton Beach Limited Partnership, which owns a senior living community located in Boynton Beach; and (iv) certain other agreements governing the relationship between Crestline and Host following the Initial E&P Distribution. Subject to certain exceptions, the Distribution Agreement will provide for, among other things, assumptions of liabilities and cross-indemnities designed to allocate to Crestline, effective as of the date of the Initial E&P 177 Distribution, financial responsibility for liabilities arising out of or in connection with the business of the senior living communities. The Distribution Agreement also will provide that by the date of the Initial E&P Distribution, Crestline and Host will take all necessary actions which may be required to amend Crestline's Articles of Incorporation and Bylaws. The Distribution Agreement also will provide that each of Crestline and Host will be granted access to certain records and information in the possession of the other, and will require the retention by each of Crestline and Host for a period of ten years following the Initial E&P Distribution of all such information in its possession, and thereafter will require that each party give the other prior notice of its intention to dispose of such information. The Distribution Agreement also will require the allocation of shared privileges with respect to certain information and will require each of Crestline and Host to obtain the consent of the other prior to waiving any shared privilege. Tax Sharing Agreement Crestline and Host will enter into a tax sharing agreement (the "Tax Sharing Agreement") which will define each party's rights and obligations with respect to deficiencies and refunds of federal, state and other income or franchise taxes relating to Crestline's business for taxable years prior to the Initial E&P Distribution and with respect to certain tax attributes of Crestline after the Initial E&P Distribution. Generally, Host will be responsible for filing consolidated returns and paying taxes for periods prior to the date of the Initial E&P Distribution, and Crestline will be responsible for filing returns and paying taxes for subsequent periods. Asset Management Agreement Crestline and Host will enter into an asset management agreement (the "Asset Management Agreement"), pursuant to which Crestline will agree to provide review and advice on the management and operation of the hotels in order to assist Host in making strategic decisions. Generally, Crestline will provide the following consulting services in its capacity as the Lessee of the hotels: (i) review of operating and financial results (including site visits) and meet with Host, at least quarterly, to review such results of the hotels; (ii) review of financial statements and budgets, including periodic accounting statements, annual operating budgets, FF&E budgets and management analysis reports; (iii) revenue and capital spending projections; (iv) administration of hotel mortgages; (v) advice relating to any changes to the hotel management agreements; (vi) review of market conditions and competition for each of the hotels; and (vii) monitoring and negotiating with governmental agencies in connection with any condemnation proceedings against the hotels. Crestline will be paid a fee of $4.5 million for each fiscal year for its consulting services under the Asset Management Agreement. The Asset Management Agreement will have a term of two years with an automatic one year renewal, unless terminated earlier by either party. Corporate Transitional Services Agreement Crestline and Host will, prior to the date of the Initial E&P Distribution, enter into a transitional services agreement (the "Corporate Transitional Services Agreement") pursuant to which Crestline and Host will provide certain limited services to each other for a fee. Among other things, Host will provide centralized administrative and computer systems services to Crestline. Non-Competition Agreement Crestline and Host will enter into a non-competition agreement that limits the respective parties' future business opportunities. See "Business and Properties--Non-Competition Agreement." 178 1998 Employee Benefits and Other Employment Matters Allocation Agreement As part of the REIT Conversion, Host, the Operating Partnership and Crestline expect to enter into the 1998 Employee Benefits Allocation Agreement relating to various compensation, benefits and labor matters. See "Management--1998 Employee Benefits Allocation Agreement." Guaranty and Pooling Agreements Crestline and certain of its subsidiaries will enter into a limited guaranty of the lease and management agreement obligations of each Lessee. For each of the four identified "pools" of hotels, the cumulative limit of the guaranty at any time will be 10% of the aggregate rents under all Leases in such pool paid with respect to the preceding twelve full calendar months (with an annualized amount based upon the Minimum Rent for those full-service Leases that have not been in effect for 12 full calendar months). 179 PRINCIPAL SECURITY HOLDERS The following table sets forth, as of July 31, 1998, the beneficial ownership of OP Units and Common Shares of (i) each person who is expected to hold more than a 5% interest in the Operating Partnership or Host REIT, (ii) directors of Host REIT, (iii) the Chief Executive Officer and the four most highly compensated executive officers of Host REIT and (iv) the directors and executive officers of Host REIT as a group. Unless otherwise indicated in the footnotes, all of such interests are owned directly and the indicated person or entity has sole voting and investment power. The "Percent of All Common Shares and OP Units" represents the number of Common Shares and OP Units the person is expected to hold immediately after the REIT Conversion, as a percentage of the total number of Common Shares and OP Units expected to be outstanding immediately after the REIT Conversion (excluding OP Units held by Host REIT and its subsidiaries). The information in this table assumes that all transactions comprising the REIT Conversion are consummated as currently expected. The address of each beneficial owner is 10400 Fernwood Road, Bethesda, Maryland 20817 unless otherwise indicated. - -------- *less than 1% (1) Represents the number of OP Units held by the person as a percentage of the total number of OP Units to be issued to persons other than Host REIT and its subsidiaries in the REIT Conversion (65.2 million OP Units), assuming a maximum value of $15.50 per OP Unit. (2) Consists of Common Shares received in the REIT Conversion as a result of ownership of Host. (3) Represents the number of Common Shares held by the person as a percentage of the total number of Common Shares expected to be outstanding immediately following the REIT Conversion (204.5 million Common Shares). (4) Assumes that all OP Units held by the person are redeemed for Common Shares. The total number of Common Shares and OP Units outstanding used in calculating this percentage (204.2 million Common Shares plus the number of OP Units beneficially owned by the person) assumes that none of the OP Units held by other persons are redeemed for Common Shares. (5) Assumes that all OP Units held by the person are redeemed for Common Shares. The total number of Common Shares and OP Units outstanding used in calculating this percentage (269.7 million) assumes that all of the OP Units held by other persons also are redeemed for Common Shares. (6) Includes (i) the shares of unvested restricted stock granted under Host's 1993 and 1997 Comprehensive Stock Incentive Plans, which are voted by the holder thereof and (ii) the following number of shares which could be acquired by the named persons through the exercise of stock options within 60 days of July 31, 1998: for J.W. Marriott, Jr., 810,447 shares; for Richard E. Marriott, 55,700 shares; for Mr. Parsons, 15,225 shares; for Mr. Townsend, 6,975 shares; and for 180
PERCENT PERCENT OF PERCENT OF NUMBER OF PERCENT OF OF ALL ALL COMMON NUMBER OF ALL OP COMMON COMMON COMMON SHARES AND NAME OP UNITS UNITS(1) SHARES(2) SHARES(3) SHARES(4) OP UNITS(5) ---- ---------- ---------- ---------- ---------- --------- ----------- R. Theodore Ammon....... 0 * 15,500 * * * Robert M. Baylis........ 0 * 13,500 * * * Terence C. Golden(6).... 0 * 781,684 * * * J.W. Marriott, Jr.(6)(7)(8)........... 14,625 * 13,275,014 6.49% 6.50% 4.93% Richard E. Marriott(6)(8)(9)...... 12,350 * 13,203,209 6.46 6.46 4.90 Ann Dore McLaughlin..... 0 * 9,500 * * * John G. Schreiber(11)... 875,000 1.34% 0 * * * Harry L. Vincent, Jr.... 0 * 25,100 * * * Christopher J. Nassetta(6)............ 0 * 356,201 * * * Robert E. Parsons, Jr.(6)................. 0 * 404,244 * * * Christopher G. Townsend(6)............ 0 * 109,417 * * * Blackstone Entities(12)........... 43,700,000 67.02 0 * 17.61 16.20 Dresdner RCM Global Investors LLC(13)...... 0 * 13,595,975 6.65 6.65 5.04 FMR Corp.(14)........... 0 * 22,532,574 11.02 11.02 8.35 Southeastern Asset Management, Inc.(15)... 0 * 36,758,000 17.98 17.98 13.63 ALL DIRECTORS AND EXECUTIVE OFFICERS AS A GROUP (11 PERSONS)(6)(10)........ 901,975 1.38% 24,209,204 11.84% 12.23% 9.31% all directors and executive officers as a group, 913,147 shares. Does not include any other shares reserved, contingently vested or awarded under the above-named Plan. (7) Common Shares includes: (i) 1,977,450 shares held in trust for which J.W. Marriott, Jr. is the trustee or a co-trustee; (ii) 68,426 shares held by the wife of J.W. Marriott, Jr.; (iii) 704,555 shares held in trust for which the wife of J.W. Marriott, Jr. is the trustee or a co-trustee; (iv) 2,451,787 shares held by the J. Willard Marriott Foundation of which J.W. Marriott, Jr. is a co-trustee; (v) 2,707,590 shares held by a limited partnership whose general partner is a corporation of which J.W. Marriott, Jr. is the controlling shareholder; and (vi) 80,000 shares held by a limited partnership whose general partner is J.W. Marriott, Jr.; does not include shares held by the adult children of J.W. Marriott, Jr., of which J.W. Marriott, Jr. disclaims beneficial ownership of all such shares. (8) By virtue of their ownership of shares of Host common stock and their positions as Chairman and Director, respectively, Richard E. Marriott and J.W. Marriott, Jr. could be deemed in control of Host within the meaning of the federal securities laws. Other members of the Marriott family might also be deemed control persons by reason of their ownership of shares and/or their relationship to other family members. J.W. Marriott, Jr., Richard E. Marriott, their mother Alice S. Marriott and other members of the Marriott family and various trusts established by members of the Marriott family owned beneficially an aggregate of 25,179,933 shares, or 12.31% of the total shares outstanding of Host common stock as of July 31, 1998. (9) Common Shares includes: (i) 1,874,709 shares held in trust for which Richard E. Marriott is the trustee or a co-trustee; (ii) 68,219 shares held by the wife of Richard E. Marriott; (iii) 603,828 shares held in trust for which the wife of Richard E. Marriott is the trustee or a co- trustee; (iv) 2,451,787 shares held by the J. Willard Marriott Foundation of which Richard E. Marriott is a co-trustee; and (v) 2,302,729 shares held by a corporation of which Richard E. Marriott is the controlling shareholder; does not include shares held by the adult children of Richard E. Marriott, of which Richard E. Marriott disclaims beneficial ownership of all such shares. (10) Common Shares includes the total number of shares held by trusts for which both J.W. Marriott, Jr. and Richard E. Marriott are co-trustees. Beneficial ownership of such shares is attributable to each of J.W. Marriott, Jr. and Richard E. Marriott in the table above under the Director subheading, but such shares are included only once in reporting the total number of shares owned by all directors and executive officers as a group. All directors and executive officers as a group (other than members of the Marriott family) owned beneficially an aggregate of 1,757,788 shares, or 0.86%, of the total shares outstanding as of July 31, 1998. In addition, Host's Retirement and Savings Plan owned 65,257 shares, or 0.03% of the total shares outstanding as of July 31, 1998. (11) OP Units include only John G. Schreiber's proportionate share of OP Units to be received by the Blackstone Entities in the Blackstone Acquisition; John G. Schreiber disclaims beneficial ownership of all other OP Units to be acquired by the Blackstone Entities. (12) The Blackstone Entities constitute a series of affiliated partnerships. Initially, a majority of the OP Units received pursuant to the Blackstone Acquisition will be held by such affiliated partnerships, but eventually will be distributed by such affiliated partnerships to their partners. (13) Represents shares of Host common stock held by Dresdner RCM Global Investors LLC ("Dresdner RCM") and its affiliates, RCM Limited L.P. ("RCM Limited") and RCM General Corporation ("RCM General"), and by Dresdner Bank AG, of which Dresdner RCM is a wholly owned subsidiary. Dresdner RCM has reported in a Schedule 13G under the Exchange Act, filed with the Commission, sole dispositive power over 12,943,675 shares and shared dispositive power over 282,000 shares. Of these shares, Dresdner RCM has reported sole voting power over 8,854,200 shares and does not share voting power with respect to any shares. In addition, Dresdner Bank AG has reported in a separate Schedule 13G under the Exchange Act, filed with the Commission, sole dispositive and voting power over 370,300 shares of Host common stock, and such shares are included in the number reported in this table. The principal business address of Dresdner RCM, RCM Limited and RCM General is Four Embarcadero Center, San Francisco, California 94111. The principal business address of Dresdner Bank AG is Jurgen Ponto-Platz 1, 60301 Frankfurt, Germany. (14) Represents shares of Host common stock held by FMR Corp. ("FMR") and its subsidiaries, Fidelity Management Trust Company ("FMT") and Fidelity Management & Research Company ("FM&R"). FMR has reported in a Schedule 13G under the Exchange Act, filed with the Commission, that FMR, through its control of FM&R and certain investment funds for which FM&R acts as an investment adviser, has sole power to dispose of 22,474,835 shares of Host common stock owned by such investment funds, including the 15,610,500 shares of Host common stock (or 7.64% of the total shares outstanding of Host common stock as of July 31, 1998) held by the Fidelity Magellan Fund. FMR has no power to vote or direct the voting of the shares of Host Common Stock owned by the investment funds, which power resides with the Board of Trustees of such investment funds. FMR, through its control of FMT and certain institutional accounts for which FMT serves as investment manager, has sole dispositive power over 57,739 shares, the sole power to vote or direct the voting of 44,301 shares, and no power to vote or direct the voting of 13,438 shares of Host common stock owned by the institutional accounts. The principal business address for FMR, FMT and FM&R is 82 Devonshire Street, Boston, Massachusetts 02109. (15) Represents shares of Host common stock held by Southeastern Asset Management, Inc. ("SAM"). SAM has reported in a Schedule 13G under the Exchange Act, filed with the Commission, sole dispositive power over 21,730,700 shares, shared dispositive power over 14,968,300 shares and no dispositive power over 59,000 shares. Of these shares, SAM has reported sole voting power over 18,338,100 shares, shared voting power over 14,968,300 shares and no power to vote 3,451,600 shares. The principal business address of SAM is 6075 Poplar Avenue, Suite 900, Memphis, Tennessee 38119. 181 DESCRIPTION OF OP UNITS Limited Partners whose Partnership participates in a Merger will receive OP Units in exchange for their Partnership Interests. Limited Partners who elect to receive Common Shares or Notes will tender (or be deemed to have tendered) all of the OP Units they receive to Host REIT in exchange for Common Shares or to the Operating Partnership in exchange for Notes. See "The Mergers and the REIT Conversion--The Mergers--Issuance of OP Units," "--Right to Exchange OP Units for Common Shares" and "--Right to Exchange OP Units for Notes." Commencing one year after the Mergers, each limited partner in the Operating Partnership (other than Host REIT) will be entitled to have each of his OP Units redeemed by the Operating Partnership at any time for cash equal to the fair market value at the time of redemption of one Common Share (subject to adjustment to reflect any stock split, stock dividend or other transaction affecting the number of Common Shares outstanding but not affecting the number of OP Units outstanding), or, at the option of Host REIT, one Common Share (subject to adjustment as described herein). The material terms of the Common Shares, including a summary of certain provisions of Host REIT's Charter and Bylaws, are set forth in "Description of Capital Stock" and "Certain Provisions of Maryland Law and Host REIT's Charter and Bylaws." The material terms of the OP Units, including a summary of certain provisions of the Partnership Agreement, are set forth below. The following description of the terms and provisions of the OP Units and certain other matters does not purport to be complete and is subject to, and qualified in its entirety by, reference to applicable provisions of Delaware law and the Partnership Agreement. A copy of the Partnership Agreement in substantially the form in which it will be adopted (subject to such modifications as do not materially and adversely affect the rights of the holders of OP Units to be issued in the Mergers) is attached as Appendix A to this Consent Solicitation. Each person acquiring OP Units in the Mergers or thereafter will be deemed bound by the terms and conditions of the Partnership Agreement. For a comparison of the voting and certain other rights of Limited Partners of the Partnerships, holders of OP Units in the Operating Partnership and shareholders of Host REIT, see "Comparison of Ownership of Partnership Interests, OP Units and Common Shares." GENERAL Holders of OP Units (other than Host REIT in its capacity as general partner) will hold a limited partnership interest in the Operating Partnership, and all holders of OP Units (including Host REIT in its capacity as general partner) will be entitled to share in cash distributions from, and in the profits and losses of, the Operating Partnership. Because Host REIT will hold a number of OP Units equal to the number of Common Shares outstanding, each OP Unit generally will receive distributions in the same amount paid on each Common Share. See "Distribution and Other Policies-- Distribution Policy." Holders of OP Units will have the rights to which limited partners are entitled under the Partnership Agreement and the Delaware Revised Uniform Limited Partnership Act (the "Delaware Act). The OP Units to be issued in the Mergers will not be listed on any exchange or quoted on any national market system. The Partnership Agreement imposes certain restrictions on the transfer of OP Units, as described below. FORMATION The Operating Partnership was formed as a Delaware limited partnership under the Delaware Act on April 15, 1998. Upon the consummation of the REIT Conversion, Host REIT will be admitted to the Operating Partnership as the sole general partner of the Operating Partnership. Following the REIT Conversion, Host REIT will hold a substantial number of the OP Units. Of the OP Units allocated to Host REIT, a 0.1% interest in the Operating Partnership will be held by Host REIT as the general partner of the Operating Partnership, and the remaining OP Units allocated to Host REIT will be held by Host REIT as a limited partner in the Operating Partnership. PURPOSES, BUSINESS AND MANAGEMENT The purpose of the Operating Partnership includes the conduct of any business that may be lawfully conducted by a limited partnership formed under the Delaware Act, except that the Partnership Agreement 182 requires the business of the Operating Partnership to be conducted in such a manner that will permit Host REIT to qualify as a REIT under Section 856 of the Code, unless Host REIT ceases to qualify as a REIT for reasons other than the conduct of the business of the Operating Partnership. Subject to the foregoing limitation, the Operating Partnership may enter into partnerships, joint ventures or similar arrangements and may own interests directly or indirectly in any other entity. Host REIT, as general partner of the Operating Partnership, has the exclusive power and authority to conduct the business of the Operating Partnership subject to the consent of the limited partners in certain limited circumstances discussed below. No limited partner may take part in the operation, management or control of the business of the Operating Partnership by virtue of being a holder of OP Units. In particular, the limited partners expressly acknowledge in the Partnership Agreement that Host REIT is acting on behalf of the Operating Partnership's limited partners and Host REIT's shareholders collectively, and is under no obligation to consider the tax consequences to limited partners when making decisions for the benefit of the Operating Partnership. Host REIT intends to make decisions in its capacity as general partner of the Operating Partnership so as to maximize the profitability of Host REIT and the Operating Partnership as a whole, independent of the tax effects on the limited partners. See "Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following the Mergers." Host REIT and the Operating Partnership will have no liability to a limited partner as a result of any liabilities or damages incurred or suffered by, or benefits not derived by, a limited partner as a result of the act or omission of Host REIT as general partner of the Operating Partnership unless Host REIT acted, or failed to act, in bad faith and the act or omission was material to the loss, liability or benefit not derived. HOST REIT MAY NOT ENGAGE IN OTHER BUSINESSES; CONFLICTS OF INTEREST Host REIT, as general partner, may not conduct any business other than the business of the Operating Partnership without the consent of limited partners holding percentage interests in the Operating Partnership ("Percentage Interests") that are more than 50% of the aggregate Percentage Interests of the outstanding limited partnership interests entitled to vote thereon, excluding any such interests held by Host REIT. Other persons (including officers, directors, employees, agents and other affiliates of Host REIT) will not be prohibited under the Partnership Agreement from engaging in other business activities. However, Host REIT, on behalf of the Operating Partnership, has adopted certain policies regarding noncompetition provisions and avoidance of conflicts of interest. See "Distribution and Other Policies-- Conflicts of Interest Policies." In addition, the Partnership Agreement does not prevent another person or entity that acquires control of Host REIT in the future from conducting other businesses or owning other assets, even though such businesses or assets may be ones that it would be in the best interests of the limited partners for the Operating Partnership to own. DISTRIBUTIONS; ALLOCATIONS OF INCOME AND LOSS The Partnership Agreement provides for the quarterly distribution of Available Cash (as determined in the manner provided in the Partnership Agreement) to Host REIT and the limited partners as holders of OP Units in proportion to their percentage interests in the Operating Partnership. "Available Cash" is generally defined as net income plus depreciation and amortization and any reduction in reserves and minus interest and principal payments on debt, capital expenditures, any additions to reserves and other adjustments. At the time of the REIT Conversion, neither Host REIT nor the limited partners will be entitled to any preferential or disproportionate distributions of Available Cash (except to the extent that Host REIT receives preferred units in the Operating Partnership with economic rights that mirror the economic rights of any preferred stock that Host has outstanding at the time of the REIT Conversion). The Partnership Agreement provides for the allocation to Host REIT, as general partner, and the limited partners of items of Operating Partnership income and loss as described in "Federal Income Tax Consequences--Tax Treatment of Limited Partners Who Hold OP Units Following the Mergers--Allocations of Operating Partnership Income, Gain, Loss and Deduction." 183 BORROWING BY THE OPERATING PARTNERSHIP Host REIT is authorized to cause the Operating Partnership to borrow money and to issue and guarantee debt as it deems necessary for the conduct of the activities of the Operating Partnership, including financing and refinancing the assets of the Operating Partnership. Such debt may be secured by mortgages, deeds of trust, liens or encumbrances on properties of the Operating Partnership. Host REIT also may cause the Operating Partnership to borrow money to enable the Operating Partnership to make distributions, including distributions to holders of OP Units, including Host REIT, in an amount sufficient to permit Host REIT, as long as it qualifies as a REIT, to avoid the payment of any federal income tax. See "Distribution and Other Policies--Financing Policies." REIMBURSEMENT OF HOST REIT; TRANSACTIONS WITH HOST REIT AND ITS AFFILIATES Host REIT will not receive any compensation for its services as general partner of the Operating Partnership. Host REIT, however, as a partner in the Operating Partnership, has the same right to allocations and distributions as other partners in the Operating Partnership. The Operating Partnership will pay all expenses relating to the Operating Partnership's organization, the REIT Conversion, the acquisition and ownership of its assets and its operations. The Operating Partnership will be responsible for and will pay (or reimburse) all expenses and liabilities of any nature that Host REIT may incur (including expenses and liabilities arising out of the REIT Conversion and expenses related to the ongoing operations of Host REIT and to the management and administration of any subsidiaries of Host REIT permitted under the Partnership Agreement). The Operating Partnership also will be responsible for paying any and all taxes incurred by Host REIT, except that the Operating Partnership will not be responsible for any taxes that Host REIT would not have been required to pay if it qualified as a REIT for federal income tax purposes or any taxes imposed on Host REIT by reason of its failure to distribute to its shareholders an amount equal to its taxable income. The Operating Partnership, however, will not be responsible for expenses or liabilities incurred by Host REIT that are excluded from the scope of the indemnification provisions of the Partnership Agreement. Except as expressly permitted by the Partnership Agreement, Host REIT and its affiliates will not engage in any transactions with the Operating Partnership, except on terms that are determined in good faith by the general partner to be fair and reasonable and no less favorable to the Operating Partnership than would be obtained from an unaffiliated third party. LIABILITY OF HOST REIT AND LIMITED PARTNERS Host REIT, as general partner of the Operating Partnership, will be liable for all general recourse obligations of the Operating Partnership to the extent not paid by the Operating Partnership. Host REIT will not be liable for the nonrecourse obligations of the Operating Partnership. The limited partners of the Operating Partnership will not be required to make additional capital contributions to the Operating Partnership. Assuming that a limited partner does not take part in the control of the business of the Operating Partnership and otherwise acts in conformity with the provisions of the Partnership Agreement, the liability of a limited partner for obligations of the Operating Partnership under the Partnership Agreement and the Delaware Act will be limited, subject to certain exceptions, generally to the loss of such limited partner's investment in the Operating Partnership represented by his OP Units. Under the Delaware Act, a limited partner may not receive a distribution from the Operating Partnership if, at the time of the distribution and after giving effect thereto, the liabilities of the Operating Partnership, other than liabilities to parties on account of their interests in the Operating Partnership and liabilities for which recourse is limited to specified property of the Operating Partnership, exceed the fair value of the Operating Partnership's assets, other than the fair value of any property subject to nonrecourse liabilities of the Operating Partnership, but only to the extent of such liabilities. The Delaware Act provides that a limited partner who receives a distribution knowing at the time that it violates the foregoing prohibition is liable to the Operating Partnership for the amount of the distribution. Unless otherwise agreed, such a limited partner will not be liable for the return of such distribution after the expiration of three years from the date of such distribution. 