AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 20, 1998     
                                                     REGISTRATION NO. 333-64793
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                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
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                            AMENDMENT NO. 3 TO     
                                   FORM S-4
                            REGISTRATION STATEMENT
                                     UNDER
                          THE SECURITIES ACT OF 1933
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                            HMC MERGER CORPORATION
      (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS GOVERNING INSTRUMENT)
        MARYLAND                     7011                     53-0085950
    (STATE OR OTHER            (PRIMARY STANDARD           (I.R.S. EMPLOYER
      JURISDICTION                INDUSTRIAL             IDENTIFICATION NO.)
  OF INCORPORATION OR         CLASSIFICATION CODE
     ORGANIZATION)                  NUMBER)
                              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
                            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)
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                                  COPIES TO:
                         J. WARREN GORRELL, JR., ESQ.
                             HOWARD I. FLACK, 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 OF THE SECURITIES 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. [_]
  If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
  If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
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                        CALCULATION OF REGISTRATION FEE
   
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PROPOSED PROPOSED MAXIMUM TITLE OF EACH CLASS OF AMOUNT MAXIMUM AGGREGATE AMOUNT OF SECURITIES TO BE TO BE OFFERING PRICE OFFERING REGISTRATION REGISTERED REGISTERED PER SHARE(1) PRICE(1) FEE - -------------------------------------------------------------------------------------- Shares of Common Stock, par value $.01 per share................ 208,000,000(2)(3) $14.00 $2,912,000,000 $858,227(3) - --------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------- (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) Includes the maximum number of shares of common stock, par value $.01 per share ("Host REIT Common Stock"), of HMC Merger Corporation, a Maryland corporation (referred to herein as "Host REIT", which will be renamed "Host Marriott Corporation" following the merger described below), to be registered hereunder that may be issuable pursuant to the merger (the "Merger") of Host Marriott Corporation, a Delaware corporation ("Host"), with and into Host REIT pursuant to the Agreement and Plan of Merger (the "Agreement") by and among Host. Host REIT and Host Marriott L.P., as described in the Proxy Statement/Prospectus that forms a part of this Registration Statement. Based upon the number of shares of common stock, par value $1.00 per share, of Host ("Host Common Stock") outstanding at the close of business on November 18, 1998. See "The Restructuring Transactions--Terms of the Merger." (3) Host REIT previously registered 204,586,035 shares of Common Stock, for which a registration fee of $844,940 was 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. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- HOST MARRIOTT CORPORATION 10400 FERNWOOD ROAD BETHESDA, MARYLAND 20817-1109 (301) 380-9000 NOVEMBER , 1998 Dear Fellow Stockholder: You are cordially invited to attend a special meeting of stockholders of Host Marriott Corporation, a Delaware corporation ("Host"), which will be held at the Ritz-Carlton Hotel, 1700 Tysons Boulevard, McLean, Virginia, 22102, on December 15, 1998 at 10:00 a.m., local time (the "Special Meeting"). At the Special Meeting, you will be asked to approve (a) the Agreement and Plan of Merger (the "Agreement"), entered into by and among Host, HMC Merger Corporation, a wholly-owned, newly formed Maryland subsidiary of Host (referred to herein as "Host REIT", which will be renamed "Host Marriott Corporation" following the merger described below), and Host Marriott, L.P., a recently formed Delaware limited partnership organized and currently wholly- owned by Host and of which Host will be the sole general partner (the "Operating Partnership") and (b) such other matters as may properly come before the meeting or any adjournments or postponements thereof. The Agreement contemplates certain restructuring transactions (the "Restructuring Transactions") consisting of (i) the contribution by Host of its wholly-owned full-service hotels, its interests in certain hotel partnerships and certain other assets to the Operating Partnership in exchange for units of limited and general partnership interest in the Operating Partnership and the assumption of liabilities (the "OP Contribution") and (ii) the reincorporation of Host from the State of Delaware to the State of Maryland (the "Reincorporation") by means of a merger (the "Merger") of Host with and into Host REIT, which was formed for the sole purpose of effecting the Reincorporation. As a result of the Reincorporation by means of the Merger, each outstanding share of common stock of Host, together with the associated right issued under Host's existing stockholder rights plan, will be converted into one share of common stock of Host REIT, together with the associated right under a stockholder rights plan to be adopted by Host REIT prior to the Merger. As described in the attached Proxy Statement/Prospectus, the Restructuring Transactions are part of an overall plan (the "REIT Conversion") adopted by Host to restructure its business operations so that it will qualify as a real estate investment trust ("REIT") for federal income tax purposes. If Host REIT qualifies as a REIT, it generally will not be subject to federal corporate income taxes on that portion of its ordinary income or capital gain that is distributed to its stockholders. Such treatment would substantially eliminate the federal "double taxation" on earnings (at the corporate and stockholder levels) that generally results from investment in a corporation. If the Agreement is approved by the stockholders of Host at the Special Meeting and the Restructuring Transactions are consummated, 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). The Host Board of Directors is proposing the Restructuring Transactions primarily for the following reasons: . The Restructuring Transactions are essential components of Host's conversion to REIT status for federal income tax purposes. In particular, the OP Contribution will enable Host REIT, following the Merger, to operate, together with the Operating Partnership, in an umbrella partnership REIT ("UPREIT") structure, through which Host REIT would continue the full-service hotel ownership business currently conducted by Host. Host believes that the UPREIT structure will improve its ability to acquire additional properties in the future on favorable terms. . The provisions of Maryland law have generally been viewed as favorable to REITs organized in corporate or trust form, as evidenced by the large number of publicly traded REITs that have chosen to operate as a regular Maryland corporation or as a special statutory Maryland real estate investment trust. . In particular, in order to satisfy certain requirements that are applicable to REITs in general, many REITs impose through their charters ownership limits and transfer restrictions similar to the ownership limit proposed by Host REIT in its charter, as described in the accompanying Proxy Statement/Prospectus. Under Delaware law, such restrictions would not be binding with respect to securities issued prior to adoption of the restriction unless holders of such securities agree to, or vote in favor of, such restriction. However, under Maryland law and by reason of the Merger, all shares of common stock of Host REIT issued in the Merger and thereafter would be subject to the ownership limit under Host REIT's charter, for which authority exists under Maryland law. . Host's principal executive offices and a substantial number of Host's employees are employed in Maryland. The Board of Directors of Host believes that the Agreement, which contemplates the Restructuring Transactions, and the other transactions comprising the REIT Conversion described in the accompanying Proxy Statement/Prospectus are advisable for Host and its stockholders, based on the belief that: (i) the REIT structure, as a more efficient tax structure, will provide improved operating results through changing economic conditions and all phases of the hotel economic cycle; (ii) 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; (iii) as a REIT, Host 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; (iv) by becoming a dividend paying company, Host's stockholder base will expand to include investors attracted by yield as well as asset quality, which is expected to facilitate Host REIT's capital-raising efforts and provide a less volatile stockholder base; and (v) the adoption of an UPREIT structure will facilitate tax-deferred acquisition of additional hotels. 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 REIT's election could be delayed until January 1, 2000). The Merger will not be consummated unless Host's Board of Directors shall have determined prior to consummating the Merger that the conditions to the Merger (including approval of the Agreement by the stockholders of Host) have been satisfied or waived, and in particular, that the transactions constituting the REIT Conversion which impact Host REIT's status as a REIT for federal income tax purposes have occurred or are reasonably likely to occur, and based on 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 prior to January 1, 1999). In the event the Agreement is not approved by Host stockholders at the Special Meeting, Host will continue to operate as a Delaware corporation, and the REIT Conversion will not be completed at this time. Details of the Agreement, including the proposed Restructuring Transactions, as well as the other transactions comprising the REIT Conversion, are contained in the attached Proxy Statement/Prospectus, which you are encouraged to read carefully. AFTER CAREFUL CONSIDERATION, YOUR BOARD OF DIRECTORS HAS DETERMINED THE AGREEMENT, WHICH CONTEMPLATES THE RESTRUCTURING TRANSACTIONS, AND THE OTHER TRANSACTIONS COMPRISING THE REIT CONVERSION, TO BE ADVISABLE FOR HOST AND ITS STOCKHOLDERS. ACCORDINGLY, YOUR BOARD OF DIRECTORS HAS APPROVED THE AGREEMENT AND THE TRANSACTIONS CONTEMPLATED THEREBY AND RECOMMENDS THAT ALL STOCKHOLDERS VOTE "FOR" APPROVAL OF THE AGREEMENT AND THE TRANSACTIONS CONTEMPLATED THEREBY. The affirmative vote of holders of two-thirds (66 2/3%) of the outstanding shares of Host common stock is necessary to approve the Agreement. Therefore, whether or not you plan to attend the Special Meeting, please complete, sign and date the enclosed proxy card and return it promptly in the enclosed postage prepaid envelope, or vote your proxy by telephone or the internet in accordance with the instructions on the admission ticket attached to the enclosed proxy card. You may revoke your proxy in the manner discussed in the 2 accompanying Proxy Statement/Prospectus at any time before it has been voted at the Special Meeting. If you attend the Special Meeting, you may vote in person if you wish, even if you have previously submitted your proxy. Your prompt cooperation will be greatly appreciated. This solicitation is made on behalf of the Board of Directors of Host. Sincerely, RICHARD E. MARRIOTT Chairman of the Board YOUR VOTE IS IMPORTANT PLEASE PROMPTLY COMPLETE, SIGN AND DATE AND RETURN THE ENCLOSED PROXY CARD OR PROMPTLY VOTEYOUR PROXY BY TELEPHONE OR THE INTERNET IF THE RESTRUCTURING TRANSACTIONS AND THE OTHER TRANSACTIONS COMPRISING THE REIT CONVERSION DO 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 TO JANUARY 1, 2000, WHICH WOULD RESULT IN HOST OR HOST REIT CONTINUING TO PAY SUBSTANTIAL CORPORATE-LEVEL INCOME TAXES IN 1999 AND COULD CAUSE OTHER RELATED TRANSACTIONS NOT TO BE CONSUMMATED. THEREFORE, IT IS EXTREMELY IMPORTANT THAT STOCKHOLDERS SUBMIT THEIR PROXIES AS SOON AS POSSIBLE. ANY DELAY IN RETURNING PROXIES COULD CAUSE THE SPECIAL MEETING TO BE DELAYED, WHICH COULD PREVENT THE RESTRUCTURING TRANSACTIONS AND THE OTHER TRANSACTIONS COMPRISING THE REIT CONVERSION FROM BEING EFFECTIVE JANUARY 1, 1999. 3 HOST MARRIOTT CORPORATION 10400 FERNWOOD ROAD BETHESDA, MARYLAND 20817-1109 (301) 380-9000 ---------------- NOTICE OF SPECIAL MEETING OF STOCKHOLDERS TO BE HELD ON DECEMBER 15, 1998 ---------------- To the Stockholders of Host Marriott Corporation: NOTICE IS HEREBY GIVEN that a special meeting of stockholders of Host Marriott Corporation, a Delaware corporation ("Host"), will be held at the Ritz-Carlton Hotel, 1700 Tysons Boulevard, McLean, Virginia, 22102, on December 15, 1998 at 10:00 a.m., local time (the "Special Meeting"), for the following purposes: 1. To consider and vote upon a proposal to approve the Agreement and Plan of Merger dated November , 1998 (the "Agreement") by and among Host, HMC Merger Corporation, a wholly-owned, newly formed Maryland subsidiary of Host (referred to as "Host REIT", which will be renamed "Host Marriott Corporation" following the merger described below), and Host Marriott, L.P., a recently formed Delaware limited partnership organized and currently wholly-owned by Host and of which Host will be the sole general partner (the "Operating Partnership"). The Agreement contemplates certain restructuring transactions (the "Restructuring Transactions") consisting of (i) the contribution by Host of its wholly-owned full-service hotels, its interests in certain hotel partnerships and certain other assets to the Operating Partnership in exchange for units of limited and general partnership interest in the Operating Partnership and the assumption of liabilities (the "OP Contribution") and (ii) the reincorporation of Host from the State of Delaware to the State of Maryland (the "Reincorporation") by means of a merger (the "Merger") of Host with and into Host REIT, which was formed for the sole purpose of effecting the Reincorporation. If the Agreement is approved by Host stockholders and the Merger is consummated, Host REIT will be the surviving entity in the Merger, the separate existence of Host will terminate and each issued and outstanding share of common stock, par value $1.00 per share, of Host (the "Host Common Stock"), together with the associated right issued under the Rights Agreement dated as of February 3, 1989 between Host and the Bank of New York, will be converted into one share of common stock, par value $.01 per share, of Host REIT (the "Host REIT Common Stock"), together with the associated right issued under a stockholder rights plan to be adopted by Host REIT prior to the Merger. In addition, the Agreement provides that, in the Merger, outstanding options and other rights to acquire Host Common Stock will be converted into rights to acquire Host REIT Common Stock, subject to certain adjustments and except as otherwise set forth in the Agreement, and any outstanding shares of preferred stock of Host would be converted into an equal number of shares of preferred stock of Host REIT having substantially the same rights and preferences. Upon consummation of the Merger, holders of Host REIT Common Stock will become subject to the Ownership Limit (described below) under the Articles of Incorporation of Host REIT that will be in effect upon consummation of the Merger (the "Host REIT Charter"). Primarily to satisfy certain requirements under the Internal Revenue Code of 1986, as amended (the "Code"), that are applicable to REITs in general, the Host REIT Charter will provide that no person or group of persons may own, or be deemed to own by virtue of the attribution provisions of the Code, more than 9.8% of the lesser of the number or value of shares of Host REIT Common Stock (or any class or series of Host REIT preferred stock) outstanding (the "Ownership Limit"), subject to waiver or modification by Host REIT in certain limited circumstances and to certain limited exceptions for a holder of shares of Host REIT Common Stock solely by reason of the Merger in excess of the Ownership Limit so long as such holder would not own, directly or by attribution under the Code, more than 9.9% by value of the outstanding capital stock of Host REIT as of 12:01 a.m. (Eastern Time) on the first day after the effective time of the Merger. THE AGREEMENT, THE RESTRUCTURING TRANSACTIONS, INCLUDING THE TERMS OF THE MERGER, AND THE OWNERSHIP LIMIT ARE MORE COMPLETELY DESCRIBED IN THE ACCOMPANYING PROXY STATEMENT/PROSPECTUS AND THE APPENDICES THERETO, WHICH FORM A PART OF THIS NOTICE. A COPY OF THE AGREEMENT IS ATTACHED AS APPENDIX A TO THE PROXY STATEMENT/PROSPECTUS. 2. To transact such other business as may properly come before the Special Meeting or any adjournments or postponements thereof. Host reserves the right to cancel or defer the Restructuring Transactions even if stockholders of Host approve the Agreement and the other conditions to the consummation of the Restructuring Transactions are satisfied or waived. Only stockholders of record of Host Common Stock at the close of business on November 13, 1998 (the "Record Date") are entitled to notice of, and to vote at, the Special Meeting and any adjournments or postponements thereof. Approval of the Agreement requires the affirmative vote of the holders of two-thirds (66 2/3%) of the shares of Host Common Stock outstanding on the Record Date for the Special Meeting. Pursuant to Delaware law, stockholders of Host will not be entitled to appraisal rights as a result of the Merger or other Restructuring Transactions. ALL STOCKHOLDERS ARE CORDIALLY INVITED TO ATTEND THE SPECIAL MEETING IN PERSON. WHETHER OR NOT YOU PLAN TO ATTEND THE SPECIAL MEETING, PLEASE COMPLETE, DATE AND SIGN THE ENCLOSED PROXY AND RETURN IT IN THE ENCLOSED ENVELOPE AS PROMPTLY AS POSSIBLE OR VOTE YOUR PROXY BY TELEPHONE OR THE INTERNET. IF A PROXY IS SIGNED BUT NO VOTING INSTRUCTIONS ARE INDICATED THEREON, SUCH PROXY WILL BE VOTED "FOR" APPROVAL OF THE AGREEMENT AND THE TRANSACTIONS CONTEMPLATED THEREBY. IF YOU ATTEND THE SPECIAL MEETING, YOU MAY WITHDRAW YOUR PROXY AND VOTE IN PERSON. HOST'S STOCKHOLDERS SHOULD NOT SEND ANY STOCK CERTIFICATES WITH THEIR PROXY CARDS. By Order of the Board of Directors, CHRISTOPHER G. TOWNSEND Secretary Bethesda, Maryland November , 1998 2 ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +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 PROXY STATEMENT/PROSPECTUS 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 NOVEMBER 20, 1998 PROXY STATEMENT OF HOST MARRIOTT CORPORATION AND PROSPECTUS OF HMC MERGER CORPORATION This Proxy Statement/Prospectus is being furnished to the holders of the common stock, par value $1.00 per share (the "Host Common Stock"), of Host Marriott Corporation, a Delaware corporation ("Host"), in connection with the solicitation of proxies on behalf of the Board of Directors of Host for use at a special meeting of stockholders of Host to be held at the Ritz-Carlton Hotel, 1700 Tysons Boulevard, McLean, Virginia, 22102, on December 15, 1998 at 10:00 a.m., local time, and at any adjournments or postponements thereof (the "Special Meeting"). At the Special Meeting, stockholders of Host will be asked to approve (a) the Agreement and Plan of Merger dated November , 1998 (the "Agreement"), by and among Host, HMC Merger Corporation, a wholly-owned, newly formed Maryland subsidiary of Host (referred to herein as "Host REIT", which will be renamed "Host Marriott Corporation" following the merger described below), and Host Marriott, L.P., a recently formed Delaware limited partnership organized and currently wholly-owned by Host and of which Host will be the sole general partner (the "Operating Partnership"); and (b) such other matters as may properly come before the meeting or any adjournments or postponements thereof. The Agreement contemplates certain restructuring transactions (the "Restructuring Transactions") consisting of (i) the contribution by Host of its wholly-owned full-service hotels, its interests in certain hotel partnerships and certain other assets to the Operating Partnership in exchange for units of limited and general partnership interest in the Operating Partnership and the assumption of liabilities (the "OP Contribution") and (ii) the reincorporation of Host from the State of Delaware to the State of Maryland (the "Reincorporation") by means of a merger (the "Merger") of Host with and into Host REIT, which was formed for the sole purpose of effecting the Reincorporation. A copy of the Agreement is attached hereto as Appendix A. The Restructuring Transactions are part of an overall plan (the "REIT Conversion") adopted by Host to restructure its business operations so that it will qualify as a real estate investment trust ("REIT") for federal income tax purposes. SEE "RISK FACTORS" BEGINNING ON PAGE 32 FOR MATERIAL RISKS THAT SHOULD BE CONSIDERED WHEN VOTING ON THE AGREEMENT, INCLUDING THE FOLLOWING: . Since Host REIT will lease virtually all of its hotels to lessees, Host REIT will be dependent for its revenue upon the ability of the lessees of Host REIT's hotels, Marriott International, Inc. ("Marriott International"), which currently manages all but 16 of Host's hotels, and other companies that manage the hotels and upon various non-controlled subsidiaries of Host REIT, and Host REIT will have limited control over the operation of the hotels and no control over the non-controlled subsidiaries. . Rental payments from the lessees of Host REIT's hotels will be the primary source of Host REIT's revenues. . 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 or Host REIT continuing to pay substantial corporate-level income taxes in 1999 (which would reduce Host REIT's cash distributions) and could cause the Blackstone Acquisition (as defined herein) not to be consummated. . The current stock price of Host reflects the current market valuation of Host's current business and assets and not the business and assets of Host REIT following the REIT Conversion. . After the REIT Conversion, Host REIT, as the sole general partner of the Operating Partnership, will have fiduciary obligations to the limited partners in the Operating Partnership, and the discharge of such obligations could result in decisions that may fail to reflect fully the interests of all holders of Host REIT Common Stock (as defined below) and limited partners of the Operating Partnership. Conflicts of interest also may be involved in Host REIT's relationships with Marriott International and the lessees of Host REIT's hotels. . The preliminary estimated initial annual cash distributions of the Operating Partnership during the twelve months ending December 31, 1999 ($231 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 by the Operating Partnership to make such distributions. . There are several uncertainties relating to the REIT Conversion that will exist at the time Host stockholders vote on the Agreement. There is no assurance as to the outcome of various matters, and if certain of these events or transactions are not consummated as expected, it is possible that the REIT Conversion may not be completed, the value of the Host REIT Common Stock and the cash available for distribution to stockholders of Host REIT could be materially adversely affected or Host REIT could fail to qualify as a REIT for federal income tax purposes. . The inability of Host, the Operating Partnership and Host REIT to obtain one or more third-party consents prior to consummation of the REIT Conversion could have a material adverse effect on the Operating Partnership and Host REIT, and thus could reduce the value of the Host REIT Common Stock. . The Ownership Limit under Host REIT's charter will adversely affect the value of any Host REIT Common Stock held in excess of such Ownership Limit and may have the effect of delaying, deferring or preventing a change in control of Host REIT. . Host REIT's charter and bylaws, the Maryland General Corporation Law, as amended (the "MGCL"), Host REIT's stockholder rights plan and certain existing rights of Marriott International contain or will contain a number of provisions that may limit the ability of outside parties to acquire, or discourage them from acquiring, control of Host REIT. . 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 Host REIT Common Stock. . 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. If the Agreement is approved by the stockholders of Host at the Special Meeting and the Restructuring Transactions are consummated, 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). See "Federal Income Tax Consequences." This Proxy Statement/Prospectus also constitutes the prospectus of Host REIT relating to the common stock, par value $.01 per share, of Host REIT (the "Host REIT Common Stock") into which the outstanding shares of Host Common Stock will be converted as part of the Reincorporation by means of the Merger. If the Agreement is approved by the Host stockholders and the Merger is consummated, Host REIT will be the surviving entity in the Merger, the separate existence of Host will terminate and each issued and outstanding share of Host Common Stock, together with the associated right (the "Host Right") issued under the Rights Agreement dated as of February 3, 1989 between Host and the Bank of New York (the "Host Rights Agreement"), will be converted into one share of Host REIT Common Stock, together with the associated right ("Host REIT Right") issued under a stockholder rights plan to be adopted by Host REIT prior to the Merger (the "Host REIT Rights Agreement"). In addition, the Agreement provides that, in the Merger, outstanding options and other rights to acquire Host Common Stock will be converted into rights to acquire Host REIT Common Stock, subject to certain adjustments to take into account aspects of the REIT Conversion, and except as set forth in the Agreement and any outstanding shares of preferred stock of Host would be converted into an equal number of shares of preferred stock of Host REIT having substantially the same rights and preferences. See "The Restructuring Transactions." ANY SHARES OF HOST REIT COMMON STOCK HELD AT THE EFFECTIVE TIME OF THE MERGER AND NOT SUBSEQUENTLY TRANSFERRED PRIOR TO THE SPECIAL MERGER OWNERSHIP LIMIT EFFECTIVE TIME (AS DEFINED HEREIN), OR ACQUIRED OR HELD AT ANY TIME AFTER THE EFFECTIVE TIME OF THE MERGER IN VIOLATION OF THE OWNERSHIP LIMIT (AS DEFINED HEREIN), WILL BE TRANSFERRED AUTOMATICALLY TO A TRUST FOR THE BENEFIT OF A DESIGNATED CHARITABLE BENEFICIARY, AND THE PERSON WHO HOLDS SUCH EXCESS SHARES OF HOST REIT COMMON STOCK WILL NOT BE ENTITLED TO ANY DISTRIBUTIONS THEREON OR TO VOTE SUCH EXCESS SHARES OF HOST REIT COMMON STOCK. TO AVOID THE ADVERSE EFFECTS OF THE OWNERSHIP LIMIT, ANY HOLDER OF HOST COMMON STOCK WHO WOULD OWN SHARES IN EXCESS OF THE OWNERSHIP LIMIT AT THE EFFECTIVE TIME OF THE MERGER SHOULD DISPOSE OF ANY SUCH EXCESS SHARES PRIOR THERETO. SEE "DESCRIPTION OF HOST REIT CAPITAL STOCK--RESTRICTIONS ON OWNERSHIP AND TRANSFER." The Board of Directors has fixed the close of business on November 13, 1998 as the record date for the determination of stockholders entitled to receive notice of and vote at the Special Meeting (the "Record Date"). As of the Record Date, there were 204,954,447 outstanding shares of Host Common Stock and 47,845 holders of record. See "Voting and Proxies." This Proxy Statement/Prospectus and the accompanying proxy card are first being mailed to stockholders of Host on or about November , 1998. This Proxy Statement/Prospectus does not cover any resales of Host REIT Common Stock to be received by stockholders of Host upon consummation of the Merger, and no person is authorized to make use of this Proxy Statement/Prospectus in connection with any such resale. --------------- THE SECURITIES DESCRIBED HEREIN HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROXY STATEMENT/PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. --------------- THE DATE OF THIS PROXY STATEMENT/PROSPECTUS IS NOVEMBER , 1998. ii TABLE OF CONTENTS
PAGE ---- SUMMARY................................................................... 1 Forward-Looking Statements.............................................. 1 Certain Key Definitions................................................. 2 Overview................................................................ 4 Risk Factors............................................................ 10 Date, Time, Place and Purpose of Special Meeting........................ 15 Stockholders Entitled to Vote........................................... 15 Vote Required; No Dissenters' Rights.................................... 15 The Restructuring Transactions.......................................... 16 The REIT Conversion..................................................... 21 Federal Income Tax Consequences......................................... 27 Recommendation of the Board of Directors................................ 28 Distributions and Market Prices of Host Common Stock.................... 28 Distribution and Dividend Policy After the Merger....................... 29 Unaudited Per Share Data................................................ 30 Summary Financial Information........................................... 30 RISK FACTORS.............................................................. 32 Risks and Effects of the Merger and the REIT Conversion................. 32 Lack of Control over Hotel Operations................................. 32 Lack of Control over Non-Controlled Subsidiaries...................... 32 Dependence upon Crestline............................................. 32 Current Host Common Stock Price Is Not Necessarily Indicative of the Price of Host REIT Common Stock Following the REIT Conversion........ 33 Cash Distributions May Exceed Cash Available for Distribution......... 33 Timing of the Restructuring Transactions and the REIT Conversion...... 33 Conflicts of Interest................................................. 34 Uncertainties at the Time of Voting on the Agreement.................. 34 Inability to Obtain Third-Party Consents May Have a Material Adverse Effect............................................................... 35 Expiration of the Leases and Possible Inability to Find Other Lessees.............................................................. 35 Leases Could Impair the Sale or Other Disposition of Host REIT's Hotels............................................................... 35 Limitations on Sale or Refinancing of Certain Hotels.................. 35 Risks of Ownership of Host REIT Common Stock............................ 36 Possible Adverse Consequences of Limits on Ownership of Host REIT Common Stock......................................................... 36 Limitations on Acquisition of Host REIT Common Stock and Change in Control.............................................................. 37 Effect on Stock Price of Shares Available for Future Sale............. 40 Effect on Stock Price of Market Conditions............................ 40 Effect on Stock Price of Earnings and Cash Distributions.............. 40 Effect on Stock Price of Market Interest Rates........................ 41 Effect on Stock Price of Unrelated Events............................. 41 Dependence on External Sources of Capital............................. 41 Federal Income Tax Risks Relating to REIT Qualification................. 41 General............................................................... 41 Required Distributions and Payments................................... 41 Consequences of Failure to Qualify as a REIT.......................... 42 "Earnings and Profits" Attributable to "C" Corporation Taxable Years.. 42 Treatment of Leases................................................... 42 Treatment of Leases of Personal Property.............................. 43 Other Tax Liabilities; Host REIT's Substantial Deferred and Contingent Tax Liabilities...................................................... 43 Failure of the Operating Partnership to Qualify as a Partnership...... 43
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PAGE ---- Other Tax Risks......................................................... 43 Tax Consequences to Host of the OP Contribution and Other Transactions Comprising the REIT Conversion....................................... 43 Effects of Subsequent Events upon Recognition of Gain................. 44 Risks of Operation...................................................... 44 Competition in the Lodging Industry................................... 44 Substantial Indebtedness of Host REIT................................. 44 No Limitation on Debt................................................. 45 The Board May Change Investment and Other Policies Without Stockholder Approval............................................................. 45 Management Agreements Could Impair the Sale or Other Disposition of Host REIT's Hotels................................................... 45 Rental Revenues from Hotels Subject to Prior Rights of Lenders........ 45 Hotels Subject to Ground Leases May Affect Host REIT's Revenues....... 45 General Real Estate Investment Risks.................................. 46 Possible Underperformance of New Acquisitions......................... 46 Seasonality........................................................... 46 Illiquidity of Real Estate............................................ 46 Miscellaneous Risks..................................................... 46 Changes in Laws....................................................... 46 Dependence upon Key Personnel......................................... 47 Potential Litigation Related to the REIT Conversion................... 47 Risk Involved in Investments through Partnerships or Joint Ventures... 47 Year 2000 Problem..................................................... 47 Uninsured Loss........................................................ 48 Americans with Disabilities Act....................................... 48 Other Regulatory Issues............................................... 48 Possible Environmental Liabilities.................................... 48 CONFLICTS OF INTEREST..................................................... 50 Responsibilities of Host REIT to Other Limited Partners in the Operating Partnership............................................................ 50 Potential Conflicts Involving Marriott International and Crestline...... 50 Policies with Respect to Conflicts of Interest.......................... 50 VOTING AND PROXIES........................................................ 51 Matters to be Considered at the Special Meeting......................... 51 Record Date and Outstanding Shares...................................... 51 Voting of Proxies....................................................... 51 Vote Required........................................................... 51 Quorum; Abstentions and Treatment of Broker Non-Votes; Adjournment; Rev- ocation................................................................ 52 Solicitation of Proxies and Expenses.................................... 53 THE RESTRUCTURING TRANSACTIONS............................................ 54 Background and Reasons for the Restructuring Transactions and the REIT Conversion............................................................. 54 The OP Contribution..................................................... 56 Terms of the Merger..................................................... 57 Absence of Dissenters' Rights........................................... 59 Accounting Treatment.................................................... 59 Conditions to the Merger................................................ 59 Comparison of Rights of Stockholders of Host and Host REIT.............. 60 Limitation of Liability and Indemnification of Directors and Officers... 75 THE REIT CONVERSION....................................................... 77 The Initial E&P Distribution............................................ 78 Other Transactions Comprising the REIT Conversion....................... 79
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PAGE ---- OPINION OF FINANCIAL ADVISOR.............................................. 85 Opinion of BT Wolfensohn, Financial Advisor to Host..................... 85 BUSINESS AND PROPERTIES................................................... 89 Business of the Company................................................. 89 General................................................................. 90 Business Objectives..................................................... 90 Business Strategy....................................................... 90 Hotel Lodging Industry.................................................. 93 Hotel Lodging Properties................................................ 94 Hotel Properties........................................................ 99 1998 Acquisitions....................................................... 101 Blackstone Acquisition.................................................. 101 Investments in Affiliated Partnerships.................................. 102 Marketing............................................................... 102 Competition............................................................. 103 Relationship with HM Services........................................... 103 Relationship with Marriott International; Marriott International Distribution........................................................... 103 Employees............................................................... 104 Environmental and Regulatory Matters.................................... 104 Legal Proceedings....................................................... 104 The Leases.............................................................. 105 The Management Agreements............................................... 111 Noncompetition Agreement................................................ 114 Indebtedness............................................................ 115 DISTRIBUTION AND OTHER POLICIES........................................... 117 Distribution Policy..................................................... 117 Investment Policies..................................................... 120 Financing Policies...................................................... 121 Lending Policies........................................................ 121 Conflicts of Interest Policies.......................................... 121 Policies with Respect to Other Activities............................... 123 SELECTED FINANCIAL DATA................................................... 124 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................................................... 126 Lack of Comparability Following the Merger and the REIT Conversion...... 126 Historical Results of Operations........................................ 126 First Three Quarters 1998 Compared to First Three Quarters 1997 (Historical).......................................................... 126 1997 Compared to 1996 (Historical)..................................... 128 1996 Compared to 1995 (Historical)..................................... 130 Pro Forma Results of Operations......................................... 131 100% Participation with No Notes Issued--First Three Quarters 1998 Compared to First Three Quarters 1997 (Pro Forma)..................... 132 100% Participation with Notes Issued--First Three Quarters 1998 Compared to First Three Quarters 1997 (Pro Forma)..................... 133 100% Participation with No Notes Issued--1997 Compared to 1996 (Pro Forma)................................................................ 134 100% Participation with Notes Issued--1997 Compared to 1996 (Pro Forma)................................................................ 135 Pro Forma Results if No Partnerships Participate in the REIT Conversion............................................................. 136 Pro Forma Results if Host REIT's Election is Delayed until January 1, 2000................................................................... 136 Liquidity and Capital Resources......................................... 137 Year 2000 Problem....................................................... 144 MANAGEMENT................................................................ 148 Directors and Executive Officers of Host REIT........................... 148
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PAGE ---- Committees of the Board of Directors.................................... 150 Compensation of Directors............................................... 151 Executive Compensation.................................................. 151 Aggregated Stock Option Exercises and Year-End Value.................... 153 Long-Term Incentive Plan................................................ 154 Employment Agreements................................................... 154 1998 Employee Benefits Allocation Agreement............................. 154 Comprehensive Stock Incentive Plan...................................... 155 Stock Purchase Plan..................................................... 156 401(k) Plan............................................................. 156 Non-Employee Director Plan.............................................. 156 Deferred Compensation Plan.............................................. 156 Limitation of Liability and Indemnification............................. 157 Indemnification Agreements.............................................. 157 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................ 158 Relationship Between Host and Marriott International.................... 158 Relationship Between Host and Host Marriott Services Corporation........ 161 Relationship Between Host and Crestline After the Initial E&P Distribution........................................................... 162 PRINCIPAL STOCKHOLDERS.................................................... 165 DESCRIPTION OF HOST REIT CAPITAL STOCK.................................... 167 General................................................................. 167 Host REIT Common Stock.................................................. 167 Preferred Stock......................................................... 168 Power to Issue Additional Host REIT Common Stock and Preferred Stock.... 168 Restrictions on Ownership and Transfer.................................. 168 Transfer Agent and Registrar............................................ 171 CERTAIN PROVISIONS OF MARYLAND LAW AND THE HOST REIT CHARTER AND BYLAWS... 172 Number of Directors; Classification and Removal of Board of Directors; Other Provisions....................................................... 172 Changes in Control Pursuant to Maryland Law............................. 173 Advance Notice of Director Nominations and New Business................. 174 Meetings of Stockholders; Call of Special Meetings; Stockholder Action in Lieu of Meeting by Unanimous Consent................................ 174 Merger, Consolidation, Share Exchange and Transfer of Assets of Host REIT................................................................... 175 Amendments to the Host REIT Charter and Bylaws.......................... 175 Anti-Takeover Effect of Certain Provisions of Maryland Law and the Host REIT Charter and Bylaws................................................ 175 Marriott International Purchase Right................................... 176 Stockholder Rights Plan................................................. 176 DESCRIPTION OF THE PARTNERSHIP AGREEMENT AND OP UNITS..................... 178 General................................................................. 178 Formation............................................................... 178 Purposes, Business and Management....................................... 178 Host REIT May Not Engage in Other Businesses; Conflicts of Interest..... 179 Distributions; Allocations of Income and Loss........................... 179 Borrowing by the Operating Partnership.................................. 179 Reimbursement of Host REIT; Transactions with Host REIT and its Affiliates............................................................. 179 Liability of Host REIT and Limited Partners............................. 180 Exculpation and Indemnification of Host REIT............................ 180
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PAGE ---- Sales of Assets.......................................................... 181 Removal or Withdrawal of Host REIT; Transfer of Host REIT's Interests.... 181 Certain Voting Rights of Holders of OP Units During the First Year Following the Effective Date of the Partnership Mergers................. 182 Restrictions on Transfers of Interests by Limited Partners............... 182 Unit Redemption Right.................................................... 183 No Withdrawal by Limited Partners........................................ 183 Issuance of Limited Partnership Interests................................ 183 Meetings; Voting......................................................... 184 Amendment of the Partnership Agreement................................... 184 Books and Reports........................................................ 185 Power of Attorney........................................................ 185 Dissolution, Winding Up and Termination.................................. 185 Ownership Limitation..................................................... 186 ERISA CONSIDERATIONS....................................................... 187 Status of Host REIT and the Operating Partnership Under ERISA............ 187 FEDERAL INCOME TAX CONSEQUENCES............................................ 188 Introduction............................................................. 188 Federal Income Tax Consequences of the Merger............................ 189 Federal Income Tax Consequences of the Initial E&P Distribution.......... 190 Federal Income Tax Consequences of the OP Contribution................... 193 Federal Income Taxation of Host REIT Following the Merger................ 194 Taxation of Taxable U.S. Stockholders Generally.......................... 206 Backup Withholding for Host REIT Distributions........................... 208 Taxation of Tax-Exempt Stockholders of Host REIT......................... 209 Taxation of Non-U.S. Stockholders........................................ 209 Tax Aspects of Host REIT's Ownership of OP Units......................... 212 Other Tax Consequences for Host REIT and Its Stockholders................ 215 LEGAL MATTERS.............................................................. 216 EXPERTS.................................................................... 216 OTHER MATTERS.............................................................. 216 STOCKHOLDER PROPOSALS...................................................... 216 AVAILABLE INFORMATION; INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE..... 216 GLOSSARY................................................................... 218 INDEX TO FINANCIAL STATEMENTS.............................................. F-1
APPENDICES Appendix A--Agreement and Plan of Merger Appendix B--Opinion of BT Wolfensohn Appendix C--Tax opinion of Hogan & Hartson L.L.P. with respect to the tax consequences of the Merger Appendix D--Tax opinion of Hogan & Hartson L.L.P. with respect to the qualification of Host REIT as a REIT vii SUMMARY This Summary does not purport to be complete and is qualified in its entirety by the more detailed information appearing elsewhere in this Proxy Statement/Prospectus, including the appendices attached hereto (this "Proxy Statement/Prospectus"), and is presented solely to provide an overview of the transactions described in detail in the remainder of this Proxy Statement/Prospectus and of the business and investment considerations and risks that should be considered carefully when voting on the Agreement. Stockholders are advised not to rely on this Summary, but to carefully review this entire Proxy Statement/Prospectus. The information contained herein, unless otherwise indicated, assumes the Restructuring Transactions and the other transactions comprising the REIT Conversion (including the Blackstone Acquisition, as defined below) occur, all Partnerships (as defined below) participate in the Partnership Mergers (as defined below) and no shares of Host REIT Common Stock or Notes (as defined below) are issued in the Partnership Mergers (the "Full Participation Scenario"). FORWARD-LOOKING STATEMENTS Certain matters discussed herein or delivered in connection with this Proxy Statement/Prospectus 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 Host 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 Proxy Statement/Prospectus 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) Host REIT's ability to compete effectively in areas such as access, location, quality of accommodations and room rate structures; (iv) Host REIT's ability to acquire or develop additional properties and the risk that potential acquisitions or developments may not perform in accordance with expectations; (v) Host's or Host REIT's ability to obtain required consents of stockholders, 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 part of 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; (ix) the effect on Host and Host REIT of the Year 2000 issue; and (x) 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 Host 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. Neither Host nor Host REIT undertakes any 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. 1 CERTAIN KEY DEFINITIONS The following terms have the meanings set forth below. See the "Glossary" on page 218 for the definitions of other capitalized terms used in this Proxy Statement/Prospectus. "Host"........................ Host Marriott Corporation, a Delaware corporation, and either the general partner or an affiliate of the general partner of each Partnership (as defined below), or, as the context may require, Host Marriott Corporation together with its subsidiaries or any of such subsidiaries. "Host Common Stock"........... Shares of common stock, par value $1.00 per share, of Host. "Host REIT"................... HMC Merger Corporation, a wholly-owned, newly formed Maryland subsidiary of Host (to be renamed "Host Marriott Corporation" in connection with the Merger), which was formed for the sole purpose of effecting the Reincorporation by means of the Merger, and 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 and the Operating Partnership collectively together with their subsidiaries or any of such subsidiaries. "Host REIT Common Stock"...... Shares of common stock, par value $.01 per share, of Host REIT. "Operating Partnership"....... Host Marriott L.P., a Delaware limited partnership, the sole general partner of which will be Host REIT, or as the context may require, such entity together with its subsidiaries, including the Non-Controlled Subsidiaries (as defined below), or any of them. "Company"..................... Host (to the extent of its business and assets to be contributed to the Operating Partnership) with respect to the period prior to the REIT Conversion, and Host REIT and the Operating Partnership collectively with respect to the period after the REIT Conversion. "Non-Controlled Subsidiaries"................. The taxable corporations in which 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. "Crestline"................... Crestline Capital Corporation (formerly HMC Senior Communities, Inc.), a Maryland corporation, or, as the context may require, such entity together with the Lessees (as defined below) 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 when Host or Host REIT distributes the common stock of Crestline to its existing stockholders as part of the Initial E&P Distribution. 2 "REIT Conversion"............. (i) The OP Contribution, (ii) the Reincorporation by means of the Merger, (iii) the Initial E&P Distribution, (iv) the recently completed refinancing and amendment of the debt securities and certain credit facilities of Host substantially in the manner described herein, (v) the Partnership Mergers (if and to the extent consummated), (vi) the Private Partnership Transactions (if and to the extent consummated), (vii) the Blackstone Acquisition (if and to the extent consummated), (viii) the creation and capitalization of the Non- Controlled Subsidiaries, (ix) the leasing of virtually all of the full-service Hotels (as defined below) owned or controlled by the Operating Partnership for initial terms ranging generally from seven to ten years (the "Leases") to lessees, which will be indirect wholly-owned subsidiaries of Crestline (the "Lessees"), whereby the Lessees will operate the hotels under their existing brand names and pursuant to their existing management agreements, and (x) such other related transactions described in "The REIT Conversion" and such other 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 REIT Conversion. "OP Contribution"............. The contribution by Host of its wholly-owned full-service hotels, its interests in certain hotel partnerships and certain other assets to the Operating Partnership in exchange for units of limited and general partnership interest in the Operating Partnership and the assumption of liabilities. "Reincorporation"............. The reincorporation of Host from the State of Delaware to the State of Maryland by means of the Merger. "Merger"...................... The proposed merger of Host with and into Host REIT, as described in this Proxy Statement/Prospectus. "Effective Date".............. The date upon which the Reincorporation by means of the Merger is consummated. "Restructuring Transactions"................. The OP Contribution and the Reincorporation by means of the Merger. "Initial E&P Distribution".... One or more taxable distributions by Host or Host REIT to its stockholders 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. "OP Units".................... The limited partnership interests in the Operating Partnership. "Partnership Mergers"......... The acquisition by merger, if and to the extent consummated, of up to eight limited partnerships (the "Partnerships") that own 3 full-service hotels in which Host or its subsidiaries are general partners in exchange for OP Units (which may, in turn, be exchanged for shares of Host REIT Common Stock or unsecured notes of the Operating Partnership (the "Notes")). "Private Partnership Transactions"................. The acquisition of the partnership interests from unaffiliated partners of four partnerships ("Private Partnerships") that own one or more full-service hotels and that, prior to the REIT Conversion, are partially but not wholly-owned by Host or one of its subsidiaries in exchange for OP Units, if and to the extent such acquisitions are consummated. "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. "Ownership Limit"............. The prohibition in the Articles of Incorporation of Host REIT that will be in effect upon consummation of the Merger (the "Host REIT Charter") against ownership, directly or indirectly by virtue of the attribution provisions of the Internal Revenue Code of 1986, as amended (the "Code"), by any person or persons acting as a group of more than (i) 9.8% of the lesser of the number or value of shares of Host REIT Common Stock outstanding or (ii) 9.8% of the lesser of the number or value of the issued and outstanding shares of any class or series of Host REIT preferred stock, subject to waiver or modification by Host REIT in certain limited circumstances and to certain limited exceptions for a holder of shares of Host REIT Common Stock solely by reason of the Merger in excess of the Ownership Limit so long as such holder would not own, directly or by attribution under the Code, more than 9.9% by value of the outstanding capital stock of Host REIT as of 12:01 a.m. (Eastern Time) on the first day after the effective time of the Merger (the "Special Merger Ownership Limit Effective Time"). OVERVIEW General. Host has adopted a plan to restructure its business operations so that it will qualify as a REIT for federal income tax purposes. Host REIT was organized as a Maryland subsidiary of Host on September 28, 1998 for the sole purpose of effecting the Reincorporation by means of the Merger. Upon consummation of the Restructuring Transactions, Host REIT will succeed to and continue the business of Host. The Restructuring Transactions are part of a series of transactions comprising the REIT Conversion. If Host REIT qualifies as a REIT, it generally will not be subject to federal corporate income taxes on that portion of its ordinary income or capital gain that is distributed to its stockholders. Such treatment would substantially eliminate the federal "double taxation" on earnings (at the corporate and stockholder levels) that generally results from investment in a corporation. See "Federal Income Tax Consequences." Host REIT has conducted no business to date other 4 than that incident to the REIT Conversion. This Proxy Statement/Prospectus is being furnished to the holders of Host Common Stock to solicit their approval of the Agreement, which contemplates the OP Contribution and the Reincorporation by means of the Merger. The principal executive offices of both Host and Host REIT are located at 10400 Fernwood Road, Bethesda, Maryland, 20817-1109, telephone number (301) 380-9000. The OP Contribution. Subject to approval of the Agreement at the Special Meeting, after the Special Meeting Host will contribute, as the OP Contribution, its wholly-owned full-service hotels, its interests in certain of the Partnerships and the Private Partnerships and certain other assets to the Operating Partnership. As a preliminary step in the REIT Conversion, during 1998, various subsidiaries of Host also have contributed or will contribute the wholly-owned full-service hotels held by such entities, their interests in certain of the Partnerships and Private Partnerships and certain other assets to the Operating Partnership (including its subsidiaries). In exchange for these contributions, the Operating Partnership will issue to Host in the aggregate a number of OP Units equal to the number of shares of Host REIT Common Stock that will be outstanding upon completion of the REIT Conversion (reduced by any OP Units to be owned by subsidiaries of Host REIT) and will assume Host's liabilities. Following these contributions, the Operating Partnership and its subsidiaries will directly or indirectly own all of Host's and its subsidiaries' wholly-owned hotels, substantially all of Host's direct and indirect interests in both the Partnerships and the Private Partnerships and all of Host's other assets (excluding its senior living assets and the cash or other consideration to be distributed as part of the Initial E&P Distribution and certain other de minimis assets that cannot be contributed to the Operating Partnership). These contributions, which include the OP Contribution, will enable Host REIT, following the Reincorporation by means of the Merger, to operate together with the Operating Partnership in an umbrella partnership REIT ("UPREIT") structure, through which Host REIT would continue the full-service hotel ownership business currently conducted by Host, and which is expected to improve Host REIT's ability to acquire additional hotel and other properties in the future on favorable terms. See "The Restructuring Transactions--The OP Contribution." Federal Income Tax Consequences of the OP Contribution. Section 721 of the Code provides that no gain or loss is recognized in the case of a contribution of property to a partnership in exchange for an interest in the partnership. However, there are a number of potential exceptions to the availability of such treatment. The application of these exceptions is highly complex and depends upon a number of factual determinations and other outside events which may or may not occur, but Host believes that it will not recognize a material amount of gain in connection with the OP Contribution. See "Federal Income Tax Consequences--Federal Income Tax Consequences of the OP Contribution." Host is not obtaining an opinion of outside counsel as to the tax consequences to it of the OP Contribution. The Reincorporation by Means of the Merger. If the requisite stockholder approval of the Agreement is obtained and certain other conditions to consummation of the Merger are satisfied (including, among others, determination by the Host Board of Directors 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 prior to January 1, 1999), approval of the Host REIT Common Stock for listing on the New York Stock Exchange (the "NYSE"), the receipt of governmental and material third-party consents and certain other conditions relating to the REIT Conversion), then pursuant to the Merger, Host would be merged with and into Host REIT, Host REIT would be the surviving entity in the Merger, the separate existence of Host would terminate and each issued and outstanding share of Host Common Stock, together with the associated Host Right under the Host Rights Agreement, would be converted into one share of Host REIT Common Stock, together with the associated Host REIT Right under the Host REIT Rights Agreement, in accordance with the terms of the Agreement. In addition, in the Merger, outstanding options and other rights to acquire Host Common Stock would be converted into rights to acquire Host REIT Common Stock, subject to adjustment for the Initial E&P Distribution and except as otherwise set forth in the Agreement, and any outstanding shares of preferred stock of Host would be converted into an equal number of shares of preferred stock of Host REIT having substantially the same rights and preferences. It is expected that, upon consummation of the Merger, the Host REIT Common 5 Stock will be listed and trade on the NYSE under the "HMT" symbol in the same manner as shares of Host Common Stock currently trade on the NYSE. See "The Restructuring Transactions--Terms of the Merger" and "--Conditions to the Merger." Federal Income Tax Consequences of the Merger. Host has received an opinion of counsel to the effect that the Merger will qualify as a tax-free reorganization within the meaning of Section 368(a) of the Code, and accordingly: (i) no gain or loss will be recognized by Host or Host REIT as a result of the Merger; (ii) no gain or loss will be recognized by holders of shares of Host Common Stock upon the conversion of such shares into Host REIT Common Stock (except for certain stockholders who are not considered "U.S. persons" for purposes of the Code and who own (or have owned) in excess of 5% of Host); (iii) the tax basis of shares of Host REIT Common Stock received by a former holder of Host Common Stock pursuant to the Merger in the aggregate will be the same as the holder's adjusted tax basis in the shares of Host Common Stock being converted in the Merger (subject to any adjustment resulting from the Initial E&P Distribution); and (iv) the holding period of shares of Host REIT Common Stock received by a former holder of Host Common Stock pursuant to the Merger will include the holder's holding period with respect to the shares of Host Common Stock being converted in the Merger, assuming that the Host Common Stock was held as a capital asset at the effective time of the Merger. See "Federal Income Tax Consequences--Federal Income Tax Consequences of the Merger." The Initial E&P Distribution. In order to qualify as a REIT for federal income tax purposes, Host REIT and/or Host, as its predecessor, must have distributed all of the accumulated "earnings and profits" ("E&P") of Host to its stockholders in one or more taxable dividends prior to the end of the first full taxable year for which the REIT election of Host is effective, which currently is expected to be the taxable year commencing January 1, 1999 (but which might not be until the year beginning January 1, 2000). In order to help accomplish the requisite distributions of the accumulated E&P of Host, Host or Host REIT will make the Initial E&P Distribution, consisting of one or more taxable distributions to its stockholders consisting of shares of common stock of Crestline and cash or other consideration in an amount to be determined. Although there is no assurance as to what form such other consideration comprising the Initial E&P Distribution will take, it is currently contemplated that it will include a special dividend (the "Special Dividend") payable, at each stockholder's election, in cash or Host Common Stock (or Host REIT Common Stock if the Merger has occurred). The actual amount of the Initial E&P Distribution will be based in part upon the estimated amount of accumulated E&P of Host as of the last day of its taxable year ending on or immediately following completion of the REIT Conversion. To the extent that the Initial E&P Distribution is not sufficient to eliminate Host's estimated accumulated E&P, Host REIT will make one or more additional taxable distributions to its stockholders (in the form of cash or securities) prior to the last day of Host REIT's first full taxable year as a REIT (currently expected to be December 31, 1999 but which instead might be December 31, 2000) in an amount intended to be sufficient to eliminate such E&P, 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 REIT Conversion--The Initial E&P Distribution." Federal Income Tax Consequences of the Initial E&P Distribution. Generally, the Initial E&P Distribution will be a taxable dividend to a Host stockholder to the extent that the Initial E&P Distribution is made out of the Host stockholder's share of the portion of the current and accumulated E&P of Host and Host REIT allocable to the Initial E&P Distribution. Host and Host REIT currently believe that the substantial majority, if not all, of the Initial E&P Distribution (the fair market value of which Host currently estimates will range from approximately $2.10 to $2.50 per share of Host Common Stock) will be considered made out of such E&P and, therefore, will be taxable as a dividend. See "Federal Income Tax Consequences--Federal Income Tax Consequences of the Initial E&P Distribution." The Ownership Limit. Primarily to satisfy certain additional requirements under the Code that are applicable to REITs in general, the Ownership Limit under the Host REIT Charter will provide that no person or persons acting as a group may own, or be deemed to own by virtue of the attribution provisions of the Code, 6 more than 9.8% of the lesser of the number or value of shares of Host REIT Common Stock (or any other class or series of Host REIT preferred stock) outstanding, subject to waiver or modification by Host REIT in certain limited circumstances and to certain limited exceptions for a holder of shares of Host REIT Common Stock solely by reason of the Merger in excess of the Ownership Limit so long as such holder would not own, directly or by attribution under the Code, more than 9.9% by value of the outstanding capital stock of Host REIT after the Special Merger Ownership Limit Effective Time. See "Description of Host REIT Capital Stock--Restrictions on Ownership and Transfer." Other Transactions Comprising the REIT Conversion. In addition to the Restructuring Transactions and the Initial E&P Distribution, the REIT Conversion includes the following transactions, among others: (i) the recently completed refinancing and amendment of the debt securities and certain credit facilities of Host substantially in the manner described herein; (ii) the Partnership Mergers (if and to the extent consummated); (iii) the Private Partnership Transactions (if and to the extent consummated); (iv) the Blackstone Acquisition (if consummated); (v) the creation and capitalization of the Non-Controlled Subsidiaries; (vi) the leasing of virtually all of the full- service Hotels (as defined herein) to the Lessees; and (vii) such other related transactions and such other steps occurring prior to, concurrent with or within a reasonable time after the Effective Date as may be necessary or desirable to complete 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 REIT Conversion. See "The REIT Conversion--Other Transactions Comprising the REIT Conversion." Because REITs are not permitted under current federal income tax law to derive revenues directly from the operation of hotels, Host REIT will lease the Hotels to Lessees that will operate the Hotels under the existing long-term management agreements (the "Management Agreements") and pay rent to Host REIT as more fully described under "Business and Properties--The Leases." The Lessees will be indirect, wholly-owned subsidiaries of Crestline. Crestline, which currently is a wholly-owned subsidiary of Host, will become a separate public company when Host distributes common stock of Crestline to its existing stockholders as part of the Initial E&P Distribution. Shares of Host REIT Common Stock and Crestline common stock will be 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 stockholders 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 (which strategy will be subject to certain limitations through October 8, 2000), Host has entered into an agreement with various affiliates of 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." Reasons for the Restructuring Transactions and the REIT Conversion. The Host Board of Directors is proposing the Restructuring Transactions primarily for the following reasons: . The Restructuring Transactions are essential components of Host's conversion to REIT status for federal income tax purposes. In particular, the OP Contribution will enable Host REIT, following the Merger, to operate, together with the Operating Partnership, in an UPREIT structure, through which Host REIT would continue the full-service hotel ownership business currently conducted by Host. Host believes that the UPREIT structure will improve its ability to acquire additional properties in the future on favorable terms. Specifically, under certain circumstances, OP Units could be issued to acquire properties in 7 transactions that would not trigger immediate tax obligations for certain sellers. Accordingly, converting to an UPREIT structure could enable Host REIT to acquire hotel and other properties in the future at lower prices because of the tax advantages to some sellers of receiving OP Units as consideration. OP Units would subsequently be redeemable for cash or common stock of Host REIT (at the option of Host REIT) at such time as the recipient desires liquidity. . The provisions of Maryland law have generally been viewed as favorable to REITs organized in corporate or trust form. As discussed below, Maryland law facilitates qualification as a REIT by authorizing the charter of a Maryland corporation to provide for restrictions on ownership and transferability designed to permit a corporation to qualify as a REIT under the Code or for any other purpose. In addition, unlike Delaware, Maryland does not impose a franchise tax on corporations, which will result in cost savings to Host in annual franchise tax payments and related fees of approximately $150,000. Maryland's status as a jurisdiction favorable to REITs is evidenced by the large number of publicly-traded REITs that have chosen to operate as a regular Maryland corporation or as a special statutory Maryland real estate investment trust. According to the National Association of Real Estate Investment Trusts, Inc. ("NAREIT"), as of September 1998, there were over 100 publicly-traded REITs organized under Maryland law. . In order to satisfy certain requirements that are applicable to REITs in general, many REITs impose ownership limits and transfer restrictions, similar to the Ownership Limit under the Host REIT Charter, by inclusion of such provisions in their charters. Under Delaware law, such restrictions would not be binding with respect to securities issued prior to adoption of the restriction unless holders of such securities agree to or vote in favor of such restriction. However, under Maryland law and by reason of the Merger, all shares of Host REIT Common Stock issued in the Merger and thereafter would be subject to the Ownership Limit, for which authority exists under Maryland law. . Host's principal executive offices and a substantial number of Host's employees are employed in Maryland. The Board of Directors of Host believes that the Restructuring Transactions and the other transactions comprising the REIT Conversion are advisable for Host and its stockholders based on the belief that: . 