184 The Operating Partnership expects to qualify to conduct business in various states in which the conduct of its business requires such qualification. Maintenance of limited liability may require compliance with certain legal requirements of those jurisdictions and certain other jurisdictions. Limitations on the liability of a limited partner for the obligations of a limited partnership have not been clearly established in many jurisdictions. Accordingly, if it were determined that the right, or exercise of the right by the limited partners, to make certain amendments to the Partnership Agreement or to take other action pursuant to the Partnership Agreement constituted "control" of the Operating Partnership's business for the purposes of the statutes of any relevant jurisdiction, the limited partners might be held personally liable for the Operating Partnership's obligations. The Operating Partnership will operate in a manner Host REIT deems reasonable, necessary and appropriate to preserve the limited liability of the limited partners. EXCULPATION AND INDEMNIFICATION OF HOST REIT The Partnership Agreement generally provides that Host REIT, as general partner of the Operating Partnership, will incur no liability to the Operating Partnership or any limited partner for losses sustained, liabilities incurred or benefits not derived as a result of errors in judgment or mistakes of fact or law or of any act or omission, unless Host REIT acted, or failed to act, in bad faith and the act or omission was material to the loss, liability or benefit not derived. In addition, Host REIT is not responsible for any misconduct or negligence on the part of its agents, provided Host REIT appointed such agents in good faith. Host REIT may consult with legal counsel, accountants, appraisers, management consultants, investment bankers and other consultants and advisors, and any action it takes or omits to take in reliance upon the opinion of such persons, as to matters that Host REIT reasonably believes to be within their professional or expert competence, shall be conclusively presumed to have been done or omitted in good faith and in accordance with such opinion. The Partnership Agreement also provides for indemnification of Host REIT, the directors and officers of Host REIT and such other persons as Host REIT may from time to time designate against any judgments, penalties, fines, settlements and reasonable expenses actually incurred by such person in connection with the proceeding unless it is established that: (i) the act or omission of the indemnified person was material to the matter giving rise to the proceeding and either was committed in bad faith or was the result of active and deliberate dishonesty; (ii) the indemnified person actually received an improper personal benefit in money, property or services; or (iii) in the case of any criminal proceeding, the indemnified person had reasonable cause to believe that the act or omission was unlawful. The Operating Partnership is obligated to advance to an indemnified person reasonable expenses incurred or expected to be incurred by such indemnified person if such indemnified person certifies to the Operating Partnership that his conduct has met the standards for indemnification and that he will repay any amounts received if it is determined subsequently that his conduct did not meet such standards. SALES OF ASSETS Under the Partnership Agreement, Host REIT generally has the exclusive authority to determine whether, when and on what terms the assets of the Operating Partnership (including the Hotels) will be sold. In addition, Host REIT is not required to take into account the tax consequences to the limited partners in deciding whether to cause the Operating Partnership to undertake a specific transaction. A sale of all or substantially all of the assets of the Operating Partnership (or a merger of the Operating Partnership with another entity) requires an affirmative vote of limited partners holding Percentage Interests that are more than 50% of the aggregate Percentage Interests of the outstanding limited partnership interests entitled to vote thereon (including Percentage Interests held by Host REIT). REMOVAL OR WITHDRAWAL OF HOST REIT; TRANSFER OF HOST REIT'S INTERESTS The Partnership Agreement provides that the limited partners may not remove Host REIT as general partner of the Operating Partnership with or without cause (unless neither Host REIT nor its parent entity is a "public company," in which case Host REIT may be removed with or without cause by limited partners holding 185 Percentage Interests that are more than 50% of the aggregate Percentage Interests of the outstanding limited partnership interests entitled to vote thereon, including any such interests held by the general partner). In addition, Host REIT may not transfer any of its interests as general or limited partner of the Operating Partnership or withdraw as a general partner, except, in each case, in connection with a merger or sale of all or substantially all of its assets, provided that (i) the limited partners of the Operating Partnership either will receive, or will have the right to receive, substantially the same consideration as holders of Common Shares, (ii) following such merger or other consolidation, substantially all of the assets of the surviving entity consist of OP Units and (iii) such transaction has been approved by partners holding Percentage Interests that are more than 50% of the aggregate Percentage Interests of the outstanding interests in the Operating Partnership entitled to vote thereon (including any such interests held by Host REIT). Host REIT initially will hold a majority of the OP Units and thus would control the outcome of this vote. See "--Sales of Assets." Although Host REIT cannot transfer its partnership interests except in a transaction in which substantially all of the assets of the surviving entity consist of OP Units, the Partnership Agreement does not prevent a transaction in which another entity acquires control (or all of the shares of capital stock) of Host REIT and that other entity owns assets and conducts businesses outside of the Operating Partnership. CERTAIN VOTING RIGHTS OF HOLDERS OF OP UNITS DURING THE FIRST YEAR FOLLOWING THE MERGERS During the first year following the Mergers, if a vote of the shareholders of Host REIT is required, then (i) a sale of all or substantially all of the assets of the Operating Partnership, (ii) a merger involving the Operating Partnership and (iii) any issuance of OP Units in connection with an issuance of Common Shares representing 20% or more of the outstanding Common Shares which would require shareholder approval under the rules of the NYSE, would require the approval of a majority of all outstanding OP Units (or, in the case of clause (iii), a majority of the OP Units that are voted, provided that at least a majority of the OP Units are voted), including OP Units held by Host REIT, voting as a single class with Host REIT voting its OP Units in the same proportion as its shareholders vote. In addition, during the one-year period following the Mergers, any taxable sale or sales of Hotels representing more than 10% of the aggregate Appraised Value of the Hotels of any Partnership would require, in addition to any other approval requirements, the approval of a majority of all outstanding OP Units held by persons who formerly were Limited Partners of such Partnership, voting as a separate class. RESTRICTIONS ON TRANSFERS OF INTERESTS BY LIMITED PARTNERS The Partnership Agreement provides that no limited partner shall, without the prior written consent of Host REIT (which consent may be withheld in Host REIT's sole and absolute discretion), sell, assign, distribute or otherwise transfer all or any portion of his interest in the Operating Partnership, except that a limited partner may transfer, without the consent of Host REIT, all or a portion of its limited partnership interest (i) in the case of a limited partner who is an individual, to a member of his immediate family, any trust formed for the benefit of himself and/or members of his immediate family, or any partnership, limited liability company, joint venture, corporation or other business entity comprised only of himself and/or members of his immediate family and entities the ownership interests in which are owned by or for the benefit of himself and/or members of his immediate family, (ii) in the case of a limited partner which is a trust, to the beneficiaries of such trust, (iii) in the case of a limited partner which is a partnership, limited liability company, joint venture, corporation or other business entity to which OP Units were transferred pursuant to (i) above, to its partners, owners, or stockholders, as the case may be, who are members of the immediate family of or are actually the person(s) who transferred OP Units to it pursuant to (i) above, (iv) in the case of a limited partner which acquired OP Units as of the closing of the Mergers and which is a partnership, limited liability company, joint venture, corporation or other business entity, to its partners, owners, stockholders or Affiliates thereof, as the case may be, or the Persons owning the beneficial interests in any of its partners, owners or stockholders or Affiliates thereof (it being understood that this clause (iv) will apply to all of each Person's partnership interests whether the OP Units relating thereto were acquired on the date hereof or hereafter), (v) in the case of a limited partner which is a partnership, limited liability company, joint venture, corporation or other business entity other than any of the foregoing described in clause (iii) or (iv), in accordance with the terms of any agreement between such limited 186 partner and the Operating Partnership pursuant to which such partnership interest was issued, (vi) pursuant to a gift or other transfer without consideration, (vii) pursuant to applicable laws of descent or distribution, (viii) to another limited partner and (ix) pursuant to a grant of security interest or other encumbrance effected in a bona fide transaction or as a result of the exercise of remedies related thereto. All of the foregoing transfers are subject to the provisions of the Partnership Agreement which require compliance with securities laws, prohibit transfers affecting the tax status of the Operating Partnership or the qualification of Host REIT as a REIT for tax purposes, prohibit transfers to holders of nonrecourse liabilities of the Operating Partnership and are also subject to the rules on substitution of limited partners. In addition, Limited Partners will be permitted to dispose of their OP Units following the first anniversary of the Mergers by exercising their Unit Redemption Right. See "--Unit Redemption Right" below. The right of any permitted transferee of OP Units to become a substitute limited partner is subject to the consent of Host REIT, which consent Host REIT may withhold in its sole and absolute discretion. If Host REIT does not consent to the admission of a transferee of OP Units as a substitute limited partner, the transferee will succeed to all economic rights and benefits attributable to such OP Units (including the Unit Redemption Right), but will not become a limited partner or possess any other rights of limited partners (including the right to vote). Transfers of OP Units may be effected only by means of entries in the record of the Operating Partnership, and Host REIT will require evidence satisfactory to it of compliance with all transfer restrictions prior to recording any transfer. UNIT REDEMPTION RIGHT Subject to certain limitations, holders of OP Units (other than Host REIT) may exercise the Unit Redemption Right by providing notice to the Operating Partnership at any time commencing one year after the Mergers. Unless Host REIT elects to assume and perform the Operating Partnership's obligation with respect to the Unit Redemption Right, as described below, the redeeming holder of OP Units will receive cash from the Operating Partnership in an amount equal to the market value of the OP Units to be redeemed. The market value of an OP Unit for this purpose will be equal to the average of the daily market price of a Common Share on the NYSE for the ten consecutive trading days before the day on which the redemption notice was given. The market price for each such trading day shall be the closing price, regular way, on such day, or if no such sales take place on such day, the average of the closing bid and asked prices on such day. In lieu of the Operating Partnership's acquiring the OP Units for cash, Host REIT will have the right (except as described below, if the Common Shares are not publicly traded) to elect to acquire the OP Units directly from a holder of OP Units exercising the Unit Redemption Right, in exchange for either cash or Common Shares, and, upon such acquisition, Host REIT will become the owner of such OP Units. In either case, acquisition of such OP Units by Host REIT will be treated as a sale of the OP Units to Host REIT for federal income tax purposes. See "Federal Income Tax Consequences-- Tax Consequences of the Mergers--Unit Redemption Right." Upon exercise of the Unit Redemption Right, the right of the holder of OP Units to receive distributions for the OP Units so redeemed or exchanged will cease. At least 1,000 OP Units (or all remaining OP Units owned by the holder of OP Units if less than 1,000 OP Units) must be redeemed each time the Unit Redemption Right is exercised. The redemption generally will occur on the tenth business day after notice of the exercise of the Unit Redemption Right by a holder of OP Units is given to the Operating Partnership, except that no redemption or exchange can occur if delivery of Common Shares would be prohibited either under the provisions of Host REIT's Charter relating to restrictions on ownership and transfer of Common Shares or under applicable federal or state securities laws as long as the Common Shares are publicly traded. See "Description of Capital Stock--Restrictions on Ownership and Transfer." In the event that the Common Shares are not publicly traded but another entity whose stock is publicly traded owns more than 50% of the shares of capital stock of Host REIT (referred to as the "Parent Entity"), the Unit Redemption Right will be determined by reference to the publicly traded shares of the Parent Entity and the general partner will have the right to elect to acquire the OP Units to be redeemed for publicly traded stock of the Parent Entity. In the event that the Common Shares are not publicly traded and there is no Parent Entity with 187 publicly traded stock, the Unit Redemption Right would be based upon the fair market value of the Operating Partnership's assets at the time the Unit Redemption Right is exercised (as determined in good faith by Host REIT), and, unless otherwise agreed by the redeeming limited partner, Host REIT and the Operating Partnership would be obligated to satisfy the Unit Redemption Right in cash, payable on the thirtieth business day after notice to the Operating Partnership of exercise of the Unit Redemption Right. NO WITHDRAWAL BY LIMITED PARTNERS No limited partner has the right to withdraw from or reduce his capital contribution to the Operating Partnership, except as a result of the redemption, exchange or transfer of OP Units pursuant to the terms of the Partnership Agreement. ISSUANCE OF LIMITED PARTNERSHIP INTERESTS Host REIT is authorized, without the consent of the limited partners, to cause the Operating Partnership to issue additional OP Units to Host REIT, to the limited partners or to other persons for such consideration and upon such terms and conditions as Host REIT deems appropriate. The Operating Partnership also may issue to any of the foregoing persons or entities partnership interests in different series or classes, which may be senior to the OP Units, including with respect to distributions and upon liquidation. If additional OP Units or partnership interests in different series or classes of equity securities are issued to Host REIT, then Host REIT must issue additional Common Shares or securities having substantially similar rights to such partnership interests, and must contribute the proceeds received by Host REIT from such issuance to the Operating Partnership. Consideration for additional partnership interests may be cash or any property or other assets permitted by the Delaware Act. No limited partner has preemptive, preferential or similar rights with respect to capital contributions to the Operating Partnership or the issuance or sale of any partnership interests therein. MEETINGS; VOTING Meetings of the limited partners may be called only by Host REIT, on its own motion or upon written request of limited partners owning at least 10% of the then outstanding OP Units (including those held by Host REIT). Limited partners may vote either in person or by proxy at meetings. Any action that is required or permitted to be taken by the limited partners may be taken either at a meeting of the limited partners or without a meeting if consents in writing setting forth the action so taken are signed by limited partners holding Percentage Interests which are not less than the minimum Percentage Interest that would be necessary to authorize or take such action at a meeting of the limited partners at which all limited partners entitled to vote on such action were present. On matters as to which limited partners are entitled to vote, each limited partner (including Host REIT to the extent it holds limited partnership interests) will have a vote equal to its Percentage Interest. A transferee of OP Units who has not been admitted as a substituted limited partner with respect to such OP Units will have no voting rights with respect to such OP Units, even if such transferee holds other OP Units as to which it has been admitted as a limited partner. The Partnership Agreement does not provide for annual meetings of the limited partners, and Host REIT does not anticipate calling such meetings. AMENDMENT OF THE PARTNERSHIP AGREEMENT Amendments to the Partnership Agreement may be proposed by Host REIT or by limited partners owning at least 25% of the then outstanding OP Units. Generally, the Partnership Agreement may be amended with the approval of Host REIT, as general partner, and limited partners (including Host REIT) holding Percentage Interests that are more than 50% of the aggregate Percentage Interests of the outstanding limited partnership interests entitled to vote thereon. Certain provisions regarding, among other things, the rights and duties of Host REIT as general partner (e.g., restrictions on Host REIT's power to conduct businesses other than owning OP Units, the dissolution of the Operating Partnership or the rights of limited partners), may not be amended without the approval of limited partners (excluding Host REIT) holding Percentage Interests that are more than 50% of the aggregate Percentage Interests of the outstanding limited partnership interests entitled to vote thereon. 188 Notwithstanding the foregoing, Host REIT, as general partner, will have the power, without the consent of the limited partners, to amend the Partnership Agreement as may be required to (i) add to the obligations of Host REIT as general partner or surrender any right or power granted to Host REIT as general partner, (ii) reflect the admission, substitution, termination or withdrawal of partners in accordance with the terms of the Partnership Agreement, (iii) establish the rights, powers, duties and preferences of any additional partnership interests issued in accordance with the terms of the Partnership Agreement, (iv) reflect a change that does not materially adversely affect any limited partner, or cure any ambiguity, correct or supplement any provisions of the Partnership Agreement not inconsistent with law or with other provisions of the Partnership Agreement, or make other changes concerning matters under the Partnership Agreement that are not otherwise inconsistent with the Partnership Agreement or applicable law or (v) satisfy any requirements of federal, state or local law. Certain amendments that would, among other things, (i) convert a limited partner's interest into a general partner's interest, (ii) modify the limited liability of a limited partner, (iii) alter the interest of a partner in profits or losses, or the rights to receive any distributions (except as permitted under the Partnership Agreement with respect to the admission of new partners or the issuance of additional OP Units (including partnership interests in a different class or series to the extent otherwise authorized under the Partnership Agreement), which actions will have the effect of changing the percentage interests of the partners and thus altering their interests in profits, losses and distributions), (iv) amend the limited partners' right to transfer or (v) alter the Unit Redemption Right, must be approved by Host REIT and each limited partner that would be adversely affected by such amendment. BOOKS AND REPORTS Host REIT is required to keep the Operating Partnership's books and records at the principal office of the Operating Partnership. The books of the Operating Partnership are required to be maintained for financial and tax reporting purposes on an accrual basis. The limited partners will have the right to receive copies of the most recent Commission filings by Host REIT and the Operating Partnership, the Operating Partnership's federal, state and local income tax returns, a list of limited partners, the Partnership Agreement, the partnership certificate and all amendments thereto and certain information about the capital contributions of the partners. Host REIT may keep confidential from the limited partners any information that Host REIT believes to be in the nature of trade secrets or other information the disclosure of which Host REIT in good faith believes is not in the best interests of the Operating Partnership or which the Operating Partnership is required by law or by agreements with unaffiliated third parties to keep confidential. Host REIT will furnish to each limited partner, no later than the date on which Host REIT mails its annual report to its shareholders, an annual report containing financial statements of the Operating Partnership (or Host REIT, if it prepares consolidated financial statements including the Operating Partnership) for each fiscal year, including a balance sheet and statements of operations, cash flow, partners' equity and changes in financial position. The financial statements will be audited by a nationally recognized firm of independent public accountants selected by Host REIT. In addition, if and to the extent that Host REIT mails quarterly reports to its shareholders, Host REIT will furnish to each limited partner, no later than the date on which Host REIT mails such reports to its shareholders, a report containing unaudited financial statements of the Operating Partnership (or Host REIT, if it prepares consolidated financial statements including the Operating Partnership) as of the last day of the calendar quarter and such other information as may be required by applicable law or regulation or as Host REIT deems appropriate. Host REIT will use reasonable efforts to furnish to each limited partner, within 90 days after the close of each taxable year, the tax information reasonably required by the limited partners for federal and state income tax reporting purposes. POWER OF ATTORNEY Pursuant to the terms of the Partnership Agreement, each limited partner and each assignee appoints Host REIT, any liquidator and the authorized officers and attorneys-in-fact of each, as such limited partner's or assignee's attorney-in-fact to do the following: execute, swear to, acknowledge, deliver, file and record in the 189 appropriate public offices various certificates, documents and other instruments (including, among other things, the Partnership Agreement and the certificate of limited partnership and all amendments or restatements thereof) that Host REIT deems appropriate or necessary to effectuate the terms or intent of the Partnership Agreement. The Partnership Agreement provides that such power of attorney is irrevocable, will survive the subsequent incapacity of any limited partner and the transfer of all or any portion of such limited partner's or assignee's OP Units and will extend to such limited partner's or assignee's heirs, successors, assigns and personal representatives. DISSOLUTION, WINDING UP AND TERMINATION The Operating Partnership will continue until December 31, 2098, unless sooner dissolved and terminated. The Operating Partnership will be dissolved prior to the expiration of its term and its affairs wound up upon the occurrence of the earliest of: (i) the withdrawal of Host REIT as general partner without the permitted transfer of Host REIT's interest to a successor general partner (except in certain limited circumstances); (ii) an election to dissolve the Operating Partnership prior to December 31, 2058 made by Host REIT with the consent of the limited partners who hold 90% of the OP Units (including OP Units held by Host REIT), (iii) the sale of all or substantially all of the Operating Partnership's assets and properties for cash or for marketable securities; (iv) the entry of a decree of judicial dissolution of the Operating Partnership pursuant to the provisions of the Delaware Act; (v) the entry of a final non-appealable order for relief in a bankruptcy proceeding of the general partner, or the entry of a final non-appealable judgment ruling that the general partner is bankrupt or insolvent (except that, in either such case, in certain circumstances the limited partners (other than Host REIT) may vote to continue the Operating Partnership and substitute a new general partner in place of Host REIT); or (vi) an election by Host REIT in its sole and absolute discretion on or after December 31, 2058. Upon dissolution, Host REIT, as general partner, or any liquidator will proceed to liquidate the assets of the Operating Partnership and apply the proceeds therefrom in the order of priority set forth in the Partnership Agreement. OWNERSHIP LIMITATION In order to help the Operating Partnership avoid being treated as a corporation for federal income tax purposes, the Partnership Agreement expressly provides that no person (other than Host REIT and the wholly owned subsidiaries (direct and indirect) thereof) or persons acting as a group may own, actually or constructively, more than 4.9% by value of any class of interests in the Operating Partnership. The Partnership Agreement contains self-executing mechanisms intended to enforce this prohibition. For a description of the consequences of the Operating Partnership being treated as a corporation for federal income tax purposes, see "Federal Income Tax Consequences--Tax Status of the Operating Partnership." As general partner of the Operating Partnership, Host REIT, in its sole and absolute discretion, may waive or modify this ownership limitation if it is satisfied that ownership in excess of this limit will not cause the Operating Partnership to be treated as a corporation for federal income tax purposes. Host has agreed to grant The Blackstone Group an exception to this prohibition subject to the condition that neither The Blackstone Group, nor any person or entity that would be considered to own OP Units owned by The Blackstone Group, may own, directly or by attribution, 9.8% or more of the stock of Crestline or the equity of any of the Lessees. 190 DESCRIPTION OF CAPITAL STOCK The summary of the terms of the capital stock of Host REIT set forth below does not purport to be complete and is subject to and qualified in its entirety by reference to the form of the Articles of Incorporation (the "Charter") and Bylaws of Host REIT to be effective upon completion of the merger of Host with and into Host REIT, copies of which have been filed as Exhibits to the Registration Statement of which this Consent Solicitation is a part. GENERAL Host REIT's Charter provides that the total number of shares of capital stock of all classes which Host REIT has authority to issue is 800,000,000 shares of capital stock, initially consisting of 750,000,000 shares of common stock, par value $.01 per share, and 50,000,000 shares of preferred stock, par value $.01 per share. The Board of Directors is authorized, without a vote of shareholders, to classify or reclassify any unissued shares of capital stock and to establish the preferences and rights of any preferred or other class or series of capital stock to be issued. At October 5, 1998, 100 Common Shares were issued and outstanding. COMMON SHARES Subject to the preferential rights of any other classes or series of shares of capital stock and to the provisions of the Charter regarding restrictions on transfers of shares of capital stock, holders of Common Shares are entitled to receive distributions if, as and when authorized and declared by the Board of Directors, out of assets legally available therefor and to share ratably in the assets of Host REIT legally available for distribution to its shareholders in the event of its liquidation, dissolution or winding-up after payment of, or adequate provision for, all known debts and liabilities of Host REIT. Host REIT currently intends to pay regular quarterly distributions. Subject to the provisions of Host REIT's Charter regarding restrictions on transfer of shares of capital stock, each outstanding Common Share entitles the holder to one vote on all matters submitted to a vote of shareholders, including the election of directors, and, except as provided with respect to any other class or series of shares of Host REIT capital stock, the holders of Common Shares will possess the exclusive voting power. There is no cumulative voting in the election of directors, which means that the holders of a majority of the outstanding Common Shares can elect all of the directors then standing for election. Holders of Common Shares have no preferences, conversion, sinking fund, redemption rights or preemptive rights to subscribe for any securities of Host REIT. Subject to the provisions of Host REIT's Charter regarding restrictions on transfer of capital stock, Common Shares have equal distribution, liquidation and other rights. Under the MGCL, a Maryland corporation generally cannot dissolve, amend its charter, merge, consolidate, effect a share exchange or transfer its assets within the meaning of the MGCL unless approved by the Board of Directors and by shareholders holding at least two-thirds of the shares entitled to vote on the matter (unless a greater or lesser percentage (but not less than a majority of all the votes entitled to be cast) is set forth in the corporation's charter). Under Host REIT's Charter, any merger, consolidation, share exchange or transfer of its assets must be approved (i) by the Board of Directors in the manner provided in the MGCL and (ii) by shareholders to the extent required under the MGCL. Host REIT's Charter generally provides for shareholder approval of such transactions by a two-thirds vote of all the votes entitled to be cast, except that any merger of Host REIT with or into a trust organized for the purpose of changing Host REIT's form of organization from a corporation to a trust will require the approval of shareholders of Host REIT by the affirmative vote only of a majority of all the votes entitled to be cast on the matter. In addition, under the MGCL, certain mergers may be accomplished without a vote of shareholders. For example, no shareholder vote is required for a merger of a subsidiary of a Maryland corporation into its parent, provided the parent owns at least 90 percent of the subsidiary. In addition, a merger need not be approved by shareholders of a Maryland successor corporation if 191 the merger does not reclassify or change the outstanding shares or otherwise amend the charter, and the number of shares to be issued or delivered in the merger is not more than 20 percent of the number of its shares of the same class or series outstanding immediately before the merger becomes effective. A share exchange need be approved by a Maryland successor only by its Board of Directors. Any amendments to the provisions contained in Host REIT's Charter relating to restrictions on transferability of shares, the classified Board and fixing the size of the Board within the range set forth in the Charter, as well as the provisions relating to removal of directors, the filling of Board vacancies and the exclusive authority of the Board of Directors to amend the Bylaws will require the approval of the Board of Directors and shareholders by the affirmative vote of the holders of not less than two-thirds of the votes entitled to be cast on the matter. Other amendments to the Charter may be effected by requisite action of the Board of Directors and approval by shareholders by the affirmative vote of not less than a majority of the votes entitled to be cast on the matter. The Charter will authorize the Board of Directors to reclassify any unissued Common Shares into other classes or series of capital stock, including preferred shares and to establish the number of shares in each class or series and to set the preferences, conversion and other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications or terms or conditions of redemption for each such class or series. PREFERRED SHARES The Charter initially will authorize the Board of Directors to issue 50 million preferred shares and to classify or reclassify any unissued preferred shares into one or more classes or series of capital stock, including Common Shares. Prior to issuance of shares of any class or series of capital stock other than Common Shares, the Board of Directors is required under the MGCL to set, subject to the provisions of the Charter regarding the restriction on transfer of capital stock, the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each such class or series. Thus, the Board of Directors could authorize the issuance of preferred shares or other capital stock with terms and conditions which could have the effect of delaying, deferring or preventing a transaction or a change in control of Host REIT that might involve a premium price for holders of Common Shares or otherwise be in their best interest. As of the date hereof, no shares other than Common Shares are outstanding, but Host REIT may issue preferred shares or other capital stock in the future, including as a result of the issuance of preferred stock by Host prior to the REIT Conversion. Although the Board of Directors has no intention at the present time of doing so (other than in connection with the proposed Shareholders Rights Plan), it could authorize Host REIT to issue a class or series of shares that could, depending upon the terms of such class or series, delay, defer or prevent a transaction or a change in control of Host REIT that might involve a premium price for holders of Common Shares or otherwise be in their best interest. POWER TO ISSUE ADDITIONAL COMMON SHARES AND PREFERRED SHARES Host REIT believes that the power of the Board of Directors to issue additional authorized but unissued Common Shares or preferred shares and to classify or reclassify unissued Common Shares or preferred shares and thereafter to cause Host REIT to issue such classified or reclassified shares of capital stock in one or more classes or series will provide Host REIT with increased flexibility in structuring possible future financings and acquisitions and in meeting other needs which might arise. The additional classes or series, as well as the Common Shares, will be available for issuance without further action by Host REIT's shareholders, unless such action is required by applicable law or the rules of any stock exchange or automated quotation system on which Host REIT's securities may be listed or traded. RESTRICTIONS ON OWNERSHIP AND TRANSFER For Host REIT to qualify as a REIT under the Code, no more than 50% in value of its outstanding shares of stock may be owned, actually or constructively, by five or fewer individuals (as defined in the Code to include 192 certain entities) during the last half of a taxable year (other than the first year for which an election to be treated as a REIT has been made) or during a proportionate part of a shorter taxable year. In addition, if Host REIT, or one or more owners (actually or constructively) of 10% or more of Host REIT, actually or constructively owns 10% or more of a tenant of Host REIT (or a tenant of any partnership in which Host REIT is a partner), the rent received by Host REIT (either directly or through any such partnership) from such tenant will not be qualifying income for purposes of the REIT gross income tests of the Code. A REIT's shares also must be beneficially owned by 100 or more persons during at least 335 days of a taxable year of twelve months or during a proportionate part of a shorter taxable year (other than the first year for which an election to be treated as a REIT has been made). Primarily because the Board of Directors believes it is desirable for Host REIT to qualify as a REIT, the Charter, subject to certain exceptions, provides that no holder may own, or be deemed to own by virtue of the attribution provisions of the Code, more than (i) 9.8% of the lesser of the number or value of Common Shares outstanding (subject to an exception for Common Shares held prior to the REIT Conversion so long as the holder thereof would not own more than 9.9% in value of the outstanding shares of capital stock of Host REIT) or (ii) 9.8% of the lesser of the number or value of the issued and outstanding preferred or other shares of any class or series of Host REIT (the "Ownership Limit"). The Ownership Limitation prohibits Marriott International and its subsidiaries and affiliates (including members of the Marriott family) from collectively owning shares of capital stock in excess of the Ownership Limit, but Host REIT's Board of Directors intends to grant an exception (pursuant to the applicable provisions of the Charter) that would permit Marriott International to exercise its right to purchase up to 20% of each class of Host REIT's voting stock in connection with a change in control of Host REIT (but only in the event that (i) Marriott International and its subsidiaries and affiliates (including members of the Marriott family) do not own at such time or thereafter, directly and by attribution, 10% or more of Crestline or any of the Lessees and (ii) such ownership of Host REIT shares would not cause the Operating Partnership to be considered to own, directly or by attribution, 10% or more of Crestline or any of the Lessees). See "Certain Relationships and Related Transactions--Relationship Between Host and Marriott International." The ownership attribution rules under the Code are complex and may cause Common Shares owned actually or constructively by a group of related individuals and/or entities to be owned constructively by one individual or entity. As a result, the acquisition or ownership of less than 9.8% of the Common Shares (or the acquisition or ownership of an interest in an entity that owns, actually or constructively, Common Shares) by an individual or entity could, nevertheless, cause that individual or entity, or another individual or entity, to own constructively in excess of 9.8% of the outstanding Common Shares and thus subject such Common Shares to the Ownership Limit. The Board of Directors may grant an exemption from the Ownership Limit with respect to one or more persons who would not be treated as "individuals" for purposes of the Code if it is satisfied, based upon an opinion of counsel and such other evidence as is satisfactory to the Board of Directors in its sole discretion, that such ownership will not cause a person who is an individual to be treated as owning Common Shares in excess of the Ownership Limit, applying the applicable constructive ownership rules, and will not otherwise jeopardize Host REIT's status as a REIT (for example, by causing any tenant of the Operating Partnership or the Partnerships (including but not limited to Crestline and the Lessees) to be considered a "related party tenant" for purposes of the REIT qualification rules). As a condition of such waiver, the Board of Directors may require undertakings or representations from the applicant with respect to preserving the REIT status of Host REIT. The Board of Directors of Host REIT has the authority to increase the Ownership Limit from time to time, but does not have the authority to do so to the extent that after giving effect to such increase, five beneficial owners of Common Shares could beneficially own in the aggregate more than 49.5% of the outstanding Common Shares. The Charter further prohibits (i) any person from actually or constructively owning shares of beneficial interest of Host REIT that would result in Host REIT being "closely held" under Section 856(h) of the Code or otherwise cause Host REIT to fail to qualify as a REIT and (ii) any person from transferring shares of capital stock of Host REIT if such transfer would result in shares of capital stock of Host REIT being owned by fewer than 100 persons. 193 Any person who acquires or attempts or intends to acquire actual or constructive ownership of shares of capital stock of Host REIT that will or may violate any of the foregoing restrictions on transferability and ownership is required to give notice immediately to Host REIT and provide Host REIT with such other information as Host REIT may request in order to determine the effect of such transfer on Host REIT's status as a REIT. If any purported transfer of shares of capital stock of Host REIT or any other event would otherwise result in any person violating the Ownership Limit or the other restrictions in the Charter, then any such purported transfer will be void and of no force or effect with respect to the purported transferee (the "Prohibited Transferee") as to that number of shares that exceeds the Ownership Limit (referred to as "excess shares") and the Prohibited Transferee shall acquire no right or interest (or, in the case of any event other than a purported transfer, the person or entity holding record title to any such shares in excess of the Ownership Limit (the "Prohibited Owner") shall cease to own any right or interest) in such excess shares. Any such excess shares described above will be transferred automatically, by operation of law, to a trust, the beneficiary of which will be a qualified charitable organization selected by Host REIT (the "Beneficiary"). Such automatic transfer shall be deemed to be effective as of the close of business on the Business Day (as defined in the Charter) prior to the date of such violating transfer. Within 20 days of receiving notice from Host REIT of the transfer of shares to the trust, the trustee of the trust (who shall be designated by Host REIT and be unaffiliated with Host REIT and any Prohibited Transferee or Prohibited Owner) will be required to sell such excess shares to a person or entity who could own such shares without violating the Ownership Limit, and distribute to the Prohibited Transferee an amount equal to the lesser of the price paid by the Prohibited Transferee for such excess shares or the sales proceeds received by the trust for such excess shares. In the case of any excess shares resulting from any event other than a transfer, or from a transfer for no consideration (such as a gift), the trustee will be required to sell such excess shares to a qualified person or entity and distribute to the Prohibited Owner an amount equal to the lesser of the fair market value of such excess shares as of the date of such event or the sales proceeds received by the trust for such excess shares. In either case, any proceeds in excess of the amount distributable to the Prohibited Transferee or Prohibited Owner, as applicable, will be distributed to the Beneficiary. Prior to a sale of any such excess shares by the trust, the trustee will be entitled to receive, in trust for the Beneficiary, all dividends and other distributions paid by Host REIT with respect to such excess shares, and also will be entitled to exercise all voting rights with respect to such excess shares. Subject to Maryland law, effective as of the date that such shares have been transferred to the trust, the trustee shall have the authority (at the trustee's sole discretion and subject to applicable law) (i) to rescind as void any vote cast by a Prohibited Transferee prior to the discovery by Host REIT that such shares have been transferred to the trust and (ii) to recast such vote in accordance with the desires of the trustee acting for the benefit of the Beneficiary. However, if Host REIT has already taken irreversible corporate action, then the trustee shall not have the authority to rescind and recast such vote. Any dividend or other distribution paid to the Prohibited Transferee or Prohibited Owner (prior to the discovery by Host REIT that such shares had been automatically transferred to a trust as described above) will be required to be repaid to the trustee upon demand for distribution to the Beneficiary. If the transfer to the trust as described above is not automatically effective (for any reason) to prevent violation of the Ownership Limit, then the Charter provides that the transfer of the excess shares will be void. In addition, shares of capital stock of Host REIT held in the trust shall be deemed to have been offered for sale to Host REIT, or its designee, at a price per share equal to the lesser of (i) the price per share in the transaction that resulted in such transfer to the trust (or, in the case of a devise or gift, the market value at the time of such devise or gift) and (ii) the market value of such shares on the date Host REIT, or its designee, accepts such offer. Host REIT will have the right to accept such offer until the trustee has sold the shares held in the trust. Upon such a sale to Host REIT, the interest of the Beneficiary in the shares sold will terminate and the trustee will distribute the net proceeds of the sale to the Prohibited Owner. The foregoing restrictions on transferability and ownership will not apply if the Board of Directors determines that it is no longer in the best interests of Host REIT to attempt to qualify, or to continue to qualify, as a REIT. 194 All certificates representing shares of capital stock will bear a legend referring to the restrictions described above. All persons who own, directly or by virtue of the attribution provisions of the Code, more than 5% (or such other percentage between 1/2 of 1% and 5% as provided in the rules and regulations promulgated under the Code) of the lesser of the number or value of the outstanding shares of capital stock of Host REIT must give a written notice to the Operating Partnership within 30 days after the end of each taxable year. In addition, each shareholder will, upon demand, be required to disclose to Host REIT in writing such information with respect to the direct, indirect and constructive ownership of shares of capital stock as the Board of Directors deems reasonably necessary to comply with the provisions of the Code applicable to a REIT, to comply with the requirements of any taxing authority or governmental agency or to determine any such compliance. These ownership limitations could have the effect of delaying, deferring or preventing a takeover or other transaction in which holders of some, or a majority, of Common Shares might receive a premium for their Common Shares over the then prevailing market price or which such holders might believe to be otherwise in their best interest. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the Common Shares will be First Chicago Trust Company of New York. 195 CERTAIN PROVISIONS OF MARYLAND LAW AND HOST REIT'S CHARTER AND BYLAWS The following summary of certain provisions of Maryland law and of the Charter and Bylaws of Host REIT does not purport to be complete and is subject to and qualified in its entirety by reference to Maryland law and the forms of the Charter and Bylaws of Host REIT to be effective upon completion of the merger of Host with and into Host REIT. The Charter and Bylaws of Host REIT will contain certain provisions that could make more difficult an acquisition or change in control of Host REIT by means of a tender offer, a proxy contest or otherwise. These provisions are expected to discourage certain types of coercive takeover practices and inadequate takeover bids and to encourage person seeking to acquire control of Host REIT to negotiate first with the Board of Directors. Host REIT believes that the benefits of these provisions outweigh the potential disadvantages of discouraging such proposals because, among other things, negotiation of such proposals might result in an improvement of their terms. See also "-- Restrictions on Ownership and Transfer." NUMBER OF DIRECTORS; CLASSIFICATION AND REMOVAL OF BOARD OF DIRECTORS; OTHER PROVISIONS The Charter will provide that the Board of Directors initially will consist of eight members and may thereafter be increased or decreased in accordance with the Bylaws of Host REIT, provided that the total number of directors may not be fewer than three nor more than 13. Pursuant to Host REIT's Bylaws, the number of directors shall be fixed by the Board of Directors within the limits set forth in the Charter. Further, the Charter will provide that the Board of Directors will be divided into three classes of directors, with each class to consist as nearly as possible of an equal number of directors. The term of office of the first class of directors will expire at the 1999 annual meeting of shareholders; the term of the second class of directors will expire at the 2000 annual meeting of shareholders; and the term of the third class of directors will expire at the 2001 annual meeting of shareholders. At each annual meeting of shareholders, the class of directors to be elected at such meeting will be elected for a three-year term, and the directors in the other two classes will continue in office. Because shareholders will have no right to cumulative voting for the election of directors, at each annual meeting of shareholders the holders of a majority of the outstanding Common Shares will be able to elect all of the successors to the class of directors whose term expires at that meeting. Host REIT's Charter also will provide that, except for any directors who may be elected by holders of a class or series of shares of capital stock other than the Common Shares, directors may be removed only for cause and only by the affirmative vote of shareholders holding at least two-thirds of all the votes entitled to be cast for the election of directors. Vacancies on the Board of Directors may be filled by the concurring vote of a majority of the remaining directors and, in the case of a vacancy resulting from the removal of a director by the shareholders, by the shareholders by at least two-thirds of all the votes entitled to be cast in the election of directors. Under Maryland law, directors may fill any vacancy only until the next annual meeting of shareholders. A vote of shareholders holding at least two-thirds of all the votes entitled to be cast thereon is required to amend, alter, change, repeal or adopt any provisions inconsistent with the foregoing classified board and director removal provisions. These provisions may make it more difficult and time-consuming to change majority control of the Board of Directors of Host REIT and, thus, may reduce the vulnerability of Host REIT to an unsolicited proposal for the takeover of Host REIT or the removal of incumbent management. Because the Board of Directors will have the power, without a vote of shareholders, to classify or reclassify any unissued shares of capital stock and to establish the preferences and rights of any preferred or other class or series of shares to be issued, the Board of Directors may afford the holders of any class or series of senior shares of capital stock preferences, powers and rights, voting or otherwise, senior to the rights of holders of Common Shares. The issuance of any such senior shares of capital stock could have the effect of delaying, deferring or preventing a change in control of Host REIT. See "Management--Limitation on Liability and Indemnification" for a description of the limitations on liability of directors and officers of Host REIT and the provisions for indemnification of directors and officers provided for under applicable Maryland law and the Charter. 196 CHANGES IN CONTROL PURSUANT TO MARYLAND LAW Maryland Business Combination Law. Under the MGCL, certain "business combinations" (including certain issuances of equity securities) between a Maryland corporation and any Interested Shareholder or an affiliate of the Interested Shareholder, are prohibited for five years after the most recent date on which the Interested Shareholder becomes an Interested Shareholder. Thereafter, any such business combination must be approved by two super- majority shareholder votes unless, among other conditions, the corporation's common shareholders receive a minimum price (as defined in the MGCL) for their shares and the consideration is received in cash or in the same form as previously paid by the Interested Shareholder for its common shares. The Board of Directors of Host REIT has not opted out of the business combination provisions of the MGCL. Consequently, the five-year prohibition and the super- majority vote requirements will apply to a business combination involving Host REIT; however, as permitted by the MGCL, Host REIT's Board of Directors may elect to opt out of these provisions in the future. Maryland Control Share Acquisition Law. Under the MGCL, "control shares" acquired in a "control share acquisition" have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the matter, excluding shares owned by the acquiror, by officers or by directors who are employees of the corporation. "Control shares" are voting shares which, if aggregated with all other such shares previously acquired by the acquiror or in respect of which the acquiror is able to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), would entitle the acquiror to exercise voting power in electing directors within one of the following ranges of voting power: (i) one-fifth or more but less than one-third, (ii) one-third or more but less than a majority or (iii) a majority or more of all voting power. Control shares do not include shares the acquiring person is then entitled to vote as a result of having previously obtained shareholder approval. A "control share acquisition" means the acquisition of control shares, subject to certain exceptions. A person who has made or proposes to make a control share acquisition, upon satisfaction of certain conditions (including an undertaking to pay expenses), may compel the board of directors of the corporation to call a special meeting of shareholders to be held within 50 days of demand to consider the voting rights of the shares. If no request for a meeting is made, the corporation may itself present the question at any shareholders meeting. If voting rights are not approved at the meeting or if the acquiring person does not deliver an acquiring person statement as required by the statute, then, subject to certain conditions and limitations, the corporation may redeem any or all of the control shares (except those for which voting rights have previously been approved) for fair value determined, without regard to the absence of voting rights for the control shares, as of the date of the last control share acquisition by the acquiror or of any meeting of shareholders at which the voting rights of such shares are considered and not approved. If voting rights for control shares are approved at a shareholders meeting and the acquiror becomes entitled to vote a majority of the shares entitled to vote, all other shareholders may exercise appraisal rights. The fair value of the shares as determined for purposes of such appraisal rights may not be less than the highest price per share paid by the acquiror in the control share acquisition. The control share acquisition statute does not apply to (a) shares acquired in a merger, consolidation or share exchange if the corporation is a party to the transaction or (b) acquisitions approved or exempted by the charter or bylaws of the corporation. The Board of Directors of Host REIT has not opted out of the control share provisions of the MGCL but, as permitted by the MGCL, may elect to opt out of these provisions in the future. ADVANCE NOTICE OF DIRECTOR NOMINATIONS AND NEW BUSINESS The Bylaws of Host REIT provide that (i) with respect to an annual meeting of shareholders, nominations of persons for election to the Board of Directors and the proposal of business to be considered by shareholders may be made only (A) pursuant to Host REIT's notice of meeting, (B) by the Board of Directors or (C) by a shareholder who is entitled to vote at the meeting and has complied with the advance notice procedures set forth in the Bylaws and (ii) with respect to special meetings of the shareholders, only the business specified in Host 197 REIT's notice of meeting may be brought before the meeting of shareholders and nominations of persons for election to the Board of Directors may be made only (A) pursuant to Host REIT's notice of the meeting, (B) by the Board of Directors or (C) provided that the Board of Directors has determined that directors shall be elected at such meeting, by a shareholder who is entitled to vote at the meeting and has complied with the advance notice provisions set forth in the Bylaws. The advance notice provisions contained in the Bylaws generally require nominations and new business proposals by shareholders to be delivered by the Secretary of Host REIT not later than the close of business on the 60th day nor earlier than the close of business on the 90th day before the date on which Host REIT first mailed its proxy materials for the prior year's annual meeting of shareholders. MEETINGS OF SHAREHOLDERS; CALL OF SPECIAL MEETINGS; SHAREHOLDER ACTION IN LIEU OF MEETING BY UNANIMOUS CONSENT Host REIT's Bylaws provide that annual meetings of shareholders shall be held on a date and at the time set by the Board of Directors during the month of May each year (commencing in May 1999). Special meetings of the shareholders may be called by the President or the Board of Directors. The Secretary of Host REIT also is required to call a special meeting of the shareholders on the written request of shareholders entitled to cast a majority of all the votes entitled to be cast at the meeting. Pursuant to the MGCL and Host REIT's Bylaws, any action required or permitted to be taken by the shareholders must be effected at a duly called annual or special meeting of shareholders and may not be effected by any consent in writing by shareholders, unless such consent is unanimous. MERGER, CONSOLIDATION, SHARE EXCHANGE AND TRANSFER OF ASSETS OF HOST REIT Pursuant to Host REIT's Charter, subject to the terms of any class or series of shares at the time outstanding, Host REIT may merge with or into another entity, may consolidate with one or more other entities, may participate in a share exchange or may transfer its assets within the meaning of the MGCL, but any such merger, consolidation, share exchange or transfer of assets must be approved (i) by the Board of Directors in the manner provided in the MGCL and (ii) by shareholders to the extent required under the MGCL. In general, such transactions by a Maryland corporation, such as Host REIT, must first be approved by a majority of the entire Board of Directors and thereafter approved by shareholders by the affirmative vote of two-thirds of all the votes entitled to be cast on the matter (unless the charter provides for a greater or lesser shareholder vote but not less than a majority of the votes entitled to be cast on the matter). Host REIT's Charter generally provides for shareholder approval of such transactions by a two-thirds vote of all votes entitled to be cast, except that any merger of Host REIT with or into a trust organized for the purpose of changing Host REIT's form of organization from a corporation to a trust will require the approval of shareholders of Host REIT by the affirmative vote only of a majority of all the votes entitled to be cast on the matter. Under the MGCL, certain mergers may be accomplished without a vote of shareholders. For example, no shareholder vote is required for a merger of a subsidiary of a Maryland corporation into its parent, provided the parent owns at least 90 percent of the subsidiary. In addition, a merger need not be approved by shareholders of a Maryland successor corporation if the merger does not reclassify or change the outstanding shares or otherwise amend the charter, and the number of shares to be issued or delivered in the merger is not more than 20% of the number of its shares of the same class or series outstanding immediately before the merger becomes effective. A share exchange need be approved by a Maryland successor only by its Board of Directors. Under the MGCL, a "transfer of assets" is defined to mean any sale, lease, exchange or other transfer of all or substantially all of the assets of the corporation but does not include (i) a transfer of assets by a corporation in the ordinary course of business actually conducted by it, (ii) a mortgage, pledge or creation of any other security interest in any or all of the assets of the corporation, whether or not in the ordinary course of its business, (iii) an exchange of shares of stock through voluntary action under any agreement with the shareholders or (iv) a transfer of assets to one or more persons if all the equity interests of the person or persons are owned, directly or indirectly, by the corporation. Pursuant to the MGCL, a voluntary dissolution of Host REIT also would require the affirmative vote of two-thirds of all the votes entitled to be cast on the matter. 198 AMENDMENTS TO HOST REIT'S CHARTER AND BYLAWS Under the MGCL, in order to amend the charter, the board of directors first must adopt a resolution setting forth the proposed amendment and declaring its advisability and direct that the proposed amendment be submitted to shareholders for their consideration either at an annual or special meeting of shareholders. Thereafter, the proposed amendment must be approved by shareholders by the affirmative vote of two-thirds of all the votes entitled to be cast on the matter, unless a greater or lesser proportion of votes (but not less than a majority of all votes entitled to be cast) is specified in the charter. The provisions contained in Host REIT's Charter relating to restrictions on transferability of the Common Shares, the classified Board and fixing the size of the Board within the range set forth in the Charter, as well as the provisions relating to removal of directors and the filling of Board vacancies may be amended only by a resolution adopted by the Board of Directors and approved at an annual or special meeting of the shareholders by the affirmative vote of the holders of not less than two-thirds of the votes entitled to be cast on the matter. Other amendments to the Charter generally may be effected by requisite action of the Board of Directors and approval by shareholders by the affirmative vote of not less than a majority of the votes entitled to be cast on the matter. As permitted under the MGCL, the Bylaws of Host REIT provide that directors have the exclusive right to amend the Bylaws. Amendment of this provision of the Charter also would require Board action and approval by holders of not less than two-thirds of all votes entitled to be cast on the matter. ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND HOST REIT'S CHARTER AND BYLAWS The business combination and control share provisions of the MGCL, the provisions of the Charter on the classification of the Board of Directors, fixing the size of the Board of Directors within a specified range and removal of directors, the provisions authorizing the Board of Directors, without a vote of shareholders, to classify or reclassify any unissued shares into one or more classes or series, the provisions relating to mergers, consolidations, share exchanges and transfers of assets, the provisions for amending certain provisions of the Charter and for amending the Bylaws, the advance notice provisions of the Bylaws and the limitations on the ability of shareholders to call special meetings, could delay, defer or prevent a transaction or a change of control of Host REIT that might involve a premium price for holders of Common Shares or otherwise be in their best interests. The share transfer restrictions that will be contained in the Charter, which are intended to help Host REIT satisfy certain requirements under the Code to qualify as a REIT for federal income tax purposes, could also delay, defer or prevent a transaction or a change of control of Host REIT that might involve a premium price for holders of Common Shares or otherwise be in their best interests. MARRIOTT INTERNATIONAL PURCHASE RIGHT In connection with Host's spinoff of Marriott International in 1993, Marriott International obtained the Marriott International Purchase Right which entitles Marriott to purchase up to 20% of each class of Host's outstanding voting shares at the then fair market value upon the occurrence of certain change of control events involving Host. The Marriott International Purchase Right will continue in effect after the Mergers (until June 2017), subject to certain limitations intended to help protect the REIT status of Host REIT. The Marriott International Purchase Right may have the effect of discouraging a takeover of Host REIT, because any person considering acquiring a substantial or controlling block of Host REIT Common Shares will face the possibility that its ability to obtain or exercise control would be impaired or made more expensive by the exercise of the Marriott International Purchase Right. SHAREHOLDER RIGHTS PLAN Host currently has in effect a stockholder rights plan, and it has preferred stock purchase rights attached to its common stock pursuant to such rights plan. Prior to the completion of the merger of Host with and into Host REIT, the Board of Directors intends to adopt a Shareholder Rights Plan ("Rights Agreement") to replace the existing Host plan and declare a dividend of one preferred share purchase right (a "Right") for each outstanding Common Share. All Common Shares issued by Host REIT between the date of adoption of the Rights Agreement 199 and the Distribution Date (as defined below), or the date, if any, on which the Rights are redeemed would have Rights attached to them. It is expected that the Rights will expire ten years after adoption of the Rights Agreement, unless earlier redeemed or exchanged. Each Right, when exercisable, would entitle the holder to purchase a fraction of a share of a newly created series of junior participating preferred shares. Until a Right is exercised, the holder thereof, as such, would have no rights as a shareholder of Host REIT including, without limitation, the right to vote or to receive dividends. The Rights Agreement is expected to provide that the Rights initially attach to all certificates representing Common Shares then outstanding. The Rights would separate from the Common Shares and a distribution of Rights certificates would occur (a "Distribution Date") upon the earlier to occur of (i) ten days following a public announcement that a person or group of affiliated or associated persons (an "Acquiring Person") has acquired, or obtained the right to acquire, beneficial ownership of 20% or more of the outstanding Common Shares (the "Share Acquisition Date") or (ii) ten business days (or such later date as the Board of Directors may determine) following the commencement of a tender offer or exchange offer, the consummation of which would result in the beneficial ownership by a person of 20% or more of the outstanding Common Shares. Until the Distribution Date, the Rights would be evidenced by the Common Share certificates, and would be transferred with, and only with, the Common Share certificates. It is expected that, if a Person becomes the beneficial owner of 20% or more of the then outstanding Common Shares (except pursuant to an offer for all outstanding Common Shares which the directors by a two-thirds vote determine to be fair to and otherwise in the best interests of Host REIT and its shareholders), each holder of a Right would, after the end of a redemption period, have the right (subject to the Ownership Limit and the other ownership restrictions contained in the Charter) to exercise the Right by purchasing Common Shares (or, in certain circumstances, cash, property or other securities of Host REIT) having a value equal to two times such amount. If at any time following the Share Acquisition Date, (i) Host REIT is acquired in a merger or other business combination transaction in which it is not the surviving corporation (other than a merger which follows an offer described in the preceding paragraph) or (ii) 50% or more of Host REIT's assets or earning power is sold or transferred, each holder of a Right would have the right to receive, upon exercise, common shares of the acquiring company having a value equal to two times the purchase price of the Right. It is expected that, in general, the Board of Directors of Host REIT may redeem the Rights at a nominal price per Right at any time until ten days after an Acquiring Person has been identified as such. If the decision to redeem the Rights occurs after a person becomes an Acquiring Person, the decision will require the concurrence of directors by a two-thirds vote. The Rights would have certain anti-takeover effects. The Rights would cause substantial dilution to a person or group that attempts to acquire Host REIT. The Rights, however, would not interfere with any merger or other business combination approved by the Board of Directors since the Board may, at its option, at any time prior to any person becoming an Acquiring Person, redeem all rights or amend the Rights Agreement to exempt the person from the Rights Agreement. 