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. . 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 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's stockholder base will expand to include investors attracted by yield as well as asset quality, which is expected to facilitate Host REIT's capital-raising efforts and provide a less volatile stockholder base. . The adoption of an UPREIT structure will facilitate tax-deferred acquisition of additional hotels (such as in the case of the Blackstone Acquisition and the Partnership 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 REIT's election could be delayed until January 1, 2000). See "The Restructuring Transactions-- Background and Reasons for the Restructuring Transactions and the REIT Conversion." 8 Opinion of Financial Advisor. Host's Board of Directors has received an opinion dated November , 1998 from BT Wolfensohn, which acted as financial advisor to Host in connection with the REIT Conversion, to the effect that the REIT Transactions (as defined in such opinion), taken together, are fair from a financial point of view to the holders of Host Common Stock. See "Opinion of Financial Advisor." The Host Board of Directors considered such opinion as well as other matters it deemed relevant in determining the advisability of the Agreement and the other transactions comprising the REIT Conversion. Certain Effects of the REIT Conversion. The Host Board believes that Host's conversion to a REIT and the distribution of Crestline shares as part of the Initial E&P Distribution will benefit Host's stockholders by providing them with a tax advantaged REIT security that is expected to provide both the opportunity for regular cash dividends and capital appreciation as Host REIT acquires additional properties, as well as a continuing interest in Crestline, Host's senior living company and the initial lessee of substantially all of Host REIT's hotels, if a Host stockholder continues to hold the Crestline common stock. As a REIT, Host REIT would be able to benefit from the tax advantages that apply to REITs, and stockholders would receive quarterly distributions that are expected to be at least sufficient to satisfy the annual distribution requirements applicable to REITs under the Code. The Host Board believes that this will highlight the value of Host REIT's hotel properties and permit stockholders to realize a regular cash return on that value. Upon completion of the REIT Conversion, Crestline is expected to own Host's 31 senior living communities, which will continue to be managed by Marriott International, and a 25% interest in the Swissotel management company expected to be acquired in the Blackstone Acquisition, and will lease substantially all of the Hotels (as defined below) owned by Host REIT and its affiliates, as further described in this Proxy Statement/Prospectus. At that time, Crestline will operate independently of Host, will be publicly traded and separately listed on the NYSE, and will pursue its own growth opportunities. Following the Restructuring Transactions and the other transactions comprising the REIT Conversion (including the Blackstone Acquisition), Host REIT and its subsidiaries are expected initially to own outright, or have controlling interests in, approximately 125 full-service hotels operated primarily under the Marriott, Ritz-Carlton, Four Seasons, Swissotel and Hyatt brand names (the "Hotels"). Upon completion of the REIT Conversion, Host REIT will be the sole general partner of the Operating Partnership and is expected to own approximately 74% of the OP Units in the Operating Partnership, and the remaining OP Units, which are intended to be substantially equivalent on an economic basis to shares of Host REIT Common Stock, will be owned by the limited partners (that are unaffiliated with Host) of the Partnerships participating in the Partnership Mergers (the "Limited Partners"), unaffiliated partners of the four Private Partnerships participating in the Private Partnership Transactions and the Blackstone Entities. Host REIT and its subsidiaries will own a number of OP Units equal to the number of shares of Host REIT Common Stock outstanding. Host REIT will be managed by its Board of Directors and will have no employees who are not also employees of the Operating Partnership. Although a number of the transactions comprising the REIT Conversion are expected to be consummated immediately prior to, or in certain instances immediately following, the Merger, the Merger will not be consummated unless the conditions to the Merger have been satisfied or waived. In particular, Host's Board of Directors will have determined, among other things, that the transactions constituting the REIT Conversion which impact Host REIT's status as a REIT for federal income tax purposes have occurred or are reasonably likely to occur, and based on 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 prior to January 1, 1999). Consistent with the foregoing, Host intends to pursue the transactions constituting the REIT Conversion at least through the date of the Special Meeting of Host stockholders. If the Agreement is approved by Host stockholders at the Special Meeting, Host intends to continue pursuing those transactions constituting the REIT Conversion which have not yet been completed, including the Blackstone 9 Acquisition (which is not expected to be consummated any earlier than December 29, 1998). In addition, if the Board of Directors has determined that the conditions to the Merger have been or likely will be satisfied or waived (and, in particular, that the transactions constituting the REIT Conversion which impact Host REIT's status as a REIT for federal income tax purposes have occurred or are reasonably likely to occur), the Board intends to declare the Initial E&P Distribution and enter into the Leases with the Lessees (which will be indirect, wholly-owned subsidiaries of Crestline). Under such circumstances, however, the Merger and other transactions comprising the REIT Conversion still might be delayed or possibly might never be consummated. Assuming the Agreement is approved by Host stockholders at the Special Meeting and the Host Board of Directors makes the determination described above, it is currently contemplated that the Merger would be consummated on or about December 29, 1998, subject to satisfaction or waiver of the remaining conditions. If, however, the Agreement is not approved by the Host stockholders at the Special Meeting or the Host Board of Directors does not make the requisite determinations, Host will continue to operate as a Delaware corporation, the REIT Conversion will not be completed at this time and the Initial E&P Distribution will not be made. If the REIT Conversion otherwise 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 estimated cash distributions per share of Host REIT Common Stock) and could cause the Blackstone Acquisition (which is conditioned, among other things, on consummation of the REIT Conversion by March 31, 1999 and Host REIT qualifying as a REIT for 1999) not to be consummated. 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, although no assurance can be given that the Company will enter into or consummate such other transaction or otherwise qualify as a REIT 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. See "The REIT Conversion." RISK FACTORS The following is a summary of the material risks associated with the Restructuring Transactions and the other transactions comprising the REIT Conversion. This summary is qualified in its entirety by the detailed discussion in the section entitled "Risk Factors" contained in this Proxy Statement/Prospectus. Some of the significant matters that stockholders of Host should consider carefully when voting on the Agreement, and the transactions contemplated thereby, include: . 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, Host REIT 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. Host REIT will not operate the Hotels or participate in the decisions affecting the daily operations of the Hotels. Host REIT 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 of their day-to-day operation or management. Host REIT 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 Host REIT's assets. Therefore, Host REIT 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. Subsidiaries of Crestline will be the Lessees of virtually all of the Hotels and their rent payments will be the primary source of Host REIT's revenues. Upon the REIT Conversion, all fees payable under the Management Agreements for subsequent periods will become the primary obligations of the Lessees, to be paid by the Lessees for so long as the Leases remain in effect. The obligations of the Lessees will be guaranteed by Crestline, subject to specified liability limitations. Crestline's and each Lessee's financial condition and ability to meet its obligations under the Leases and the Management Agreements will determine the Operating Partnership's ability to make distributions to 10 holders of OP Units, including Host REIT, and Host REIT's ability, in turn, to make distributions to its stockholders. As of September 11, 1998, on a pro forma basis, after giving effect to the REIT Conversion, Crestline would have had approximately $300 million of indebtedness (including approximately $85 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 or any Lessee will have sufficient assets, income and access to financing to enable it to satisfy its obligations under the Leases or to make payments of fees under the Management Agreements. Host REIT remains obligated to the Managers in case the Lessee fails to pay these fees (but it would be entitled to reimbursement from the Lessee under the terms of the Leases). The credit rating of the Operating Partnership and Host REIT will be affected by the general creditworthiness of Crestline. . Current Host Common Stock Price Is Not Necessarily Indicative of the Price of Host REIT Common Stock Following the REIT Conversion. Host's current stock price is not necessarily indicative of how the market will value Host REIT Common Stock 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. . Cash Distributions May Exceed Cash Available for Distribution. The preliminary estimated initial annual cash distributions of the Operating Partnership during the twelve months ending December 31, 1999 ($231 million) will exceed the estimated cash available for distribution ($144 million) and cash from contingent rents ($64 million) during the twelve months ending December 31, 1999, which would require borrowings by the Operating Partnership of approximately $23 million to make such distributions in accordance with the Operating Partnership's distribution policy. Moreover, if estimated cash from contingent rents were less than $64 million, then the Operating Partnership also would be required to borrow any such shortfall in order to make such distributions. . Timing of the Restructuring Transactions and the REIT Conversion. Host intends to cause the Restructuring Transactions and the other transactions comprising the REIT Conversion to be completed as soon as possible, but there is no assurance that the REIT Conversion will be completed during 1998 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 be expected to reduce Host REIT's estimated cash distributions during 1999 to $0.53 per share from $0.84 per share if its REIT election were effective on January 1, 1999) and could cause the Blackstone Acquisition (which is conditioned, among other things, on consummation of the REIT Conversion by March 31, 1999 and Host REIT qualifying as a REIT for 1999) not to be consummated. . Responsibilities of Host REIT to Other Limited Partners in the Operating Partnership. Maryland law imposes certain duties on the Board of Directors of Host REIT to its stockholders. In addition, after the REIT Conversion, Host REIT, as the sole general partner of the Operating Partnership, will have fiduciary obligations under Delaware law with respect to the other limited partners in the Operating Partnership (to the extent such duties have not been modified or eliminated pursuant to the terms of the amended and restated agreement of limited partnership of the Operating Partnership (the "Partnership Agreement"). Although Delaware law provides that Host REIT, as general partner, is subject to the duties of care and loyalty with respect to the limited partners of the Operating Partnership, the Partnership Agreement imposes certain limitations on Host REIT's fiduciary obligations with respect to such limited partners. See "Distribution and Other Policies--Conflicts of Interest Policies." Although some courts 11 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, notwithstanding the contractual limitations in the Partnership Agreement, the fiduciary duties of the directors of Host REIT to the stockholders may be less than those of Host REIT, as general partner of the Operating Partnership, to the limited partners of the Operating Partnership. Thus, the discharge of Host REIT's obligations to its stockholders and to the limited partners in the Operating Partnership could result in decisions that may fail to reflect fully the interest of all holders of Host REIT Common Stock and limited partners of the Operating Partnership. . 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 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 and officer 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 5.33% and 5.31%, 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. . Uncertainties at the Time of Voting on the Agreement. There are several uncertainties relating to the REIT Conversion that will exist at the time Host stockholders vote on the Agreement, including (i) the occurrence of the Blackstone Acquisition, (ii) the results of the Partnership Mergers and the number and value of the OP Units to be issued to the Limited Partners therein, (iii) the assets and liabilities of the Non-Controlled Subsidiaries and (iv) the value and components of the Initial E&P Distribution. There is no assurance as to the outcome of such matters, and if certain of these transactions or events are not consummated as expected, either the REIT Conversion may not be consummated or the value of Host REIT Common Stock and the amount of cash available for distribution to stockholders could be adversely affected, and Host REIT could fail to qualify as a REIT for federal income tax purposes. . 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 Restructuring Transactions and the other transactions comprising 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 Host REIT Common Stock. . 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 (or if relet, will be relet on terms as favorable to Host REIT). If the Hotels are not relet to the Lessees, Host REIT 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 Host REIT 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. . Leases Could Impair the Sale or Other Disposition of Host REIT's Hotels. Each Lease generally provides for a termination payment if the Lease is terminated by Host REIT prior to the expiration of the term of such Lease, 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 Host REIT leases 12 to the Lessee a comparable substitute hotel. The payment of such termination fee under the Leases could have the effect of impairing the ability of Host REIT to sell its Hotels if market conditions otherwise warrant such a sale and would reduce the net proceeds of any such sale. . 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, the Operating Partnership will agree generally not to dispose of the Blackstone Hotels for five or ten years, depending on the circumstances. Thus, it may be difficult or impossible for Host REIT to sell such Hotels or refinance such debt during their respective lock-out periods. . Possible Adverse Consequences of the Ownership Limit. Any shares of Host REIT Common Stock held at the effective time of the Merger and not subsequently transferred prior to the Special Merger Ownership Limit Effective Time, or acquired or held at any time after the effective time of the Merger, in violation of the Ownership Limit, will be transferred automatically to a trust for the benefit of a designated charitable beneficiary, and the person holding such excess shares of Host REIT Common Stock will not be entitled to any distributions thereon or to vote such excess shares of Host REIT Common Stock. The holder of any such excess shares of Host REIT Common Stock will receive the lesser of the value of such excess shares as of the effective time of the Merger or the cash proceeds from the sale of such excess shares of Host REIT Common Stock by the designated charitable beneficiary. After the effective time of the Merger, any person who acquires Host REIT Common Stock in excess of the Ownership Limit will not 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. As a result, the Ownership Limit would adversely effect the value of any Host REIT Common Stock held in excess of the Ownership Limit. In addition, the Ownership Limit may have the effect of delaying, deferring or preventing a change in control of Host REIT and, as a result, could adversely effect the value of Host REIT Common Stock. . Anti-Takeover Effect of Certain Provisions of the Host REIT Charter and Bylaws, Maryland Law and the Host REIT Rights Agreement. The Host REIT Charter and the bylaws of Host REIT (the "Host REIT Bylaws") to be effective upon completion of the Merger, as well as provisions of Maryland law, will 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 Host REIT Common Stock. Certain of these provisions provide for a staggered board and allow Host REIT to issue, without stockholder approval, preferred stock or other stock having rights senior to those of the Host REIT Common Stock. The Board of Directors also will be authorized, without a vote of stockholders, to classify or reclassify unissued common stock or preferred stock into another class or series of stock. Other provisions impose various procedural and other requirements that could make it difficult for stockholders to effect certain corporate actions. The Host REIT Charter also will provide that no person or persons acting as a group may own more that 9.8% (in number or value) of the outstanding shares of any class or series of Host REIT stock, subject to certain exceptions. Host REIT also intends to adopt the Host REIT Rights Agreement 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 has the right to purchase 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 Merger until June 2017, subject to certain limitations intended to protect the REIT status of Host REIT. See "Certain Provisions of Maryland Law and the Host REIT Charter and Bylaws--Marriott International Purchase Right." . 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 13 its income and property, would, among other things, have the effect of reducing cash available for distribution to Host REIT's stockholders and materially reducing the value of the Host REIT Common Stock. . 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. . 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 Host REIT stockholders and causing Host REIT to fail to qualify as a REIT for tax purposes, thereby materially reducing the value of the Host REIT Common Stock. . Failure of the Leases to Qualify as Leases for REIT Purposes. If one or more of the Leases were to be disregarded for tax purposes (for example, because a Lease was determined to lack economic substance) or if the rent payable under a Lease were determined to be based upon the income or profits of the applicable Lessees, Host REIT would fail to qualify as a REIT and the Operating Partnership might be treated as a corporation for federal income tax purposes, all of which would have a material adverse impact on Host REIT and the value of the Host REIT Common Stock. . Host REIT's Substantial Deferred and Contingent Tax 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. . 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 Host REIT), 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 Host REIT. . Substantial Indebtedness of Host REIT. Host REIT will have substantial indebtedness. As of September 11, 1998, on a pro forma basis assuming the Full Participation Scenario, Host REIT had outstanding indebtedness totaling approximately $5 billion, which represents an approximately 59% debt-to-total market capitalization ratio on a pro forma basis at such date (based upon an assumed price per share of Host REIT Common Stock of $12.50 after giving effect to the REIT Conversion). Host REIT's business is capital intensive and it will have significant capital requirements in the future. Host REIT's leverage level and other factors beyond its control (including market conditions) could affect its ability to (i) obtain financing in the future, (ii) undertake refinancings on terms and subject to conditions deemed acceptable by Host REIT, (iii) make distributions, (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 the Operating Partnership's or Host REIT's organizational documents limiting the amount of indebtedness that either may incur, although certain of Host REIT's debt instruments will contain a number of restrictions on the amount of indebtedness that Host REIT may incur. In addition, Host REIT will have a policy of incurring debt only if upon such 14 incurrence the debt-to-total market capitalization of Host REIT and the Operating Partnership would be 60% or less. Host REIT's Board of Directors, however, may unilaterally change this policy without stockholder approval. If Host REIT's policy of incurring debt were changed, Host REIT could become more highly leveraged which could adversely affect Host REIT's cash flow and the cash available for distribution to stockholders of Host REIT, and could increase the risk of default on Host REIT's indebtedness. . The Board May Change Investment and Other Policies Without Stockholder Approval. Host REIT's Board of Directors may change the investment, financing and other policies of Host REIT without stockholder approval. Such policy changes may have adverse consequences to Host REIT. . Management Agreements Could Impair the Sale or Other Disposition of Host REIT's Hotels. The Hotels generally may not be sold, leased or otherwise transferred unless the transferee assumes the Management Agreements relating thereto and meets certain other conditions. The possible desire of Host REIT, from time to time, to finance, refinance or effect a sale of any of the properties managed by Marriott International (which currently serves as manager for all but 16 of Host REIT's Hotels) may, depending upon the structure of such transactions, result in a need to obtain Marriott International's consent, which could include modification of the Management Agreement with Marriott International with respect to such property. The lack of any required consent from Marriott International would prohibit Host REIT from consummating such financing or sale without breaching such Management Agreement. .Year 2000 Problem. Year 2000 issues have arisen because many existing computer programs and chip-based embedded technology systems use only the last two digits to refer to a year, and therefore do not properly recognize a year that begins with "20" instead of the familiar "19". Although Host has adopted a compliance program in recognition of the possible interruptions that may occur as a result of Year 2000 issues and taken certain steps toward Year 2000 remediation, there can be no assurances that the steps taken toward Year 2000 remediation by Host or third parties will be properly and timely completed, and failure to do so could have a material adverse effect on Host, its business and its financial condition. Following the REIT Conversion, Host REIT will be dependent upon Crestline to interface with third parties in addressing Year 2000 issues at the Hotels leased to Crestline. .Tax Consequences to Host of the OP Contribution and the Other Transactions Comprising the REIT Conversion. Because of the numerous transactions that comprise the OP Contribution and the REIT Conversion and the inherently factual nature of a number of the critical determinations relevant to the tax consequences to Host of the OP Contribution and the REIT Conversion, Host has not sought (and likely could not obtain) an opinion of outside counsel as to the tax consequences to it (in terms of the actual amount of income and gain that would be recognized) of the OP Contribution and the other transactions comprising the REIT Conversion (other than the Merger). Host believes, based upon its knowledge of the relevant facts and advice that it has received from various professional advisers (including both attorneys and accountants on its staff and outside attorneys and accountants) as to the applicable general principles of law, that it will not recognize a material amount of income and gain as a result of the OP Contribution and the other transactions comprising the REIT Conversion. Host, however, will recognize some income and gain in connection with these various transactions, and there can be no assurance that under the relevant facts and circumstances such income and gain would not be material. If Host were to recognize a material amount of income and gain as a result of these various transactions, the resulting income tax liability could be material to Host, and the increase in E&P resulting from such income and gain could materially increase the amount that Host must distribute to its stockholders in order to qualify as a REIT, all of which could have adverse consequences to Host REIT and its stockholders. 15 DATE, TIME, PLACE AND PURPOSE OF SPECIAL MEETING The Special Meeting will be held at the Ritz-Carlton Hotel, 1700 Tysons Boulevard, McLean, Virginia, 22102, on December 15, 1998 at 10:00 a.m., local time, to approve the Agreement. STOCKHOLDERS ENTITLED TO VOTE The Board of Directors has fixed the close of business on November 13, 1998 as the Record Date for the determination of stockholders entitled to receive notice of and vote at the Special Meeting. As of the Record Date, Host had outstanding and entitled to vote 204,954,447 shares of Host Common Stock and 47,845 holders of record. See "Voting and Proxies." VOTE REQUIRED; NO DISSENTERS' RIGHTS Under the Delaware General Corporation Law, as amended (the "DGCL"), the affirmative vote of a majority of the outstanding capital stock of the corporation entitled to vote thereon is needed to adopt a merger agreement. Similarly, if the OP Contribution were deemed to constitute a sale, lease or exchange of all or substantially all of the assets of Host under the DGCL, the affirmative vote of a majority of the outstanding 15--1 capital stock of the corporation entitled to vote thereon would be needed to approve the OP Contribution. Pursuant to Host's Restated Certificate of Incorporation (the "Host Certificate"), the affirmative vote of the holders of two-thirds (66 2/3%) of the outstanding shares of Host Common Stock is necessary for approval of the Merger, as well as the OP Contribution if it were deemed to constitute a sale, lease or exchange of all or substantially all of the assets of Host. On the Record Date, directors and executive officers of Host, together with their affiliates, as a group, beneficially owned approximately 13.7% of the issued and outstanding shares of Host Common Stock. It is currently expected that each director and executive officer of Host will vote the shares of Host Common Stock beneficially owned by such director or executive officer for approval of the Agreement and the transactions contemplated thereby. See "Principal Stockholders." Under the DGCL, Host's stockholders will not be entitled to dissenters' rights of appraisal as a result of the Merger or other Restructuring Transactions. See "Voting and Proxies" and "The Restructuring Transactions-- Absence of Dissenters' Rights." IF THE RESTRUCTURING TRANSACTIONS AND THE OTHER TRANSACTIONS COMPRISING THE REIT CONVERSION DO 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 TO JANUARY 1, 2000, WHICH WOULD RESULT IN HOST OR HOST REIT CONTINUING TO PAY SUBSTANTIAL CORPORATE-LEVEL INCOME TAXES IN 1999 AND COULD CAUSE THE BLACKSTONE ACQUISITION (WHICH IS CONDITIONED, AMONG OTHER THINGS, ON CONSUMMATION OF THE REIT CONVERSION BY MARCH 31, 1999 AND HOST REIT QUALIFYING AS A REIT FOR 1999) NOT TO BE CONSUMMATED. THEREFORE, IT IS EXTREMELY IMPORTANT THAT STOCKHOLDERS RETURN THE PROXY CARDS AS SOON AS POSSIBLE OR PROPERLY SUBMIT THEIR PROXIES BY TELEPHONE OR THE INTERNET IN ACCORDANCE WITH THE INSTRUCTIONS ON THE ADMISSION TICKET ATTACHED TO THE ENCLOSED PROXY CARD. ANY DELAY IN RETURNING PROXIES COULD CAUSE THE SPECIAL MEETING TO BE DELAYED, WHICH COULD PREVENT THE RESTRUCTURING TRANSACTIONS AND THE OTHER TRANSACTIONS COMPRISING THE REIT CONVERSION FROM BEING EFFECTIVE JANUARY 1, 1999. THE RESTRUCTURING TRANSACTIONS Background and Reasons for the Restructuring Transactions and the REIT Conversion. Host is proposing the Restructuring Transactions 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 (but which might not be until the year beginning January 1, 2000). The Host Board of Directors is proposing the Restructuring Transactions primarily for the following reasons: . The Restructuring Transactions are essential components of Host's conversion to REIT status for federal income tax purposes. In particular, the OP Contribution will enable Host REIT, following the Merger, to operate, together with the Operating Partnership, in an UPREIT structure, through which Host REIT would continue the full-service hotel ownership business currently conducted by Host. Host believes that the UPREIT structure will improve its ability to acquire additional properties in the future on favorable terms. Specifically, under certain circumstances, OP Units could be issued to acquire properties in transactions that would not trigger immediate tax obligations for certain sellers. Accordingly, converting to an UPREIT structure could enable Host REIT to acquire hotels and other properties in the future at lower prices because of the tax advantages to some sellers of receiving OP Units as consideration. OP Units would subsequently be redeemable for cash or common stock of Host REIT (at the option of Host REIT) at such time as the recipient desires liquidity. . The provisions of Maryland law have generally been viewed as favorable to REITs organized in corporate or trust form. As discussed below, Maryland law facilitates qualification as a REIT by authorizing the charter of a Maryland corporation to provide for restrictions on ownership and transferability designed to permit a corporation to qualify as a REIT under the Code or for any other purpose. In addition, unlike Delaware, Maryland does not impose a franchise tax on corporations, which will result in cost savings to 16 Host in annual franchise tax payments and related fees of approximately $150,000. Maryland's status as a jurisdiction favorable to REITs is evidenced by the large number of publicly-traded REITs that have chosen to operate as a regular Maryland corporation or as a special statutory Maryland real estate investment trust. According to NAREIT, as of September 1998, there were over 100 publicly-traded REITs organized under Maryland law. . In particular, in order to satisfy certain requirements that are applicable to REITs in general, many REITs impose ownership limits and transfer restrictions, similar to the Ownership Limit under the Host REIT Charter, by inclusion of such provisions in their charters. Under Delaware law, such restrictions would not be binding with respect to securities issued prior to adoption of the restriction unless holders of such securities agree to or vote in favor of such restriction. However, under Maryland law and by reason of the Merger, all shares of Host REIT Common Stock issued in the Merger and thereafter would be subject to the Ownership Limit, for which authority exists under Maryland law. . Host's principal executive offices and a substantial number of Host's employees are employed in Maryland. The Board of Directors of Host believes that the Restructuring Transactions and the other transactions comprising the REIT Conversion are advisable for Host and its stockholders based on the belief that: . 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. . 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 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's stockholder base will expand to include investors attracted by yield as well as asset quality, which is expected to facilitate Host REIT's capital-raising efforts and provide a less volatile stockholder base. . The adoption of an UPREIT structure will facilitate tax-deferred acquisition of additional hotels (such as in the case of the Blackstone Acquisition and the Partnership 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). 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 requirement 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. 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 if Host were to convert to a REIT. See "Restructuring Transactions--Background and Reasons for the Restructuring Transactions and the REIT Conversion." The Host Board believes that Host's conversion to a REIT and the distribution of Crestline shares as part of the Initial E&P Distribution will benefit Host's stockholders by providing them with a tax advantaged REIT security that is expected to provide both the opportunity for regular cash dividends and capital appreciation as 17 Host REIT acquires additional properties, as well as a continuing interest in Crestline, Host's senior living company and the initial lessee of substantially all of Host REIT's Hotels, if a Host stockholder continues to hold the Crestline common stock. If Host REIT qualifies for taxation as a REIT, it generally will not be subject to federal corporate income taxes on that portion of its ordinary income or capital gain that is distributed to stockholders. As a REIT, Host REIT would be able to benefit from the tax advantages that apply to REITs, and stockholders will receive quarterly distributions that are at least sufficient to satisfy the annual distribution requirements applicable to REITs under the Code. The Host Board believes that this will highlight the value of Host REIT's hotel properties and permit stockholders to realize a regular cash return on that value. Upon completion of the REIT Conversion, Crestline is expected to own Host's 31 senior living communities, which will continue to be managed by Marriott International, and a 25% interest in the Swissotel management company expected to be acquired in the Blackstone Acquisition, and will lease substantially all of the Hotels owned by Host REIT and its affiliates. At that time, Crestline will operate independently of Host, will be publicly traded and separately listed on the NYSE, and will pursue its own growth opportunities. Host's Board of Directors has received an opinion dated November , 1998 from BT Wolfensohn, which acted as financial advisor to Host in connection with the REIT Conversion, to the effect that the REIT Transactions (as defined in the opinion), taken together, are fair from a financial point of view to the holders of Host Common Stock. See "Opinion of Financial Advisor." The Host Board of Directors considered such opinion as well as other matters it deemed relevant in determining the advisability of the Agreement and the other transactions comprising the REIT Conversion. Following the Restructuring Transactions and the other transactions comprising the REIT Conversion (including the Blackstone Acquisition), Host REIT and its subsidiaries are expected initially to own outright, or have controlling interests in, approximately 125 full-service Hotels operated primarily under the Marriott, Ritz-Carlton, Four Seasons, Swissotel and Hyatt brand names. Upon completion of the REIT Conversion, Host REIT will be the sole general partner of the Operating Partnership and is expected to own approximately 74% of the OP Units in the Operating Partnership, and the remaining OP Units, which are intended to be substantially equivalent on an economic basis to shares of Host REIT Common Stock, will be owned by the Limited Partners, unaffiliated partners of the Private Partnerships and the Blackstone Entities. Host REIT and its subsidiaries will own a number of OP Units equal to the number of shares of Host REIT Common Stock outstanding. Host REIT will be managed by its Board of Directors and will have no employees who are not also employees of the Operating Partnership. THE BOARD OF DIRECTORS OF HOST BELIEVES THAT THE AGREEMENT, WHICH CONTEMPLATES THE RESTRUCTURING TRANSACTIONS AND THE OTHER TRANSACTIONS COMPRISING THE REIT CONVERSION DESCRIBED IN THIS PROXY STATEMENT/PROSPECTUS, ARE ADVISABLE FOR HOST AND ITS STOCKHOLDERS AND RECOMMENDS THAT STOCKHOLDERS VOTE "FOR" APPROVAL OF THE AGREEMENT AND THE TRANSACTIONS CONTEMPLATED THEREBY. In the event the Agreement is not approved by Host stockholders at the Special Meeting, Host will continue to operate as a Delaware corporation and the REIT Conversion (including the Initial E&P Distribution) will not be completed at this time. See "The Restructuring Transactions--Background and Reasons for the Restructuring Transactions and the REIT Conversion" and "--Comparison of Rights of Stockholders of Host and Host REIT." The OP Contribution. Subject to approval of the Agreement at the Special Meeting, after the Special Meeting Host will contribute, as the OP Contribution, its wholly-owned full-service hotels, interests in certain of the Partnerships and the Private Partnerships (other than their interests in the general partners of the Partnerships, each of which is Host or a wholly-owned, direct or indirect subsidiary of Host, and certain other subsidiaries of Host who will remain in existence as subsidiaries of Host REIT and will receive OP Units in the Partnership Mergers) and certain other assets (excluding Host's 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. As a preliminary step in the REIT Conversion, during 1998, various subsidiaries of Host also have contributed or will contribute the wholly-owned full-service hotels held by such entities, their interests in certain of the Partnerships and Private Partnerships and certain other assets to the Operating Partnership (including its subsidiaries). In exchange for these contributions, 18 the Operating Partnership (i) will issue to Host in the aggregate a number of OP Units equal to the number of outstanding shares of Host Common Stock at the completion of the REIT Conversion, reduced by the number of OP Units to be received by the general partners of the Partnerships and other subsidiaries of Host in the Partnership Mergers (together with preferred partnership interests in the Operating Partnership corresponding to any shares of Host preferred stock outstanding at the time of the REIT Conversion) and (ii) will assume 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 and its subsidiaries' wholly-owned hotels, substantially all of Host's direct and indirect interests in both the Partnerships and the Private Partnerships and all of Host's other assets (excluding its senior living assets, 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). See "The Restructuring Transactions--The OP Contribution." The above-described contributions, which include the OP Contribution, will enable Host REIT, following the Reincorporation by means of the Merger, to operate together with the Operating Partnership in an UPREIT structure, which is expected to improve Host REIT's ability to acquire additional hotels and other properties in the future on favorable terms. Terms of the Merger. The Reincorporation will be effected through the merger of Host with and into Host REIT. As a result of the Merger, Host REIT will be the surviving entity, the separate existence of Host will terminate and each issued and outstanding share of Host Common Stock, together with the associated Host Right, will be converted into one share of Host REIT Common Stock, together with the associated Host REIT Right under the Host REIT Rights Agreement. In addition, in the Merger, outstanding options and certain other rights to acquire Host Common Stock will be converted into rights to acquire Host REIT Common Stock, subject to adjustment for the Initial E&P Distribution and except as otherwise set forth in the Agreement, and any outstanding shares of preferred stock of Host would be converted into an equal number of shares of preferred stock of Host REIT having substantially the same rights and preferences. Upon consummation of the Merger, the holders of Host REIT Common Stock will become subject to the Ownership Limit under the Host REIT Charter. THE OWNERSHIP LIMIT WILL PROVIDE THAT NO PERSON OR PERSONS ACTING AS A GROUP 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 SHARES OF HOST REIT COMMON STOCK OUTSTANDING OR (II) 9.8% OF THE LESSER OF THE NUMBER OR VALUE OF THE ISSUED AND OUTSTANDING SHARES OF ANY CLASS OR SERIES OF HOST REIT PREFERRED STOCK, SUBJECT TO WAIVER OR MODIFICATION BY HOST REIT IN CERTAIN LIMITED CIRCUMSTANCES AND SUBJECT TO (A) AN EXCEPTION FOR A HOLDER OF SHARES OF HOST REIT COMMON STOCK SOLELY BY REASON OF THE MERGER IN EXCESS OF THE OWNERSHIP LIMIT SO LONG AS SUCH HOLDER WOULD NOT OWN, DIRECTLY OR BY ATTRIBUTION UNDER THE CODE, MORE THAN 9.9% BY VALUE OF THE OUTSTANDING CAPITAL STOCK OF HOST REIT AS OF THE SPECIAL MERGER OWNERSHIP LIMIT EFFECTIVE TIME, AND (B) A LIMITATION ON THE APPLICATION OF THE "GROUP" LIMITATION (BUT NO OTHER ELEMENT OF THE OWNERSHIP LIMIT) TO ANY "GROUP" THAT OTHERWISE WOULD EXCEED THE OWNERSHIP LIMIT AT THE EFFECTIVE TIME OF THE MERGER SOLELY BY REASON OF ITS STATUS AS A "GROUP." THE OWNERSHIP LIMIT WILL BECOME APPLICABLE TO ALL HOST REIT STOCKHOLDERS AS OF THE EFFECTIVE TIME OF THE MERGER. ANY SHARES OF HOST REIT COMMON STOCK HELD AT THE EFFECTIVE TIME OF THE MERGER AND NOT SUBSEQUENTLY TRANSFERRED PRIOR TO THE SPECIAL MERGER OWNERSHIP LIMIT EFFECTIVE TIME, OR OTHERWISE HELD AT ANY TIME AFTER THE EFFECTIVE TIME OF THE MERGER 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 (OR HELD) SUCH EXCESS SHARES OF HOST REIT COMMON STOCK WILL NOT BE ENTITLED TO ANY DISTRIBUTIONS THEREON OR TO VOTE SUCH EXCESS SHARES OF HOST REIT COMMON STOCK. THE HOLDER OF ANY SUCH EXCESS SHARES OF HOST REIT COMMON STOCK WILL RECEIVE THE LESSER OF THE VALUE OF SUCH EXCESS SHARES AS OF THE EFFECTIVE TIME OF THE MERGER OR THE CASH PROCEEDS FROM THE SALE OF SUCH EXCESS SHARES OF HOST REIT COMMON STOCK BY THE TRUSTEE OF THE TRUST. AFTER THE EFFECTIVE TIME OF THE MERGER, ANY PERSON WHO ACQUIRES HOST REIT COMMON STOCK IN EXCESS OF THE OWNERSHIP LIMIT WILL NOT 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 HOST REIT COMMON STOCK TO 19 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 SHARES OF HOST REIT COMMON STOCK IN EXCESS OF THE OWNERSHIP LIMIT. TO AVOID THE ADVERSE EFFECTS OF THE OWNERSHIP LIMIT, ANY HOLDER OF HOST COMMON STOCK WHO WOULD OWN SHARES IN EXCESS OF THE OWNERSHIP LIMIT AT THE EFFECTIVE TIME OF THE MERGER SHOULD DISPOSE OF ANY SUCH EXCESS SHARES PRIOR THERETO. See "Description of Host REIT Capital Stock-- Restrictions on Ownership and Transfer." As a consequence of the Merger, among other things, the assets of Host will become assets of Host REIT without further action, and Host REIT will become liable for all the debts and obligations of Host. As soon as practicable following the Merger, Host REIT will complete any other transactions comprising the REIT Conversion that have not already been completed. See "The REIT Conversion." Following the Merger, each person who was a director of Host will continue as a director of Host REIT, certain of the officers of Host will remain officers of Host REIT (others will have become officers of Crestline in connection the distribution of Crestline shares as part of the Initial E&P Distribution) and the rights of stockholders of Host REIT will be governed by the Host REIT Charter attached to the Agreement as Exhibit B and the Host REIT Bylaws attached to the Agreement as Exhibit C. See "The Restructuring Transactions-- Comparison of Rights of Stockholders of Host and Host REIT." The Agreement has been adopted by the Board of Directors of Host, subject to stockholder approval. The Merger will become effective at the time the Articles of Merger are accepted for filing by the State Department of Assessments and Taxation of Maryland (the "SDAT") in accordance with the MGCL and the time the Certificate of Merger is accepted for filing by the Secretary of State of Delaware in accordance with the DGCL, or later if so specified in such Articles and Certificate (the "Effective Time"). It is expected that the listing of Host REIT Common Stock on the NYSE will occur at or prior to the Effective Time and that the listing of Host Common Stock on the NYSE will be terminated at the Effective Time. Host anticipates that the Merger will become effective as promptly as practicable following stockholder approval of the Agreement at the Special Meeting and the satisfaction or waiver of the other conditions to the Merger. The Agreement provides that the Merger may be abandoned by Host or Host REIT at any time prior to its effectiveness. However, Host has no current intention of abandoning or causing Host REIT to abandon the Merger subsequent to the Special Meeting if stockholder approval is obtained and the other conditions to the Merger are satisfied or waived. See "The Restructuring Transactions--Conditions to the Merger." In connection with the REIT Conversion and the Initial E&P Distribution, Host expects to enter into the Employee Benefits and Other Employment Matters Allocation Agreement (the "1998 Employee Benefits Allocation Agreement") among Host, the Operating Partnership and Crestline. The 1998 Employee Benefits Allocation Agreement is expected to provide that the Operating Partnership will assume from Host, to the extent provided therein, the rights and obligations of Host under the Host Marriott Corporation 1997 Comprehensive Stock Incentive Plan (formerly called the Host Marriott Corporation 1993 Comprehensive Stock Inventive Plan), the Host Marriott Corporation Employee Stock Purchase Plan, the Host Marriott Corporation (HMC) Retirement and Savings Plan and the Host Marriott Corporation Executive Deferred Compensation Plan (the "Plans"). See "The Restructuring Transactions--Terms of the Merger," "Description of Host REIT Capital Stock" and "Management--1998 Employee Benefits Allocation Agreement." Neither Host nor Host REIT is aware of any federal, state or local regulatory requirements that must be complied with or approvals that must be obtained prior to consummation of the Merger pursuant to the Agreement, other than compliance with applicable federal and state securities laws, the filing of the Articles of Merger as required under the MGCL and the filing of a Certificate of Merger as required under the DGCL and various state and local governmental authorizations. See "The Restructuring Transactions--Terms of the Merger." 20 Conditions to the Merger. Consummation of the Merger is subject to the satisfaction or waiver of various conditions, including satisfaction of the following conditions: (i) approval of the Agreement by the stockholders of Host; (ii) determination by the Host Board of Directors that the transactions constituting the REIT Conversion which impact Host REIT's status as a REIT for federal income tax purposes have occurred or are reasonably likely to occur, and 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 prior to January 1, 1999); (iii) approval of the Host REIT Common Stock for listing on the NYSE; (iv) the receipt of all governmental and third-party consents to the Restructuring Transactions except for 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; and (v) the United States Congress shall not have proposed or enacted adverse tax legislation. See "The Restructuring Transactions--Conditions to the Merger." In addition, Host will amend the Host Rights Agreement to provide that each Host Right issuable pursuant to the Host Rights Agreement will be converted into a Host REIT Right issuable under the Host REIT Rights Agreement. Host REIT intends to adopt the Host REIT Rights Agreement prior to the completion of the Merger and each share of Host REIT Common Stock issued in the Merger will have a Host REIT Right attached to it. See "Certain Provisions of Maryland Law and the Host REIT Charter and Bylaws--Stockholder Rights Plan." Comparison of Rights of Stockholders of Host and Stockholders of Host REIT. The rights of stockholders of Host are currently governed by the DGCL, the Host Certificate, the Amended Bylaws of Host (the "Host Bylaws") and the Host Rights Agreement. If the Agreement is approved by Host's stockholders and the Merger is consummated, Host REIT will be the surviving entity in the Merger and the rights of the stockholders of Host REIT will be governed by the MGCL, the Host REIT Charter, the Host REIT Bylaws and the Host REIT Rights Agreement. Certain important differences exist between the rights of stockholders of Host and the rights of stockholders of Host REIT. See "The Restructuring Transactions--Comparison of Rights of Stockholders of Host and Host REIT." Copies of the Host REIT Charter and Host REIT Bylaws are attached to the Agreement (which is attached to this Proxy Statement/Prospectus) as Exhibits B and C, respectively. Limitation of Liability and Indemnification of Directors and Officers. The Host REIT Charter and Host REIT Bylaws contain provisions limiting the liability of Host REIT's present and former directors and officers to the corporation and its stockholders and obligating Host REIT to indemnify present and former directors and officers all in accordance with Maryland law. See "The Restructuring Transactions--Limitation of Liability and Indemnification of Directors and Officers." THE REIT CONVERSION The transactions summarized below, together with the Restructuring Transactions, constitute the transactions pursuant to which Host will restructure its business so that it will qualify as a REIT. If the required 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). Although the Restructuring Transactions are expected to occur at the final stages of the REIT Conversion, certain of the REIT Conversion transactions (such as the Partnership Mergers, the Private Partnership Transactions and the Blackstone Acquisition) may occur following the Restructuring Transactions to the extent they are consummated. Although a number of the transactions comprising the REIT Conversion are expected to be consummated immediately prior to, or in certain instances immediately following, the Merger, the Merger will not be consummated unless the conditions to the Merger have been satisfied or waived. In particular, Host's Board of Directors will have determined, among other things, that the transactions constituting the REIT Conversion which impact Host REIT's status as a REIT for federal income tax purposes have occurred or are reasonably likely to occur, and based on advice of counsel, that Host REIT can elect to be treated as a REIT for federal 21 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 prior to January 1, 1999). Consistent with the foregoing, Host intends to pursue the transactions constituting the REIT Conversion at least through the date of the Special Meeting of Host stockholders. If the Agreement is approved by Host stockholders at the Special Meeting, Host intends to continue pursuing those transactions constituting the REIT Conversion which have not yet been completed, including the Blackstone Acquisition (which is not expected to be consummated any earlier than December 29, 1998). In addition, if the Board of Directors has determined that the conditions to the Merger have been or likely will be satisfied or waived (and, in particular, that the transactions constituting the REIT Conversion which impact Host REIT's status as a REIT for federal income tax purposes have occurred or are reasonably likely to occur), the Board intends to declare the Initial E&P Distribution and enter into the Leases with the Lessees (which will be indirect, wholly-owned subsidiaries of Crestline). Under such circumstances, however, the Merger and other transactions comprising the REIT Conversion still might be delayed or possibly might never be consummated. Assuming the Agreement is approved by Host stockholders at the Special Meeting and the Host Board of Directors makes the determination described above, it is currently contemplated that the Merger would be consummated on or about December 29, 1998, subject to satisfaction or waiver of the remaining conditions. If, however, the Agreement is not approved by the Host stockholders at the Special Meeting or the Host Board of Directors does not make the requisite determinations, Host will continue to operate as a Delaware corporation, the REIT Conversion will not be completed at this time and the Initial E&P Distribution will not be made. 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 estimated cash distributions per share of Host REIT Common Stock) and could cause the Blackstone Acquisition (which is conditioned, among other things, on consummation of the REIT Conversion by March 31, 1999 and Host REIT qualifying as a REIT for 1999) not to be consummated. In view of the complexity of the REIT Conversion, the number of transactions that must occur to complete the REIT Conversion and the time and expense involved, Host believes that it is advisable to complete the REIT Conversion, or as many of the transactions comprising the REIT Conversion as possible, as soon as practicable even if such completion is after January 1, 1999 (and, thus, a REIT election would not be effective until January 1, 2000). Moreover, completion of the REIT Conversion (or a significant number of the transactions comprising the REIT Conversion) could possibly facilitate another transaction (such as a merger into another entity) that would enable Host (or its successor) to elect to be treated as a REIT prior to January 1, 2000. 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, although no assurance can be given that the Company will enter into or consummate such other transaction or otherwise qualify as a REIT 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. The Initial E&P Distribution. In order to qualify as a REIT for federal income tax purposes, among other things, Host REIT and/or Host, as its predecessor, must have distributed all of the accumulated E&P of Host to its stockholders in one or more taxable dividends prior to the end of the first full taxable year for which the REIT election of Host is effective, which currently is expected to be the taxable year commencing January 1, 1999 (but which might not be until the year beginning January 1, 2000). In an effort to help accomplish the requisite distributions of the accumulated E&P of Host, Host or Host REIT will make the Initial E&P Distribution, consisting of one or more taxable distributions, to its stockholders in connection with the REIT Conversion. Such taxable distributions would consist of shares of common stock of 22 Crestline and cash or other consideration in an amount to be determined. Although there is no assurance as to what form such other consideration comprising the Initial E&P Distribution will take, it is currently contemplated that it will include the Special Dividend payable, at each stockholder's election, in cash or Host Common Stock (or Host REIT Common Stock if the Merger has occurred). If the Special Dividend is declared, stockholders of record on the Special Dividend record date are expected to be given approximately 20 days to decide whether to take cash, Host Common Stock (or Host REIT Common Stock if the Merger has occurred), or a combination of cash and stock in payment of the Special Dividend. It is anticipated that the cash/stock election will be available on a per-share basis and that, once made, stockholders' elections will be irrevocable. Stockholders entitled to the Special Dividend who fail to make a timely election will receive shares of Host Common Stock (or Host REIT Common Stock if the Merger has occurred), subject to the Ownership Limit, in payment of the Special Dividend. In any event, cash would be paid in lieu of fractional shares, and the Special Dividend payment would be made promptly following expiration of the election period. The aggregate value of the Crestline common stock and the cash or other consideration to be distributed to Host stockholders (and the Blackstone Entities) in connection with 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 stockholders), of which approximately $200 to $300 million (or approximately $.80 to $1.20 per share) is expected to be represented by the Special Dividend. The actual amount of the Initial E&P Distribution will be based in part upon the estimated amount of accumulated E&P of Host as of the last day of its taxable year ending on or immediately following completion of the REIT Conversion. To the extent that the Initial E&P Distribution is not sufficient to eliminate Host's accumulated E&P, Host REIT will make one or more additional taxable distributions to its stockholders (in the form of cash or securities) prior to the last day of Host REIT's first full taxable year as a REIT (currently expected to be December 31, 1999 but which instead might be December 31, 2000) in an amount intended to be sufficient to eliminate such E&P, 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. Limited Partners who elect to receive Host REIT Common Stock in exchange for OP Units in connection with the Partnership 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 stockholders of Host REIT (approximately 25 trading days after the effective date of the Partnership Mergers). However, following receipt of such shares of Host REIT Common Stock, such Limited Partners would participate as stockholders of Host REIT in other dividends or distributions by Host REIT to holders of Host REIT Common Stock, including any additional taxable distributions necessary to eliminate Host's accumulated E&P to the extent the Initial E&P Distribution is not sufficient to eliminate such accumulated E&P. The Limited Partners who elect to retain OP Units also will participate in such additional distributions because distributions by the Operating Partnership to its partners (including Host REIT) would be the source of such additional distributions. No holder of Host Common Stock will be required to pay any cash or other consideration to Host or Host REIT for shares of Crestline common stock received in the Initial E&P Distribution or to surrender or exchange their Host Common Stock or Host REIT Common Stock in order to receive shares of Crestline common stock or other cash or securities as part of the Initial E&P Distribution. See "The REIT Conversion--The Initial E&P Distribution." In addition, following the Restructuring Transactions, the Blackstone Entities are entitled to receive a pro rata portion of the same consideration received by Host REIT's stockholders in connection with the Initial E&P Distribution, except to the extent the Blackstone Entities elected to receive additional OP Units in lieu thereof pursuant to the terms of the Blackstone Acquisition. The payment to the Blackstone Entities of Crestline common stock and other consideration is expected to be approximately $90 to $110 million of the aggregate Initial E&P Distribution of approximately $525 to $625 million if the REIT Conversion and the Blackstone Acquisition are consummated. See "Business and Properties--Blackstone Acquisition." Following the Initial E&P 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 23 and the Lessees. The shares of Crestline common stock distributed to Host stockholders as part of the Initial E&P Distribution and the Blackstone Entities will become a separately traded security from the Host REIT Common Stock, and Crestline will operate independently from Host REIT. There will be substantial overlap of stockholders of Crestline and Host REIT initially, but this overlap likely will diverge over time. The Host Board believes that the distribution of Crestline common stock to Host stockholders as part of the Initial E&P Distribution will provide those Host stockholders who continue to hold Crestline common stock with a separate identifiable interest in a diversified company that generates revenue from both its senior living business and its leasing business. Even under circumstances where the Crestline common stock is distributed to Host stockholders as part of the Initial E&P Distribution but the Merger or other transactions comprising the REIT Conversion are delayed or possibly never consummated, the Host Board believes that having existing leasing arrangements in place with Crestline could facilitate any subsequent efforts by Host to qualify as a REIT for federal income tax purposes (including efforts to pursue a merger with another entity or another transaction that would permit it to commence a new taxable year and elect REIT status prior to January 1, 2000). Other Transactions Comprising the REIT Conversion. In addition to the Restructuring Transactions and the Initial E&P Distribution, the REIT Conversion includes the following additional transactions: . Debt Refinancing. In August 1998, Host refinanced $1.55 billion of outstanding senior notes (the "Senior Note 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 Senior Note 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 Convertible Quarterly Income Preferred Securities of Host (the "Convertible Preferred Securities"). As the successor to Host, Host REIT also will be liable on the debentures and the debentures will become convertible into Host REIT Common Stock, 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, Host REIT will issue shares of Host REIT Common Stock, which will be delivered to such holder. Upon the issuance of such shares by Host REIT, the Operating Partnership will issue to Host REIT a number of OP Units equal to the number of shares of Host REIT Common Stock issued in exchange for the debentures. As a result of the distribution of Crestline common stock and any cash and other consideration to Host or Host REIT stockholders 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 "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." . The Partnership Mergers. Immediately following the Effective Date, each Partnership that participates in the Partnership Mergers will merge with a subsidiary of the Operating Partnership. Such participating Partnerships will be the surviving entities of the Partnership Mergers and will continue in existence as indirect subsidiaries of the Operating Partnership. In the Partnership Mergers, each Limited Partner will receive a number of OP Units with a deemed value equal to the stated exchange value of his respective partnership interest. If a Limited Partner elects to receive Host REIT Common Stock or a Note in exchange for OP Units in connection with the Partnership 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 shares of Host REIT Common Stock or to the Operating Partnership in exchange for a Note with a specified principal amount. The general partners of the Partnerships and other subsidiaries of Host also will receive OP Units in exchange for their interests in the Partnerships, and 24 such general partners will continue as wholly-owned, direct or indirect subsidiaries of Host REIT. Partnerships that do not participate in a Partnership Merger will continue as separate partnerships, but the Operating Partnership would contribute some or all of the interests in certain of these Partnerships that it receives from Host and its subsidiaries to a Non-Controlled Subsidiary. . Restructuring of the Private Partnerships. The Operating Partnership will acquire in the Private Partnership Transactions 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 Blackstone Acquisition. Subject to various terms and conditions, the Operating Partnership expects to acquire from the Blackstone Entities ownership of, or controlling interests in, the Blackstone Hotels. 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. See "The REIT Conversion--Other Transactions Comprising the REIT Conversion--The Blackstone Acquisition." . 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 ("FF&E") 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 Partnership Mergers, certain of the Partnerships (assuming they participate in the Partnership Mergers) will sell to a Non-Controlled Subsidiary an estimated $180 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 Statutory Employee/Charitable Trust, the beneficiaries of which will be certain employees of Host REIT and a designated charity (the "Host Employee/Charitable 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 REIT Conversion--Other Transactions Comprising the REIT Conversion." . Leases of Hotels. The Operating Partnership, its subsidiaries and its controlled partnerships, including the Partnerships participating in the Partnership Mergers, 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." 25 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 shares of Host REIT Common Stock or Notes; excludes Host and its subsidiaries. (2) Also will include Limited Partners in the Partnership Mergers who elect to receive shares of Host REIT Common Stock in exchange for the OP Units received in the Partnership Mergers. Immediately following the Restructuring Transactions and the distribution by Host of Crestline common stock to its stockholders and receipt of Crestline common stock by the Blackstone Entities, the stockholders of Crestline will consist of the stockholders of Host REIT (other than Limited Partners who elect to receive Host REIT Common Stock in connection with the Partnership 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 Host REIT Common Stock or Notes in connection with the Partnership Mergers and that the price per share of Host REIT Common Stock is $ 12.50 for purposes of the Partnership Mergers. (4) The Operating Partnership will own all or substantially all of the equity interests in the Partnerships participating in the Partnership Mergers, 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 Partnerships that do not participate in the Partnership Mergers 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. 26 Ownership Interests in the Operating Partnership Following the Restructuring Transactions and the Other Transactions Comprising the REIT Conversion. Following the Restructuring Transactions and the other transactions comprising the REIT Conversion, the Operating Partnership is expected to be owned as set forth below: OWNERSHIP OF THE OPERATING PARTNERSHIP
PERCENTAGE ENTITY INTEREST(1) ------ ----------- Host REIT....................................................... 74.5% Limited Partners of the Partnerships............................ 8.4 Private Partnerships............................................ 1.2 Blackstone Entities............................................. 15.9 ----- TOTAL......................................................... 100.0% =====
- -------- (1) Assumes that all Partnerships participate in the Partnership Mergers, that the Blackstone Acquisition is consummated, that all Limited Partners in the Partnership Mergers elect to retain OP Units and that the price of an OP Unit is $12.50 per share for purposes of the Partnership 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 Host REIT Common Stock or Notes in exchange for their OP Units in connection with the Partnership Mergers or if the price per OP Unit in the Partnership Mergers is greater than $12.50. The percentage interest of Host REIT will decrease, and the percentage interest of the Limited Partners will increase, if the price per OP Unit in the Partnership Mergers is less than $12.50. FEDERAL INCOME TAX CONSEQUENCES Federal Income Tax Consequences of the OP Contribution. Section 721 of the Code provides that no gain or loss is recognized in the case of a contribution of property to a partnership in exchange for an interest in the partnership. However, there are a number of potential exceptions to the availability of such treatment. The application of these exceptions is highly complex and depends upon a number of factual determinations and other outside events which may or may not occur, but Host believes that it will not recognize a material amount of gain in connection with the OP Contribution. See "Federal Income Tax Consequences--Federal Income Tax Consequences of the OP Contribution." Host is not obtaining an opinion of outside counsel as to the tax consequences to it of the OP Contribution. Federal Income Tax Consequences of the Merger. Host has received an opinion of counsel to the effect that the Merger will qualify as a tax-free reorganization within the meaning of Section 368(a) of the Code, and accordingly, (i) no gain or loss will be recognized by Host or Host REIT as a result of the Merger; (ii) no gain or loss will be recognized by holders of shares of Host Common Stock upon the conversion of such shares into Host REIT Common Stock (except for certain stockholders who are not considered "U.S. persons" for purposes of the Code and who own (or have owned) in excess of 5% of Host); (iii) the tax basis of shares of Host REIT Common Stock received by a former holder of Host Common Stock pursuant to the Merger in the aggregate will be the same as the holder's adjusted tax basis in the shares of Host Common Stock being converted in the Merger (subject to any adjustment resulting from the Initial E&P Distribution); and (iv) the holding period of shares of Host REIT Common Stock received by a former holder of Host Common Stock pursuant to the Merger will include the holder's holding period with respect to the shares of Host Common Stock being converted in the Merger, assuming that the Host Common Stock was held as a capital asset at the Effective Time. See "Federal Income Tax Consequences--Federal Income Tax Consequences of the Merger." Federal Income Tax Consequences of the Initial E&P Distribution. Generally, the Initial E&P Distribution will be a taxable dividend to a Host stockholder to the extent that the Initial E&P Distribution is made out of the Host stockholder's share of the portion of the current and accumulated E&P of Host and Host REIT allocable to 27 the Initial E&P Distribution. Host and Host REIT currently believe that the substantial majority, if not all, of the Initial E&P Distribution (the fair market value of which Host currently estimates will range from approximately $2.10 to $2.50 per share of Host Common Stock) will be considered made out of such E&P and, therefore, will be taxable as a dividend. See "Federal Income Tax Consequences--Federal Income Tax Consequences of the Initial E&P Distribution." 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 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 stockholders, allowing the income represented by such dividends to avoid taxation at the entity level and to be taxed only at the stockholder 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 stockholder 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 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 stockholders, including a requirement that Host REIT distribute to its stockholders at least 95% of its taxable income each year. RECOMMENDATION OF THE BOARD OF DIRECTORS FOR THE REASONS STATED HEREIN, THE BOARD OF DIRECTORS OF HOST RECOMMENDS THAT HOST'S STOCKHOLDERS VOTE "FOR" APPROVAL OF THE AGREEMENT AND THE TRANSACTIONS CONTEMPLATED THEREBY. DISTRIBUTIONS AND MARKET PRICES OF HOST COMMON STOCK Host Common Stock has been listed on the NYSE under the symbol "HMT" since October 8, 1993. Prior thereto, Host and Marriott International were operated as a single consolidated company. See "Certain Relationships and Related Transactions--Relationship Between Host and Marriott International." The table below sets forth, for the periods indicated, the reported high and low sale prices of Host Common Stock on the NYSE. On April 15, 1998, the last full trading day prior to the public announcement of the proposed REIT Conversion, the closing sale price of Host Common Stock on the NYSE was $20.00 per share. On November 19, 1998, the latest practicable date before the printing of this Proxy Statement/Prospectus, the closing sale price of Host Common Stock on the NYSE was $14 1/4 per share. Host has not declared any cash dividends on the Host Common Stock during the two fiscal years ended January 2, 1998 and through the date hereof.