200 DESCRIPTION OF THE NOTES The Notes will be issued under the Indenture between the Operating Partnership and Marine Midland Bank, as trustee (the "Indenture Trustee"). A copy of the form of Indenture is filed as an exhibit to the Registration Statement of which this Consent Solicitation is a part. The terms of the Notes include those provisions contained in the Indenture and those made part of the Indenture by reference to the Trust Indenture Act of 1939, as amended (the "Trust Indenture Act"). The Notes are subject to all such terms, and holders of Notes are referred to the Indenture and the Trust Indenture Act for a statement thereof. The following summary of certain provisions of the Indenture does not purport to be complete and is subject to and qualified in its entirety by reference to the Indenture. As used in this section, the term "Operating Partnership" means Host Marriott, L.P. and not any of its Subsidiaries, unless otherwise expressly stated or the context otherwise requires. GENERAL A separate series of Notes will be issued to Limited Partners of each Partnership who elect to receive Notes in exchange for the OP Units received in connection with the Mergers. The terms of each series of Notes will be substantially identical. The Notes will be direct, senior unsecured and unsubordinated obligations of the Operating Partnership and will rank pari passu with each other and with all other unsecured and unsubordinated indebtedness of the Operating Partnership from time to time outstanding. The Notes will be recourse obligations of the Operating Partnership, but the holders thereof will not have recourse against any partner of the Operating Partnership (including Host REIT, as general partner of the Operating Partnership). The Notes will be effectively subordinated to mortgages and other secured indebtedness of the Operating Partnership to the extent of the value of the property securing such indebtedness. The Notes also will be effectively subordinated to all existing and future third party indebtedness and other liabilities of the Operating Partnership's Subsidiaries (including the Partnerships). As of June 19, 1998, on a pro forma basis assuming the Full Participation Scenario, the Operating Partnership and its Subsidiaries would have had aggregate consolidated debt of approximately $5.6 billion (including $567 million of debentures relating to the Convertible Preferred Securities), to which the Notes were effectively subordinated or which ranked equal with such Notes. The Notes will mature on December 15, 2005 (the "Maturity Date"), which is approximately seven years following the currently expected Effective Date. The Notes are not subject to any sinking fund provisions, although the Operating Partnership is required to make mandatory prepayments of principal in certain events. See "--Principal and Interest." Except as described under "--Limitation on Incurrence of Debt" and "-- Merger, Consolidation or Sale," the Indenture does not contain any other provisions that would limit the ability of the Operating Partnership or any of its Subsidiaries to incur indebtedness or that would afford Holders (as defined below) of the Notes protection in the event of (i) a highly leveraged or similar transaction involving the Operating Partnership, the management of the Operating Partnership or Host REIT, or any subsidiary of any of them, (ii) a change of control of the Operating Partnership or Host REIT or (iii) a reorganization, restructuring, merger or similar transaction involving the Operating Partnership that may adversely affect the Holders of the Notes. In addition, subject to the limitations set forth under "--Merger, Consolidation or Sale," the Operating Partnership may, in the future, enter into certain transactions such as the sale of all or substantially all of its assets or the merger or consolidation of the Operating Partnership that would increase the amount of the Operating Partnership's indebtedness or substantially reduce or eliminate the Operating Partnership's assets, which may have an adverse effect on the Operating Partnership's ability to service its indebtedness, including the Notes. The Operating Partnership and its management have no present intention of engaging in a highly leveraged or similar transaction involving the Operating Partnership. The Notes will be issued in fully registered form. PRINCIPAL AND INTEREST The principal amount of the Notes with respect to each Partnership will be equal to the Note Election Amount for such Partnership, which will be equal to the Liquidation Value or, if greater, 80% of the Exchange Value for such Partnership. 201 The Notes will bear interest at a fixed rate of interest equal to 6.56% per annum, which was determined based on 120% of the applicable federal rate as of the Record Date. Interest will accrue from the closing of the Mergers or from the immediately preceding Interest Payment Date (as defined below) to which interest has been paid, payable semi-annually in arrears on each June 15 and December 15, commencing June 15, 1999 (each, an "Interest Payment Date"), and on the Maturity Date, to the persons (the "Holders") in whose names the Notes are registered in the security register for the Notes at the close of business on the date 14 calendar days prior to such payment day regardless of whether such day is a Business Day, as defined in the Indenture. Interest on the Notes will be computed on the basis of a 360-day year of twelve 30-day months. The principal of each Note payable on the Maturity Date will be paid against presentation and surrender of such Note at an office or agency maintained by the Operating Partnership in New York City (the "Paying Agent") in United States dollars. Initially, the Indenture Trustee will act as Paying Agent. REDEMPTION The Notes of any series may be redeemed at any time at the option of the Operating Partnership, in whole or from time to time in part, at a redemption price equal to the sum of the principal amount of the Notes being redeemed plus accrued interest thereon to the redemption date (the "Redemption Price"). In the event that, following the closing of the Mergers, any Partnership (i) sells or otherwise disposes of any Hotel owned by the Partnership immediately prior to the Merger and realizes net cash proceeds in excess of (a) the amount required to repay mortgage indebtedness (outstanding immediately prior to the Mergers) secured by such Hotel or otherwise required to be applied to the reduction of indebtedness of such Partnership and (b) the costs incurred by the Partnership in connection with such sale or other disposition or (ii) refinances (whether at maturity or otherwise) any indebtedness secured by any Hotel owned by the Partnership immediately prior to the Merger and realizes net cash proceeds in excess of (a) the amount of indebtedness secured by such Hotel at the time of the Mergers, calculated prior to any repayment or other reduction in the amount of such indebtedness in the Mergers and (b) the costs incurred by the Operating Partnership or such Partnership in connection with such refinancing (in either case, "Net Cash Proceeds"), the Operating Partnership will be required within 90 days of the receipt of the total Net Cash Proceeds to redeem at the Redemption Price an aggregate amount of principal of the particular series of the Notes which were issued to the Holders who were partners of such Partnership prior to the REIT Conversion equal to 80% of such Net Cash Proceeds. If the paying agent (other than the Operating Partnership, any of its Subsidiaries or an affiliate thereof) holds on the redemption date of any Notes money sufficient to pay such Notes, then on and after that date such Notes will cease to be outstanding and interest on them will cease to accrue. Notice of any optional or mandatory redemption of any Notes will be given to Holders at their addresses, as shown in the security register for the Notes, not more than 60 nor less than 30 days prior to the date fixed for redemption. The notice of redemption will specify, among other items, the Redemption Price and the principal amount of the Notes held by such Holder to be redeemed. If less than all the Notes of any series are to be redeemed, the Indenture Trustee shall select, in such manner as it shall deem fair and appropriate, the Notes to be redeemed in whole or in part. LIMITATION ON INCURRENCE OF INDEBTEDNESS The Operating Partnership will not, and will not permit any of its Subsidiaries to, incur any indebtedness (including acquired indebtedness) other than intercompany indebtedness (representing indebtedness to which the only parties are the Operating Partnership, Host REIT and/or any of their subsidiaries, but only so long as such indebtedness is held solely by any of such parties) that is subordinate in right of payment to the Notes, if immediately after giving effect to the incurrence of such indebtedness, the aggregate principal amount of all outstanding indebtedness of the Operating Partnership and its Subsidiaries on a consolidated basis, determined in accordance with GAAP, is greater than 75% of the Operating Partnership's Total Assets. 202 As used in the Indenture and the description thereof herein: "Subsidiary" means (i) a corporation, partnership, limited liability company, trust, REIT or other entity a majority of the voting power of the voting equity securities of which are owned, directly or indirectly, by the Operating Partnership or by one or more Subsidiaries of the Operating Partnership, (ii) a partnership, limited liability company, trust, REIT or other entity not treated as a corporation for federal income tax purposes, a majority of the equity interests of which are owned, directly or indirectly, by the Operating Partnership or a Subsidiary of the Operating Partnership or (iii) one or more corporations which, either individually or in the aggregate, would be Significant Subsidiaries (as defined below, except that the investment, asset and equity thresholds for purposes of this definition shall be 5%), the majority of the value of the equity interests of which are owned, directly or indirectly, by the Operating Partnership or by one or more Subsidiaries. "Total Assets" means the sum of (i) Undepreciated Real Estate Assets and (ii) all other assets (excluding intangibles) of the Operating Partnership and its Subsidiaries determined on a consolidated basis (it being understood that the accounts of Subsidiaries shall be consolidated with those of the Operating Partnership only to the extent of the Operating Partnership's proportionate interest therein). "Undepreciated Real Estate Assets" means, as of any date, the cost (being the original cost to the Operating Partnership or any of its Subsidiaries plus capital improvements) of real estate assets of the Operating Partnership and its Subsidiaries on such date, before depreciation and amortization of such real estate assets, determined on a consolidated basis (it being understood that the accounts of Subsidiaries shall be consolidated with those of the Operating Partnership only to the extent of the Operating Partnership's proportionate interest therein). MERGER, CONSOLIDATION OR SALE The Operating Partnership will not merge or consolidate with or into, or sell, lease, convey, transfer or otherwise dispose of all or substantially all of its property and assets (as an entirety or substantially as an entirety in one transaction or a series of related transactions) to any individual, corporation, limited liability company, partnership, joint venture, association, joint stock company, trust, REIT, unincorporated organization or government or any agency or political subdivision thereof (any such entity, a "Person"), or permit any Person to merge with or into the Operating Partnership, unless: (i) either the Operating Partnership shall be the continuing Person or the Person (if other than the Operating Partnership) formed by such consolidation or into which the Operating Partnership is merged or that acquired such property and assets of the Operating Partnership shall be an entity organized and validly existing under the laws of the United States of America or any state or jurisdiction thereof and shall expressly assume, by a supplemental indenture, executed and delivered to the Indenture Trustee, all of the obligations of the Operating Partnership, on the Notes and under the Indenture; (ii) immediately after giving effect, on a pro forma basis, to such transaction, no Default or Event of Default shall have occurred and be continuing; and (iii) the Operating Partnership will have delivered to the Indenture Trustee an officers' certificate and an opinion of counsel, in each case stating that such consolidation, merger or transfer and such supplemental indenture complies with such conditions. EVENTS OF DEFAULT, NOTICE AND WAIVER The following events are "Events of Default" with respect to the Notes of any series: (i) default for 30 days in the payment of any installment of interest on any Note of such series; (ii) default in the payment of the principal of any Note when due and payable at maturity, redemption, by acceleration or otherwise; (iii) default in the payment of any mandatory redemption of principal on or before the date 90 days after the receipt of the total Net Cash Proceeds from the applicable sale or other disposition or refinancing of a Hotel giving rise to the obligation to make such redemption; (iv) default in the performance of any other covenant or agreement of the Operating Partnership contained in the Indenture, such default having continued for 60 days after written notice as provided in the Indenture; and (v) certain events of bankruptcy, insolvency or reorganization, or court 203 appointment of a receiver, liquidator, assignee or trustee of the Operating Partnership or any Significant Subsidiary or any of their respective property. The term "Significant Subsidiary" means any Subsidiary which is a "significant subsidiary" of the Operating Partnership (as defined by Regulation S-X promulgated under the Securities Act). If an Event of Default under the Indenture occurs and is continuing, then in every such case other than a bankruptcy-related Event of Default as described in (v) above, in which case the principal amount of the Notes shall ipso facto become immediately due and payable, the Indenture Trustee or the Holders of not less than 25% in principal amount of the outstanding Notes of any series may declare the principal amount of all of the Notes of any series to be due and payable immediately by written notice thereof to the Operating Partnership (and to the Indenture Trustee if given by the Holders). However, at any time after such a declaration of acceleration with respect to any series of Notes has been made, but before a judgment or decree for payment of the money due has been obtained by the Indenture Trustee, the Holders of not less than a majority of the principal amount of outstanding Notes of any series may rescind and annul such declaration and its consequences if (i) the Operating Partnership shall have paid or deposited with the Indenture Trustee all required payments of the principal of and interest on the Notes of any series, plus certain fees, expenses, disbursements and advances of the Indenture Trustee and (ii) all Events of Default, other than the nonpayment of accelerated principal of (or specified portion thereof) and interest on the Notes have been cured or waived. The Indenture provides that the Holders of not less than a majority of the principal amount of the outstanding Notes of a series may waive any past default with respect to such series and its consequences, except a default (x) in the payment of the principal of or interest on any Note or (y) in respect of a covenant or provision contained in the Indenture that cannot be modified or amended without the consent of the Holder of each outstanding Note affected thereby. The Indenture Trustee will be required to give notice to the Holders of Notes within 90 days of a default under the Indenture unless such default has been cured or waived; provided, however, that the Indenture Trustee may withhold notice to the Holders of any default (except a default in the payment of the principal of or interest on any Note or in the payment of any mandatory redemption installment in respect of any Note) if specified Responsible Officers (as defined in the Indenture) of the Indenture Trustee determine in good faith such withholding to be in the interest of such Holders. The Indenture provides that no Holders of Notes may institute any proceeding, judicial or otherwise, with respect to the Indenture or for the appointment of a receiver or trustee, or for any other remedy thereunder, except in the case of failure of the Indenture Trustee, for 60 days, to act after it has received a written request to institute proceedings in respect of an Event of Default from the Holders of not less than 25% in principal amount of the outstanding Notes, as well as an offer of indemnity reasonably satisfactory to it. This provision will not prevent, however, any Holder of Notes from instituting suit for the enforcement of payment of the principal of and interest on such Notes at the respective due dates thereof. Subject to provisions in the Indenture relating to its duties in case of default, the Indenture Trustee is under no obligation to exercise any of its rights or powers under the Indenture at the request, order or direction of any Holders of any outstanding Notes under the Indenture, unless such Holders shall have offered to the Indenture Trustee thereunder reasonable security or indemnity. The Holders of not less than a majority in principal amount of the outstanding Notes shall have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Indenture Trustee, or of exercising any trust or power conferred upon the Indenture Trustee. However, the Indenture Trustee may refuse to follow any direction which is in conflict with any law or the Indenture, which may involve the Indenture Trustee if the Indenture Trustee in good faith determines that the proceeding will involve the Indenture Trustee in personal liability or which may be unduly prejudicial to the Holders of Notes of such series not joining therein. Within 120 days after the close of each fiscal year, the Operating Partnership must deliver to the Indenture Trustee a certificate, signed by one of several specified officers of Host REIT, stating whether or not such officer has knowledge of any default under the Indenture and, if so, specifying each such default and the nature and status thereof. 204 MODIFICATION OF THE INDENTURE Modifications and amendments of the Indenture will be permitted to be made by the Operating Partnership and the Indenture Trustee without the consent of any Holder of Notes for any of the following purposes: (i) to cure any ambiguity, defect or inconsistency in the Indenture; (ii) to evidence the succession of another Person to the Operating Partnership as obligor under the Indenture; (iii) to permit or facilitate the issuance of the Notes in uncertificated form; (iv) to make any change that does not adversely affect the rights of any Holder of Notes; (v) to provide for the issuance of and establish the form and terms and conditions of the Notes of any series as permitted by the Indenture; (vi) to add to the covenants of the Operating Partnership or to add Events of Default for the benefit of Holders or to surrender any right or power conferred upon the Operating Partnership in the Indenture; (vii) to evidence and provide for the acceptance of appointment by a successor Indenture Trustee or facilitate the administration of the trusts under the Indenture by more than one Indenture Trustee; (viii) to provide for guarantors or collateral for the Notes of any series; or (xi) to comply with requirements of the Commission in order to effect or maintain the qualification of the Indenture under the Trust Indenture Act. Modifications and amendments of the Indenture, other than those described above, will be permitted to be made only with the consent of the Holders of not less than a majority in principal amount of all outstanding Notes which are affected by such modification or amendment; provided, however, that no such modification or amendment may, without the consent of each Holder of such Note affected thereby, (i) change the stated maturity of the principal of, or any installment of interest on, any such Note; (ii) reduce the principal amount of or interest on any such Note, (iii) change the place of payment, or the coin or currency, for the payment of principal of or interest on any such Note; (iv) impair the right to institute suit for the enforcement of any payment on or with respect to any such Note; (v) waive a default in the payment of principal of or interest on the Notes (other than a recission of acceleration of the Notes of any series and a waiver of the payment default that resulted from such acceleration, as provided in the Indenture); or (vi) reduce the percentages of outstanding Notes of any series necessary to modify or amend the Indenture or to waive compliance with certain provisions thereof or certain defaults and consequences. The Indenture provides that the Holders of not less than a majority in principal amount of outstanding Notes have the right to waive compliance by the Operating Partnership with certain covenants in the Indenture. SATISFACTION AND DISCHARGE The Operating Partnership may discharge certain obligations to Holders of Notes that have not already been delivered to the Indenture Trustee for cancellation and that either have become due and payable or will become due and payable within one year (or scheduled for redemption within one year) by irrevocably depositing with the Indenture Trustee, in trust, funds in an amount sufficient to pay the entire indebtedness on such Notes in respect of principal and interest to the date of such deposit (if such Notes have become due and payable) or to the stated maturity or redemption date, as the case may be, and delivering to the Indenture Trustee an officers' certificate and a legal opinion stating that the conditions precedent to such discharge have been complied with. NO CONVERSION RIGHTS The Notes will not be convertible into or exchangeable for any capital stock of Host REIT or equity interest in the Operating Partnership. GOVERNING LAW The Indenture will be governed by and shall be construed in accordance with the laws of the State of New York. 205 COMPARISON OF OWNERSHIP OF PARTNERSHIP INTERESTS, OP UNITS AND COMMON SHARES The information below highlights a number of the significant differences between the Partnerships, the Operating Partnership and Host REIT relating to, among other things, form of organization, investment objectives, policies and restrictions, asset diversification, capitalization, management structure, compensation and fees and investor rights, and compares certain legal rights associated with the ownership of Partnership Interests, OP Units and Common Shares, respectively. These comparisons are intended to assist Limited Partners in understanding how their investments will be changed if, as a result of the Mergers and the REIT Conversion, their Partnership Interests are exchanged for OP Units, which are exchangeable with Host REIT for Host REIT Common Shares if timely and properly elected during the Election Period or, if retained, are redeemable at the option of the holder thereof beginning one year after the Mergers, for either Common Shares or the cash equivalent thereof, at the option of Host REIT. THIS DISCUSSION IS SUMMARY IN NATURE AND DOES NOT CONSTITUTE A COMPLETE DISCUSSION OF THESE MATTERS. LIMITED PARTNERS SHOULD CAREFULLY REVIEW THE BALANCE OF THIS CONSENT SOLICITATION FOR ADDITIONAL IMPORTANT INFORMATION. PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- FORM OF ORGANIZATION AND PURPOSE All of the Partnerships The Operating Partner- Host REIT is a Maryland are Delaware limited ship is a Delaware lim- corporation and will be partnerships, except for ited partnership. Fol- the sole general partner Chicago Suites, which is lowing the Mergers, the of the Operating Part- a Rhode Island limited Operating Partnership nership. Host REIT will partnership. The General will succeed to the own- make an election to be Partner of each Partner- ership of the Partici- taxed as a REIT under ship is Host or a direct pating Partnerships the Code and intends to or indirect wholly owned through wholly owned maintain its qualifica- subsidiary of Host. The subsidiaries. The sole tion as a REIT. Host purpose of each Partner- general partner of the REIT's only significant ship, other than Atlanta Operating Partnership asset will be its inter- Marquis, generally in- will be Host REIT. The est in the Operating cludes investing in, ac- Participating Partner- Partnership and conse- quiring, developing, op- ships, as wholly owned quently an indirect in- erating, selling or dis- subsidiaries of the Op- vestment in the Hotels posing of hotel proper- erating Partnership, owned by subsidiaries of ties or interests in ho- will own the Partnership the Operating Partner- tel properties and en- Hotels and lease them to ship. See "Distribution gaging in other activi- the Lessees. Following and Other Policies." ties related or inciden- the REIT Conversion and tal thereto. The purpose the Blackstone Acquisi- of Atlanta Marquis is to tion, the Operating acquire and own a gen- Partnership and its sub- eral partner interest in sidiaries initially is a hotel partnership and expected to own approxi- to engage in other ac- mately 125 full-service tivities related or in- hotels operating primar- cidental thereto. ily under the Marriott, Ritz-Carlton, Four Sea- sons, Swissotel and Hyatt brand names. The Operating Partnership will seek to invest in a real estate portfolio primarily consisting of upscale and luxury full- service hotels. The business of the Operat- ing Partnership will be limited to and conducted in such a manner as to permit Host REIT at all times to be qualified as a REIT under the Code. See "Distribution and Other Policies." 206 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- LENGTH AND TYPE OF INVESTMENT The Partnerships are fi- The Operating Partner- Host REIT has a perpet- nite-life entities whose ship has a stated term ual term and intends to existence expires as of approximately 100 continue its operations follows: Atlanta Mar- years. Events which may for an indefinite time quis, 2085; Chicago cause the dissolution of period. To the extent Suites, 2063; Desert the Operating Partner- Host REIT sells or refi- Springs, 2087; Hanover, ship prior to the expi- nances its assets, the 2086; MDAH, 2089; MHP, ration of the stated net proceeds therefrom 2106; MHP2, 2088 and term include: (i) the will generally be re- PHLP, 2080. Other events withdrawal of Host REIT tained by Host REIT which may cause the dis- as general partner with- (through the Operating solution of certain out the permitted trans- Partnership) for working Partnerships include: fer of Host REIT's in- capital and other gen- (i) the bankruptcy of terest to a successor eral purposes, except to the Partnership, (ii) general partner (except the extent distributions the withdrawal or re- in certain limited cir- thereof must be made to moval of the General cumstances), (ii) the permit Host REIT to Partner, unless a sub- entry of a decree of ju- qualify as a REIT for stitute general partner dicial dissolution of tax purposes. See "Dis- is elected by the Lim- the Operating Partner- tribution and Other Pol- ited Partners, (iii) the ship pursuant to the icies--Investment Poli- dissolution or bank- provisions of the Dela- cies." ruptcy of the General ware Act, (iii) the en- Partner, unless a sub- try of a final non-ap- stitute general partner pealable order for re- is elected by the Lim- lief in a bankruptcy ited Partners, (iv) the proceeding of the gen- sale or disposition of eral partner, or the en- all or substantially all try of a final non-ap- of the property of the pealable judgment ruling Partnership, (v) any that the general partner event that makes it un- is bankrupt or insolvent lawful for the business (except that, in either of the Partnership to be such case, in certain carried on or for the circumstances the lim- Partners to carry it on ited partners (other in a limited partnership than Host REIT) may vote or (vi) upon the agree- to continue the Operat- ment of the Partners. ing Partnership and sub- Partners are entitled to stitute a new general receive cash distribu- partner in place of Host tions out of the Part- REIT), or (iv) on or af- nership's net operating ter December 31, 2058, income, if any, and to on election by Host receive cash distribu- REIT, in its sole and tions, if any, upon re- absolute discretion. The financing of a Partner- Operating Partnership ship's debt or liquida- has no specific plans tion of the Partner- for disposition of the ship's real estate in- assets acquired through vestments. See "Back- the REIT Conversion or ground and Reasons for that may be subsequently the Mergers and the REIT acquired. To the extent Conversion--Background the Operating Partner- of the Partnerships." ship sells or refinances its assets, the net pro- ceeds therefrom will generally be retained by the Operating Partner- ship for working capital and new investments rather than being dis- tributed to its partners (including Host REIT), except to the extent distributions thereof must be made to permit Host REIT to qualify as a REIT for tax purposes. See "Background and Rea- sons for the Mergers and the REIT Conversion-- Reasons for the Mergers" and "Distribution and Other Policies--Invest- ment Policies." The Partnerships are structured to dissolve when the assets of the Partnerships are liquidated (or after approximately 75 to 120 years, if no liquidation occurs sooner). In contrast, the Operating Partnership and Host REIT as an enterprise are intended to be infinite life entities which will constitute an operating company and will reinvest the proceeds of asset dispositions, if any, in new properties or other appropriate investments consistent with the Operating Partnership's and Host REIT's investment objectives. 