HIGH LOW ---- ---- 1997 First Quarter......................................... $18 3/4 $15 3/4 Second Quarter........................................ 18 1/8 15 1/4 Third Quarter......................................... 20 13/16 17 1/2 Fourth Quarter........................................ 23 3/4 18 1/16 1998 First Quarter......................................... $20 7/16 $17 1/2 Second Quarter........................................ 21 3/8 17 1/8 Third Quarter......................................... 18 15/16 12 13/16 Fourth Quarter (through November 19, 1998)............ 15 5/16 9 7/8
28 It is expected that, upon consummation of the Merger, the Host REIT Common Stock will be listed and trade on the NYSE in the same manner as shares of Host Common Stock currently trade on the NYSE. The historical trading prices of Host's Common Stock are not necessarily indicative of the future trading prices of Host REIT Common Stock because, among other things, 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 to be distributed in connection with the Initial E&P Distribution) and does not necessarily take into account the changes in Host's business and operations (including the leasing of its Hotels to Crestline) that will occur in connection with the REIT Conversion. See "Risk Factors--Current Host Common Stock Price Is Not Necessarily Indicative of the Price of Host REIT Common Stock Following the REIT Conversion." DISTRIBUTION AND DIVIDEND POLICY AFTER THE MERGER The Operating Partnership and Host REIT intend to pay regular quarterly distributions to holders of OP Units and Host REIT Common Stock, 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 stockholders an amount equal to 100% of Host REIT's 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. Host REIT 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 $231 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 ($144 million) and cash from contingent rents ($64 million) during 1999, then the Operating Partnership would be required to borrow approximately $23 million (or $0.08 per OP Unit) to make such distributions. While Host does not believe this will be necessary, it believes that the Operating Partnership 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 stockholders per share of Host REIT Common Stock 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 prior to January 1, 1999, then Host REIT's distributions to stockholders 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 $0.53 per share of Host REIT Common Stock 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 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 intends to establish a dividend reinvestment plan. 29 UNAUDITED PER SHARE DATA The following table sets forth selected historical per share data for Host. The per share data presented below are based on and derived from, and should be read in conjunction with the historical consolidated statements and the related notes thereto of Host, which are included in this Proxy Statement/Prospectus. Interim data for the thirty-six weeks ended September 11, 1998 ("First Three Quarters 1998") and September 12, 1997 ("First Three Quarters 1997") and as of September 11, 1998 and September 12, 1997 are unaudited, but include, in the opinion of management of Host, all adjustments (which are normal and recurring) necessary for a fair presentation of such data. Results for the First Three Quarters 1998 are not necessarily indicative of the results that may be expected for any other interim periods or for the year as a whole.
AS OF AND FOR THE AS OF AND FOR THE FISCAL YEAR(1) FIRST THREE QUARTERS -------------------- --------------------- 1997 1996 1995 1998 1997 ----- ------ ------ ---------- ---------- Basic income from continuing operations....................... $0.23 $(0.07) $(0.39) $ 0.49 $ 0.19 Diluted income from continuing operations....................... $0.23 $(0.07) $(0.39) $ 0.48 $ 0.19 Cash distributions per share(2)... 0 0 0 0 0 Book value per share.............. $5.89 $ 5.58 $ 4.23 $ 5.63 $ 5.89
- -------- (1) Host's fiscal year ends on the Friday nearest to December 31. Fiscal years 1997 and 1995 included 52 weeks compared to 53 weeks for fiscal year 1996. (2) See "--Distributions and Market Prices of Host Common Stock." SUMMARY FINANCIAL INFORMATION The following table sets forth unaudited pro forma financial and other information for the Operating Partnership 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 September 11, 1998 and for the fiscal year ended January 2, 1998 and the First Three Quarters 1998 for the 100% Participation Presentation are presented as if the REIT Conversion occurred as of September 11, 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 Proxy Statement/Prospectus. The pro forma information does not purport to represent what the Operating Partnership'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 Operating Partnership'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 Operating Partnership 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 Operating Partnership will own the Hotels but will lease them to the Lessees and receive rental payments in connection therewith. 30 SUMMARY FINANCIAL INFORMATION (IN MILLIONS)
OPERATING PARTNERSHIP OPERATING PARTNERSHIP PRO FORMA HOST REIT PRO FORMA PRO FORMA HOST REIT PRO FORMA ----------------------- ----------------------- ----------------------- ----------------------- HOST FIRST THREE FIRST THREE FISCAL YEAR 1997 FISCAL YEAR 1997 HISTORICAL QUARTERS 1998 QUARTERS 1998 ----------------------- ----------------------- ---------- ----------------------- ----------------------- 100% REIT 2000 100% REIT 2000 100% REIT 2000 100% REIT 2000 PARTICIPATION WITH PARTICIPATION WITH PARTICIPATION WITH PARTICIPATION WITH WITH NO NO NOTES WITH NO NO NOTES FISCAL WITH NO NO NOTES WITH NO NOTES NO NOTES NOTES ISSUED ISSUED(1) NOTES ISSUED ISSUED(1) YEAR 1997 NOTES ISSUED ISSUED(1) ISSUED ISSUED(1) ------------- --------- ------------- --------- ---------- ------------- --------- ------------- --------- REVENUES: Hotel revenues.... $ -- $ -- $ -- $ -- $1,093 $ -- $ -- $ -- $ -- Rental revenues... 1,135 998 1,135 998 -- 540 468 540 468 Other revenues.... (4) (4) (4) (4) 54 2 2 2 2 ------ ----- ------ ----- ------ ----- ----- ----- ----- Total revenues.. 1,131 994 1,131 994 1,147 542 470 542 470 ------ ----- ------ ----- ------ ----- ----- ----- ----- OPERATING COSTS AND EXPENSES: Hotel............. 600 513 600 513 649 394 336 394 336 Other............. 11 11 11 11 49 15 15 15 15 ------ ----- ------ ----- ------ ----- ----- ----- ----- Total operating costs and expenses........ 611 524 611 524 698 409 351 409 351 ------ ----- ------ ----- ------ ----- ----- ----- ----- Operating profit... 520 470 520 470 449 133 119 133 119 Minority interest.. (10) (10) (17) (12) (32) (14) (14) 38 (1) Corporate expenses........... (44) (44) (44) (44) (47) (30) (30) (30) (30) REIT Conversion expenses........... -- -- -- -- -- -- -- -- -- Interest expense... (468) (420) (430) (382) (302) (328) (292) (302) (266) Dividends on Convertible Preferred Securities......... -- -- (37) (37) (37) -- -- (26) (26) Interest income.... 29 36 29 36 52 24 30 24 30 ------ ----- ------ ----- ------ ----- ----- ----- ----- Income (loss) before income taxes.............. 27 32 21 31 83 (215) (187) (163) (174) Benefit (provision) for income taxes... (1) (2) (1) (13) (36) 11 9 8 71 ------ ----- ------ ----- ------ ----- ----- ----- ----- Income (loss) before extraordinary items ................... $ 26 $ 30 $ 20 $ 18 $ 47 $(204) $(178) $(155) $(103) ====== ===== ====== ===== ====== ===== ===== ===== ===== HOST HISTORICAL ----------- FIRST THREE QUARTERS 1998 ----------- REVENUES: Hotel revenues.... $ 922 Rental revenues... -- Other revenues.... 118 ----------- Total revenues.. 1,040 ----------- OPERATING COSTS AND EXPENSES: Hotel............. 502 Other............. 45 ----------- Total operating costs and expenses........ 547 ----------- Operating profit... 493 Minority interest.. (36) Corporate expenses........... (33) REIT Conversion expenses........... (14) Interest expense... (245) Dividends on Convertible Preferred Securities......... (26) Interest income.... 36 ----------- Income (loss) before income taxes.............. 175 Benefit (provision) for income taxes... (75) ----------- Income (loss) before extraordinary items ................... $ 100 ===========
AS OF SEPTEMBER 11, 1998
OPERATING PARTNERSHIP PRO FORMA HOST REIT PRO FORMA ---------------------------- ---------------------------- REIT 2000 REIT 2000 100% PARTICIPATION WITH 100% PARTICIPATION WITH WITH NO NOTES NO NOTES WITH NO NOTES NO NOTES HOST ISSUED ISSUED(1) ISSUED ISSUED(1) HISTORICAL ------------------ --------- ------------------ --------- ---------- BALANCE SHEET DATA: Property and equipment, net.................... $7,069 $5,619 $7,069 $5,619 $5,937 Total assets........... 7,952 6,696 7,952 6,696 6,969 Debt, excluding convertible debt....... 4,970 4,370 4,970 4,370 4,224 Convertible debt ...... 567 567 -- -- -- Total liabilities...... 6,560 6,112 6,000 5,546 5,267 Convertible Preferred Securities............. -- -- 550 550 550 Limited Partner interests of third parties at redemption value.................. 989 333 -- -- -- Equity................. 403 251 1,048 467 1,152
- ---- (1) Assumes all Partnerships participate in the Partnership Mergers, 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. 31 RISK FACTORS In considering whether to approve the Agreement and the transactions contemplated thereby, stockholders of Host should consider carefully, among other factors, the material risks described below. RISKS AND EFFECTS OF THE MERGER AND THE REIT CONVERSION 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, Host REIT 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. Host REIT will not operate the Hotels or participate in the decisions affecting the daily operations of the Hotels. Host REIT 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 Host REIT under the Leases, Host REIT has only a limited ability to require the Lessees or the Managers to change their method of operation or management. Therefore, Host REIT will be dependent for its revenue upon the ability of the Lessees and the Managers to operate and manage the Hotels. Host REIT 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 Host REIT'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 Host REIT), consisting primarily of interests in hotels which are not leased, certain FF&E used in the Hotels and certain international hotels. The direct ownership or control of most of these assets by Host REIT could jeopardize Host REIT's status as a REIT. Although Host REIT will own 95% of the total economic interests of the Non-Controlled Subsidiaries, the Host Employee/Charitable 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/Charitable 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, Host REIT 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 its revenues (and the activities of the Non-Controlled Subsidiaries could cause Host REIT to be in default under its principal debt facilities). DEPENDENCE UPON CRESTLINE. Subsidiaries of Crestline will be the Lessees of virtually all of the Hotels and their rent payments will be the primary source of Host REIT's revenues. Upon the REIT Conversion, all fees payable under the Management Agreements for subsequent periods will become the primary obligations of the Lessees, to be paid by the Lessees for so long as the Leases remain in effect. The obligations of the Lessees will be guaranteed by Crestline, subject to specified liability limitations. Crestline's and each Lessee's financial condition and ability to meet its obligations under the Leases and the Management Agreements 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 stockholders. As of September 11, 1998, on a pro forma basis, after giving effect to the REIT Conversion, Crestline would have had approximately $300 million of indebtedness (including approximately $85 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 or any Lessee will have sufficient assets, income and access to financing to enable it to 32 satisfy its obligations under the Leases or to make payments of fees under the Management Agreements. Host REIT remains obligated to the Managers in case the Lessee fails to pay these fees (but it would be entitled to reimbursement from the Lessee under the terms of the Leases). In addition, the credit rating of Host REIT will be affected by the general creditworthiness of Crestline. CURRENT HOST COMMON STOCK PRICE IS NOT NECESSARILY INDICATIVE OF THE PRICE OF HOST REIT COMMON STOCK FOLLOWING THE REIT CONVERSION. Host's current stock price is not necessarily indicative of how the market will value Host REIT Common Stock following the REIT Conversion, because of the effect of the distribution of 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) and does not necessarily take into account the changes in Host's business and operations (including the leasing of its Hotels to Crestline) that will occur in connection with the REIT Conversion. Host's current stock price also is affected by general market conditions. CASH DISTRIBUTIONS MAY EXCEED CASH AVAILABLE FOR DISTRIBUTION. 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 ($231 million) will exceed its estimated cash available for distribution ($144 million) and cash from contingent rents ($64 million) during the twelve months ending December 31, 1999, which would require borrowings by the Operating Partnership of approximately $23 million (or $0.08 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 $64 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. TIMING OF THE RESTRUCTURING TRANSACTIONS AND THE REIT CONVERSION. Host currently expects to complete the Restructuring Transactions and the other transactions comprising the REIT Conversion during 1998, which would permit Host REIT to qualify as a REIT for its 1999 taxable year. 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 be expected to reduce Host REIT's estimated cash distributions during 1999 to $0.52 per share from $0.84 if its REIT election were not effective on January 1, 1999) and could cause the Blackstone Acquisition (which is conditioned, among other things, on consummation of the REIT Conversion by March 31, 1999 and Host REIT qualifying as a REIT for 1999) 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 believes that it is beneficial to the stockholders 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 33 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 assuming it so qualified. CONFLICTS OF INTEREST RESPONSIBILITIES OF HOST REIT TO OTHER LIMITED PARTNERS IN THE OPERATING PARTNERSHIP. Maryland law imposes certain duties on the Board of Directors of Host REIT to its stockholders. In addition, after the REIT Conversion, Host REIT, as the sole general partner of the Operating Partnership, will have fiduciary obligations under Delaware law with respect to the other limited partners in the Operating Partnership (to the extent such duties have not been modified or eliminated pursuant to the terms of the Partnership Agreement). Although Delaware law provides that Host REIT, as general partner, is subject to the duties of care and loyalty with respect to the limited partners of the Operating Partnership, the Partnership Agreement imposes certain limitations on Host REIT's fiduciary obligations with respect to such limited partners. See "Distribution and Other Policies--Conflicts of Interest Policies." 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, notwithstanding the contractual limitations in the Partnership Agreement, the fiduciary duties of the directors of Host REIT to the stockholders may be less than those of Host REIT, as general partner of the Operating Partnership, to the limited partners of the Operating Partnership. Thus, the discharge of Host REIT's obligations to its stockholders and to the limited partners in the Operating Partnership could result in decisions that may fail to reflect fully the interests of all holders of Host REIT Common Stock and limited partners of the Operating Partnership. 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 and officer 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 5.33% and 5.31%, 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. UNCERTAINTIES AT THE TIME OF VOTING ON THE AGREEMENT. There are several uncertainties relating to the REIT Conversion, including the uncertainties described below, that will exist at the time Host stockholders vote on the Agreement. The results of the Partnership Mergers, including whether all or less than all of the Partnerships voted to participate in the Partnership Mergers, will not be known at the time Host stockholders vote on the Agreement. The benefits to Host of the REIT Conversion will be markedly reduced if one or more of the Partnerships do not participate in the Partnership Mergers. In addition, the price of an OP Unit for purposes 34 of the Partnership Mergers will be equal to the average closing price on the NYSE of a share of Host REIT Common Stock for the first 20 trading days after the effective date of the Partnership 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 share of Host Common Stock or Host REIT Common Stock. Because the value of the OP Units issued to the Limited Partners in the Partnership Mergers will not be determined until after the Partnership Mergers, stockholders cannot know at the time they vote on the Agreement (a) the value of the OP Units to be issued to the Limited Partners, which value could be higher or lower than the value of Host REIT Common Stock at the time of the Merger, and (b) the percentage interest in the Operating Partnership that 34--1 such OP Units represent, which affects the allocation of distributions from the Operating Partnership to Host REIT and the Limited Partners. Moreover, because the Limited Partners can tender the OP Units they receive in the Partnership Mergers to Host REIT in exchange for an equal number of shares of Host REIT Common Stock, which Host REIT Common Stock will be issued promptly following the 20th trading day after the effective date of the Partnership Mergers, or to the Operating Partnership for Notes, Host stockholders cannot know the exact number of Notes or shares of Host REIT Common Stock that may be issued in connection with the Partnership Mergers or the extent of the dilutive effect on Host REIT stockholders from the issuance of additional shares of Host REIT Common Stock to the Limited Partners. In addition, the assets and liabilities of the Non-Controlled Subsidiaries will not be known at the time stockholders vote on the Agreement. Although the Restructuring Transactions may be consummated with the expectation that certain other transactions comprising the REIT Conversion, such as the Private Partnership Transactions and the Blackstone Acquisition, will occur, there is no assurance that such will be the case. There is no assurance as to the outcome of such matters, and if certain of these transactions or events are not consummated as expected, either the REIT Conversion may not be consummated or the value of Host REIT Common Stock and the amount of cash available for distribution to stockholders could be adversely affected, and Host REIT could fail to qualify as a REIT for federal income tax purposes. 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 Restructuring Transactions and the other transactions comprising 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 cross-default provisions of the Company's principal credit facilities. Although Host will not consummate the Restructuring Transactions 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 Host REIT Common Stock. 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 Host REIT). If the Hotels are not relet, Host REIT 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 Host REIT 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. LEASES COULD IMPAIR THE SALE OR OTHER DISPOSITION OF HOST REIT'S HOTELS. Each Lease generally provides for a termination payment if the Lease is terminated by Host REIT prior to the expiration of the term of such Lease (including due to a change in the federal income tax laws that allows Host REIT 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 Host REIT 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 Host REIT 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 Full- Service Hotels." 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 35 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). Thus, even if it were in the best interests of Host REIT to sell such hotels or refinance the debt secured by any of these Hotels, it may be difficult or impossible for Host REIT to do so during their respective lock-out periods. RISKS OF OWNERSHIP OF HOST REIT COMMON STOCK POSSIBLE ADVERSE CONSEQUENCES OF LIMITS ON OWNERSHIP OF HOST REIT COMMON STOCK. 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 Merger--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 lesser of the number or value of the issued and outstanding shares of Host REIT Common Stock 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 lesser of the number or value of the issued and outstanding shares of any class or series of Host REIT's preferred stock. The Ownership Limit will become applicable to all Host REIT stockholders at the Effective Time (subject to a limited exception for a holder of shares of Host REIT Common Stock solely by reason of the Merger in excess of the Ownership Limit so long as the holder thereof would not own, directly or by attribution under the Code, more than 9.9% in value of the outstanding shares of capital stock of Host REIT as of the Special Merger Ownership Limit Effective Time, and to a limitation on the application of the "group" limitation (but not any other element of the Ownership Limit) to any "group" that otherwise would exceed the Ownership Limit at the Effective Time solely by reason of its status as a "group"). 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 Host REIT or any of the Partnerships or Private Partnerships (including but not limited to Crestline and the Lessees) to be considered a "related party tenant" for purposes of the REIT qualification rules). The constructive ownership rules are complex and may cause Host REIT Common Stock owned directly or constructively by a group of related individuals or entities to be constructively owned by one individual or entity. As a result, the acquisition of less than 9.8% of the outstanding shares of Host REIT Common Stock or 9.8% of the outstanding shares of any class of Host REIT preferred stock (or the acquisition of an interest in an entity which owns shares of Host REIT's capital stock) by an individual or entity could cause that individual or entity (or another individual or entity) to own constructively in excess of 9.8% of the outstanding shares of Host REIT Common Stock or 9.8% of the outstanding shares of any class of Host REIT's preferred stock and thus subject such shares to the remedy provisions under the Ownership Limit. ANY SHARES OF HOST REIT COMMON STOCK HELD AT THE EFFECTIVE TIME AND NOT SUBSEQUENTLY TRANSFERRED PRIOR TO THE SPECIAL MERGER OWNERSHIP LIMIT EFFECTIVE TIME, OR ACQUIRED OR HELD AT ANY TIME AFTER THE EFFECTIVE TIME 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 EXCESS SHARES OF HOST REIT COMMON STOCK WILL NOT BE ENTITLED TO ANY DISTRIBUTIONS THEREON OR TO VOTE SUCH EXCESS SHARES OF HOST REIT COMMON STOCK. THE HOLDER OF ANY SUCH EXCESS SHARES OF HOST REIT COMMON STOCK WILL RECEIVE THE LESSER OF THE VALUE OF SUCH EXCESS SHARES AS OF THE EFFECTIVE TIME OR THE CASH PROCEEDS FROM THE SALE OF SUCH EXCESS SHARES OF HOST REIT COMMON STOCK BY THE TRUSTEE OF THE TRUST. AFTER THE EFFECTIVE TIME, ANY PERSON WHO ACQUIRES HOST REIT COMMON STOCK IN EXCESS OF THE OWNERSHIP LIMIT WILL NOT RECEIVE ANY PROCEEDS 36 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 HOST REIT COMMON STOCK 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 HOST REIT COMMON STOCK IN EXCESS OF THE OWNERSHIP LIMIT. TO AVOID THE ADVERSE EFFECTS OF THE OWNERSHIP LIMIT, ANY HOLDER OF HOST COMMON STOCK WHO WOULD OWN SHARES IN EXCESS OF THE OWNERSHIP LIMIT AT THE EFFECTIVE TIME SHOULD DISPOSE OF ANY SUCH EXCESS SHARES PRIOR THERETO. See "Description of Host REIT 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 stockholders' ability to realize a premium over the then-prevailing market price for Host REIT Common Stock in connection with such transaction. LIMITATIONS ON ACQUISITION OF HOST REIT COMMON STOCK AND CHANGE IN CONTROL. The Host REIT Charter and Host REIT Bylaws, the Partnership Agreement, the Host REIT Rights Agreement (to be adopted by Host REIT to replace the existing stockholder rights plan under the Host Rights Agreement) and Maryland law will contain a number of provisions (as further described under "Certain Provisions of Maryland Law and the Host REIT Charter and Bylaws" and "The Restructuring Transactions--Comparison of Rights of Stockholders of Host and Host REIT") 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 Host REIT Common Stock 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 Host REIT Common Stock" above 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 stockholders of Host REIT (and even if such change in control would not reasonably jeopardize the REIT status of Host REIT). STAGGERED BOARD. The Host REIT 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 Host REIT Bylaws, provided that the total number of directors may not be fewer than three nor more than thirteen. Pursuant to the Host REIT Bylaws, the number of directors shall be fixed by the Board of Directors within the limit set forth in the Host REIT 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 stockholders' ability to effect a change in control of Host REIT even if a change in control would be in the interest of the stockholders of Host REIT. REMOVAL OF BOARD OF DIRECTORS. The Host REIT 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 Host REIT Common Stock, directors may be removed only for cause and only by the affirmative vote of stockholders 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 the case of a vacancy resulting from the removal of a director by the stockholders by at least two-thirds of all the votes entitled to be cast in the election of directors. PREFERRED STOCK; CLASSIFICATION OR RECLASSIFICATION OF UNISSUED SHARES OF CAPITAL STOCK WITHOUT STOCKHOLDER APPROVAL. The Host REIT 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 shares of Host REIT Common Stock, par value $.01 per share, and 50,000,000 shares of preferred stock, par value $.01 per share ("Host REIT Preferred Stock"). The Board of Directors is authorized, without a vote of stockholders, to classify or reclassify any unissued shares of stock, including Host REIT Common Stock into Host REIT Preferred Stock or vice versa, and to establish the preferences and rights of any preferred or other class or series of stock to be issued. The issuance of preferred stock or other stock 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 stockholders of Host REIT. Because the Board of Directors will have the power to establish the preferences and rights of additional classes or series of stock without a stockholder vote, the Board of Directors may afford the holders of any 37 such class or series preferences, powers and rights, including voting rights, senior to the rights of holders of Host REIT Common Stock. 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 in the Operating Partnership ("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 Host REIT Common Stock. Host REIT, as holder of a majority of the OP Units, would be able to control the outcome of such vote. Under the Host REIT Charter, the approval of the holders of at least two-thirds of the outstanding shares of Host REIT Common Stock generally will be necessary to effectuate such merger or consolidation. MARYLAND BUSINESS COMBINATION LAW. Under the MGCL, unless an exemption is available, 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 of capital stock (an "Interested Stockholder") or an affiliate of the Interested Stockholder are prohibited for five years after the most recent date in which the Interested Stockholder becomes an Interested Stockholder. Thereafter, any such business combination must be approved by (i) a supermajority (80%) of outstanding voting shares, and (ii) two-thirds of voting shares (other than voting shares held by an Interested Stockholder) unless, among other conditions, the corporation's common stockholders 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 Stockholder. A business combination that is approved by the board of directors of a Maryland corporation at any time before an Interested Stockholder first becomes an Interested Stockholder is not subject to the special voting requirements. Host REIT has not "opted- out" of the business combination provisions of the MGCL and, accordingly, will be subject to such provisions although Host REIT may elect to opt-out of these provisions in the future. The Board of Directors of Host REIT has adopted a resolution exempting from the operation of the "business combination" statute the acquisition of shares by Marriott International (together with its successors and permitted assignees, if any) pursuant to the terms of the Marriott International Purchase Right as well as any other transactions involving Host REIT, Marriott International, J.W. Marriott, Jr. and Richard E. Marriott; provided that any such other transaction with Marriott International that is not in the ordinary course of business or with J.W. Marriott, Jr. or Richard E. Marriott must be approved by a majority of the directors of Host REIT present at a meeting at which a quorum is present, including a majority of the disinterested directors, in addition to any vote of stockholders required by other provisions of the MGCL. See "Certain Provisions of Maryland Law and the Host REIT Charter and Bylaws--Changes in Control Pursuant to Maryland Law." MARYLAND CONTROL SHARE ACQUISITION LAW. Under the MGCL, unless a corporation elects not to be subject thereto, "control shares" acquired in a "control share acquisition" have no voting rights except to the extent approved by stockholders 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 stockholder 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. The Bylaws of Host REIT will contain an exemption from the control share acquisition provisions for any shares acquired by Marriott International (together with its successors and permitted assignees, if any) pursuant to the Marriott International Purchase Right, to the extent it is exercised. ADVANCE NOTICE OF DIRECTOR NOMINATIONS AND NEW BUSINESS. The Host REIT Bylaws impose certain advance notice requirements that must be met for nominations of persons for election to the Board of 38 Directors and the proposal of business to be considered by stockholders. The advance notice provisions contained in the Host REIT Bylaws generally require nominations and new business proposals by stockholders to be 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 stockholders. MEETINGS OF STOCKHOLDERS; CALL OF SPECIAL MEETINGS; STOCKHOLDER ACTION IN LIEU OF MEETING BY UNANIMOUS CONSENT. The Host REIT Bylaws provide that annual meetings of stockholders 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 stockholders may be called by the President or the Board of Directors or on the written request of stockholders 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 stockholders must be effected at a duly called annual or special meeting of stockholders or by unanimous written consent. MERGER, CONSOLIDATION, SHARE EXCHANGE AND TRANSFER OF ASSETS OF HOST REIT. Pursuant to provisions to be contained in the Host REIT 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 stockholders 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 stockholders 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 stockholders 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 THE HOST REIT CHARTER AND BYLAWS. The provisions to be contained in the Host REIT Charter relating to restrictions on transferability of Host REIT Common Stock, the classified Board and fixing the size of the Board within the range set forth in the Host REIT 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 stockholders 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 Host REIT Charter and the Host REIT Bylaws will provide that directors have the exclusive right to amend the Host REIT Bylaws. Amendments to this provision of the Host REIT Charter also would require Board action and approval by two-thirds of all votes entitled to be cast on the matter. HOST REIT RIGHTS AGREEMENT. Host REIT intends to adopt the Host REIT Rights Agreement to replace the existing stockholder rights plan under the Host Rights Agreement. The new Host REIT Rights Agreement is expected to provide, among other things, that upon the occurrence of certain events, stockholders will be entitled to purchase from Host REIT a newly created series of junior preferred stock, subject to Host REIT's Ownership Limit. The preferred stock 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 shares of Host REIT Common Stock 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 shares of Host REIT Common Stock. The preferred stock purchase rights would cause substantial dilution to a person or group that attempts to acquire Host REIT on terms not approved by the Board of Directors. See "Description of Host REIT Capital Stock" and "Certain Provisions of Maryland Law and the Host REIT Charter and Bylaws." MARRIOTT INTERNATIONAL PURCHASE RIGHT. In connection with Host's spin-off 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 39 Host (the "Marriott International Purchase Right"). The Marriott International Purchase Right will continue in effect after the Merger (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 Stock 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. EFFECT ON STOCK PRICE OF SHARES AVAILABLE FOR FUTURE SALE. Sales of a substantial number of shares of Host REIT Common Stock, or the perception that such sales could occur, could adversely affect prevailing market prices for Host REIT Common Stock. Limited Partners who elect to receive shares of Host REIT Common Stock in connection with the Partnership 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 the holder's right to redeem them for shares of Host REIT Common Stock or the cash equivalent thereof (as elected by Host REIT) ("Unit Redemption Right"), an additional 25% will be redeemable on October 1, 1999, and the balance will be redeemable on January 1, 2000. In addition, beginning at least one year after the effective date of the Partnership Mergers (or after a lesser period in certain circumstances), other holders of OP Units, including Limited Partners who retain OP Units received in the Partnership Mergers, may be able to sell shares of Host REIT Common Stock received upon exercise of their Unit Redemption Right in the public market pursuant to registration or exemptions from registration. Further, a substantial number of shares of Host REIT Common Stock would, pursuant to employee benefit plans, be issued or reserved for issuance from time to time, including Host REIT Common Stock reserved for issuance pursuant to options granted prior to the consummation of the REIT Conversion, and these shares of Host REIT Common Stock 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 Host REIT Common Stock by Host REIT in the future (including any Host REIT Common Stock 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 the Special Dividend entitling Host stockholders 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 share of Host REIT Common Stock if the Merger has occurred). No prediction can be made about the effect that future sales of shares of Host REIT Common Stock would have on the market price of Host REIT Common Stock. EFFECT ON STOCK PRICE OF MARKET CONDITIONS. As with other publicly traded equity securities, the value of Host REIT Common Stock will depend upon various market conditions, which may change from time to time. Among the market conditions that may affect the value of the Host REIT Common Stock 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. There can be no assurance that these market conditions would not have a material adverse effect on the market price of Host REIT Common Stock or that the Host REIT Common Stock will not trade at prices below the net asset value of Host REIT's business and assets. EFFECT ON STOCK 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, Host REIT Common Stock may trade at prices that are higher or lower than the net asset value per share. To the extent Host REIT retains operating cash flow for investment purposes, working capital reserves or other purposes rather than distributing such cash 40 flow to stockholders, these retained funds, while increasing the value of Host REIT's underlying assets, may not correspondingly increase the market price of Host REIT Common Stock. 