207 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- LIQUIDITY The Partnership Units in Each limited partner The Common Shares of each of the Partnerships will have the right, Host REIT will be freely represent relatively il- beginning one year after transferable upon regis- liquid investments with the closing of the tration under the Secu- a limited resale market Mergers, to exercise his rities Act, except for for such Partnership Unit Redemption Right. Common Shares held by Units. The trading vol- Upon redemption, such affiliates. The Common ume of such Partnership limited partner will Shares will be listed on Units in the resale mar- receive, at the election the NYSE. A public mar- ket is thin and the of Host REIT, either ket currently exists for prices at which Partner- Common Shares of Host Host's common stock. The ship Units trade are REIT or the cash breadth and strength of generally not equal to equivalent thereof in the market for Host REIT their net asset value. exchange for such OP Common Shares will de- No Limited Partner can Units. A limited partner pend upon, among other require a Partnership to may in certain things, the number of dispose of the Partner- circumstances transfer Common Shares outstand- ship's assets or redeem his OP Units. See ing, Host REIT's finan- the Limited Partner's "Description of OP cial results and pros- interest in the Partner- Units--Restrictions on pects and the general ship. Transfers of Interests interest in Host REIT's by Limited Partners." dividend yield compared to that of other debt and equity securities. See "Background and Rea- sons for the Mergers and the REIT Conversion-- Reasons for the Merg- ers." Partnership Units in the Partnerships have a relatively limited resale market. Beginning one year after the Mergers, limited partners of the Operating Partnership (other than Host REIT) will be able to exercise their Unit Redemption Right and receive, at the option of Host REIT, either cash or Common Shares on a one-for-one basis (subject to adjustment). The Common Shares of Host REIT will be freely transferable upon registration under the Securities Act, except for Common Shares held by affiliates. Shareholders of Host REIT are expected to achieve liquidity of their investment by selling the Common Shares in the open market. 208 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- NATURE OF INVESTMENT The Partnership Inter- The OP Units constitute The Common Shares con- ests of each Partnership equity interests enti- stitute equity interests constitute equity inter- tling each limited part- in Host REIT. Host REIT ests entitling each lim- ner to his pro rata is entitled to receive ited partner to his pro share of cash distribu- its pro rata share of rata share of cash dis- tions made to the part- distributions made by tributions made to the ners of the Operating the Operating Partner- partners of the Partner- Partnership. The Operat- ship with respect to the ship (except Chicago ing Partnership gener- OP Units it holds, and Suites, Hanover and ally intends to retain each shareholder will be MHP2, where the limited and reinvest proceeds of entitled to his pro rata partners are entitled to the sale of property or share of any dividends certain preferential excess refinancing pro- or distributions paid cash distributions, and ceeds in its business. with respect to the Com- except for Atlanta Mar- See "Distribution and mon Shares. The divi- quis, where the General Other Policies." dends payable to the Partner is entitled to shareholders are not certain preferential fixed in amount and are cash distributions). The only paid if, when and Partnerships generally as declared by the Board maintain a policy of of Directors. In order long-term ownership for to qualify as a REIT, current cash flow and Host REIT must distrib- long-term appreciation. ute at least 95% of its The partnership agree- taxable income (exclud- ment for each Partner- ing capital gains), and ship specifies how the any taxable income (in- cash available for dis- cluding capital gains) tribution, whether aris- not distributed will be ing from operation, subject to corporate in- sales or refinancing, is come tax. See "Distribu- to be shared among the tion and Other General Partner and the Policies." Limited Partners. The distributions payable to the partners are not fixed in amount and de- pend upon the operating results and net sale or refinancing proceeds available from the dis- position of the Partner- ship's assets. The limited partner interests in the Partnerships and the Operating Partnership, and the Common Shares in Host REIT, constitute equity interests in each, respectively. Each limited partner in Desert Springs, MDAH, MHP and PHLP is entitled to his pro rata share of the cash distributions by his respective Partnership; each limited partner in Chicago Suites, Hanover and MHP2 is entitled to certain preferential cash distributions; and the general partner in Atlanta Marquis is entitled to certain preferential cash distributions. The general partner and each limited partner is entitled to his pro rata share of cash distributions by the Operating Partnership, and each shareholder is entitled to his pro rata share of any dividends or distributions by Host REIT which are paid with respect to the Common Shares. 209 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- PROPERTIES AND DIVERSIFICATION The investment portfolio As a result of the REIT As a result of the REIT of each of the Partner- Conversion, the Operat- Conversion, Host REIT ships currently con- ing Partnership is ex- will be the sole general sists, directly or indi- pected initially to own partner and a substan- rectly, of one to eight a portfolio of approxi- tial limited partner of Hotels and certain re- mately 125 Hotels. The the Operating Partner- lated assets. The small ownership of these Ho- ship, which is expected number of Hotels owned tels, along with future initially to own a port- by each Partnership lim- hotel acquisitions by folio of approximately its each Partnership's the Operating Partner- 125 Hotels. ability to diversify its ship, will diversify the investment risk over ge- investment risks to lim- ographic locations, mar- ited partners over a kets and economic condi- broader and more varied tions. See "Background group of hotels and geo- and Reasons for the graphic locations and Mergers and the REIT will reduce the depen- Conversion--Background dence of an investment of the Partnerships." upon the performance of, and the exposure to the risks associated with, any one or more Hotels currently owned by a Partnership. The investment portfolio of each Partnership is currently limited to between one and eight Hotels (and certain related assets) in limited geographic locations. Through the REIT Conversion, and through additional investments that may be made from time to time, Host REIT and the Operating Partnership intend to create an investment portfolio substantially larger, more varied and more geographically diversified than the assets of any of the Partnerships individually. In addition, the larger portfolio will diversify the risks to the limited partners and shareholders over a broader group of Hotels, thereby reducing the dependence of an investment upon the performance of, and the exposure to the risks associated with, any particular Hotel or group of Hotels currently owned by an individual Partnership. 210 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- ADDITIONAL EQUITY/POTENTIAL DILUTION Each Partnership was de- The Operating Partner- Host REIT may issue ad- signed as a finite-life ship is authorized to ditional equity securi- investment vehicle. None issue OP Units and other ties, including shares of the Partnerships are partnership interests of capital stock which authorized to raise ad- (including partnership may be classified as one ditional funds for (or interests of different or more classes or se- reinvest net sale or re- series or classes that ries of common or pre- financing proceeds in) may be senior to OP ferred shares and con- new investments, absent Units) as determined by tain certain prefer- amendments to their Host REIT, in its sole ences, in the discretion partnership agreements discretion, including in of the Board of Direc- or approval of a major- connection with acquisi- tors. Any proceeds from ity of the outstanding tions of properties. The the issuance of equity limited partnership in- Operating Partnership securities by Host REIT terests. Since such may issue OP Units and must be contributed to Partnerships were not other partnership inter- the Operating Partner- structured to issue ad- ests to Host REIT, as ship in exchange for OP ditional equity securi- long as such interests Units or corresponding ties, there is little are issued in connection equity interests in the chance of dilution of with a comparable issu- Operating Partnership. the partners' share of ance of Common Shares or The issuance of addi- cash available for dis- other equity interests tional equity securities tribution. of Host REIT and pro- by Host REIT may result ceeds raised in connec- in the dilution of the tion with the issuance interests of the share- of such shares are con- holders, as well as in- tributed to the Operat- terests of holders of OP ing Partnership. In ad- Units in the Operating dition, the Operating Partnership. See "Dis- Partnership may issue tribution and Other additional OP Units upon Policies--Investment exercise of the options Policies." granted pursuant to op- tion plans or restricted shares issued under re- stricted share plans or other employee benefit plans adopted by Host REIT and the Operating Partnership. 211 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- FINANCING POLICIES The General Partner of The Operating Partner- Host REIT is not re- each Partnership is gen- ship may incur debt or stricted under its Char- erally authorized to enter into similar cred- ter from incurring debt. cause the Partnership to it, guarantee, financing However, under the Part- borrow money from the or refinancing arrange- nership Agreement, Host General Partner or oth- ments for any purpose REIT, as general partner ers and issue evidence with any person upon of the Operating Part- of indebtedness neces- such terms that Host nership, may not incur sary, convenient or in- REIT, as sole general any debts except those cidental to the accom- partner, determines ap- for which it may be lia- plishment of the pur- propriate. See "Distri- ble as general partner poses of the Partnership bution and Other Poli- of the Operating Part- and to secure the same cies--Financing Poli- nership and certain by mortgage, pledge or cies." other limited circum- other lien on the assets stances. Therefore, all of the Partnership. indebtedness incurred by Host REIT will be through the Operating Partnership. Host REIT will have a policy of incurring debt only if immediately following such incurrence the debt-to-total market capitalization ratio would be 60% or less. The Board of Directors could waive, alter or eliminate this policy without a shareholder vote. See "Distribution and Other Policies--Fi- nancing Policies." In conducting their business, each of the Partnerships, Host REIT and the Operating Partnership may incur indebtedness to the extent deemed appropriate by their general partner or Board of Directors, as the case may be. 212 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- OTHER INVESTMENT RESTRICTIONS The partnership agree- There are no restric- Neither Host REIT's ments of all of the tions upon the Operating Charter nor its Bylaws Partnerships contain re- Partnership's authority impose any restrictions strictions upon the ac- to enter into certain upon the types of in- quisition of interests transactions, including vestments that may be in other partnerships or among others, making made by Host REIT. Under hotel properties in ad- investments, lending Op- the MGCL, a contract or dition to such Partner- erating Partnership other transaction be- ship's current assets. funds or reinvesting the tween the Company and a None of the Partnerships Operating Partnership's director or between the are authorized to raise cash flow and net sale Company and any other additional funds for (or or refinancing proceeds corporation or other en- reinvest net sale or re- except (i) restrictions tity in which a director financing proceeds in) precluding investments of the Company is a di- new investments, absent by the Operating Part- rector or has a material amendments to their nership that would ad- financial interest is partnership agreements versely affect Host not void or voidable or approval of a major- REIT's status as a REIT, solely on the grounds of ity of the outstanding (ii) general restric- such interest, the pres- limited partnership in- tions on transactions ence of the director at terests. with Affiliates and the meeting at which the (iii) the noncompetition contract or transaction agreements. See "Busi- is approved or the di- ness and Properties-- rector's vote in favor Noncompetition Agree- thereof if (a) the fact ments." of the common director- ship or interest is dis- closed or known to (i) the board of direc- tors or committee, and the board or committee authorizes, approves or ratifies the contract or transaction by the af- firmative vote of a ma- jority of disinterested directors, even if the disinterested directors constitute less than a quorum, or (ii) the shareholders entitled to vote, and the transac- tion or contract is au- thorized, approved or ratified by a majority of the votes cast by the shareholders entitled to vote other than the votes of shares owned of record or beneficially by the interested direc- tor or corporation, firm or other entity, or (b) the transaction or con- tract is fair and rea- sonable to the Company. Host REIT also intends to adopt a policy which requires that all mate- rial contracts and transactions between Host REIT, the Operating Partnership or any of its subsidiaries, on the one hand, and a director or executive officer of Host REIT or any entity in which such director or executive officer is a director or has a ma- terial financial inter- est, on the other hand, must be approved by the affirmative vote of a majority of the disin- terested directors. Lastly, Host REIT must conduct its investment activities through the Operating Partnership for so long as the Oper- ating Partnership ex- ists. See "Distribution and Other Policies-- Policies with Respect to Other Activities." All of the partnership agreements of the Partnerships contain provisions which hinder further investment by the Partnership. The Partnership Agreement permits the Operating Partnership wide latitude in choosing the type of investments to pursue. For so long as the Operating Partnership exists, Host REIT must conduct all investment activities through the Operating Partnership. 213 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- MANAGEMENT CONTROL Under each of the part- The Board of Directors nership agreements of All management powers will direct the manage- the Partnerships, the over the business and ment of Host REIT's General Partners control affairs of the Operating business and affairs. the Partnerships and, Partnership are vested The Board of Directors subject to certain limi- in Host REIT, as sole will be classified into tations, are vested with general partner, and no three classes of direc- the exclusive right and limited partner of the tors. A majority of the power to conduct the Operating Partnership initial directors will business and affairs of will have any right to be independent. At each the Partnership and may participate in or exer- annual meeting of the appoint, contract or cise control or manage- shareholders, the suc- otherwise deal with any ment power over the cessors of the class of person, including em- business and affairs of directors whose terms ployees of its affili- the Operating Partner- expire at that meeting ates, to perform any ship except (i) Host will be elected. The acts or services for the REIT, as sole general policies adopted by the Partnership necessary or partner, may not, with- Board of Directors may appropriate for the con- out written consent of be altered or eliminated duct of the business and all the limited partners without a vote of the affairs of the Partner- or such lower percentage shareholders. According- ship. A Limited Partner of OP Units as may be ly, except for their has no right to partici- specifically provided vote in the elections of pate in the management for in the Partnership directors and their vote and control of a Part- Agreement or the in certain major trans- nership and has no voice Delaware Act, take any actions, shareholders in its affairs except on action in contravention will have no control certain limited matters of the Partnership over the ordinary busi- that may be submitted to Agreement; (ii) Host ness policies of Host a vote of the Limited REIT, as sole general REIT. Partners under the terms partner, may not dispose of the partnership of all or substantially agreements of the Part- all of the Operating nerships. Under each Partnership's assets partnership agreement, without the consent of Limited Partners have the holders of a major- the right to remove ity of the outstanding their General Partner by OP Units (including OP a majority vote (except Units held by Host for Atlanta Marquis, REIT); and (iii) until which requires a 66 2/3% December 31, 2058, Host vote of its Class A lim- REIT may not cause or ited partner interests), permit the Operating subject to certain con- Partnership to dissolve ditions. Each of the (except in connection partnership agreements with a sale of all or permits removal of the substantially all of the general partner only for Operating Partnership's breach of certain provi- assets, with the ap- sions of the partnership proval described above) agreement, fraud or un- more than 10% of the remedied acts of bad limited partners object faith or gross negli- to such dissolution. gence or breach of fidu- Host REIT may not be re- ciary duty. Furthermore, moved as general partner the MDAH and MHP2 part- by the limited partners nership agreements allow with or without cause removal of the General unless Host REIT ceases Partner only if certain to be a "public compa- favorable legal opinions ny," and then Host REIT concerning liability of could be removed as gen- the Limited Partners and eral partner with or tax status of the Part- without cause by limited nership are obtained. In partners holding Per- all cases of removal of centage Interests in the the General Partner, Operating Partnership however, the Partnership that are more than 50% may continue only if the of the aggregate Per- Limited Partners find a centage Interests of the successor general part- outstanding limited ner. partnership interests entitled to vote there- on, including any such interests held by the general partner. See "Risk Factors--Risks and Effects of the Mergers-- No Control Over Major Decisions," "Description of OP Units--Purposes, Business and Management" and "--Dissolution, Winding Up and Termination." Under the partnership agreements of the Partnerships and the Partnership Agreement of the Operating Partnership, the general partners control the partnerships and are vested with the exclusive right and power to conduct the business and affairs of the partnerships. In both cases, limited partners have no voice in the affairs of the partnership except on certain limited matters. All of the Partnerships permit removal of the General Partner by the Limited Partners with cause. The Partnership Agreement of the Operating Partnership does not permit removal of Host REIT as general partner by the limited partners with or without cause unless Host REIT ceases to be a "public company," and then Host REIT could be removed as general partner with or without cause. Under the Charter and Bylaws, the Board of Directors directs the management of Host REIT. Except for their vote in the elections of directors and their vote in certain major transactions, shareholders have no control over the management of Host REIT. 214 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- FIDUCIARY DUTIES The Delaware Act and Under the Delaware Act, Under Maryland law, the Rhode Island Act provide Host REIT, as general directors must perform that the General Part- partner of the Operating their duties in good ners are accountable as Partnership, is account- faith, in a manner that fiduciaries to the Part- able to the Operating they reasonably believe nerships and are re- Partnership as a fidu- to be in the best inter- quired to exercise good ciary and, consequently, ests of Host REIT and faith, loyalty and in- is required to exercise with the care of an or- tegrity in their deal- good faith and integrity dinary prudent person in ings in conducting the in all of its dealings a like position. Direc- affairs of the Partner- with respect to partner- tors of Host REIT who ships. The duty of good ship affairs. However, act in such a manner faith requires that the under the Partnership generally have no lia- General Partners deal Agreement, Host REIT, as bility by reason of be- fairly and with complete general partner, is un- ing or having been di- candor toward the Lim- der no obligation to rectors. ited Partners. The duty consider the separate of loyalty requires interests of the limited that, without the Lim- partners in deciding ited Partners' consent, whether to cause the Op- the General Partners may erating Partnership to not have business or take (or decline to other interests that are take) any actions, and adverse to the interests Host REIT, as general of the Partnerships. The partner, is not liable duty of fair dealing for monetary damages for also requires that all losses sustained, lia- transactions between the bilities incurred, or General Partners and the benefits not derived by Partnerships be fair in limited partners in con- the manner in which the nection with such deci- transactions are ef- sion, provided that Host fected and in the amount REIT, as general part- of the consideration re- ner, has acted in good ceived by the General faith and pursuant to Partners. its authority under the Partnership Agreement. The General Partners, Host REIT, as general partner of the Operating Partnership, and the Board of Directors of Host REIT, respectively, owe fiduciary duties to their constituent parties. Although some courts have interpreted the fiduciary duties of the Board of Directors in the same way as the duties of a general partner in a limited partnership, it is unclear whether, or to what extent, there are differences in such fiduciary duties. It is possible that the fiduciary duties of the directors of Host REIT to the shareholders may be less than those of the General Partners to the Limited Partners and Host REIT, as general partner of the Operating Partnership, to the limited partners of the Operating Partnership. The Partnership Agreement contains a specific provision to the effect that Host REIT, as general partner of the Operating Partnership, is under no obligation to consider the separate interests of the limited partners of the Operating Partnership in taking partnership action. Since the partnership agreements of the Partnerships do not contain such a provision, the fiduciary duties of Host REIT, as general partner of the Operating Partnership, to the limited partners of the Operating Partnership may be less than those of the General Partners to their Limited Partners. 215 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- MANAGEMENT LIABILITY AND INDEMNIFICATION Under the Delaware Act Under the Delaware Act, The MGCL permits a Mary- and the Rhode Island Host REIT, as general land corporation to in- Act, each General Part- partner of the Operating clude in its charter a ner is liable for the Partnership, is liable provision limiting the payment of partnership for the payment of the liability of its direc- obligations and debts, obligations and debts of tors and officers to the unless limitations upon the Operating Partner- corporation and its such liability are ex- ship unless limitations shareholders for money pressly stated in the upon such liability are damages except for lia- document or instrument stated in the document bility resulting from evidencing the obliga- or instrument evidencing (i) actual receipt of an tion (e.g., a loan the obligation. Under improper benefit or structured as a nonre- the Partnership Agree- profit in money, prop- course obligation). Each ment, the Operating erty or services or partnership agreement of Partnership agrees to (ii) acts committed in the Partnerships gener- indemnify Host REIT or bad faith or active and ally provides that the any director or officer deliberate dishonesty General Partner will not of Host REIT from and established by a final be held liable for any against all losses, judgment as being mate- costs arising out of its claims, damages, liabil- rial to the cause of ac- action or inaction ex- ities, joint or several, tion. Host REIT's char- cept that the General expenses (including le- ter contains such a pro- Partner will be liable gal fees), fines, set- vision. As permitted by for any costs which tlements and other Maryland law, Host arise from the General amounts incurred in con- REIT's Charter also pro- Partner's own fraud, nection with any actions vides broad indemnifica- negligence, misconduct relating to the opera- tion to directors and or other breach of fidu- tions of the Operating officers, whether serv- ciary duty. In cases in Partnership as set forth ing Host REIT, or at its which the General Part- in the Partnership request, any other enti- ner is indemnified, any Agreement in which Host ty, to the fullest ex- indemnity is payable REIT or any such direc- tent permitted under only from the assets of tor or officer is in- Maryland law. Host REIT the Partnership. volved, unless (i) the will indemnify its pres- act or omission of Host ent and former directors REIT was material to the and officers, among oth- matter giving rise to ers, against judgments, the proceeding and ei- penalties, fines, set- ther was committed in tlements and reasonable bad faith or was the re- expenses actually in- sult of active and de- curred by them in con- liberate dishonesty; nection with any pro- (ii) Host REIT or the ceeding to which they other person to be in- may be made a party by demnified actually re- reason of their service ceived an improper per- in those or other capac- sonal benefit in money, ities unless it is es- property or services or tablished that (i) the (iii) in the case of any act or omission of the criminal proceeding, director or officer was Host REIT or the other material to the matter person to be indemnified giving rise to the pro- had reasonable cause to ceeding and (a) was com- believe the act or omis- mitted in bad faith or sion was unlawful. The (b) was the result of reasonable expenses in- active and deliberate curred by Host REIT may dishonesty, (ii) the di- be reimbursed by the Op- rector or officer actu- erating Partnership in ally received an im- advance of the final proper personal benefit disposition of the pro- in money, property or ceeding upon receipt by services or (iii) in the the Operating Partner- case of any criminal ship of an affirmation proceeding, the director by Host REIT or the or officer had reason- other person to be in- able cause to believe demnified of its good that the act or omission faith belief that the was unlawful. However, standard of conduct nec- under Maryland law, Host essary for indemnifica- REIT may not indemnify tion has been met and an for an adverse judgment undertaking by Host REIT in a suit by or in the to repay the amount if right of Host REIT. The it is determined that Bylaws of Host REIT re- such standard was not quire it, as a condition met. to advancing expenses, to obtain (i) a written affirmation by the di- rector or officer of his good faith belief that he has met the standard of conduct necessary for indemnification by Host REIT as authorized by the Bylaws and (ii) a written statement by or on his behalf to repay the amount paid or reimbursed by Host REIT if it shall ultimately be determined that the standard of conduct was not met. Host REIT also intends to enter into indemnification agree- ments indemnifying each of its directors and of- ficers to the fullest extent permitted by Maryland law and advance to its directors and of- ficers all related ex- penses subject to reim- bursement if it is sub- sequently determined that indemnification is not permitted. In each of the Partnerships, the General Partners will only be held liable for costs which arise from the General Partners' own fraud, negligence, misconduct or other breach of fiduciary duty, and may be indemnified in certain cases. While Host REIT, as general partner of the Operating Partnership, is generally liable for the payment of the obligations and debts of the Operating Partnership, the Operating Partnership generally agrees to indemnify Host REIT, except regarding certain unauthorized acts of Host REIT. The liability of Host REIT's directors and officers is limited to the fullest extent permitted under Maryland law and such directors and officers are indemnified by Host REIT to the fullest extent permitted by Maryland law. 216 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- LIABILITY OF INVESTORS Under each of the part- Under the Partnership Under Maryland law, nership agreements, the Agreement and the Dela- shareholders are not Delaware Act and the ware Act, the liability personally liable for Rhode Island Act, the of limited partners for the obligations of Host liability of Limited the Operating Partner- REIT. Partners for the Part- ship's debts and obliga- nership's debts and ob- tions is generally lim- ligations is generally ited to the amount of limited to the amount of their investment in the their investment in the Operating Partnership, Partnership, together together with their in- with an interest in un- terest in undistributed distributed income, if income, if any. any. In the Partnerships and the Operating Partnership, a limited partner's liability is limited to the amount of his investment. Shareholders of Host REIT generally have no liability under applicable Maryland law for the debts and obligations of Host REIT. 217 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- ANTITAKEOVER PROVISIONS For each of the Partner- Applicable Maryland law ships, a change in man- Except in limited cir- and the Charter and By- agement may be effected cumstances (see "Voting laws of Host REIT will only by removal of the Rights" below) Host contain a number of pro- General Partner. See REIT, in its capacity as visions that may have "Management Control" general partner of the the effect of delaying above for a discussion Operating Partnership, or discouraging a change of the ability to remove has exclusive management in control of Host REIT a General Partner. A power over the business that might be in the transfer of limited and affairs of the Oper- best interests of share- partnership interests in ating Partnership. Host holders. These provi- a Partnership is gener- REIT