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 Host REIT Common Stock. EFFECT ON STOCK PRICE OF MARKET INTEREST RATES. One of the factors that will influence the price of Host REIT Common Stock will be the dividend yield on Host REIT Common Stock (as a percentage of the price of Host REIT Common Stock) relative to market interest rates. Thus, an increase in market interest rates may lead prospective purchasers of Host REIT Common Stock to expect a higher dividend yield, which would adversely affect the market price of Host REIT Common Stock. EFFECT ON STOCK PRICE OF UNRELATED EVENTS. As with other publicly traded equity securities, the value of Host REIT Common Stock 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 Host REIT Common Stock 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 stockholders 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 Host REIT Common Stock. FEDERAL INCOME TAX RISKS RELATING TO REIT QUALIFICATION GENERAL. Host REIT intends to operate so as to qualify as a REIT under the Code effective for Host REIT's first full taxable year commencing following the REIT Conversion. A REIT generally is not taxed at the corporate level on income it currently distributes to its stockholders 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 has received an opinion of Hogan & Hartson L.L.P. to the effect that Host REIT, effective for its first full taxable year commencing after the REIT Conversion is completed, 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 is conditioned upon 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 Partnerships, the Private Partnerships, the Subsidiary Partnerships, the Non- Controlled Subsidiaries, the Host Employee/Charitable Trust, and Crestline and the Lessees, and the economic and other terms of the Leases and the expectations of Host REIT and the Lessees with respect thereto. In addition, this opinion is based upon the factual representations of Host REIT concerning its business and properties as set forth in this Proxy Statement/Prospectus and assumes that the actions described in this Proxy Statement/Prospectus are completed in a timely fashion (generally, prior to the first day of the first taxable year for which Host REIT's election to be treated as a REIT would be effective). 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 stockholders 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 41 Taxable Years," to qualify as a REIT, Host REIT also will have to distribute to its stockholders not later than the end of its first full taxable year as a REIT an amount equal to the 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 stockholders 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 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. Host REIT also could be required to pay taxes and liabilities attributable to periods and events prior to the REIT Conversion and taxes 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 stockholders. Failure of Host REIT to qualify as a REIT could reduce materially the value of the Host REIT Common Stock and would cause all distributions to stockholders 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 Merger--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 full 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 full 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 has relied, 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 non-REIT E&P as of the end of 1999. See "Federal Income Tax Consequences--Federal Income Taxation of Host REIT Following the Merger-- 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 42 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, (b) the Lessees must not be regarded as "related party tenants" (as defined in the Code) and (c) no portion of the rent can be based upon the income or profits of the tenant (although rent based upon the gross revenue of a tenant is permissible unless the arrangement does not conform with normal business practice but in reality is used as a means of basing rent on the income or profits of the tenant). The Host REIT Charter will contain the Ownership Limit, which is intended in part to help ensure that neither the Lessees nor future lessees will be treated as "related party tenants," but there can be no assurance that the Ownership Limit will be effective for achieving that result in all circumstances. With regard to the treatment of the Leases for federal income tax purposes, Hogan & Hartson L.L.P. has provided to Host REIT an opinion to the effect that, based upon certain representations of Host REIT regarding the economic and other 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 REIT regarding the Leases. Finally, with regard to whether the rent under the Leases is based upon the income or profits of the Lessees, such rent is based only upon the gross revenues of the Lessees, and Host REIT has represented that the rental provisions and other terms of the Leases conform with normal business practice and were not intended to be used as a means of basing rent on the income or profits of the Lessees. If the Leases were not respected as true leases for federal income tax purposes, if the Lessees were regarded as "related party tenants" or if the rent payable under the Leases were considered based, in whole or in part, upon the income or profits of the Lessees, 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 stockholders. See "Federal Income Tax Consequences-- Federal Income Taxation of Host REIT Following the Merger--Income Tests Applicable to REITs." TREATMENT OF LEASES OF PERSONAL PROPERTY. Rent that is considered attributable to personal property under the applicable provisions of the Code is not "qualifying" income for purposes of the gross income tests that a REIT must satisfy. Significant portions of hotels (e.g., FF&E) constitute personal property for purposes of these rules. In order to protect Host REIT's ability to qualify as a REIT, the Operating Partnership will sell to a Non-Controlled Subsidiary an estimated $180 million in value of personal property associated with certain Hotels. The Non-Controlled Subsidiary will lease the personal property it acquires associated with each Hotel directly to the Lessee that is leasing the Hotel. Under each personal property lease, the Non-Controlled Subsidiary will receive rent payments directly from the applicable Lessee, which Host REIT believes represent the fair rental value of the personal property. If for any reason these lease arrangements are not respected for federal income tax purposes, Host REIT likely would not qualify as a REIT. 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, the Partnerships and the Private 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 Merger--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 (within the 10-year period beginning on the effective date of the OP Contribution) of assets, including the full-service hotels, contributed to the Operating Partnership by Host in connection with the OP Contribution, 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 or the Operating Partnership. In addition, the IRS may assert liabilities against Host REIT for corporate income taxes for taxable years of Host prior to the time Host REIT qualifies as a REIT. Finally, 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. 43 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 Merger--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 Host REIT (and thus its stockholders). See "Federal Income Tax Consequences--Tax Aspects of Host REIT's Ownership of OP Units." OTHER TAX RISKS TAX CONSEQUENCES TO HOST OF THE OP CONTRIBUTION AND OTHER TRANSACTIONS COMPRISING THE REIT CONVERSION. Because of the numerous transactions that comprise the OP Contribution and the REIT Conversion and the inherently factual nature of a number of the critical determinations relevant to the tax consequences to Host of the OP Contribution and the REIT Conversion, Host has not sought (and likely could not obtain) an opinion of outside counsel as to the tax consequences to it (in terms of the actual amount of income and gains that would be recognized) of the OP Contribution and the other transactions comprising the REIT Conversion (other than the Merger). Host believes, based upon its knowledge of the relevant facts and advice that it has received from various professional advisers (including both attorneys and accountants on its staff and outside attorneys and accountants) as to the applicable general principles of law, that it will not recognize a material amount of income and gain as a result of the OP Contribution and the other transactions comprising the REIT Conversion. Host, however, will recognize some income and gain in connection with these various transactions, and there can be no assurance that under the relevant facts and circumstances such income and gain would not be material. If Host were to recognize a material amount of income and gain as a result of these various transactions, the resulting income tax liability could be material to Host, and the increase in E&P resulting from such income and gain could materially increase the amount that Host must distribute to its stockholders in order to qualify as a REIT, all of which could have adverse consequences to Host REIT and its stockholders. 43--1 EFFECTS OF SUBSEQUENT EVENTS UPON RECOGNITION OF GAIN. In addition to any gain that might be recognized by Host at the time of the OP Contribution, there are a variety of subsequent events and transactions including (i) the sale or other taxable disposition of appreciated assets contributed by Host to the Operating Partnership in the OP Contribution (including one or more of the Hotels contributed by Host), (ii) the refinancing or repayment of certain liabilities secured by one or more of the Hotels contributed to the Operating Partnership by Host in the OP Contribution, (iii) the issuance of additional OP Units, including in connection with 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 one or more of the Hotels contributed to the Operating Partnership by Host in the OP Contribution resulting from capital expenditures and (v) the elimination over time of the disparity between the current tax basis of one or more of the Hotels contributed to the Operating Partnership by Host in the OP Contribution and the "book basis" of such assets (based upon their fair market value at the time of the OP Contribution) that could cause Host REIT to recognize part or all of the taxable gain that otherwise has been deferred pursuant to the Merger and the OP Contribution. 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 Host REIT's hotel properties differs from market to market, Host REIT 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, Host REIT's strategy is to affiliate its properties with managers operating under the highest quality brand names in the industry which Host REIT 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 Host REIT's properties. See "Business and Properties--Competition." The lodging industry, including the Hotels (and thus Host REIT), 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 Host REIT. SUBSTANTIAL INDEBTEDNESS OF HOST REIT. Host REIT will have substantial indebtedness. As of September 11, 1998, on a pro forma basis assuming the Full Participation Scenario, Host REIT had outstanding indebtedness totaling approximately $5 billion, which represents an approximately 59% debt-to-total market capitalization ratio on a pro forma basis at such date (based upon a price per share of Host REIT Common Stock of $12.50 after giving effect to the REIT Conversion). Host REIT's business is capital intensive and it will have significant capital requirements in the future. Host REIT's leverage level and other factors beyond its control (including market conditions) could affect its ability to (i) obtain financing in the future, (ii) undertake refinancings on terms and subject to conditions deemed acceptable by Host REIT, (iii) make distributions, (iv) pursue its acquisition strategy or (v) compete effectively or operate successfully under adverse economic conditions. In the event that Host REIT's cash flow and working capital are not sufficient to fund Host REIT's expenditures or to service its indebtedness, Host REIT 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 Host REIT to meet its obligations. Moreover, even if Host REIT 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. 44 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 the Operating Partnership's and Host REIT's debt instruments will contain certain restrictions on the amount of indebtedness that Host REIT may incur. Accordingly, the Board of Directors could alter or eliminate this policy unilaterally without stockholder approval from time to time to the extent permitted by its debt agreements. If this policy were changed, Host REIT could become more highly leveraged, resulting in an increase in debt service payments that could adversely affect Host REIT's cash flow and consequently, the cash available for distributions to holders of OP Units, including Host REIT and, in turn, to stockholders of Host REIT and could increase the risk of default on Host REIT's indebtedness. THE BOARD MAY CHANGE INVESTMENT AND OTHER POLICIES WITHOUT STOCKHOLDER APPROVAL. Host REIT's Board of Directors may change the investment, financing and other policies of Host REIT without stockholder approval. Such policy changes may have adverse consequences to Host REIT. MANAGEMENT AGREEMENTS COULD IMPAIR THE SALE OR OTHER DISPOSITION OF HOST REIT'S HOTELS. Marriott International serves as the manager for all but 16 of Host REIT'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, Host REIT will remain liable thereunder. The Hotels generally may not be sold, leased or otherwise transferred unless the transferee assumes the Management Agreements relating thereto and meets certain other conditions. The possible desire of Host REIT, 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 obtain Marriott International's consent, which could include modification of the Management Agreements with Marriott International or such other manager with respect to such property. Any such modification proposed by Host REIT may not be acceptable to Marriott International or such other manager, and the lack of any required consent from Marriott International or such other manager would prohibit Host REIT from consummating such financing, refinancing or sale without breaching such Management Agreement. 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 Host REIT. Nevertheless, Host REIT believes that there is sufficient mutuality of interest between Host REIT and Marriott International or another manager to result in a mutually productive relationship. RENTAL REVENUES FROM HOTELS SUBJECT TO PRIOR RIGHTS OF LENDERS. In accordance with the mortgage loan agreements with respect to outstanding indebtedness of certain of the Partnerships or the Private Partnerships, the rental revenues received by such 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 such Partnership or Private 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), which affects Host REIT's ability, in turn, to make distributions to stockholders of Host REIT. HOTELS SUBJECT TO GROUND LEASES MAY AFFECT HOST REIT'S REVENUES. Of the approximately 125 Hotels in which Host REIT initially is expected to hold an interest, approximately 60 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 distributions to holders of OP Units, including Host REIT, and Host REIT's ability, in turn, to make cash available for distributions to its stockholders. 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 45 Host REIT in such sale might not be as high if such Hotel were not sold subject to such ground lease or were sold subject thereto. GENERAL REAL ESTATE INVESTMENT RISKS. Host REIT stockholders will continue to bear risks associated with real estate investments. The yields available from equity investments in real estate and Host REIT'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. Host REIT's income and ability to make distributions will be dependent upon the rent payable by the Lessees exceeding the amounts required for debt service, property taxes and other expenses payable by Host REIT (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. Host REIT'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 the Operating Partnership, 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, Host REIT'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 Host REIT's rental income from the Hotel. If any of the above occurs, 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 stockholders, could be adversely affected. POSSIBLE UNDERPERFORMANCE OF NEW ACQUISITIONS. In the future, Host REIT 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. Host REIT anticipates that, in certain circumstances, it may use OP Units in the Operating Partnership 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 Host REIT's leverage and which may impair Host REIT's ability to take actions that would otherwise be in the best interests of Host REIT. 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 Host REIT could adversely affect the ability of the Operating Partnership to make distributions to holders of OP Units, including Host REIT, and Host REIT's ability, in turn, to make distributions to its stockholders. ILLIQUIDITY OF REAL ESTATE. Real estate investments are relatively illiquid and, therefore, will tend to limit the ability of Host REIT to sell and purchase hotels promptly in response to changes in economic or other conditions. This could make it difficult for Host REIT to sell any of its Hotels, even if a sale were in the interest of Host REIT. MISCELLANEOUS RISKS CHANGES IN LAWS. Increases in real estate or business improvement district taxes will not result in increased rental payments to Host REIT 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 46 to holders of OP Units, including Host REIT, and, in turn, to Host REIT's stockholders. 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 Host REIT as the lessor of the Hotels, would adversely affect the Operating Partnership's cash flow from operations and its ability to make distributions to holders of OP Units, including Host REIT and Host REIT's ability, in turn, to make distributions to its stockholders. DEPENDENCE UPON KEY PERSONNEL. Host REIT is dependent upon the efforts of its executive officers. While Host REIT 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 Host REIT. Host REIT does not intend to obtain key-man life insurance with respect to any of its executive officers. 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. Certain lawsuits are pending against Host and its affiliates by limited partners in certain limited partnerships. If any lawsuits are filed in connection with the Partnership Mergers or other transactions comprising the REIT Conversion, such lawsuits could delay the closing of the REIT Conversion or result in substantial damage claims against Host REIT or the general partners of the Partnerships, each of which is a wholly-owned, direct or indirect subsidiary of Host. 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 Host REIT will be acquiring the Partnerships or Private Partnerships through the Partnership Mergers, the Operating Partnership and Host REIT indirectly will be subject to the indemnification obligations of the Partnerships and the Private Partnerships to their general partners and any obligations of the Partnerships and the Private Partnerships to pay damages to the extent not covered by any available insurance. See "Business and Properties--Legal Proceedings." RISK INVOLVED IN INVESTMENTS THROUGH PARTNERSHIPS OR JOINT VENTURES. Instead of purchasing hotel properties directly, Host REIT 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 Host REIT, or be in a position to take action contrary to the instructions or the requests of Host REIT or contrary to Host REIT'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 Host REIT generally will seek to maintain sufficient control of any joint venture to permit Host REIT'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 Host REIT's consent. Additionally, should a joint venture partner become bankrupt, Host REIT could become liable for such partner's share of joint venture liabilities. YEAR 2000 PROBLEM. Year 2000 issues have arisen because many existing computer programs and chip-based embedded technology systems use only the last two digits to refer to a year, and therefore do not properly recognize a year that begins with "20" instead of the familiar "19". If not corrected, many computer applications could fail or create erroneous results. Although Host has adopted a compliance program in recognition of the possible interruptions that may occur as a result of Year 2000 issues and taken certain steps toward Year 2000 remediation, there can be no assurances that the steps taken toward Year 2000 remediation by 47 Host or third parties will be properly and timely completed, and failure to do so could have a material adverse effect on Host, its business and its financial condition. Host cannot predict the actual effects on its business of Year 2000 issues, which depend on uncertainties such as whether significant third parties properly and timely address Year 2000 issues and whether broad- based or systematic economic failures may occur. Host is also unable to predict the severity and duration of any such failures, which could include disruptions in passenger transportation or transportation systems generally, loss of utility and/or telecommunications services, the loss or disruption of hotel reservations made on centralized reservation systems and errors or failures in financial transactions or payment processing systems such as credit cards. Moreover, following the REIT Conversion, Host REIT will be dependent upon Crestline to interface with third parties in addressing Year 2000 issues at the Hotels leased to Crestline. Due to the general uncertainty inherent with respect to Year 2000 issues and Host's dependence on third parties (including Crestline following the REIT Conversion), Host is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on Host or Host REIT. Although Host's Year 2000 compliance program and Crestline's adoption thereof following the REIT Conversion are expected to significantly reduce the level of uncertainty concerning Year 2000 issues and management believes that the possibility of significant interruptions of normal operations should be reduced, there is no assurance that this will be the case. UNINSURED LOSS. Host REIT will carry comprehensive liability, fire, flood, extended coverage and rental loss (for rental losses extending up to 12 months) with respect to its Hotels with policy specification 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, Host REIT 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 with disabilities in certain public areas of Host REIT's Hotels where such removal is readily achievable. Host REIT 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 holders of OP Units, including Host REIT and Host REIT's ability, in turn, to make distributions to its stockholders. Under the Leases, Host REIT would be required to fund all such expenditures. OTHER REGULATORY ISSUES. Host REIT'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. Host REIT 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 Host REIT, (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. 48 In addition, no assurances can be given that all potential environmental liabilities have been identified or properly quantified or that no prior owner, operator or past or current guest has created an environmental condition not known to Host REIT. 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 Host REIT. 49 CONFLICTS OF INTEREST As discussed below, the operation of Host REIT involves various potential conflicts of interest. RESPONSIBILITIES OF HOST REIT TO OTHER LIMITED PARTNERS IN THE OPERATING PARTNERSHIP Maryland law imposes certain duties on the Board of Directors of Host REIT to its stockholders. In addition, after the REIT Conversion, Host REIT, as the sole general partner of the Operating Partnership, will have fiduciary obligations under Delaware law with respect to the other limited partners in the Operating Partnership (to the extent such duties have not been modified or eliminated pursuant to the terms of the Partnership Agreement). Although Delaware law provides that Host REIT, as general partner, is subject to the duties of care and loyalty with respect to the limited partners of the Operating Partnership, the Partnership Agreement imposes certain limitations on Host REIT's fiduciary obligations with respect to such limited partners. See "Distribution and Other Policies--Conflicts of Interest Policies." 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, notwithstanding the contractual limitations in the Partnership Agreement, the fiduciary duties of the directors of Host REIT to the stockholders may be less than those of Host REIT, as general partner of the Operating Partnership, to the limited partners of the Operating Partnership. Thus, the discharge of Host REIT's obligations to its stockholders and to the limited partners in the Operating Partnership could result in decisions that may fail to reflect fully the interests of all holders of Host REIT Common Stock and limited partners of the Operating Partnership. 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 and officer 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 5.33% and 5.31%, 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. POLICIES WITH RESPECT TO CONFLICTS OF INTEREST Host REIT has adopted certain policies and will enter into agreements with the Operating Partnership and others designed to minimize the adverse effects of these potential conflicts of interest. See "Distribution and Other Policies--Conflicts of Interest Policies" and "Business and Properties-- Noncompetition Agreement." There can be no assurance, however, that the policies and agreements 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 not fully reflect fully the interests of the stockholders of Host REIT. 50 VOTING AND PROXIES This Proxy Statement/Prospectus is being furnished to holders of Host Common Stock on the Record Date in connection with the solicitation of proxies by Host's Board of Directors for use at the Special Meeting to be held at the Ritz-Carlton Hotel, 1700 Tysons Boulevard, McLean, Virginia, 22102, on December 15, 1998 at 10:00 a.m., local time, or at any adjournments or postponements thereof, for the purposes set forth herein and in the accompanying Notice of Special Meeting of Stockholders of Host. This Proxy Statement/Prospectus and the accompanying proxy cards are being first mailed to Host's stockholders on or about November , 1998. MATTERS TO BE CONSIDERED AT THE SPECIAL MEETING At the Special Meeting, stockholders of record as of the close of business on the Record Date will be asked to (i) consider and vote upon the Agreement which contemplates (a) the OP Contribution and (b) the Merger, and (ii) transact such other business as may properly come before the Special Meeting or any adjournments or postponements thereof. RECORD DATE AND OUTSTANDING SHARES Only holders of record of Host Common Stock at the close of business on the Record Date are entitled to notice of and to vote at the Special Meeting. As of the Record Date, there were 204,954,447 shares of Host Common Stock and no shares of preferred stock of Host issued and outstanding and 47,845 holders of record. Each stockholder of Host is entitled to one vote for each share of Host Common Stock held as of the close of business on the Record Date. VOTING OF PROXIES General Information. The proxy accompanying this Proxy Statement/Prospectus is solicited on behalf of Host's Board of Directors for use at the Special Meeting. All properly executed written proxy cards, and all properly completed proxies voted by telephone or the internet, which are delivered pursuant to this solicitation (and not later revoked) will be voted at the Special Meeting in accordance with the instructions given in the proxy. If no instructions are indicated, such proxies will be voted FOR approval of the Agreement at the Special Meeting. Host's Board of Directors currently is not aware of any matters other than the Agreement referred to herein which will come before the Special Meeting. If any other matter should be properly presented at the Special Meeting for action, the persons named in the accompanying proxy card will vote the proxy in their own discretion. Voting by Written Proxy Card. Stockholders intending to vote by written proxy card are requested to complete, date and sign the accompanying proxy and promptly return it in the accompanying envelope or otherwise mail it to Host. Voting by Telephone or the Internet. Instructions for voting by telephone or the internet are set forth on the enclosed admission ticket attached to the proxy card. The telephone and internet voting procedures are designed to authenticate votes cast by use of a personal identification number. The procedures, which comply with Delaware law, allow stockholders to appoint a proxy to vote their shares and to confirm that their instructions have been properly recorded. VOTE REQUIRED Under the DGCL, the affirmative vote of a majority of the outstanding capital stock of the corporation entitled to vote thereon is needed to adopt a merger agreement. Similarly, if the OP Contribution were deemed to constitute a sale, lease or exchange of all or substantially all of the assets of Host under the DGCL, the affirmative vote of a majority of the outstanding capital stock of the corporation entitled to vote thereon would be needed to approve the OP Contribution. Pursuant to the Host Certificate, the affirmative vote of the holders of 51 two-thirds (66 2/3%) of the outstanding shares of Host Common Stock is necessary for approval of the Merger, as well as the OP Contribution if it were deemed to constitute a sale, lease or exchange of all or substantially all of the assets of Host. On the Record Date, directors and executive officers of Host, together with their affiliates, as a group, beneficially owned approximately 13.7% of the issued and outstanding shares of Host Common Stock. It is currently expected that each director and executive officer of Host will vote the shares of Host Common Stock beneficially owned by such director or executive officer "FOR" approval of the Agreement and the transactions contemplated thereby. See "Principal Stockholders." Under the DGCL, the stockholders of Host will not be entitled to dissenters' rights of appraisal as a result of the Merger or other Restructuring Transactions. See "The Restructuring Transactions--Absence of Dissenters' Rights." QUORUM; ABSTENTIONS AND TREATMENT OF BROKER NON-VOTES; ADJOURNMENT; REVOCATION The holders of a majority of the shares of Host Common Stock issued and outstanding and entitled to vote at the Special Meeting, present in person or by proxy, will constitute a quorum at the Special Meeting. Abstentions and broker non-votes will be counted for purposes of determining the presence of a quorum at the Special Meeting. Votes cast in person or by proxy at the Special Meeting will be tabulated by the inspectors of election appointed for the Special Meeting, who will determine whether or not a quorum is present. Votes may be cast for, against or as abstentions. Broker/dealers who hold their customers' shares in street name may, under the applicable rules of the exchange and other self-regulatory organizations of which the broker/dealers are members, submit proxies for such shares and may vote such shares on routine matters, which, under such rules, typically include the election of directors. However, broker/dealers may not vote such shares on certain other matters, which typically include transactions related to mergers, without specific instructions from the customer who owns such shares. Properly executed proxies submitted by broker/dealers which have not been voted on certain matters as described in the previous sentence are referred to as broker non-votes. Because approval of the Agreement requires the affirmative vote of not less than two-thirds percent (66 2/3%) of the shares of Host Common Stock outstanding, abstentions and broker non-votes will have the same effect as votes AGAINST the Agreement. In the event that a quorum is not present at the time the Special Meeting is convened, or if for any other reason Host believes that additional time should be allowed for the solicitation of proxies, Host may adjourn the Special Meeting with or without a vote of the stockholders. If Host proposes to adjourn the Special Meeting by a vote of the stockholders, the persons named in the enclosed proxy card will vote all shares of Host Common Stock for which they have voting authority in favor of such adjournment. Each stockholder who signs and returns a proxy in the form enclosed with this Proxy Statement/Prospectus or properly submits their proxy by telephone or the internet may revoke it at any time prior to its exercise by giving notice of such revocation in writing to the Secretary of Host, by a later dated proxy either signed and returned by mail or by using the telephone or internet voting procedures or by voting in person at the Special Meeting. Unless so revoked, the shares of Host Common Stock represented by each such proxy will be voted at the meeting and any adjournment thereof. Presence at the meeting of a stockholder who has properly submitted a proxy but does not duly revoke it or request to vote in person does not revoke that proxy. IF THE RESTRUCTURING TRANSACTIONS AND THE OTHER TRANSACTIONS COMPRISING THE REIT CONVERSION DO 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 TO JANUARY 1, 2000, WHICH WOULD RESULT IN HOST OR HOST REIT CONTINUING TO PAY SUBSTANTIAL CORPORATE-LEVEL INCOME TAXES IN 1999 AND COULD CAUSE THE BLACKSTONE ACQUISITION (WHICH IS CONDITIONED, AMONG OTHER THINGS, ON CONSUMMATION OF THE REIT CONVERSION BY MARCH 31, 1999 AND HOST REIT QUALIFYING AS A REIT FOR 1999) NOT TO BE CONSUMMATED. THEREFORE, IT IS EXTREMELY IMPORTANT THAT 52 STOCKHOLDERS RETURN THE PROXY CARDS AS SOON AS POSSIBLE OR PROPERLY SUBMIT THEIR PROXIES BY TELEPHONE OR THE INTERNET IN ACCORDANCE WITH THE INSTRUCTIONS ON THE ADMISSION TICKET ATTACHED TO THE ENCLOSED PROXY CARD. ANY DELAY IN RETURNING PROXIES COULD CAUSE THE SPECIAL MEETING TO BE DELAYED, WHICH COULD PREVENT THE RESTRUCTURING TRANSACTIONS AND THE OTHER TRANSACTIONS COMPRISING THE REIT CONVERSION FROM BEING EFFECTIVE JANUARY 1, 1999. SOLICITATION OF PROXIES AND EXPENSES The solicitation of proxies for the Special Meeting is being made by the Board of Directors of Host and will be done principally by mail. Host will bear the entire cost of solicitation of proxies from Host's stockholders and of preparing, assembling, printing and mailing this Proxy Statement/Prospectus, the proxy and any additional information furnished to Host's stockholders. Copies of solicitation materials will be furnished to brokerage houses, banks, fiduciaries and other custodians or nominees holding in their names shares of Host Common Stock beneficially owned by others to forward to such beneficial owners. Host may reimburse persons representing owners of shares of Host Common Stock for their expenses in forwarding solicitation materials to such beneficial owners. Original solicitation of proxies by mail may be supplemented by telephone, telegram or personal solicitation by directors, officers or other regular employees of Host. In addition, Host has engaged MacKenzie Partners, Inc. to furnish solicitation services on its behalf. No additional compensation will be paid to directors, officers or other regular employees for such services, but MacKenzie Partners, Inc. will be paid a fee for its services, estimated to be approximately $5,500, plus reimbursement of its expenses. HOST'S STOCKHOLDERS SHOULD NOT SEND ANY STOCK CERTIFICATES WITH THEIR PROXY CARDS. THE BOARD OF DIRECTORS OF HOST HAS DETERMINED THE AGREEMENT, WHICH CONTEMPLATES THE RESTRUCTURING TRANSACTIONS, AND THE OTHER TRANSACTIONS COMPRISING THE REIT CONVERSION TO BE ADVISABLE FOR HOST AND ITS STOCKHOLDERS. ACCORDINGLY, THE BOARD OF DIRECTORS HAS APPROVED THE AGREEMENT AND THE TRANSACTIONS CONTEMPLATED THEREBY AND RECOMMENDS THAT ALL STOCKHOLDERS VOTE "FOR" APPROVAL OF THE AGREEMENT AND THE TRANSACTIONS CONTEMPLATED THEREBY. 