may not be removed sions will include, ally restricted if (i) as general partner of among others, (i) a it is on a day other the Operating Partner- Board of Directors with than the first day in an ship by the limited three-year staggered accounting period, (ii) partners with or without terms whose size is it would, when combined cause (unless Host REIT fixed within a range; with the total of other is no longer a "public (ii) authorized capital partnership interests company," in which case stock that may be clas- transferred within past the general partner may sified and issued as a 12 consecutive months, be removed with or with- variety of equity secu- in the opinion of coun- out cause by limited rities, in the discre- sel, result in the Part- partners holding Per- tion of the Board of Di- nership being deemed to centage Interests in the rectors, including secu- have been terminated Operating Partnership rities having superior within the meaning of that are more than 50% voting rights to the Section 708 of the Code of the aggregate Per- Common Shares; (iii) re- (except for MHP2), (iii) centage Interests of the strictions on business it would, in the opinion outstanding limited combinations with per- of counsel for the as- partnership interests sons who acquire more signee or assignor, re- entitled to vote there- than a certain percent- quire the filing of a on, including any such age of the outstanding registration statement interests held by the voting securities of under the Securities general partner). Under Host REIT; (iv) a re- Act, or would otherwise the Partnership Agree- quirement that share- be in violation of any ment, Host REIT may, in holders approve voting federal or state securi- its sole and absolute rights for "Control ties or blue sky laws, discretion, prevent a Shares" acquired in (iv) it would result in limited partner from "control share" acquisi- the assignor or assignee transferring his inter- tions; (v) a provision holding a fraction of a est or any rights as a that only the Board of partnership unit, (v) it limited partner except Directors may amend the would, in the opinion of in certain limited cir- Bylaws; (vi) advance no- counsel, result in the cumstances. Host REIT tice provisions for Partnership being may exercise this right shareholders to submit treated as an associa- of approval to deter, new business or nominate tion taxable as a corpo- delay or hamper attempts candidates for director; ration, (vi) it would, by Persons to acquire a (vii) limitations on the in the opinion of coun- majority interest in the ability of shareholders sel, result in the Part- Operating Partnership. to call special meet- nership failing to ob- In addition, Host REIT ings; (viii) a require- tain or continue in ef- has the power to impose ment that directors be fect any license permit- limits on transfers if, removed only for cause ting the service or sale and to the extent, nec- and only by a vote of of alcoholic beverages essary to cause the Op- shareholders holding at at one or more hotels or erating Partnership not least two-thirds of all (vii) it is an assign- to be a "publicly traded the shares entitled to ment to a tax-exempt en- partnership" that would be cast for the election tity or non-U.S. person be taxed as a corpora- of directors; (ix) a re- within the meaning of tion, including the pro- quirement of an affirma- Section 7701(a)(30) of hibition contained in tive vote of two-thirds the Code. In addition to the Partnership Agree- of all votes entitled to such restrictions, the ment restricting the be cast to approve cer- General Partners of At- ownership, actually or tain amendments to the lanta Marquis, Chicago constructively, of more Charter; and (x) certain Suites, Hanover, Desert than 4.9% by value of ownership limitations Springs and MHP may, in any class of interests which are designed to their sole discretion, in the Operating Part- protect Host REIT's sta- restrict any transfer of nership. See "Descrip- tus as a REIT under the limited partnership in- tion of OP Units." Code. In addition, Host terests. In each of the REIT intends to adopt a Partnerships, an as- Shareholder Rights Plan signee of a limited whereby shareholders partner interest may not will be entitled to pre- become a substitute lim- ferred share purchase ited partner, entitling rights in certain situa- him to vote on matters tions. See "Certain Pro- that may be submitted to visions of Maryland Law the Limited Partners for and Host REIT's Charter approval, unless the and Bylaws." General Partner consents to such substitution. Certain provisions of the governing documents of the Partnerships, the Operating Partnership and Host REIT could be used to deter attempts to obtain control of the Partnerships, the Operating Partnership and Host REIT in transactions not approved by the General Partners, the general partner of the Operating Partnership or the Board of Directors, respectively. 218 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- LIMITED PARTNER VOTING RIGHTS Generally, the General All decisions relating Host REIT will be man- Partners have the au- to the operation and aged and controlled by a thority to manage the management of the Oper- Board of Directors con- affairs of the Partner- ating Partnership will sisting of three classes ships and to approve all be made by Host REIT, in having staggered terms Partnership actions, and its capacity as general of office. At each an- the Limited Partners of partner of the Operating nual meeting of share- the Partnerships have Partnership, and the holders, the successors voting rights only as to limited partners have to the class of direc- certain major partner- voting rights under the tors whose term expires ship transactions to the Partnership Agreement at such meeting shall be extent provided in the only as to the sale of elected to hold office partnership agreements substantially all of the for a term expiring at of each Partnership. assets of the Operating the annual meeting of Such voting rights Partnership, certain shareholders in the include: acquisition of consolidations and merg- third year following the interests in other prop- ers and amendments of year of their election. erties, incurrence of the Partnership Agree- Maryland law requires certain debt, merger or ment. During the first that certain major consolidation with an- year following the Merg- transactions, including other entity, sale of ers, the limited part- most amendments to Host all or substantially all ners also have voting REIT's Charter, may not of the assets of a Part- rights as to the sale of be consummated without nership, certain amend- all or substantially all the approval of share- ments to the partnership of the assets of the Op- holders. Each Common agreement, termination erating Partnership, a Share will have one vote of certain agreements to merger involving the Op- and Host REIT's Charter which the Partnership is erating Partnership, permits the Board of Di- party, expansion of one certain issuances of OP rectors to classify and or more hotels in cer- Units and for certain issue shares of capital tain cases, dissolution limited partners, cer- stock in one or more se- of the Partnership or tain sales of hotels ries having voting power removal of the General that are held by the Op- which may differ from Partner. erating Partnership. that of the Common Shares. See "Description of Capital Stock." The general partners have the authority to manage the affairs of the Partnerships and the Operating Partnership and to approve all partnership actions, and the limited partners of the Partnerships and the Operating Partnership have only limited voting rights. The shareholders of Host REIT will have voting rights that permit them to elect the Board of Directors and to approve or disapprove certain major transactions. See "Risk Factors--Risks and Effects of the Mergers--No Control over Major Decisions." 219 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- Sale Other Than to an Affiliate The Atlanta Marquis, Under the Partnership Pursuant to Host REIT's Desert Springs and Hano- Agreement, Host REIT Charter, subject to the ver partnership agree- generally has the exclu- terms of any class or ments allow the sale of sive authority to deter- series of shares at the all or substantially all mine whether, when and time outstanding, Host of the assets of the on what terms the assets REIT may transfer its partnership to a buyer of the Operating Part- assets within the mean- without the consent of nership (including the ing of the MGCL, but any the Limited Partners. Hotels) will be sold. such merger, consolida- The Chicago Suites part- See "Description of OP tion, share exchange or nership agreement allows Units-- Sales of As- transfer of assets must the sale of its Hotel or sets." However, Host be approved (i) by the a material portion of REIT, as general partner Board of Directors in its assets with the con- of the Operating Part- the manner provided in sent of a majority of nership, generally may the MGCL and (ii) by the outstanding limited not sell, exchange, shareholders to the ex- partner interests and transfer or otherwise tent required under the the receipt of an ap- dispose of all or sub- MGCL. In general, such praisal from an MAI stantially all of the transactions by a Mary- qualified appraiser. The Operating Partnership's land corporation, such MDAH partnership agree- assets in a single as Host REIT, must first ment allows the sale of transaction or a series be approved by a major- the Fairview Park Hotel, of related transactions ity of the entire Board or more than two other (including by way of of Directors and there- MDAH Hotels, only with merger, consolidation or after approved by share- the consent of a major- other combination with holders by the affirma- ity of the outstanding any other Persons), tive vote of two-thirds limited partner inter- without the consent of of all the votes enti- ests including any lim- more than 50% of the tled to be cast on the ited partner interests outstanding limited matter (unless the char- held by the General partnership interests, ter provides for a Partner. The MHP part- including any limited greater or lesser share- nership agreement allows partnership interests holder vote but not less the General Partner to held by Host REIT. In than a majority of the sell or dispose of any addition, during the number of votes entitled assets of MHP, including first year following the to be cast on the mat- its interest in the Har- Mergers, the holders of ter). Host REIT's Char- bor Beach Partnership, OP Units of the Operat- ter provides for share- to any person. The MHP2 ing Partnership have holder approval of such partnership agreement certain voting rights if transactions by a two- allows the sale of any a vote of shareholders thirds vote of all the Hotel or the Partner- of Host REIT is re- votes entitled to be ship's interest in the quired. In connection cast. Under the MGCL, a Santa Clara Partnership with a sale of all or "transfer of assets" is with the consent of a substantially all of the defined to mean any majority of the out- assets of the Operating sale, lease, exchange or standing limited partner Partnership during this other transfer of all or interests, including any first year following the substantially all of the limited partner inter- Mergers, the approval of assets of the corpora- ests held by the General a majority of all out- tion but does not Partner. standing OP Units would include (i) a transfer be required, including of assets by a corpora- The PHLP partnership the OP Units held by tion in the ordinary agreement allows the Host REIT, voting as a course of business actu sale of an asset which single class with Host ally conducted by it, has a cost basis at the REIT voting its OP Units (ii) a mortgage, pledge time of sale in excess in the same proportion or creation of any other of 5% of the aggregate as its shareholders security interest in any cost basis of all assets vote, would be required. or all of the assets of of PHLP only with the In addition, during the the corporation, whether consent of a majority of first year following the or not in the ordinary the outstanding limited Mergers, any taxable course of its business, partner interests, in- sale or sales of Hotels (iii) an exchange of cluding any limited representing more than shares of stock through partner interests held 10% of the aggregate Ap- voluntary action under by the General Partner. praised Value of the Ho- any agreement with the tels of any Partnership shareholders or (iv) a would require, in addi- transfer of assets to tion to any other ap- one or more persons if proval requirements, the all the equity interests approval of a majority of the person or persons of all outstanding OP are owned, directly or Units held by persons indirectly, by the cor- who formerly were Lim- poration. ited Partners of such Partnership, voting as a separate class. 220 Under Host REIT's Charter, the Board of Directors is required to obtain approval of the shareholders by the affirmative vote of two-thirds of all the votes entitled to be cast on the matter in order to transfer its assets within the meaning of the MGCL. No approval of the shareholders is required for a sale, lease, exchange or other transfer of all or substantially all of the assets of Host REIT in the ordinary course of business actually conducted by it; a mortgage, pledge or creation of any other security interest in any or all of the assets of Host REIT, whether or not in the ordinary course of its business; an exchange of shares of stock through voluntary action under any agreement with shareholders; or a sale, lease, exchange, or other transfer of all or substantially all of the assets of Host REIT to one or more persons if all the equity interests of the person or persons are owned, directly or indirectly, by Host REIT. Under each of the partnership agreements, the Partnership Agreement and Host REIT's Charter, the sale of assets may be effected with various levels of limited partner or shareholder consent. Under most of the partnership agreements and the Charter, the sale of assets which do not amount to all or substantially all of the assets of the Partnerships, the Operating Partnership or Host REIT does not require any consent of the limited partners or shareholders, respectively. 221 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - -------------------------------------------------------------------------------- Sale to the General Partner or Its Affiliates The General Partners of The Operating Partner- Neither the Charter nor MDAH and MHP2 may cause ship shall not, directly the Bylaws of Host REIT those Partnerships to or indirectly, sell, has any specified addi- sell any of their assets transfer or convey any tional requirements for to its General Partner property to any affili- sales of assets to af- or an affiliate of the ate of Host REIT that is filiates of Host REIT. General Partner (i) with not also a subsidiary of the consent of the Lim- the Operating Partner- ited Partners holding a ship, except as ex- majority of the out- pressly permitted in the standing limited partner Partnership Agreement or interests in the Part- except on terms that are nership (with, in the fair and reasonable and case of MDAH, the Gen- no less favorable to the eral Partner being Operating Partnership barred from voting any than would be obtained limited partner inter- from an unaffiliated ests it or its affiliate third party. holds or, in the case of MHP2, the General Part- ner being required to vote its or its affili- ate's limited partner interests in the same manner as the majority of "outside" limited partner interests actu- ally voted (so long as a majority of the outside limited partners are present for purposes of a vote by submitting ballots or otherwise)) and (ii) by complying with certain notice and independent appraisal requirements as follows: (a) the General Partner must provide to its Lim- ited Partners at least 30 days' notice of the proposed sale, which no- tice must set forth the price and other material terms and conditions of the proposed transac- tion, (b) the Partner- ship must obtain three appraisals of the fair market sales value of the Hotel(s) to be sold, which appraisals must be prepared by independent, nationally recognized appraisers who have been selected by the General Partner and are experi- enced in the valuation of hotel properties (the cost of all such ap- praisals must be borne by the General Partner or its affiliate), (c) such appraisers may not have, directly or indi- rectly, any material in- terest in or material business or professional relationship with the General Partner or any of its affiliates and the compensation of each such appraiser must be determined in accordance with a written contract before such appraisal is prepared, (d) the price at which the sale is ef- fected must not be less than the average of the three amounts determined by the three appraisers, disregarding entirely any appraisal that dif- fers by more than 20% from the amount deter- mined by the appraiser whose determination is between the highest and lowest of the amounts determined by the three appraisers, (e) the pur- chase price must be pay- able in cash, (f) no real estate commission may be paid by the Part- nership in connection with such sale and (g) the General Partner must include copies of such appraisals with the notice to its Limited Partners. 222 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - -------------------------------------------------------------------------------- The General Partners of Atlanta Marquis, Desert Springs, Hanover and MHP may cause those Partnerships to sell any hotels to the Gen- eral Partner or any af- filiate (i) with the consent of Limited Partners holding of a majority of the out- standing limited part- ner interests in the Partnership (with the General Partners or their affiliates of Desert Springs, Hanover and MHP being required to vote any limited partner interests it holds in the same man- ner as the majority of "outside" limited part- ner interests actually voted (so long as a ma- jority of the outside limited partners are present for purposes of a vote by submitting ballots or otherwise)), and (ii) by complying with certain notice and independent appraisal requirements as fol- lows: (a) the General Partner must provide notice of the proposed sale to its Limited Partners, who thereaf- ter have 30 days to elect a nationally rec- ognized appraiser hav- ing the approval of the holders of a majority of the limited partner interests, (b) such ap- praiser has 30 days from the date of elec- tion to prepare and submit to the General Partner an appraisal of the fair market value of the Hotel in ques- tion, (c) the purchaser must submit to the Gen- eral Partner an ap- praisal of the fair market value of the Ho- tel, such appraisal to be submitted within the time limit provided by clause (b) above in the case of the appraisal to be submitted by the appraiser elected by the Limited Partners and (d) the General Partner must thereafter seek the required con- sent and include there- with copies of the two appraisals. If the Lim- ited Partners do not select an appraiser as provided in (a) above or such appraiser does not supply an appraisal within the time frame in (b) above, then the General Partner must submit three appraisals with its request for consent, one such ap- praisal prepared by an appraiser selected by the purchaser and the other two appraisals prepared by appraisers selected by the first appraiser (all of such appraisal costs to be borne by the purchas- er). The Chicago Suites and PHLP partnership agree- ments contain no spe- cial provisions con- cerning a sale of part- nership assets to the General Partner or its affiliates. Under most of the partnership agreements and the Partnership Agreement, in addition to the general restrictions on sale of assets, there are provisions which must be met when partnership assets are sold to the general partner or an affiliate of the general partner. Neither the Charter nor the Bylaws of Host REIT contain any provisions restricting the sale of assets to an affiliate of Host REIT. 223 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- Merger The partnership agree- Under the Partnership Pursuant to the Charter, ment of MDAH allows a Agreement, Host REIT subject to the terms of merger of the Partner- generally may not cause any class or series of ship with the approval a merger or consolida- shares at the time out- of the General Partner tion of the Operating standing, Host REIT may and the consent of a ma- Partnership without the merge with or into an- jority of the outstand- consent of a majority of other entity, but any ing limited partner in- the outstanding partner- such merger must be ap- terests, but the General ship interests (includ- proved (i) by the Board Partner may not vote any ing the partnership in- of Directors in the man- of its limited partner terests held by Host ner provided in the MGCL interests. The partner- REIT) and the general and (ii) by shareholders ship agreement of MHP2 partner. In addition, to the extent required allows a merger of the during the one-year pe- under the MGCL. Under Partnership with the ap- riod following the Merg- the MGCL, mergers of a proval of the General ers, the holders of OP Maryland corporation, Partner and the consent Units of the Operating such as Host REIT, with of a majority of the Partnership have certain or into another entity outstanding limited voting rights if a vote must first be approved partner interests, in- of shareholders of Host by a majority of the en- cluding the limited REIT is required in con- tire Board of Directors partner interests held nection with a merger. and thereafter approved by the General Partner, In such case, approval by shareholders by the unless the General Part- of a majority of all affirmative vote of two- ner has an interest in outstanding OP Units, thirds of all the votes the transaction, in including the OP Units entitled to be cast on which case it must vote held by Host REIT, vot- the matter (unless the all of its or its affil- ing as a single class Charter provides for a iates limited partner with Host REIT voting lesser shareholder vote interests in the same its OP Units in the same but not less than a ma- manner as the majority proportion as its share- jority of the number of of "outside" limited holders vote, would be votes entitled to be partner interests actu- required. cast on the matter). ally voted (so long as a Host REIT's Charter gen- majority of the outside erally provides for limited partners are shareholder approval of present for purposes of such transactions by a a vote by submitting two-thirds vote of all ballots or otherwise). the votes entitled to be Each of the Atlanta Mar- cast, except that any quis, Chicago Suites, merger of Host REIT with Desert Springs, Hanover, or into a trust orga- MHP and PHLP partnership nized for the purpose of agreements contain no changing Host REIT's merger provision. Under form of organization the Delaware Act and the from a corporation to a Rhode Island Act, a trust will require the merger may be effected approval of shareholders upon approval by its of Host REIT by the af- General Partner and the firmative vote only of a holders of a majority of majority of all the the limited partner in- votes entitled to be terests of each class of cast on the matter. Un- limited partner. In At- der the MGCL, certain lanta Marquis, the Gen- mergers may be accom- eral Partner may vote plished without a vote the limited partner in- of shareholders. For ex- terests it holds. In ample, no shareholder Chicago Suites the Gen- vote is required for a eral Partner holds no merger of a subsidiary limited partner inter- of a Maryland corpora- ests and a merger may be tion into its parent, effectuated by the af- provided the parent owns firmative vote of a ma- at least 90% of the sub- jority of the outstand- sidiary. In addition, a ing limited partner in- merger need not be ap- terests. In Desert proved by shareholders Springs, Hanover and if the merger does not MHP, the General Partner reclassify or change the may vote its limited outstanding shares or partner interests. otherwise amend the Charter, and the number of shares to be issued 224 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- or delivered in the merger is not more than 20% of the number of its shares of the same class or series outstanding immediately before the merger becomes effec- tive. Subject to the terms of any class or series of shares at the time outstanding, under the Charter Host REIT also may to the extent permitted by law, con- solidate Host REIT with one or more other enti- ties into a new entity or effect a share ex- change, but any such ac- tion must be approved by the Board of Directors and, after notice to all shareholders entitled to vote on the matter, by the affirmative vote of two-thirds of all the votes entitled to be cast on the matter. Un- der the MGCL, a share exchange by a Maryland successor corporation needs to be approved only by its board of di- rectors. Under applicable law, the partnership agreements of the Partnerships, the Partnership Agreement, and the Charter of Host REIT, the merger of the respective partnerships and Host REIT is permitted subject to the approval of the general partner (or board of directors) and a certain level of limited partner (or shareholder) consent, respectively. 225 - ------------------------------------------------------------------------------- PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- Dissolution Upon breach of certain Under the Charter, sub- provisions of its part- The Operating Partner- ject to the provisions nership agreement, ship will continue until of any class or series breach of fiduciary du- December 31, 2098, un- of shares at the time ty, fraud or unremedied less sooner dissolved outstanding, the Board acts of bad faith or and terminated. The Op- of Directors must obtain gross negligence, each erating Partnership will approval of holders of of Chicago Suites, Des- be dissolved prior to at least two-thirds of ert Springs, Hanover, the expiration of its all of the votes enti- MDAH, MHP, MHP2 and PHLP term, and its affairs tled to be cast on the may be dissolved with wound up, (i) until De- matter in order to dis- the consent of a major- cember 31, 2058 with the solve Host REIT. ity of the outstanding consent of the limited limited partner inter- partners who hold 90% of ests and without the the OP Units (including consent of the General OP Units held by Host Partner. In the case of REIT) or (ii) upon a de- Desert Springs, Hanover cision to dissolve the and MHP, the General Operating Partnership Partner must vote any made by Host REIT on or limited partner inter- after December 31, 2058 ests it or its affili- in its sole and absolute ates hold in the same discretion or (iii) upon manner as the majority a decision, with the of "outside" limited consent of a majority of partner interests actu- the partners holding at ally voted (so long as a least a majority of the majority of the outside outstanding partnership limited partners are interests, to sell all present for purposes of or substantially all of a vote by submitting the Operating Partner- ballots or otherwise). ship's assets and prop- The Atlanta Marquis erties. Upon dissolu- partnership agreement tion, Host REIT, as gen- contains no provision eral partner, or any concerning the ability liquidator will proceed of the limited partners to liquidate the assets to dissolve the Partner- of the Operating Part- ship. In the absence of nership and apply the such a provision, the proceeds therefrom in Delaware Act provides the order of priority that a limited partner- set forth in the Part- ship may be dissolved by nership Agreement. the affirmative vote of the general partner and 66 2/3% of the limited partnership interests. The Rhode Island Act provides that a limited partnership may be dis- solved by the written consent of all partners to such dissolution. Under each of the partnership agreements, the Partnership Agreement and Host REIT's Charter, the respective entities may be dissolved with the consent of a certain percentage of the outstanding interests. 226 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- Amendments The Chicago Suites and Amendments to the Part- Under the MGCL, in order PHLP partnership agree- nership Agreement may be to amend the charter, ments allow the General proposed by Host REIT, the board of directors Partner to amend the as general partner of first must adopt a reso- partnership agreement the Operating Partner- lution setting forth the with the consent of a ship, or any limited proposed amendment and majority of the out- partner holding 25% or declaring its advisabil- standing limited partner more of the limited ity and direct that the interests. The Desert partnership interests. proposed amendment be Springs, Hanover, MHP Subject to certain ex- submitted to sharehold- and MHP2 partnership ceptions, such proposed ers for their considera- agreements allow the amendment must be ap- tion either at an annual General Partner to amend proved by the vote of or special meeting of the partnership agree- Host REIT, as general shareholders. Thereaf- ment with the consent of partner, and limited ter, the proposed amend- a majority of outstand- partners holding Per- ment must be approved by ing limited partner in- centage Interests that shareholders by the af- terests, including any are more than 50% of the firmative vote of two- such interests held by aggregate Percentage In- thirds of all votes en- the General Partner, un- terests of the outstand- titled to be cast on the less the General Partner ing limited partnership matter, unless a greater has an interest in the interests entitled to or lesser proportion of vote, in which case, the vote thereon including votes (but not less than General Partner must any such limited part- a majority of all votes vote any limited partner nership interests held entitled to be cast) is interests it holds in by Host REIT (which ini- specified in the char- the same manner as the tially will hold approx- ter. The provisions con- majority of "outside" imately 76% of the OP tained in Host REIT's limited partner inter- Units, following the Charter relating to re- ests actually voted (so REIT Conversion, assum- strictions on transfera- long as a majority of ing the full Participa- bility of the Common the outside limited tion Scenario). In addi- Shares, the classified partners are present for tion, with certain ex- Board and fixing the purposes of a vote by ceptions, Host REIT, as size of the Board within submitting ballots or general partner, has the range set forth in otherwise). The MDAH broad discretion to the Charter, as well as partnership agreement amend the Partnership the provisions relating allows the General Part- Agreement without the to removal of directors, ner to amend the part- consent of the limited the filling of Board va- nership agreement with partners. cancies and the provi- the consent of a major- sions relating to the ity of outstanding lim- exclusive authority of ited partner interests, the Board to amend the but the General Partner Bylaws may be amended is prohibited from vot- only by a resolution ing its limited partner adopted by the Board of interests. In the case Directors and approved of Desert Springs, Hano- at an annual or special ver, MDAH, MHP and MHP2, meeting of the share- amendments may be made holders by the affirma- with the consent of a tive vote of the holders majority in interest of of not less than two- the Limited Partners, thirds of the votes en- except certain amend- titled to be cast on the ments to the partnership matter. Other amendments agreements generally re- to the Charter generally quire the unanimous con- may be effected by req- sent of the Limited uisite action of the Partners, including: Board of Directors and (i) converting the in- approval by shareholders terest of a Limited by the affirmative vote Partner into a general of not less than a ma- partner's interest; (ii) jority of the votes en- any act adversely af- titled to be cast on the fecting the liability of matter. a Limited Partner; (iii) altering the interest of As permitted under the a Partner in net prof- MGCL, the Charter and its, net losses, gain, Bylaws of Host REIT pro- loss or distributions of vide that directors have cash available for dis- the exclusive right to tribution, sale proceeds amend the Bylaws. or refinancing proceeds; (iv) reducing the per- centage of Partners which is required to consent to any action in the partnership agree- ment; (v) limiting in any manner the liability of the General Partner (vi) permitting the Gen- eral Partner to take certain actions which are prohibited by the Partnership Agreement, (vii) causing the Part- nership to be taxed, for federal income tax 227 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- Amendments (cont'd) purposes, as an associa- tion taxable as a corpo- ration or (viii) effect- ing any amendment or modification to clauses (i) through (vii) above. In the case of Atlanta Marquis, amendments to the partnership agree- ment may be made by the General Partner with the consent of a majority of interest of the Class A Limited Partners, except certain amendments gen- erally require the unan- imous consent of all the Partners, including: (i) converting the interest of a Limited Partner into a general partner's interest; (ii) modifying the limited liability of a Limited Partner; (iii) permitting the General Partner to take certain actions which are pro- hibited by the Partner- ship Agreement (i.e., take an action which re- quires the consent of the Limited Partners without such consent); (iv) causing the Part- nership to be taxed for federal income tax pur- poses as an association taxable as a corpora- tion; or (v) affecting any amendment or modifi- cation to the require- ments set forth in clauses (i) through (iv) above. In the case of Chicago Suites and PHLP, amend- ments to the Partnership Agreements may be made by the General Partner with the consent of the majority of interest of the Limited Partners, except the unanimous consent of all Partners adversely affected is required for certain amendments, including (i) converting the in- terest of a Limited Partner into a general partner's interest; (ii) modifying the limited liability of a Limited Partner; (iii) altering the interest of a Part- ner in net profits, net losses, gain, loss or distributions of cash available for distribu- tion, sale proceeds or refinancing proceeds; or (iv) reducing the per- centage of Partners which is required to consent to any action in the partnership agree- ment. Under both the partnership agreements and the Partnership Agreement, amendments to the respective partnership agreement may be made with the consent of the limited partners. Under the provisions of the Partnership Agreement, Host REIT, as general partner of the Operating Partnership, has broad discretion to make amendments without the consent of the limited partners. Amendment of Host REIT's Charter generally will require the approval of both the Board of Directors and the shareholders by either a majority or two-thirds of all votes entitled to be cast depending upon the type of charter amendment. 228 PARTNERSHIPS OPERATING PARTNERSHIP HOST REIT - ------------------------------------------------------------------------------- COMPENSATION, FEES AND DISTRIBUTIONS Under the partnership The Operating The Directors of Host agreements of the Partnership will pay (or REIT will receive Partnerships, the reimburse Host REIT for) compensation for their General Partners do not all expenses that Host services as described receive any fees or REIT incurs (subject to herein under other compensation from several very limited "Management." their Partnerships in exceptions), including exchange for their expenses incurred services as general relating to the REIT partner. The General Conversion, the ongoing Partner of each operation of Host REIT Partnership is entitled, and any other offering however, to of additional OP Units reimbursement for the or Common Shares, cost of providing any including all expenses, administrative or other damages and other services rendered to its payments resulting from Partnership. The General or arising in connection Partners are also with litigation related entitled to to any of the foregoing, distributions with and expenses for respect to their federal, state and local respective percentage income taxes incurred by interests in the Host REIT. Partnerships, as well as certain additional back- end participations in cash flow and excess sale and refinancing proceeds after the Limited Partners have received certain investment returns. See "Background and Reasons for the Mergers and the REIT Conversion-- Reimbursements and Distributions to the General Partners and Marriott International." Neither the General Partners nor Host REIT, as general partner of the Operating Partnership, receive compensation in exchange for their services as general partner. The Directors of Host REIT, however, do receive compensation for their services as Directors. 229 ERISA CONSIDERATIONS STATUS OF HOST REIT AND THE OPERATING PARTNERSHIP UNDER ERISA This section discusses the extent to which the fiduciary requirements of ERISA and the prohibited transaction provisions of ERISA and the Code would apply to Host REIT or the Operating Partnership because one or more investors in Host REIT or the Operating Partnership is an ERISA Plan or Other Plan. If the underlying assets of Host REIT are deemed to be assets of an investing ERISA Plan and Other Plan ("Plan Assets"), (i) the prudence standards and other provisions of Part 4 of Title I of ERISA and the prohibited transaction provisions of ERISA and the Code would be applicable to any transactions involving Host REIT's assets, and (ii) persons who exercise any authority or control over Host REIT's assets, or who provide investment advice to Host REIT for a fee or other compensation, would be (for purposes of ERISA and the Code) fiduciaries of ERISA Plans and Other Plans that acquire Common Shares of Host REIT. Similarly, if the underlying assets of the Operating Partnership are deemed to be Plan Assets, (i) the prudence standards and other provisions of Part 4 of Title I of ERISA and the prohibited transaction provisions of ERISA and the Code would be applicable to any transactions involving the Operating Partnership's assets, and (ii) persons who exercise any authority or control over the Operating Partnership's assets, or who provide investment advice to the Operating Partnership for a fee or other compensation, would be (for purposes of ERISA and the Code) fiduciaries of ERISA Plans and Other Plans that acquire Common Shares of Host REIT. The United States Department of Labor ("DOL"), which has certain administrative responsibility over ERISA Plans and certain Other Plans, has issued a regulation defining plan assets for certain purposes ("DOL Regulation"). The DOL Regulation generally provides that when an ERISA Plan or Other Plan acquires a security that is an equity interest in an entity and that security is neither a "publicly offered security" nor a security issued by an investment company registered under the 1940 Act, the assets of the ERISA Plan or Other Plan include both the equity interest and an undivided interest in each of the underlying assets of the entity, unless it is established either that the entity is an "operating company" (as defined in the DOL Regulation) or that equity participation in the entity by "benefit plan investors" is not "significant." The DOL Regulation defines a "publicly offered security" as a security that is "widely-held," "freely transferable," and either part of a class of securities registered under the Exchange Act, or sold pursuant to an effective registration statement under the Securities Act (provided the securities are registered under the Exchange Act within 120 days, or such later time as may be allowed by the Commission (the "Registration Period"), after the end of the fiscal year of the issuer during which the offering occurred). Host REIT anticipates that the Common Shares will be considered "publicly offered securities," and therefore the underlying assets of Host REIT would not be deemed to be Plan Assets of any ERISA Plan or Other Plan that invests in the Common Shares. The DOL Regulation defines "benefit plan investors" to consist of any employee benefit plan as defined in section 3(3) of ERISA, any Other Plan, or any entity whose underlying assets include Plan Assets by reason of an employee benefit plan's investment in the entity. Equity participation in an entity by "benefit plan investors" is deemed "significant" if, immediately after the most recent acquisition of any equity interest in the entity, 25% or more of the value of any class of equity interest is held by "benefit plan investors." Furthermore, for purposes of determining the percentage interest in a class of equity held by "benefit plan investors," the value of interests held by persons who either have discretionary authority or control over the entity's assets, or who provide investment advice for a fee, or are affiliates of such persons, is disregarded. Based upon the value of the interests in the Partnerships owned by "benefit plan investors" relative to the value of the interests in the Partnerships owned by other Partnership investors, the expected Exchange Value for each of the Partnerships, and the percentage of the Operating Partnership that the Blackstone Entities will own immediately following the REIT Conversion, the Operating Partnership believes that immediately following the REIT Conversion "benefit plan investors" will not own a "significant" percentage of OP Units, and, thus, the underlying assets of the Operating Partnership will not constitute Plan Assets of any ERISA Plan or Other Plan that owns OP Units. Furthermore, the Partnership Agreement will restrict ownership of OP Units by benefit plan investors to less than 25%. 230 FEDERAL INCOME TAX CONSEQUENCES INTRODUCTION The following discussion summarizes the federal income tax consequences reasonably anticipated to be material to a Limited Partner in connection with (i) the acquisition of the Partnerships by the Operating Partnership through the mergers of the Merger Partnerships into the Partnerships and the resulting distribution of OP Units to the Limited Partners; (ii) the ownership and subsequent disposition by the Limited Partners of such OP Units; (iii) the acquisition and ownership of Notes received by Limited Partners who elect to tender the OP Units received in the Mergers to the Operating Partnership in exchange for Notes; (iv) the acquisition and ownership of Common Shares received by Limited Partners who elect to exchange their OP Units received in the Mergers for Common Shares in connection with the Mergers; and (v) the ownership and disposition of Common Shares that could be issued to Limited Partners upon the exercise of their Unit Redemption Right. The following discussion is intended to address only those federal income tax consequences that are generally relevant to all Limited Partners in the Partnerships. Accordingly, it does not discuss all aspects of federal income taxation that might be relevant to a specific Limited Partner in light of his particular investment or tax circumstances. Therefore, it is imperative that a Limited Partner review the following discussion and consult with his own tax advisors to determine the interaction of his individual tax situation with the anticipated tax consequences of the Mergers and the REIT Conversion and the subsequent ownership and disposition of OP Units, Notes and/or Common Shares, as applicable. The following discussion provides general information only, is not exhaustive of all possible tax considerations and is not intended to be (and should not be construed as) tax advice. For example, this summary does not give a detailed description of any state, local or foreign tax considerations. In addition, the discussion does not purport to deal with all aspects of taxation that may be relevant to Limited Partners subject to special treatment under the federal income tax laws, including, without limitation, insurance companies, financial institutions or broker-dealers, tax-exempt organizations (except to the extent discussed under the heading "Taxation of Tax-Exempt Shareholders of Host REIT") or foreign corporations and persons who are not citizens or residents of the United States (except to the extent discussed under the heading "Taxation of Non-U.S. Shareholders of Host REIT"). The information in this section is based on the Code, current, temporary and proposed Treasury Regulations thereunder, the legislative history of the Code, current administrative interpretations and practices of the IRS (including its practices and policies as endorsed in private letter rulings, which are not binding on the IRS), and court decisions, all as of the date hereof. No assurance can be given that future legislation, Treasury Regulations, administrative interpretations and court decisions will not significantly change the current law or adversely affect existing interpretations of current law. Any such change could apply retroactively to transactions preceding the date of the change. No assurance can be provided that the statements set forth herein (which do not bind the IRS or the courts) will not be challenged by the IRS or will be sustained by a court if so challenged. With the one exception described in the next sentence below, neither Host REIT, the Operating Partnership nor the General Partners have requested or plan to request any rulings from the IRS concerning the tax consequences of the Mergers or the treatment of either the Operating Partnership or Host REIT subsequent to the REIT Conversion. The Operating Partnership has requested from the IRS a ruling to the effect that certain indebtedness that might be incurred by the Operating Partnership that is not secured by any particular property of the Operating Partnership, the proceeds of which may be used to repay indebtedness of the Operating Partnership or one or more Hotel Partnerships after the REIT Conversion, would qualify as "nonrecourse liabilities" for purposes of Code Section 752 and as "qualified nonrecourse financing" for purposes of Code Section 465. This ruling request is discussed below, in "Tax Consequences of the Mergers--IRS Ruling Request Regarding Allocation of Partnership Liabilities." Host REIT, the Operating Partnership and the General Partners have obtained an opinion of counsel to the effect that the discussion set forth in this section, to the extent it contains descriptions of applicable federal income tax law, is correct in all material respects. Such opinion, however, does not purport to address the tax 231 consequences of the Mergers and the REIT Conversion to any particular Limited Partner in a Partnership in light of his particular circumstances, nor does it purport to predict whether, and the extent to which, future events and transactions, only some of which may be within the control of Host REIT and/or the Operating Partnership, will have a material adverse impact on the income tax positions of Limited Partners, either in particular Partnerships or as a whole. The following description does not address the income tax consequences of the Mergers for Host or the General Partners. The following discussion is not intended to be, and should not be construed by a Limited Partner as, tax advice. THE SPECIFIC TAX ATTRIBUTES OF A PARTICULAR LIMITED PARTNER COULD HAVE A MATERIAL IMPACT ON THE TAX CONSEQUENCES OF THE MERGERS (INCLUDING THE DECISION WHETHER TO EXERCISE THE NOTE ELECTION OR THE COMMON SHARE ELECTION) AND THE SUBSEQUENT OWNERSHIP AND DISPOSITION OF OP UNITS, COMMON SHARES AND/OR NOTES. THEREFORE, IT IS ESSENTIAL THAT EACH LIMITED PARTNER CONSULT WITH HIS OWN TAX ADVISORS WITH REGARD TO THE APPLICATION OF THE FEDERAL INCOME TAX LAWS TO SUCH LIMITED PARTNER'S PERSONAL TAX SITUATION, AS WELL AS ANY TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY STATE, LOCAL OR FOREIGN TAXING JURISDICTION. THE FOLLOWING DISCUSSION IS NOT INTENDED AS A SUBSTITUTE FOR CAREFUL TAX PLANNING. SUMMARY OF TAX OPINIONS Hogan & Hartson L.L.P. ("Hogan & Hartson"), counsel to Host REIT, Host and the Operating Partnership, has provided to Host REIT and the Operating Partnership an opinion letter (attached as Appendix C hereto) as to certain federal income tax consequences to the Operating Partnership and the Limited Partners resulting from the REIT Conversion and the Mergers. The opinion letter is based upon certain assumptions and certain factual representations provided by Host REIT, Host, the Operating Partnership and the General Partners. These representations generally involve factual matters relating to the organization, ownership and operations (including the income, assets, businesses, liabilities and properties) of the Partnerships and the Hotels contributed to the Operating Partnership by Host and the Blackstone Entities prior to the REIT Conversion and the Mergers and of Host REIT, the Operating Partnership and the Partnerships following the REIT Conversion and the Mergers. The specific opinions that Hogan & Hartson has provided (as they relate to the Limited Partners and the impact on them of the Mergers and the REIT Conversion) are: 1. The proposed method of operation of the Operating Partnership is such that it, each of the Partnerships and each of the Subsidiary Partnerships will be treated as a partnership for federal income tax purposes and will not be subject to tax as a corporation or an association taxable as a corporation. 2. Except for any gain attributable to the sale of personal property to a Non-Controlled Subsidiary in connection with the REIT Conversion, the Mergers will not result in the recognition of taxable gain or loss at the time of the Mergers to a Limited Partner (i) who does not receive a Note upon the exercise of his right to make the Note Election or Common Shares upon the exercise of his right to make the Common Share Election; (ii) who does not exercise his Unit Redemption Right on a date sooner than the date two years after the date of the consummation of the Mergers; (iii) who does not receive a cash distribution (or a deemed cash distribution resulting from relief from liabilities, including as a result of the prepayment of certain indebtedness) in connection with the Mergers in excess of such Limited Partner's aggregate adjusted basis in his Partnership Interest at the time of the Mergers; (iv) who is not required to recognize gain by reason of the exercise by another Limited Partner in the same Partnership of his right to make the Note Election or the Common Share Election; and (v) whose "at risk" amount does not fall below zero as a result of the Mergers. 3. The Unit Redemption Right will not be considered "other consideration" such that its receipt in the Mergers would result in a Limited Partner being treated under the "disguised sale" rules (as set forth in 232 Section 707 of the Code and the Treasury Regulations thereunder) as having sold all or a portion of his Partnership Interest to the Operating Partnership in the Mergers. 4. A Limited Partner's exercise of his Unit Redemption Right more than two years after the date of consummation of the Mergers will not cause the Mergers to constitute a taxable transaction for the Limited Partner (or for the other Limited Partners in the same Partnership). 5. It is more likely than not that a Limited Partner's exercise of his Unit Redemption Right more than one year after the date of consummation of the Mergers but less than two years after such date will not cause the Mergers to constitute a taxable transaction for the Limited Partner (or for the other Limited Partners in the same Partnership). 6. It is more likely than not that a Limited Partner who does not exercise his right to make the Note Election or the Common Share Election in connection with the Mergers but retains his OP Units will not be required to recognize gain by reason of the exercise of either such right by another Limited Partner in the same Partnership. 7. A Limited Partner's relief from Partnership liabilities allocable to such Limited Partner in connection with the Mergers and the REIT Conversion and/or any subsequent repayment of certain indebtedness encumbering the Hotels will not cause such Limited Partner to recognize taxable gain at the time of the Mergers unless (and only to the extent that) the amount thereof exceeds such Limited Partner's adjusted basis in his Partnership Interest at the time of the Mergers. 8. Based upon factual representations made by Host, Host REIT, and the Operating Partnership relating to the facts and circumstances surrounding each such liability, all direct or indirect liabilities of the Partnerships fall into one of the four categories of "qualified liabilities" described in Treasury Regulations Section 1.707-5(a)(6). 9. The sale by each of Atlanta Marquis, Desert Springs, Hanover, MHP and PHLP in connection with the REIT Conversion of a portion of the personal property associated with the Hotels owned by such Partnerships to a Non- Controlled Subsidiary will be a taxable transaction. Each such sale by a Partnership will result in the recognition by the Partnership of taxable income equal to the amount by which the fair market value of the personal property at the time of the sale exceeds the Partnership's adjusted tax basis in the personal property at that time. This taxable gain will be recharacterized as recapture income pursuant to Section 1245 of the Code, and each Limited Partner will be allocated by his Partnership a portion of the recapture income, determined in the same proportions and to the same extent that such Limited Partner was allocated any deductions directly or indirectly giving rise to the treatment of such gain as recapture income prior to the Mergers. Such recapture income allocated to a Limited Partner will be subject to tax at ordinary federal income tax rates. The sale of personal property by Hanover to a Non-Controlled Subsidiary in connection with the REIT Conversion, however, will not result in the allocation of any taxable income to the Hanover Limited Partners (even if such income is recognized by Hanover). 10. The discussion herein under the heading "Federal Income Tax Consequences," and under such heading in each of the Partnership Supplements to the Consent Solicitation, to the extent each such discussion contains descriptions of applicable federal income tax law, is correct in all material respects. The foregoing assumes that the ability to exercise the Common Share Election or the Note Election either is not a separate property right for federal income tax purposes or does not have any ascertainable value. The Operating Partnership believes that the ability to exercise the Common Share Election or the Note Election is not property and, even if it were property, does not have any independent ascertainable value, given the nature and terms of the OP Units and the terms and limited duration of the election arrangements. If, however, the ability to exercise such elections were considered property and to have an ascertainable value, Limited Partners could recognize gain in amount up to the amount of such value (whether or not they exercise such elections). In addition, prior to the Effective Date, Hogan & Hartson expects to provide to Host REIT and the Operating Partnership an opinion letter (substantially in the form of Appendix D hereto) to the effect that (i) Host REIT, beginning with its first full taxable year commencing after the REIT Conversion is completed, will be organized 233 in conformity with the requirements for qualification as a REIT, and its proposed method of operation will enable it to meet the requirements for qualification and taxation as a REIT under the Code; (ii) the Leases will be respected as leases for federal income tax purposes; and (iii) even if the Operating Partnership were a "publicly traded partnership" under the Code, it would qualify as a partnership for federal income tax purposes because, based upon factual representations made by Host, Host REIT and the Operating Partnership as to the proposed method of operation of the Operating Partnership after the Mergers and the REIT Conversion, at least ninety percent of its income will consist of "qualifying income," as defined in the Code. The receipt of this opinion letter is a condition to the REIT Conversion and each of the Mergers. This opinion letter will be conditioned upon the completion of the REIT Conversion and upon certain assumptions and certain factual representations provided by Host REIT, Host, the Operating Partnership and the General Partners. These representations generally will involve factual matters relating to the organization, ownership and operations (including the income, assets, businesses, liabilities, properties and accumulated undistributed earnings and profits) of Host REIT, the Operating Partnership, the Hotel Partnerships, the Subsidiary Partnerships (as defined below), the Non- Controlled Subsidiaries, the Host Employee Trust, Crestline and the Lessees following the REIT Conversion. The opinions already rendered by Hogan & Hartson are based on the Code and Treasury Regulations in effect on the date hereof, current administrative interpretations and positions of the IRS and existing court decisions and the opinions to be rendered by Hogan & Hartson prior to the Effective Date will be based on the same authorities as of the date such opinions are rendered. No assurance can be given that future legislation, Treasury Regulations, administrative interpretations and court decisions will not significantly change the law or the above conclusions reached by counsel. In addition, any such change could apply retroactively to transactions preceding the date of change. Moreover, opinions of counsel merely represent counsel's best judgment with respect to the probable outcome on the merits and are not binding on the IRS or the courts. Accordingly, even if there is no change in applicable law, no assurance can be provided that such opinions (which do not bind the IRS or the courts) will not be challenged by the IRS or will be sustained by a court if so challenged. With the exception of the ruling request described below in "Tax Consequences of the Mergers--IRS Ruling Request Regarding Allocation of Partnership Liabilities," neither Host REIT, the Operating Partnership nor the General Partners have requested or plan to request any rulings from the IRS concerning the tax consequences of the Mergers or the treatment of either the Operating Partnership or Host REIT subsequent to the REIT Conversion. TAX STATUS OF THE OPERATING PARTNERSHIP An entity classified as a partnership for federal income tax purposes generally is not itself a taxable entity and incurs no federal income tax liability. Therefore, partners are required to take into account in computing their federal income tax liability their allocable shares of income, gains, losses, deductions and credits of the partnership, regardless of whether cash distributions are made by the partnership to the partners. A distribution of money by a partnership to a partner generally is not taxable unless the amount of the distribution is in excess of the partner's adjusted basis in his partnership interest. Pursuant to Treasury Regulations under Section 7701 of the Code, a partnership will be treated as a partnership for federal income tax purposes unless it elects to be treated as a corporation or would be treated as a corporation because it is a "publicly traded partnership." Neither the Operating Partnership, any of the Hotel Partnerships, nor any of the partnerships or limited liability companies in which either the Operating Partnership or the Hotel Partnerships will have an interest following the REIT Conversion (the "Subsidiary Partnerships") will elect to be treated as a corporation, and therefore, subject to the disclosure below, each will be treated as a partnership for federal income tax purposes (or if it has only one partner or member, disregarded entirely for federal income tax purposes). Pursuant to Section 7704 of the Code, however, a partnership that does not elect to be treated as a corporation nevertheless will be treated as a corporation for federal income tax purposes if it is a "publicly traded partnership," unless at least ninety percent (90%) of its income consists of "qualifying income" within the meaning of that section. A "publicly traded partnership" is any partnership (i) the interests in which are traded 234 on an established securities market or (ii) the interests in which are readily tradable on a "secondary market (or the substantial equivalent thereof)." OP Units will not be traded on an established securities market. There is a significant risk, however, that after the Unit Redemption Right becomes exercisable, the OP Units would be considered readily tradable on the substantial equivalent of a secondary market. Host REIT expects to receive from Hogan & Hartson prior to the Effective Date an opinion to the effect that, based upon representations by Host REIT and the Operating Partnership as to the expected ownership and operations of the Operating Partnership, even if the Operating Partnership were considered to be a publicly traded partnership because OP Units were considered to be readily tradable on the substantial equivalent of a secondary market, the proposed method of operation of the Operating Partnership is such that it will qualify as a partnership for federal income tax purposes because it will have sufficient "qualifying income." In this regard, the income requirements generally applicable to REITs and the definition of "qualifying income" under Section 7704 of the Code are similar in most key respects. There is one significant difference, however, that is relevant to the Operating Partnership. For a REIT, rent from a tenant does not qualify as "rents from real property" if the REIT and/or one or more actual or constructive owners of 10% or more of the REIT actually or constructively own 10% or more of the tenant; under Section 7704 of the Code, however, rent from a tenant is not qualifying income if a partnership and/or one or more actual or constructive owners of 5% or more of the partnership actually or constructively own 10% or more of the tenant. A substantial majority of the Operating Partnership's income will come from rent payments by the Lessees, which will be indirectly controlled subsidiaries of Crestline. Accordingly, because The Blackstone Group, Host REIT and any owner of 10% or more of Host REIT will own (or be deemed to own) 5% or more of the Operating Partnership, if The Blackstone Group, Host REIT and/or any owner of 10% or more of Host REIT were to own (or be deemed to own) 10% or more of Crestline, none of the rent from the Lessees would be qualifying income for purposes of determining whether the Operating Partnership should be taxed as a corporation. In order to avoid this result, the Crestline Articles of Incorporation expressly provide that no person (or persons acting as a group), including The Blackstone Group, Host REIT and any owner of 10% or more of Host REIT, may own, actually and/or constructively, more than 9.8% by value of the interests in Crestline, and the Crestline Articles of Incorporation contain self-executing mechanisms intended to enforce this prohibition. In addition, the Partnership Agreement prohibits any person (or persons acting as a group) or entity (other than The Blackstone Group and Host REIT) from owning, actually and/or constructively, more than 4.9% of the value of the Operating Partnership, and Host REIT's Charter prohibits any person (or persons acting as a group) or entity (including The Blackstone Group and the Marriott family and their affiliated entities as a group) from owning, actually and/or constructively, more than 9.8% of the lesser of the number or value of the total outstanding shares of Host REIT. Assuming that all of these prohibitions are enforced at all times in accordance with their terms (as to which there can be no assurance), then so long as the Operating Partnership's income is such that Host REIT could meet the gross income tests applicable to REITs (see "Federal Income