53 THE RESTRUCTURING TRANSACTIONS The following summary of the terms of the Restructuring Transactions is qualified in its entirety by reference to the Agreement, a copy of which is attached as Appendix A to this Proxy Statement/Prospectus and is incorporated by reference into this Proxy Statement/Prospectus. Stockholders of Host are urged to review the Agreement in its entirety. BACKGROUND AND REASONS FOR THE RESTRUCTURING TRANSACTIONS AND THE REIT CONVERSION Host is proposing the Restructuring Transactions in connection with a plan adopted by Host to restructure its business operations so that it will qualify as a REIT under the Code. If the Agreement is approved by Host stockholders at the Special Meeting and the Restructuring Transactions are consummated, 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). The Host Board of Directors is proposing the Restructuring Transactions primarily for the following reasons: . The Restructuring Transactions are essential components of Host's conversion to REIT status for federal income tax purposes. In particular, the OP Contribution will enable Host REIT, following the Merger, to operate, together with the Operating Partnership, in an UPREIT structure, through which Host REIT would continue the full-service hotel ownership business currently conducted by Host. Host believes that the UPREIT structure will improve its ability to acquire additional properties in the future on favorable terms. Specifically, under certain circumstances, OP Units could be issued to acquire properties in transactions that would not trigger immediate tax obligations for certain sellers. Accordingly, converting to an UPREIT structure could enable Host REIT to acquire hotels and other properties in the future at lower prices because of the tax advantages to some sellers of receiving OP Units as consideration. OP Units would subsequently be redeemable for cash or common stock of Host REIT (at the option of Host REIT) at such time as the recipient desires liquidity. . The provisions of Maryland law have generally been viewed as favorable to REITs organized in corporate or trust form. As discussed below, Maryland law facilitates qualification as a REIT by authorizing the charter of a Maryland corporation to provide for restrictions on ownership and transferability designed to permit a corporation to qualify as a REIT under the Code or for any other purpose. In addition, unlike Delaware, Maryland does not impose a franchise tax on corporations, which will result in cost savings to Host in annual franchise tax payments and related fees of approximately $150,000. Maryland's status as a jurisdiction favorable to REITs is evidenced by the large number of publicly-traded REITs that have chosen to operate as a regular Maryland corporation or as a special statutory Maryland real estate investment trust. According to NAREIT, as of September 1998, there were over 100 publicly-traded REITs organized under Maryland law. . In order to satisfy certain requirements that are applicable to REITs in general, many REITs impose ownership limits and transfer restrictions, similar to the Ownership Limit under the Host REIT Charter, by inclusion of such provisions in their charters. Under Delaware law, such restrictions would not be binding with respect to securities issued prior to adoption of the restriction unless holders of such securities agree to or vote in favor of such restriction. However, under Maryland law and by reason of the Merger, all shares of Host REIT Common Stock issued in the Merger and thereafter would be subject to the Ownership Limit, for which authority exists under Maryland law. . Host's principal executive offices and a substantial number of Host's employees are employed in Maryland. The Board of Directors of Host believes that the Restructuring Transactions and the other transactions comprising the REIT Conversion are advisable for Host and its stockholders based on the belief that: . 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. 54 . The REIT Conversion, which will reduce corporate-level taxes and the need to incur debt to reduce corporate-level 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 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's stockholder base will expand to include investors attracted by yield as well as asset quality, which is expected to facilitate Host REIT's capital-raising efforts and provide a less volatile stockholder base. . The adoption of the UPREIT structure will facilitate tax-deferred acquisition of additional hotels (such as in the case of the Blackstone Acquisition and the Partnership 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). 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 requirement 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. 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 if Host were to convert to a REIT. 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 and Notes to be issued to the Limited Partners of the Partnerships in the Partnership Mergers. On October 9, 1998, the Operating Partnership commenced the offering of such OP Units and Notes if the Partnership Mergers are approved and Host REIT commenced its offer to exchange Host REIT Common Stock for OP Units to be issued in the Partnership Mergers. The Host Board believes that Host's conversion to a REIT and the distribution of Crestline shares as part of the Initial E&P Distribution will benefit Host's stockholders by providing them with a tax advantaged REIT security that is expected to provide both the opportunity for regular cash dividends and capital appreciation as Host REIT acquires additional properties, as well as a continuing interest in Crestline, Host's senior living company and the initial lessee of substantially all of Host REIT's Hotels, if a Host stockholder continues to hold the Crestline common stock. If Host REIT qualifies for taxation as a REIT, it generally will not be subject to 55 federal corporate income taxes on that portion of its ordinary income or capital gain that is distributed to stockholders. As a REIT, Host REIT would be able to benefit from the tax advantages that apply to REIT's, and stockholders will receive quarterly distributions that are at least sufficient to satisfy the annual distribution requirements applicable to REITs under the Code. The Host Board believes that this will highlight the value of Host REIT's hotel properties and permit stockholders to realize a regular cash return on that value. Upon completion of the REIT Conversion, Crestline is expected to own Host's 31 senior living communities, which will continue to be managed by Marriott International, and a 25% interest in the Swissotel management company expected to be acquired in the Blackstone Acquisition, and will lease substantially all of the Hotels owned by Host REIT and its affiliates. At such time, Crestline will operate independently of Host, will be publicly traded and separately listed on the NYSE, and will pursue its own growth opportunities. Host's Board of Directors has received an opinion dated November , 1998 from BT Wolfensohn, which acted as financial advisor to Host in connection with the REIT Conversion, to the effect that the REIT Transactions (as defined in such opinion), taken together, are fair from a financial point of view to the holders of Host Common Stock. See "Opinion of Financial Advisor." The Host Board of Directors considered such opinion as well as other matters it deemed relevant in determining the advisability of the Agreement and the other transactions comprising the REIT Conversion. Following the Restructuring Transactions and the other transactions comprising the REIT Conversion (including the Blackstone Acquisition), Host REIT and its subsidiaries are expected initially to own outright, or have controlling interests in, approximately 125 full-service hotels operated primarily under the Marriott, Ritz-Carlton, Four Seasons, Swissotel and Hyatt brand names. Upon completion of the REIT Conversion, Host REIT will be the sole general partner of the Operating Partnership and is expected to own approximately 74% of the OP Units in the Operating Partnership, and the remaining OP Units, which are intended to be substantially equivalent on an economic basis to shares of Host REIT Common Stock, will be owned by the Limited Partners, unaffiliated partners of the four Private Partnerships participating in the Private Partnership Transactions and the Blackstone Entities. Host REIT and its subsidiaries will own a number of OP Units equal to the number of shares of Host REIT Common Stock outstanding. Host REIT will be managed by its Board of Directors and will have no employees who are not also employees of the Operating Partnership. THE BOARD OF DIRECTORS OF HOST BELIEVES THAT THE AGREEMENT, WHICH CONTEMPLATES THE RESTRUCTURING TRANSACTIONS AND THE OTHER TRANSACTIONS COMPRISING THE REIT CONVERSION DESCRIBED IN THIS PROXY STATEMENT/PROSPECTUS, ARE ADVISABLE FOR HOST AND ITS STOCKHOLDERS AND RECOMMENDS THAT STOCKHOLDERS VOTE "FOR" APPROVAL OF THE AGREEMENT AND THE TRANSACTIONS CONTEMPLATED THEREBY. In the event the Agreement is not approved by Host stockholders at the Special Meeting, Host will continue to operate as a Delaware corporation, and the other transactions comprising the REIT Conversion (including the Initial E&P Distribution) will not be completed at this time. THE OP CONTRIBUTION Subject to approval of the Agreement at the Special Meeting, after the Special Meeting Host will contribute, as the OP Contribution, its wholly-owned full-service hotels, interests in certain of the Partnerships and the Private Partnerships (other than their interests in the general partners of the Partnerships, each of which is Host or a wholly-owned direct or indirect subsidiary of Host, and certain other subsidiaries of Host who will remain in existence as subsidiaries of Host REIT and will receive OP Units in the Partnership Mergers) and certain other assets (excluding Host's senior living assets and the cash or other consideration to be distributed in connection with the Initial E&P Distribution and certain de minimis assets that cannot be contributed to the Operating Partnership) to the Operating Partnership. As a preliminary step in the REIT Conversion, during 1998, various subsidiaries of Host also have contributed or will contribute the wholly-owned full-service hotels held by such entities, their interests in certain of the Partnerships and Private Partnerships and certain other assets to the Operating Partnership (including its subsidiaries). In exchange for these contributions, the Operating Partnership (i) will issue to Host in the aggregate a number of OP Units equal to the number of outstanding shares of Host Common Stock at the time of the REIT Conversion, reduced by the number of OP Units to be received by the general partners of the Partnerships and other subsidiaries of Host in the Partnership Mergers (together with 56 preferred partnership interests in the Operating Partnership corresponding to any shares of Host preferred stock outstanding at the time of the REIT Conversion) and (ii) will assume all liabilities of Host (including past and future contingent liabilities and liabilities for the Plans in accordance with the 1998 Employee Benefits Allocation Agreement), other than liabilities of Crestline. A portion of Host REIT's OP Units represents a 0.1% general partnership interest in the Operating Partnership. Following these contributions, the Operating Partnership and its subsidiaries will directly or indirectly own all of Host's and its subsidiaries' wholly-owned hotels, substantially all of Host's direct and indirect interests in the Partnerships and the Private 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 de minimis assets that cannot be contributed to the Operating Partnership). The above-described contributions, which include the OP Contribution, will enable Host REIT, following the Reincorporation by means of the Merger, to operate together with the Operating Partnership in an UPREIT structure, which is expected to improve Host REIT's ability to acquire additional hotels and other properties in the future on favorable terms. TERMS OF THE MERGER The Reincorporation will be effected through the merger of Host with and into Host REIT. As a result of the Merger, Host REIT will be the surviving entity and the separate existence of Host will terminate. At the Effective Time, each outstanding share of Host Common Stock, together with the associated Host Right, will be converted into one share of Host REIT Common Stock, together with the associated Host REIT Right, and holders thereof will become subject to the Ownership Limit under the Host REIT Charter. In addition, rights and obligations of Host under the Plans and related and other agreements will be assumed by Host REIT, and all rights of the participants therein to acquire shares of Host Common Stock on the terms and conditions of the Plans and such agreements will be converted into rights to acquire shares of Host REIT Common Stock in accordance with the 1998 Employee Benefits Allocation Agreement (other than with respect to individuals who will be employed by Crestline following the Initial E&P Distribution). Any outstanding shares of preferred stock of Host would be converted into an equal number of shares of preferred stock of Host REIT having substantially the same rights and preferences. Certain rights and obligations of Host under the Plans and related agreements to acquire shares of Host Common Stock, to the extent held by participants who will be employed by Crestline following the Initial E&P Distribution, will be assumed by Crestline and converted into rights to acquire shares of Crestline common stock in accordance with the 1998 Employee Benefits Allocation Agreement. See "Description of Host REIT Capital Stock" and "Management--1998 Employee Benefits Allocation Agreement." As a consequence of the Merger, among other things, the assets of Host will become assets of Host REIT without further action, and Host REIT will become liable for all the debts and obligations of Host. As soon as practicable following the Merger, Host REIT will complete any other transactions comprising the REIT Conversion that have not already been completed. See "The REIT Conversion." Following the Merger, each person who was a director of Host will continue as a director of Host REIT and certain of the officers of Host will remain officers of Host REIT (others will have become officers of Crestline in connection with the distribution of Crestline shares as part of the Initial E&P Distribution). Certain information about each person who currently is a member of the Board of Directors and an executive officer of Host is set forth herein under the caption "Management--Directors and Executive Officers of Host REIT." In addition, upon consummation of the Merger, Host REIT and its stockholders will be governed by the MGCL and by the Host REIT Charter and Host REIT Bylaws, copies of which are attached as Exhibits B and C, respectively, to the Agreement, which is attached to this Proxy Statement/Prospectus as Appendix A. See "--Comparison of Rights of Stockholders of Host and Host REIT." PRIMARILY TO SATISFY CERTAIN REQUIREMENTS UNDER THE CODE THAT ARE APPLICABLE TO REITS IN GENERAL, THE OWNERSHIP LIMIT WILL PROVIDE THAT NO PERSON OR PERSONS ACTING AS A GROUP 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 SHARES OF HOST REIT COMMON STOCK OUTSTANDING OR (II) 9.8% OF THE LESSER OF THE NUMBER OR VALUE OF 57 THE ISSUED AND OUTSTANDING SHARES OF ANY CLASS OR SERIES OF HOST REIT PREFERRED STOCK, SUBJECT TO WAIVER OR MODIFICATION BY HOST REIT IN CERTAIN LIMITED CIRCUMSTANCES AND SUBJECT TO (A) AN EXCEPTION FOR A HOLDER OF SHARES OF HOST REIT COMMON STOCK SOLELY BY REASON OF THE MERGER IN EXCESS OF THE OWNERSHIP LIMIT SO LONG AS SUCH HOLDER WOULD NOT OWN, DIRECTLY OR BY ATTRIBUTION UNDER THE CODE, MORE THAN 9.9% BY VALUE OF THE OUTSTANDING CAPITAL STOCK OF HOST REIT AS OF THE SPECIAL MERGER OWNERSHIP LIMIT EFFECTIVE TIME, AND (B) A LIMITATION ON THE APPLICATION OF THE "GROUP" LIMITATION (BUT NO OTHER ELEMENT OF THE OWNERSHIP LIMIT) TO ANY "GROUP" THAT OTHERWISE WOULD EXCEED THE OWNERSHIP LIMIT AT THE EFFECTIVE TIME SOLELY BY REASON OF ITS STATUS AS A "GROUP." THE OWNERSHIP LIMIT WILL BECOME APPLICABLE TO ALL HOST REIT STOCKHOLDERS AS OF THE EFFECTIVE TIME. ANY SHARES OF HOST REIT COMMON STOCK HELD AT THE EFFECTIVE TIME AND NOT SUBSEQUENTLY TRANSFERRED PRIOR TO THE SPECIAL MERGER OWNERSHIP LIMIT EFFECTIVE TIME, OR ACQUIRED OR OTHERWISE HELD AT ANY TIME AFTER THE EFFECTIVE TIME 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 (OR HELD) SUCH EXCESS SHARES OF HOST REIT COMMON STOCK WILL NOT BE ENTITLED TO ANY DISTRIBUTIONS THEREON OR TO VOTE SUCH EXCESS SHARES OF HOST REIT COMMON STOCK. THE HOLDER OF ANY SUCH EXCESS SHARES OF HOST REIT COMMON STOCK WILL RECEIVE THE LESSER OF THE VALUE OF SUCH EXCESS SHARES AS OF THE EFFECTIVE TIME OR THE CASH PROCEEDS FROM THE SALE OF SUCH EXCESS SHARES OF HOST REIT COMMON STOCK BY THE TRUSTEE OF THE TRUST. AFTER THE EFFECTIVE TIME, ANY PERSON WHO ACQUIRES HOST REIT COMMON STOCK IN EXCESS OF THE OWNERSHIP LIMIT WILL NOT 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 HOST REIT COMMON STOCK 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 SHARES OF HOST REIT COMMON STOCK IN EXCESS OF THE OWNERSHIP LIMIT. TO AVOID THE ADVERSE EFFECTS OF THE OWNERSHIP LIMIT, ANY HOLDER OF HOST COMMON STOCK WHO WOULD OWN SHARES IN EXCESS OF THE OWNERSHIP LIMIT AT THE EFFECTIVE TIME SHOULD DISPOSE OF ANY SUCH EXCESS SHARES PRIOR THERETO. Host anticipates that the Merger will become effective as promptly as practicable following stockholder approval of the Agreement at the Special Meeting and satisfaction or waiver of the other conditions to the Merger. The Agreement provides that the Merger may be abandoned by Host or Host REIT at any time prior to its effectiveness. Host has no current intention of abandoning or causing Host REIT to abandon the Merger subsequent to the Special Meeting if stockholder approval is obtained and the other conditions to the Merger are satisfied or waived. See "--Conditions to the Merger." The Board of Directors of Host has approved the Agreement, and the transactions contemplated thereby, subject to stockholder approval. Assuming the stockholders of Host approve the Agreement at the Special Meeting and the other conditions to the Merger are satisfied or waived, the Merger will become effective at the time the Articles of Merger are accepted for filing by the SDAT in accordance with the MGCL and the time the Certificate of Merger is accepted for filing by the Secretary of State of Delaware in accordance with the DGCL, or later if so specified in such Articles and Certificate. It is expected that the listing of Host REIT Common Stock on the NYSE will occur at or prior to the Effective Time and that the listing of Host Common Stock on the NYSE will be terminated at the Effective Time. At the Effective Time, each certificate representing shares of Host Common Stock will be deemed for all purposes to evidence the same number of shares of Host REIT Common Stock. As soon as reasonably practicable after the Effective Time, Host REIT will instruct First Chicago Trust Company of New York, the transfer agent and registrar for Host REIT Common Stock and the exchange agent for purposes of the Merger (the "Transfer and Exchange Agent"), to mail a letter of transmittal and instructions to each holder of a certificate or certificates which immediately prior to the Effective Time represented outstanding shares of Host Common Stock ("Certificates"), advising the securityholder of the procedure for surrendering the Certificates in exchange for certificates representing shares of Host REIT Common Stock. Upon surrender of the Certificates for cancellation to the Transfer and Exchange Agent, together with a duly executed letter of transmittal and such other documents as may be reasonably required by the Transfer and Exchange Agent or the Agreement, the holder of the Certificates will be entitled to receive in exchange therefor a certificate evidencing that number of shares of Host 58 REIT Common Stock which such holder has the right to receive in respect of the rights formerly evidenced by such Certificates. CERTIFICATES SHOULD NOT BE SURRENDERED UNTIL THE LETTER OF TRANSMITTAL IS RECEIVED. Neither Host nor Host REIT is aware of any federal, state or local regulatory requirements that must be complied with or approvals that must be obtained prior to consummation of the Merger pursuant to the Agreement, other than compliance with applicable federal and state securities laws, the filing and acceptance for record of the Articles of Merger by the SDAT as required under the MGCL and the filing of a Certificate of Merger as required under the DGCL and the receipt of various state and local governmental authorizations. ABSENCE OF DISSENTERS' RIGHTS Pursuant to Section 262(b)(1) of the DGCL, the stockholders of Host will not be entitled to appraisal rights as a result of the Merger or other Restructuring Transactions. ACCOUNTING TREATMENT The OP Contribution and the Merger will be accounted for as a transfer or exchange between enterprises under common control. Therefore, the assets and liabilities so transferred will be accounted for at historical cost in a manner similar to that in pooling-of-interests accounting. CONDITIONS TO THE MERGER Consummation of the Merger is subject to the satisfaction or waiver of various conditions, including satisfaction of the following: . Host Stockholder Approval. The affirmative vote of the holders of Host Common Stock representing not less than two-thirds (66 2/3%) of the outstanding shares of Host Common Stock shall have approved the Agreement, which shall be deemed to be approval of the Merger for purposes of Section 251 of the DGCL (applicable to mergers), as well as approval of the OP Contribution for purposes of Section 271 of the DGCL (applicable to the sale, lease or exchange of all or substantially all of the assets of a corporation) if such OP Contribution were deemed to constitute a sale, lease or exchange of all or substantially all of the assets of Host. . REIT Qualification. Host's Board of Directors shall have determined, (i) that the transactions constituting the REIT Conversion which impact Host REIT's status as a REIT for federal income tax purposes have occurred or are reasonably likely to occur, and (ii) 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 prior to January 1, 1999). . NYSE Listing. The Host REIT Common Stock shall have been approved for listing on the NYSE. . Governmental and Third-Party Consents. Host shall have received all governmental and third-party consents to the Restructuring Transactions, including consents of lenders and Marriott International, except for 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. 59 In addition, Host will amend the Host Rights Agreement to provide that each Host Right issuable pursuant to the Host Rights Agreement will be converted into a Host REIT Right issuable under the Host REIT Rights Agreement. Host REIT intends to adopt the Host REIT Rights Agreement prior to the completion of the Merger and each share of Host REIT Common Stock issued in the Merger will have a Host REIT Right attached to it. See "Certain Provisions of Maryland Law and the Host REIT Charter and Bylaws--Stockholder Rights Plan." COMPARISON OF RIGHTS OF STOCKHOLDERS OF HOST AND HOST REIT The rights of stockholders of Host are currently governed by the DGCL, the Host Certificate, the Host Bylaws and the Host Rights Agreement. If the Agreement is approved by Host's stockholders and the Merger is consummated, Host REIT will be the surviving entity in the Merger and the rights of the stockholders of Host REIT will be governed by the MGCL, the Host REIT Charter, the Host REIT Bylaws and Host REIT's Stockholder Rights Plan. The following discussion compares certain of the existing rights of stockholders of Host with those of stockholders of Host REIT. FORM OF ORGANIZATION AND PURPOSE Host. Host is a Delaware corporation. Pursuant to the Host Certificate, Host is authorized to engage in any lawful acts or activities for which corporations may be organized under the DGCL, including conducting a general hotel business. Host REIT. Host REIT is a Maryland corporation and will be the sole general partner of the Operating Partnership. Host REIT will make an election to be taxed as a REIT under the Code and intends to maintain its qualification as a REIT. Host REIT's only significant asset will be its interest in the Operating Partnership and consequently an indirect investment in the hotels owned by the Operating Partnership and its subsidiaries. CAPITALIZATION Host. The Host Certificate authorizes a total of 601,000,000 shares of stock consisting of 600,000,000 shares of Host Common Stock, par value $1.00 per share, and 1,000,000 shares of Host preferred stock without par value ("Host Preferred Stock"). Of the Host Preferred Stock, 300,000 shares are designated as Series A Junior Participating Preferred Stock without par value, and 4,000 shares are designated as Series A Cumulative Convertible Preferred Stock without par value. At November 13, 1998, Host had 204,954,447 shares of Host Common Stock issued and outstanding and no shares of Host Preferred Stock issued and outstanding. Host REIT. The Host REIT 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 shares of Host REIT Common Stock, par value $.01 per share, and 50,000,000 shares of Host REIT Preferred Stock, par value $.01 per share. The Board of Directors is authorized, without a vote of stockholders, to classify or reclassify any unissued shares of stock and to establish the preferences and rights of any preferred or other class or series of stock to be issued. At November 13, 1998, 100 shares of Host REIT Common Stock were issued and outstanding. PREEMPTIVE RIGHTS DGCL. Under the DGCL, stockholders of a corporation have only such preemptive rights as may be provided in the corporation's certificate of incorporation. Host. The Host Certificate does not provide for preemptive rights. MGCL. Under the MGCL, stockholders of a Maryland corporation have only such preemptive rights as may be provided in the Maryland corporation's charter. Host REIT. The Host REIT Charter will not provide for preemptive rights. 60 RESTRICTIONS ON OWNERSHIP AND TRANSFER OF STOCK DGCL. Under the DGCL, a written restriction on the transfer of a security, if permitted by the DGCL and noted conspicuously on the certificate representing the security or, in the case of uncertificated shares, contained in the notice required to be sent to the security holder pursuant to the DGCL, may be enforced against the holder or any successor or transferee of the holder. A restriction on the transfer of securities of a corporation may be imposed either by the certificate of incorporation or by the by-laws or by an agreement among any number of security holders or among such holders and the corporation. No restriction so imposed is binding with respect to securities issued prior to adoption of the restriction unless the holders of the securities are parties to an agreement or voted in favor of the restriction. A restriction on the transfer of securities of a corporation is permitted under the DGCL if, among other things, it prohibits the transfer of the restricted securities to designated persons or classes of persons, and such designation is not manifestly unreasonable. Any other lawful restriction on the transfer of securities also is permitted under the DGCL. The DGCL expressly provides that any restriction on the transfer of shares imposed for the purpose of maintaining a tax advantage to the corporation is conclusively presumed to be for a reasonable purpose. Host. Neither the Host Certificate nor the Host Bylaws will provide for restrictions on the transfer of Host securities. MGCL. Under the MGCL, a Maryland corporation may impose a restriction on the transfer of its stock in the corporation's charter, articles of incorporation or bylaws. If a Maryland corporation which issues stock imposes a restriction on its transferability, the stock certificate must (i) contain a full statement of the restriction, or (ii) state that the corporation will furnish information about the restriction to the stockholder on request and without charge. The MGCL expressly authorizes the charter of a Maryland corporation to provide for restrictions on transferability designed to permit a corporation to qualify as a REIT under the Code or for any other purpose. Host REIT. The Ownership Limit under the Host REIT Charter will provide that, subject to certain exceptions, no person or persons acting as a group 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 shares of Host REIT Common Stock outstanding or (ii) 9.8% of the lesser of the number or value of the issued and outstanding preferred or other stock of any class or series of Host REIT (subject to a limited exception for a holder of shares of Host REIT Common Stock solely by reason of the Merger in excess of the Ownership Limit so long as the holder thereof would not own, directly or by attribution under the Code, more than 9.9% in value of the outstanding shares of capital stock of Host REIT as of the Special Merger Ownership Limit Effective Time, and to a limitation on the application of the "group" limitation). The Host REIT Charter will further prohibit (a) any person from actually or constructively owning shares of the capital stock 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 (b) any person from transferring shares of Host REIT Common Stock or Host REIT Preferred Stock if such transfer would result in all classes and series of the capital stock of Host REIT being owned by fewer than 100 persons. See "Description of Host REIT Capital Stock--Restrictions on Ownership and Transfer." AMENDMENT OF HOST CERTIFICATE/HOST REIT CHARTER DGCL. Under the DGCL, an amendment to a corporation's certificate of incorporation generally requires the approval of the board of directors and the approval of a majority of the outstanding stock entitled to vote thereon and a majority of the outstanding stock of each class entitled to vote thereon. Under the DGCL, the holders of the outstanding shares of a class are entitled to vote as a separate class on a proposed amendment that would increase or decrease the aggregate number of authorized shares of such class, increase or decrease the par value of the shares of such class or alter or change the powers, preferences or special rights of the shares of such class so as to affect them adversely. If any proposed amendment would alter or change the powers, preferences or special rights of one or more series of any class so as to affect them adversely, but would not so affect the entire class, then only the shares of the series so affected by the amendment will be considered a separate class for purposes of voting by classes. 