Taxation of Host REIT Following the Mergers--Income Tests Applicable to REITs" and "--Ownership of Partnership Interests by a REIT"), the Operating Partnership's "qualifying income" should be sufficient for it to avoid being classified as a corporation even if it were considered a publicly traded partnership. If the Operating Partnership were considered a publicly traded partnership (because the OP Units were considered readily tradable on the substantial equivalent of a secondary market) but not treated as a corporation for federal income tax purposes because it meets the "qualifying income" exception, a Limited Partner still could be subject to certain special rules applicable to publicly traded partnerships. In particular, if the Operating Partnership were a publicly traded partnership, a Limited Partner would be unable to apply unused passive activity losses arising in connection with his investment in the Partnership or other investments to offset his allocable share of Operating Partnership gain and income. Conversely, any Operating Partnership losses allocable to a Limited Partner could be used only as an offset against such Limited Partner's allocable share of Operating Partnership income and gains and not against income and gains from other passive activities. The Operating Partnership and the General Partners have estimated that each Limited Partner in Atlanta Marquis, Chicago Suites, Desert Springs, MDAH and MHP who purchased his Partnership Interest at the time of the original offering of such Partnership Interests, has held such Partnership Interest continuously since that time, and whose 235 Partnership Interest has been his only investment in a passive activity would have a passive activity loss carryforward as of December 31, 1998. The entire discussion of the federal income tax consequences of the Mergers and the subsequent ownership of OP Units is based on the Operating Partnership being classified as a partnership for federal income tax purposes. If the Operating Partnership instead were taxable as a corporation, most, if not all, of the tax consequences described below would be inapplicable. In particular, the Operating Partnership itself would be subject to federal and state income tax, thereby reducing the cash available for distribution to holders of OP Units. Under such circumstances, the Mergers should be treated for federal income tax purposes as contributions of the Partnership Interests to a corporation under Section 351 of the Code, and, accordingly, a Limited Partner would recognize gain or loss on the transaction to the extent that the Partnership liabilities allocable to the Limited Partner at the time of the Mergers (see "Tax Consequences of the Mergers--Relief from Liabilities/Deemed Cash Distribution" below) exceeded the Limited Partner's adjusted basis in his Partnership Interest (i.e., the Limited Partner had a "negative capital account"). Finally, under such circumstances, Host REIT would not qualify as a REIT because the value of Host REIT's ownership interest in the Operating Partnership would exceed 5% of Host REIT's assets and Host REIT would be considered to hold more than 10% of the voting securities of another corporation (see "Federal Income Taxation of Host REIT Following the Mergers-- Asset Tests Applicable to REITs"), which would adversely affect the value of the Common Shares (and, indirectly, the value of the OP Units) (see "Federal Income Taxation of Host REIT Following the Mergers--Failure of Host REIT to Qualify as a REIT"). However, as described above, Hogan & Hartson, counsel to the Operating Partnership, is of the opinion that the proposed method of operation of the Operating Partnership (as represented by the Operating Partnership and Host) is such that it will be treated as a partnership for federal income tax purposes and will not be subject to tax as a corporation or an association taxable as a corporation. As noted previously, an opinion of counsel does not bind the courts and no assurance can be provided that such opinion will not be challenged by the IRS or will be sustained by a court if so challenged. TAX CONSEQUENCES OF THE MERGERS Overview. As described in greater detail above (see "The Mergers and the REIT Conversion"), the Operating Partnership will acquire the Partnerships through the mergers of the Merger Partnerships into the Partnerships, resulting in the receipt of OP Units by the partners of the Partnerships. The Operating Partnership intends that the Mergers will be treated for federal income tax purposes as the transfer by the partners of their interests in the Partnerships to the Operating Partnership in exchange for OP Units (which OP Units may be tendered for Notes or exchanged for Common Shares, at the election of the Limited Partner, in connection with the Mergers) and the discussion herein assumes that the Mergers will be so treated. There can be no assurance, however, that the IRS will not seek to recharacterize each Merger as either (i) the liquidation of a Partnership followed by the distribution by the Partnership of its assets to its partners and the subsequent transfers by such partners of such assets to the Operating Partnership in exchange for OP Units (which OP Units may be tendered for Notes or exchanged for Common Shares, at the election of each Limited Partner, in connection with the Mergers) or (ii) the transfer by a Partnership of its assets to the Operating Partnership in exchange for OP Units and/or Notes (and, possibly, Common Shares) and the subsequent distribution of such OP Units and/or Notes (and, possibly, Common Shares) to its partners. For a discussion of the tax consequences that would occur if the Mergers are recharacterized in either of these two alternative manners, see "--Alternative Recharacterizations of the Mergers." Section 721 of the Code provides that no gain or loss is recognized in the case of a contribution of property to the partnership in exchange for an interest in the partnership. The nonrecognition rule of Section 721 ordinarily applies even when the property transferred is subject to liabilities (so long as the assumption of such liabilities does not result in a deemed distribution of cash in excess of a transferor's basis in the property transferred to a partnership). Accordingly, Section 721 generally would apply to prevent the recognition of gain by a Limited Partner in the Mergers. However, there are several potential exceptions to the availability of nonrecognition treatment under Section 721, including the following: 1. Any decrease in a contributing partner's liabilities (including its share of liabilities with respect to a partnership interest contributed to another partnership), if not offset by a corresponding increase in the 236 partner's share of other partnership liabilities, could cause the partner to recognize taxable gain as a result of the partner being deemed to have received a cash distribution from the partnership. This recognition of gain could occur even if the decrease arose in connection with a contribution that would otherwise qualify for tax-free treatment under Section 721 of the Code. A decrease in a partner's liabilities (and a resulting deemed cash distribution) also might occur after a contribution upon a repayment by the partnership of all or part of such liabilities. For example, a Limited Partner would be deemed to receive a cash distribution upon the prepayment or repayment of existing indebtedness of his Partnership, unless such prepayment or repayment were accompanied by the incurrence of new debt in an equal or greater amount that would be considered to be nonrecourse liabilities properly attributable to the Hotels owned by the Partnership whose existing debt was repaid. 2. A contribution of property that is treated in whole or in part as a "disguised sale" of the contributed property under the Code. 3. A contribution of property to a partnership that is classified as an "investment company" under the Code. 4. Recapture under Section 465(e) of the Code. The Operating Partnership, the General Partners and Hogan & Hartson believe that the foregoing exceptions, which are discussed in greater detail below, should not result in the recognition of taxable gain or loss at the time of the Mergers to a Limited Partner (i) who does not make the Common Share Election or the Note Election, (ii) who does not receive a distribution (or a deemed distribution resulting from relief from liabilities) that exceeds such Limited Partner's aggregate adjusted basis in his OP Units after the Mergers and (iii) whose at risk amount does not go below zero as a result of the Mergers. See, however, "--Taxable Income Attributable to Sales of Personal Property in Connection with the REIT Conversion." The Operating Partnership and the General Partners also believe that a Limited Partner who acquired his Partnership Interests in the original offering of such interests and who has held such interests at all times since (a) should not be considered to receive, as a result of the Mergers, a distribution (or a deemed distribution resulting from relief from liabilities) that exceeds such Limited Partner's aggregate adjusted basis in his OP Units at the time of the Mergers and (b) should not have his "at risk" amount fall below zero as a result of the Mergers. See "--Assumptions Used in Determining Tax Consequences of the Mergers" below. The adjusted tax basis of a Limited Partner who did not acquire his Partnership Interest in the original offering of such interests, however, could vary materially from that of a Limited Partner who did so, and, thus, the Mergers could result in the receipt by such Limited Partner of a distribution (or deemed distribution) of cash in excess of such Limited Partner's adjusted tax basis in his Partnership Interest and/or a reduction in his "at risk" amount below zero, either of which could result in the recognition of income or gain by such Limited Partner. Even if a Limited Partner who retains his OP Units does not recognize gain at the time of the Mergers as a result of the foregoing exceptions to nonrecognition treatment, a variety of events and transactions subsequent to the Mergers (including a sale or other disposition of one or more Hotels owned by the Partnerships or a refinancing or repayment of indebtedness currently secured by one or more of the Hotels owned by the Partnerships) could cause a Limited Partner to recognize all or part of the gain that has been deferred through the Mergers. See "--Effect of Subsequent Events" below. Certain Hotels (including all of the Blackstone Hotels) will be covered by agreements with third parties that will restrict the Operating Partnership's ability to dispose of those properties or refinance their indebtedness. In addition, if Atlanta Marquis chooses to participate in the Mergers, the Operating Partnership will succeed to an existing agreement that will restrict its ability to dispose of the Hotel owned by Atlanta Marquis or refinance the indebtedness secured by such Hotel (without compensating certain outside partners for the resulting adverse tax consequences). As for the remaining properties (including the Hotels owned by the Partnerships), the Partnership Agreement of the Operating Partnership does not impose any restrictions on the Operating Partnership's ability to dispose of the Hotels or to refinance indebtedness secured by the Hotels. In addition, the Partnership Agreement provides that Host REIT, as general partner of the Operating Partnership, is not required to take into account the tax consequences for the 237 Limited Partners in deciding whether to cause the Operating Partnership to undertake specific transactions and the Limited Partners, as holders of OP Units, have no right to approve or disapprove such transactions owned by the Partnerships. See "Description of OP Units--Sales of Assets." Taxable Income Attributable to Sales of Personal Property in Connection with the REIT Conversion. As discussed below in "Federal Income Taxation of Host REIT Following the Mergers--Income Tests Applicable to REITs," if the rent attributable to personal property leased in connection with the lease of each Hotel is greater than 15% of the total rent received under the lease of such Hotel, the portion of the rent attributable to the personal property will not constitute qualifying income to Host REIT (the "15% Personal Property Test"). The Operating Partnership and the General Partners have determined that the percentage of rent attributable to the personal property to be leased in connection with the lease of certain of the Hotels owned by Atlanta Marquis, Desert Springs, Hanover, MHP and PHLP would not satisfy the 15% Personal Property Test. Accordingly, immediately prior to the Mergers, the Operating Partnership will require each of those Partnerships, if it chooses to participate in the Mergers, to sell to a Non-Controlled Subsidiary a portion of the personal property associated with some or all of its Hotels. This sale, which will be a taxable transaction, would result in the recognition by each such Partnership of taxable income to the extent that there is a difference between the fair market value of the personal property at the time of the sale and the adjusted tax basis of such property at that time. If any such taxable income is recognized by a Partnership, this taxable income will be allocated to the partners of each such Partnership, except that the Limited Partners of Hanover will not be allocated any portion of such taxable income. The actual amount of any such income will be determinable only at the time of the sale and will be affected by the specific personal property selected to be sold and the fair market value and adjusted basis of that personal property. Pursuant to the partnership agreement of each Partnership, such taxable gain, if any, will be recharacterized as ordinary recapture income and will be allocated to the partners in the same proportions and to the same extent that such partners were allocated any deductions directly or indirectly giving rise to the treatment of such gains as recapture income prior to the Mergers. Relief from Liabilities/Deemed Cash Distribution. A Limited Partner will be deemed to receive a cash distribution in connection with the Mergers to the extent that his share of Operating Partnership liabilities immediately after the Mergers is less than his share of Partnership liabilities immediately prior to the Mergers. A Limited Partner will recognize taxable gain as a result of this deemed cash distribution, however, only to the extent that the deemed cash distribution exceeds such Limited Partner's adjusted tax basis in his Partnership Interest immediately prior to the Mergers. Whether the deemed cash distribution results in taxable gain depends upon a number of circumstances that can be determined only with full knowledge of the circumstances of both the Operating Partnership and the particular Limited Partner. Under the applicable provisions of the Code, partners in a partnership include their share of the partnership's liabilities, as determined in accordance with the Treasury Regulations under Section 752 of the Code, in calculating the basis of their partnership interests. Partners also include in the basis of their partnership interests the adjusted tax basis of any capital contributions that they have actually made to the partnership and their allocable share of all partnership income and gains; partners reduce the basis in their partnership interests by the amount of all distributions that they receive from the partnership and their allocable share of all partnership losses. For purposes of these rules, if a partner's share of the partnership's liabilities is reduced for any reason, the partner is deemed to have received a cash distribution equal to the amount of such reduction. In the case of the Mergers, these rules generally will be applied by reference to a Limited Partner's share of liabilities in a Partnership immediately before the Mergers and such Limited Partner's share of liabilities in the Operating Partnership immediately after the Mergers. Any deemed cash distribution resulting from a reduction in such Limited Partner's share of liabilities will be considered to be a deemed cash distribution from the Operating Partnership (rather than from the Partnership with respect to which such Limited Partner's share of liabilities would be reduced). A Limited Partner may offset his share of the liabilities of the Operating Partnership against the elimination of the Limited Partner's share of liabilities of a Partnership in determining the amount of the deemed cash distribution to the Limited Partner from the Operating Partnership; however, if a Limited Partner 238 is deemed under these rules to receive a cash distribution from the Operating Partnership in an amount in excess of the basis of the Partnership Interest owned by that Limited Partner immediately prior to the Mergers, the Limited Partner may recognize taxable gain. If a Limited Partner owns interests in more than one Participating Partnership, then such Limited Partner should be able to aggregate his bases in such Partnership Interests in determining whether such Limited Partner is deemed to receive a taxable cash distribution from the Operating Partnership so long as the intended characterization of the Mergers is respected (i.e., the Mergers are treated as contributions by the Limited Partners of their Partnership Interests in exchange for OP Units). Section 752 of the Code and the Treasury Regulations thereunder provide that a partner's share of partnership liabilities includes the partner's share of partnership recourse liabilities plus the partner's share of partnership nonrecourse liabilities. A partnership liability is a recourse liability to the extent that any partner (or a person related to any partner) bears the "economic risk of loss" for that liability within the meaning of the Treasury Regulations; a partnership liability is nonrecourse to the extent that no partner (or related person) bears the "economic risk of loss." No Limited Partner (other than possibly Host REIT or an affiliate of Host REIT) will have any share of any recourse liability of the Operating Partnership by reason of his status as a Limited Partner. The following paragraphs describe the manner in which a Limited Partner's share of the nonrecourse liabilities of the Operating Partnership will be determined. Pursuant to Section 752 of the Code and the Treasury Regulations thereunder, a partner's share of partnership nonrecourse liabilities is determined under a three-tier approach. Under this approach, a partner's share of partnership nonrecourse liabilities equals the sum of (i) the partner's share of "partnership minimum gain," determined in accordance with the rules of Section 704(b) of the Code and the Treasury Regulations thereunder ("tier one"); (ii) the amount of any taxable gain that would be allocated to the partner under Section 704(c) of the Code (or in the same manner as Section 704(c) of the Code in connection with a revaluation of partnership property) if the partnership disposed of all partnership property (in a taxable transaction) subject to one or more nonrecourse liabilities of the partnership in full satisfaction of such liabilities and for no other consideration ("Section 704(c) Minimum Gain" or "tier two"); and (iii) the partner's share of "excess nonrecourse liabilities" (i.e., those not allocated under (i) and (ii) above), which are allocated in accordance with the partner's "share of partnership profits" ("tier three"). A partner's "share of partnership profits" is determined by taking into account all facts and circumstances of the economic arrangement among the partners. At the time of the Mergers, the Operating Partnership will not have any "partnership minimum gain," determined in accordance with the rules of Section 704(b) of the Code and the Treasury Regulations thereunder. Therefore, each nonrecourse liability of the Operating Partnership secured by a Hotel (or considered allocable to such Hotel pursuant to Section 752 of the Code and the Treasury Regulations thereunder) will be allocated to each Limited Partner in accordance with "tiers" two and three described in the Treasury Regulations under Section 752 of the Code. First, pursuant to "tier two," such liabilities will be allocated to each Limited Partner in the amount of such Limited Partner's share of any Section 704(c) Minimum Gain with respect to such Hotel, after taking into account any reduction in the liabilities occurring in connection with the Mergers. Next, pursuant to "tier three," any remaining nonrecourse liabilities will be allocated to each Limited Partner in accordance with such Limited Partner's share of Operating Partnership profits, taking into account for such purposes Host REIT's share of Operating Partnership profits. The nonrecourse liabilities, if any, allocable to a Limited Partner by reason of Section 704(c) Minimum Gain will depend upon a number of factors, including, for example, (i) the Limited Partner's share of existing Section 704(c) Minimum Gain of the Partnerships at the time of the Mergers; (ii) the extent to which the Operating Partnership causes nonrecourse liabilities as to which there exists Section 704(c) Minimum Gain immediately prior to the Mergers to be repaid or refinanced in connection with the Mergers in a manner that reduces or eliminates that Section 704(c) Minimum Gain; and (iii) the method selected by the Operating Partnership to allocate gain under Section 704(c) of the Code. The Operating Partnership generally will elect to allocate gain under Section 704(c) of the Code under the "traditional method," with a provision for a curative allocation of gain on sale to the extent prior allocations of depreciation with respect to a specific Hotel were limited by the "ceiling rule" applicable under such method (although there may be certain exceptions). In the 239 case of the Limited Partners of a Participating Partnership that owns a Hotel with Section 704(c) Minimum Gain, this method may not result in as great an allocation of Operating Partnership nonrecourse liabilities by reason of Section 704(c) Minimum Gain to the Limited Partners as might be allocated pursuant to another method. However, the use of this method will decrease the ordinary taxable income that will be allocated to such Limited Partners (by reason of depreciation adjustments), as compared with the amount that would be allocated had another method been selected. See "Tax Treatment of Limited Partners Who Hold OP Units Following the Mergers--Tax Allocations With Respect to Book-Tax Difference on Contributed Hotels." The Operating Partnership will allocate any "excess nonrecourse liabilities" in accordance with a Limited Partner's share of Operating Partnership profits as represented by the Limited Partner's percentage ownership interest the Operating Partnership. Host REIT and the Operating Partnership believe that immediately after the Mergers, and taking into account the election described above and the assumptions set forth below (see "--Assumptions Used in Determining Tax Consequences of the Mergers"), each Limited Partner who does not exercise his right to make the Note Election or the Common Share Election and thus retains the OP Units received in the Mergers and whose adjusted basis in his Partnership Interest is equal to or greater than the Original Limited Partner's Adjusted Basis (as defined below in "--Assumptions Used in Determining Tax Consequences of the Mergers") for that Partnership will be allocated nonrecourse liabilities in an amount such that the Limited Partner will not be deemed for federal income tax purposes to have received a deemed cash distribution in excess of such Limited Partner's basis in his Partnership Interest as a result of the Mergers. However, a Limited Partner whose adjusted basis in his Partnership Interest is less than the Original Limited Partner's Adjusted Basis for that Partnership could be deemed for federal income tax purposes to have received a deemed cash distribution in excess of such Limited Partner's basis in his Partnership Interest as a result of the Mergers. IRS Ruling Request Regarding Allocation of Partnership Liabilities. Except as described herein, the Operating Partnership has no current plan or intention to cause the prepayment of the nonrecourse liabilities encumbering the Hotels owned by the Partnerships (other than with the proceeds of indebtedness that would be considered nonrecourse liabilities allocable to those Hotels). The Operating Partnership, however, will have to repay mortgage indebtedness secured by a Hotel at the time such indebtedness matures. There can be no assurance that at such time the Operating Partnership will be able to obtain nonrecourse mortgage indebtedness secured only by such Hotel in an amount sufficient to avoid a deemed cash distribution to the former Limited Partners in the Partnership that owns the Hotel. These considerations are particularly relevant with respect to the Limited Partners in PHLP, where the existing mortgage indebtedness, which matures in December 1999, will have to be refinanced within one year following the Mergers. Moreover, the Operating Partnership's current long-term financing strategy is to have as little debt as possible that is secured by individual Hotels and to have as much debt as possible in the form of unsecured debt, held either by the public or by institutional investors, which debt may or may not be recourse to Host REIT, as general partner of the Operating Partnership. In view of these considerations and the potential adverse consequences to Limited Partners in certain Partnerships, the Operating Partnership has requested from the IRS a ruling to the effect that such unsecured indebtedness of the Operating Partnership that is issued initially to institutional investors and is not recourse to Host REIT (i) would qualify as "nonrecourse liabilities" for purposes of Code Section 752, (ii) to the extent the proceeds thereof are applied to repay existing nonrecourse mortgage indebtedness secured by one or more Hotels, would be considered to be "secured" by those Hotels for purposes of computing the Section 704(c) Minimum Gain with respect to such Hotels (and thus would be allocable under "tier two" to the former Limited Partners in the Partnership owning those Hotels) and (iii) would constitute "qualified nonrecourse financing" secured by such Hotels for purposes of Code Section 465. The IRS has recently issued a ruling to that effect to another taxpayer, and has indicated to the Operating Partnership's representatives that it is favorably inclined to issue that ruling to the Operating Partnership. Assumptions Used in Determining Tax Consequences of the Mergers. The estimated adjusted tax basis in the OP Units used by the Operating Partnership and the General Partners for purposes of this discussion has been computed based on the assumption that each of the Limited Partners acquired his Partnership Interest in the 240 original offering of such Partnership Interests (this basis is referred to as an "Original Limited Partner's Adjusted Basis"). The General Partners have set forth on Appendix E to this Consent Solicitation for each Partnership (i) the Original Limited Partner's Adjusted Basis as of December 31, 1997 and (ii) an estimate of the Original Limited Partner's Adjusted Basis as of December 31, 1998 (computed without regard to the Mergers and based upon the assumptions set forth in Appendix E to this Consent Solicitation). The General Partners also have set forth on Appendix E to this Consent Solicitation for each Limited Partner whose adjusted basis in his Partnership Interest is the same as the Original Limited Partner's Adjusted Basis (i) the Partnership liabilities allocable to such Limited Partner as of December 31, 1997 and (ii) an estimate of the Partnership liabilities allocable to such Limited Partner as of December 31, 1998 (computed without regard to the Mergers and based upon the assumptions set forth in Appendix E to this Consent Solicitation). The actual adjusted tax basis of a Limited Partner in his Partnership Interest (and thus the Partnership liabilities allocable, and the gain, if any, to such Limited Partner resulting from the Mergers and the REIT Conversion) could vary materially from the amount set forth in Appendix E to this Consent Solicitation, depending upon a number of factors, including when, and the manner in which, such Limited Partner acquired his Partnership Interest. See "Tax Treatment of Limited Partners Who Hold OP Units Following the Mergers-- Initial Tax Basis of OP Units." Also, the determination of the amount of the Operating Partnership's nonrecourse liabilities that will be allocated to a Limited Partner following the Mergers assumes that the method to be used by the Operating Partnership to allocate the liabilities among the Hotels will be respected for federal income tax purposes. Finally, the Operating Partnership and the General Partners assumed that the Mergers will be treated for federal income tax purposes as the transfer by the Partners of their interests in the Partnerships to the Operating Partnership in exchange for OP Units. There can be no assurance, however, that the IRS will not seek to recharacterize each Merger as either (i) the liquidation of a Partnership followed by the distribution by the Partnership of its assets to its Partners and the subsequent transfers by such Partners of such assets to the Operating Partnership in exchange for OP Units or (ii) the transfer by a Partnership of its assets to the Operating Partnership in exchange for OP Units and/or Notes (and, possibly, Common Shares) and the subsequent distribution of such OP Units and/or Notes (and, possibly, Common Shares) to its Partners. If the Mergers are recharacterized in such a manner, the tax consequences of the Mergers to the Limited Partners likely will be materially affected. Disguised Sale Regulations. The Mergers also will not be tax free to a Limited Partner to the extent that a Merger is treated as a "disguised sale" of all or a portion of such Limited Partner's Partnership Interest under the Code or Treasury Regulations. Section 707 of the Code and the Treasury Regulations thereunder (the "Disguised Sale Regulations") generally provide that, unless one of certain prescribed exceptions is applicable, a partner's contribution of property to a partnership and a simultaneous transfer of money or other consideration (other than an interest in the partnership) from the partnership to the partner will be treated as a sale, in whole or in part, of such property by the partner to the partnership. Further, the Disguised Sale Regulations provide generally that transfers of money or other consideration between a partnership and a partner that are made within two years of each other are presumed to be a sale unless the facts and circumstances clearly establish that either the transfers do not constitute a sale or an exception to disguised sale treatment applies. For purposes of these rules, certain reductions in a partner's share of partnership liabilities are treated as a transfer of money or other property from the partnership to the partner which may give rise to a disguised sale, even if that reduction would not otherwise result in a taxable deemed cash distribution in excess of the partner's basis in his partnership interest. The method of computing the existence and amount of any such reduction under the Disguised Sale Regulations is different from, and generally more onerous than, that applied under the rules discussed at "--Relief From Liabilities/Deemed Cash Distribution," above. However, if a transfer of property by a partner to a partnership is not otherwise treated as part of a disguised sale, then any reduction in the partner's share of "qualified liabilities" (discussed below) also will not be treated as part of a disguised sale. Moreover, even if some or all of the transfer does otherwise constitute a disguised sale, the amount of the reduction in the partner's share of "qualified liabilities" may, in some cases, be computed under a more favorable method than the amount of the reduction in the partner's share of other liabilities. 241