61 Host. The Host Certificate provides that, unless otherwise specified by the Host Certificate, Host reserves the right to amend, alter, change or repeal any provision contained in the Host Certificate in the manner prescribed by the DGCL. The Host Certificate provides further that the affirmative vote of at least 66 2/3% of the voting power of all the shares of the corporation entitled to vote generally in the election of directors ("Voting Stock") is required to alter, amend or repeal, or to adopt any provisions inconsistent with certain provisions in the Host Certificate relating to, among other things: the number and election of Host Directors, the removal of Host Directors, vacancies on the Host Board, the voting requirements for specified business combinations, stockholder action by written consent, special stockholder meetings, the amendment of the Host Bylaws, and the voting requirements for certain "interested stockholder" transactions. See "--Number and Election of Directors," "--Removal of Directors," "--Vacancies on the Board of Directors," "--Changes in Control Pursuant to Delaware/Maryland Law," "--Transactions Involving Directors or Officers," "--Stockholder Action by Written Consent," "--Special Stockholder Meetings," and "--Amendment of Bylaws." MGCL. 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 stockholders for their consideration either at an annual or special meeting of stockholders. Thereafter, the proposed amendment must be approved by stockholders 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. Host REIT. The provisions to be contained in the Host REIT Charter relating to restrictions on transferability of Host REIT Common Stock, preemptive rights, the classified Board and fixing the size of the Board within the range set forth in the Host REIT Charter, as well as the provisions relating to removal of directors, the filling of Board vacancies, liability and indemnification of directors and officers, the calling of special stockholder meetings, the authority of the Board of Directors to issue stock, amendment of the Host REIT Charter and the exclusive authority of the Board to amend the Bylaws may be amended only by a resolution adopted by the Board of Directors and approved at an annual or special meeting of the stockholders 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 Host REIT Charter generally may be effected by requisite action of the Board of Directors and approval by stockholders by the affirmative vote of not less than a majority of the votes entitled to be cast on the matter. AMENDMENT OF BYLAWS DGCL. Under the DGCL, the adoption of, amendment to, or repeal of, a corporation's bylaws requires the approval of the stockholders, unless the certificate of incorporation confers the power to amend the bylaws upon the board of directors. Even if the power to adopt, amend or repeal the bylaws is conferred upon the board of directors, the stockholders may not be divested of the power to adopt, amend or repeal the bylaws. Host. Subject to the exceptions described below, the Host Certificate provides that the Host Board of Directors is authorized to make, alter, amend and repeal the Host Bylaws (except insofar as the Host Bylaws adopted by the shareholders shall otherwise provide). Any bylaws made by the Board of Directors may be altered, amended or repealed by the directors or by the stockholders. The Host Bylaws provide that, subject to the exceptions described below, the Host Bylaws may be altered, amended or repealed (a) by a majority vote of the shares represented and entitled to vote at any regular meeting of the stockholders (or at any special meeting called for that purpose), or (b) subject to Delaware law, by a majority vote of those directors present at any meeting at which a quorum of the Board of Directors is present. The Host Certificate and/or the Host Bylaws provides that certain provisions in the Host Bylaws may not be altered, amended or repealed, and no provision inconsistent therewith adopted, without the affirmative vote of the holders of at least 66 2/3% of the Voting Stock, including provisions relating to, among other things: the number and election of Host directors; vacancies on the Board of Directors and the removal of directors from 62 the Host Board; director nominations; notice to directors and stockholders; bylaw amendments; and the prohibition on stockholder action by written consent. See "--Number and Election of Directors," "--Vacancies on the Board of Directors," "--Removal of Directors" and "--Stockholder Action by Written Consent." MGCL. Under the MGCL, the adoption of, an amendment to, or the repeal of, a Maryland corporation's bylaws requires the approval of the stockholders, unless the charter or bylaws confer the power to amend the bylaws upon the board of directors. Host REIT. As permitted under the MGCL, the Host REIT Charter and Bylaws will provide that directors have the exclusive right to adopt, amend or repeal the Host REIT Bylaws. STOCKHOLDER VOTING RIGHTS GENERALLY DGCL. Under the DGCL, unless otherwise provided in the certificate of incorporation and subject to certain provisions of the DGCL, each stockholder is entitled to one vote for each share of capital stock held by such stockholder. Each stockholder entitled to vote at a meeting of stockholders or to express consent or dissent to corporate action in writing without a meeting may authorize another person or persons to act for him by proxy, but no such proxy shall be voted or acted upon after three years from its date, unless the proxy provides for a longer period. The DGCL further provides that in all matters other than the election of directors, the affirmative vote of the majority of shares present in person or represented by proxy at a duly held meeting at which a quorum is present and entitled to vote on the subject matter is deemed to be the act of the stockholders, unless the DGCL, the certificate of incorporation or the bylaws specify a different voting requirement. Where a separate vote by a class or classes is required, a majority of the outstanding shares of such class or classes, present in person or represented by proxy, shall constitute a quorum entitled to take action with respect to that vote on that matter and the affirmative vote of the majority of shares of such class or classes present in person or represented by proxy at the meeting shall be the act of such class. Host. The Host Bylaws provide that in all matters, when a quorum is present at any meeting, the vote of the holders of a majority of the stock having voting power present in person or represented by proxy shall decide any question brought before such meeting, unless the question is one upon which by express provision of the statutes or of the Host Certificate, a different vote is required in which case such express provision shall govern and control the decision of such question. The Host Bylaws also provide that each stockholder shall at every meeting of the stockholders be entitled to one vote in person or by proxy for each share of the capital stock having voting power held by such stockholder, but no proxy shall be voted on after three years from its date, unless the proxy provides for a longer period. Each share of Host Common Stock has one vote and Host's Certificate of Incorporation permits the Board of Directors to classify and issue shares of capital stock in one or more series having voting power which may differ from that of the Common Stock. MGCL. Under the MGCL, unless the charter provides for a greater or lesser number of votes per share or limits or denies voting rights, each outstanding share of stock, regardless of class, is entitled to one vote on each matter submitted to a vote at a meeting of stockholders. A stockholder may vote the stock the stockholder owns either in person or by proxy, which proxy is not valid more than eleven months after its date, unless such proxy provides otherwise. Unless the MGCL or charter specify a different voting requirement, a majority of all the votes cast at a duly held meeting at which a quorum is present and entitled to vote on the subject matter is deemed to be the act of the stockholders. Additionally, unless the MGCL or charter provide otherwise, if two or more classes of stock are entitled to vote separately on any matter for which the MGCL requires approval by two-thirds of all the votes entitled to be cast, the matter must be approved by two-thirds of all the votes of each class. Host REIT. Each share of Host REIT Common Stock will have one vote and Host REIT's Charter will permit the Board of Directors to classify and issue shares of capital stock in one or more classes or series having voting power which may differ from that of the shares of Host REIT Common Stock. The Host REIT Bylaws provide that, except with respect to the election of directors, and unless otherwise provided in the Host REIT 63 Charter, a majority of the votes cast at a meeting of stockholders duly called and at which a quorum is present is sufficient to approve any matter properly before the meeting, unless more than a majority is required by statute or the Host REIT Charter. Each stockholder is entitled to cast the votes owned of record by him either in person or by proxy, but no proxy shall be valid after 11 months from the date of its execution, unless otherwise provided in the proxy. STOCKHOLDER ACTION BY WRITTEN CONSENT DGCL. Under the DGCL, unless otherwise provided in a corporation's certificate of incorporation, any action that may be taken at any annual or special meeting of stockholders may be taken without a meeting, without prior notice and without a vote, if a consent (or consents) in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted and shall be delivered to the corporation. Host. The Host Certificate and Host Bylaws provide that any action required or permitted to be taken by the stockholders of the corporation must be effected at a duly called annual or special meeting of such holders and may not be effected by any consent in writing by such holders. MGCL. Under the MGCL, any action required or permitted to be taken at a meeting of stockholders may be taken without a meeting if the following are filed with the records of stockholder meetings: (i) an unanimous written consent which sets forth the action and is signed by each stockholder entitled to vote on the matter; and (ii) a written waiver of any right to dissent signed by each stockholder entitled to notice of the meeting but not entitled to vote at it. Host REIT. Pursuant to the MGCL and Host REIT Bylaws, subject to the rights of the holders of any class or series of stock (other than Host REIT Common Stock) to elect additional directors under specific circumstances, any action required or permitted to be taken by the stockholders must be effected at a duly called annual or special meeting of stockholders and may not be effected by any consent in writing by stockholders, unless such consent is unanimous. SPECIAL STOCKHOLDER MEETINGS DGCL. Under the DGCL, special meetings of the stockholders may be called by the board of directors or by such person or persons as may be authorized by the certificate of incorporation or by the bylaws. Host. The Host Certificate and Host Bylaws provide that, subject to the rights of holders of any series of preferred stock, special meetings of stockholders of the corporation may be called only by the Board of Directors pursuant to a resolution approved by a majority of the entire Board of Directors. Stockholders are not permitted to call a special meeting or to require that the Host Board call a special meeting of stockholders. Moreover, the business permitted to be conducted at any special meeting of stockholders is limited to the business brought before the meeting by or at the direction of the Host Board. MGCL. Under the MGCL, a special meeting of a Maryland corporation's stockholders may be called by (i) the president, (ii) the board of directors, or (iii) any other person specified in the charter or the by-laws. The MGCL further provides that the secretary of a Maryland corporation shall call a special meeting of the stockholders on the written request of stockholders entitled to cast at least 25% of all the votes entitled to be cast at the meeting, unless a Maryland corporation includes in its charter or bylaws a provision that requires the written request of stockholders entitled to cast a greater or lesser percentage of all votes entitled to be cast at the meeting, except that in no event shall the percentage provided for in the charter or bylaws be greater than a majority of all the votes entitled to be cast at the meeting. Notwithstanding the foregoing, the MGCL provides that unless requested by stockholders entitled to cast a majority of all the votes entitled to be cast at the meeting, a special meeting need not be called to consider any matter which is substantially the same as a matter voted on at any special meeting of the stockholders held during the preceding 12 months. 64 Host REIT. The Host REIT Charter will provide that special meetings of the stockholders may be called by the President, the Board of Directors of Host REIT or any other person specified in the Host REIT Bylaws. The Host REIT Charter will provide further that the Secretary of Host REIT also is required to call a special meeting of the stockholders on the written request of stockholders entitled to cast a majority of all the votes entitled to be cast at the meeting. The Host REIT Bylaws contain similar provisions to the Host REIT Charter regarding the calling of special stockholder meetings. In addition, the Host REIT Bylaws provide that special stockholder meetings may be called by the holders of any class or series of stock having a preference over the Host REIT Common Stock as to dividends or upon liquidation in the manner (if any) specified in articles supplementary filed as part of the Host REIT Charter. NUMBER AND ELECTION OF DIRECTORS DGCL. Under the DGCL, the minimum number of directors is one. The DGCL provides that the number of directors shall be fixed by, or in the manner provided in, the bylaws, unless the certificate of incorporation fixes the number of directors, in which case a change in the number of directors may be made only upon amendment of the certificate of incorporation. In addition, the DGCL permits, but does not require, a classified board of directors, with staggered terms under which one-half or one-third of the directors are elected for terms of two or three years, respectively. The DGCL provides that directors shall be elected by a plurality of the votes of the shares present in person or represented by proxy at a stockholder meeting and entitled to vote on the election of directors. The DGCL further provides that the vote of the majority of the directors present at a meeting at which a quorum is present shall be the act of the board of directors unless the certificate of incorporation or the bylaws shall require a vote of greater number. Host. The Host Certificate provides that the number of directors shall be fixed from time to time by or pursuant to the Host Bylaws. The Host Bylaws provide that the Host Board shall be fixed from time to time by the Board of Directors but shall not be less than three. The Host Certificate and Host Bylaws provide that the Board of Directors is divided into three classes, each consisting of approximately one-third of the total number of directors. The term of office for each director is three years and such terms expire in successive years at the time of the annual meeting of stockholders. The current number of directors is eight. There are no cumulative voting rights in the election of directors under the Host Certificate. MGCL. Under the MGCL, the minimum number of directors is three. The MGCL provides that the number of directors shall be provided by the charter until changed by the by-laws. The bylaws may both (i) alter the number of directors set by the charter, and (ii) authorize a majority of the entire board of directors to alter within specified limits the number of directors set by the charter or the bylaws, but the action may not affect the tenure of office of any director. In addition, the MGCL permits, but does not require, a classified board of directors. If the directors are divided into classes, the term of office may be provided in the by-laws, except that (i) the term of office of a director may not be longer than five years or, except in the case of an initial or substitute director, shorter than the period between annual meetings, and (ii) the term of office of at least one class must expire each year. Each share of stock may be voted for as many individuals as there are directors to be elected and for whose election the share is entitled to be voted. Unless the charter or bylaws provide otherwise, a plurality of all the votes cast at a meeting at which a quorum is present is sufficient to elect a director. Host REIT. The Host REIT Charter will provide that, effective upon completion of the Merger, the Board of Directors will consist of eight members and may thereafter be increased or decreased in accordance with the Host REIT Bylaws, provided that the total number of directors may not be fewer than three nor more than thirteen. Pursuant to the Host REIT Bylaws, the number of directors shall be fixed by the Board of Directors within the limits set forth in the Host REIT Charter. Further, the Host REIT Charter will provide that the Board of Directors, other than those who may be elected by the holders of any class or series of stock having a preference over the Host REIT Common Stock as to dividends or upon liquidation, 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 stockholders; the term of the second class of directors will expire at the 2000 annual meeting of stockholders; and the term of the third class of 65 directors will expire at the 2001 annual meeting of stockholders. The Host REIT Charter will provide further that in the event of any increase or decrease in the number of directors, other than resulting from the rights of the holders of any class or series of stock having a preference over the Host REIT Common Stock as to dividends or upon liquidation to elect additional directors pursuant to the specified provisions of the Host REIT Charter, the newly created or eliminated directorship resulting from such increase or decrease shall be apportioned by the Board of Directors among the three classes of directors so as to maintain such classes as nearly equal in number as possible. At each annual meeting of stockholders, 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 stockholders of Host REIT will have no right to cumulative voting for the election of directors, at each annual meeting of stockholders the holders of a majority of the outstanding shares of Host REIT Common Stock will be able to elect all of the successors to the class of directors whose term expires at that meeting. REMOVAL OF DIRECTORS DGCL. The DGCL provides that a director of a corporation may be removed with or without cause by the holders of a majority of shares then entitled to vote at an election of directors, provided, that, when a corporation has a classified board of directors, a director may be removed only for cause, unless the certificate of incorporation provides otherwise. Host. The Host Certificate and Host Bylaws provide that directors may be removed from office, with or without cause, only by the affirmative vote of the holders of at least 66 2/3% of the Voting Stock. MGCL. Under the MGCL, unless the charter provides otherwise, the stockholders of a Maryland corporation may remove any director, with or without cause, by the affirmative vote of a majority of all the votes entitled to be cast for the election of directors, except that, unless the charter provides otherwise, (i) if the stockholders of any class or series are entitled separately to elect one or more directors, a director elected by a class or series may not be removed without cause except by the affirmative vote of a majority of all the votes of that class or series, (ii) if a corporation has cumulative voting for the election of directors and less than the entire board is to be removed, a director may not be removed without cause if the votes cast against his removal would be sufficient to elect him if then cumulatively voted at an election of the entire board of directors, or, if there is more than one class of directors, at an election of the class of directors of which he is a member, and (iii) if the directors have been divided into classes, a director may not be removed without cause. Host REIT. The Host REIT Charter and Host REIT Bylaws will provide that, except for any directors who may be elected by holders of a class or series of shares other than Host REIT Common Stock, directors may be removed only for cause and only by the affirmative vote of stockholders holding at least two- thirds of all the votes entitled to be cast for the election of directors. VACANCIES ON THE BOARD OF DIRECTORS DGCL. Under the DGCL, vacancies and newly created directorships resulting from any increase in the authorized number of directors elected by all of the stockholders having the right to vote as a single class may be filled by a majority of the directors then in office, although less than a quorum, unless otherwise provided in the certificate of incorporation or the bylaws. However, if the certificate of incorporation directs that a particular class is to elect such director, such vacancy may be filled only by the other directors elected by such class. If, at the time of filling any vacancy or newly created directorship, the directors then in office constitute less than a majority of the whole board as constituted immediately prior to such increase, the Delaware Court of Chancery may, upon application of stockholders holding at least ten percent of the total number of shares outstanding having the right to vote for such directors, order an election to be held to fill any such vacancies or newly created directorships or to replace the directors chosen by the directors then in office. Under the DGCL, unless otherwise provided in the certificate of incorporation or bylaws, when one or more directors resigns from the board, effective at a future date, a majority of the directors then in office, including those who have so resigned, shall have the power to fill such vacancy or vacancies, the vote thereon to take effect when such resignation or 66 resignations shall become effective, and each director so chosen shall hold office as provided in the DGCL in the filling of other vacancies. Host. The Host Certificate provides that, subject to any rights of the holders of preferred stock, newly created directorships resulting from any increase in the number of directors and any vacancies on the board of directors resulting from death, resignation, disqualification, removal or other cause shall be filled by the affirmative vote of a majority of the remaining directors then in office, even though less than a quorum of the board of directors. Any director elected in this manner shall hold office for the remainder of the full term of the class of directors in which the new directorship was created or the vacancy occurred and until such director's successor shall have been elected and qualified. No decrease in the number of directors may shorten the term of any incumbent director. MGCL. Under the MGCL, the stockholders may fill vacancies on the board of directors caused by the removal of a director, except that if the stockholders of any class or series are entitled separately to elect one or more directors, the stockholders of that class or series may elect a successor to fill a vacancy which results from the removal of a director elected by that class or series. The MGCL further provides that unless the charter or bylaws provide otherwise, a majority of the remaining directors, whether or not sufficient to constitute a quorum, may fill a vacancy on the board of directors which results from any cause except that (i) a vacancy caused by an increase in the number of directors may be filled by a majority of the entire board, and (ii) if the stockholders of any class or series are entitled separately to elect one or more directors, a majority of the remaining directors elected by that class or series or the sole remaining director elected by that class or series may fill any vacancy among the number of directors elected by that class or series. Under the MGCL, a director elected by the board of directors to fill a vacancy serves until the next annual meeting of stockholders and until his successor is elected and qualifies. A director elected by the stockholders to fill a vacancy which results from the removal of a director serves for the balance of the term of the removed director. Host REIT. The Host REIT Charter and Host REIT Bylaws provide that except in the case of a vacancy on the Board of Directors among the directors elected by a class or series of stock other than Host REIT Common Stock, any vacancy on the Board of Directors may be filled by the affirmative vote of a majority of the remaining directors (except that a vacancy which results from an increase in the number of directors may be filled by a majority of the entire Board of Directors). In addition, the Host REIT Charter will provide that in the case of a vacancy resulting from the removal of a director, by the stockholders by the affirmative vote of two-thirds of the votes entitled to be cast for the election of directors. The Host REIT Charter will provide further that any vacancy on the Board of Directors among the directors elected by a class or series of stock other than Host REIT Common Stock may be filled by a majority of the remaining directors elected by that class or series, or by the stockholders of that class or series unless otherwise provided in the articles supplementary for that class or series. ADVANCE NOTICE OF DIRECTOR NOMINATIONS AND OF NEW BUSINESS PROPOSALS Host. The Host Bylaws provide that (i) nominations for persons for election to the Board of Directors may be made (A) with respect to an annual meeting of the stockholders, by the Board of Directors or a proxy committee appointed by the Board of Directors, or by any stockholder entitled to vote in the election of directors if written notice of such stockholder's intent to make such nomination or nominations is given to the Secretary of Host not later than ninety days in advance of the date established by the Host Bylaws for the holding of such meeting, or (B) with respect to special meetings of the stockholders, by the Board of Directors or a proxy committee appointed by the Board of Directors, or by any stockholder entitled to vote in the election of directors if written notice of such stockholder's intent to make such nomination or nominations is given to the Secretary of Host not later than the close of business on the seventh day following the date on which notice of such meeting is first given to stockholders, and (ii) stockholder proposals may be made by any stockholder entitled to vote in the election of directors and who satisfies the requirements of the proxy rules under the Exchange Act by notice in writing, such notice to be received by the Secretary of Host not less than (X) with respect to an annual meeting 67 of the stockholders, one hundred and twenty days in advance of the date established for the holding of such meeting, or (Y) with respect to special meeting of the stockholders, the close of business on the seventh day following the date on which notice of such meeting is first given to stockholders. Host REIT. The Host REIT Bylaws provide that (i) with respect to an annual meeting of stockholders, subject to the rights of holders of any class or series of stock having a preference over the Host REIT Common Stock as to dividends or upon liquidation to elect directors under specified circumstances, nominations of persons for election to the Board of Directors and the proposal of business to be considered by stockholders may be made only (A) pursuant to Host REIT's notice of meeting, (B) by or at the direction of the Board of Directors or (C) by a stockholder who was a stockholder of record both at the time of giving notice provided for in the Host REIT Bylaws and at the time of the annual meeting, and who is entitled to vote at the meeting and has complied with the advance notice procedures set forth in the Host REIT Bylaws and (ii) with respect to special meetings of the stockholders, only the business specified in Host REIT's notice of meeting may be brought before the meeting of stockholders and except as otherwise provided for or fixed by or pursuant to the provisions of the Host REIT Charter relating to the rights of the holders of any class or series of stock having a preference over the Host REIT Common Stock as to dividends or upon liquidation to elect directors under specified circumstances, nominations of persons for election to the Board of Directors may be made only (X) pursuant to Host REIT's notice of the meeting, (Y) by or at the direction of the Board of Directors or (Z) provided that the Board of Directors has determined that directors shall be elected at such meeting, by a stockholder who was a stockholder of record both at the time of giving notice provided for in the Host REIT Bylaws and at the time of the special meeting, and who is entitled to vote at the meeting and has complied with the advance notice provisions set forth in the Host REIT Bylaws. The advance notice provisions contained in the Host REIT Bylaws generally require nominations and new business proposals by stockholders to be 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 first mailed its proxy materials for the prior year's annual meeting of stockholders. TRANSACTIONS INVOLVING DIRECTORS OR OFFICERS DGCL. Under the DGCL, no contract or transaction between a corporation and one or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organization in which one or more of its directors or officers, are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee which authorizes the contract or transaction, or solely because such director's votes are counted for such purpose, if (i) the material facts as to such director's relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; (ii) the material facts as to such director's relationship or interest and as to the contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the stockholders; or (iii) the contract or transaction is fair to the corporation as of the time it is authorized, approved or ratified by the board of directors, a committee or the stockholders. A corporation may lend money to, or guarantee any obligation of, or otherwise assist any officer or other employee of the corporation or of its subsidiary, including any officer who is a director of the corporation or its subsidiary, whenever, in the judgment of the directors, such loan, guaranty or assistance may reasonably be expected to benefit the corporation. Host. The Host Certificate provides that the corporation may enter into contracts or transact business with one or more of its officers or directors, or with any firms of which one or more of its officers or directors is a member, or may invest its funds in the securities of and may enter into contracts, or transact business with any corporation or association in which any one or more of its officers or directors is a stockholder, officer or director, and in the absence of bad faith, or unfair dealing, such contract or transaction or investment shall not be 68 invalidated or to any extent affected by the fact that any such officer or officers or any such director or directors has or may have interests therein which are or might be adverse to the interests of the corporation, provided that the remaining directors are sufficient in number to ratify and approve the transaction. MGCL. Under the MGCL, a 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 director, or has a material financial interest, is not 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. As a Maryland corporation, Host REIT will be subject to the foregoing provisions with respect to transactions between Host REIT and its directors. Host REIT's Board of Directors also intends to adopt 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. See "Distribution and Other Policies--Conflicts of Interest Policies." LIMITATION OF LIABILITY AND INDEMNIFICATION OF DIRECTORS AND OFFICERS DGCL. Under the DGCL, directors may be indemnified for liabilities incurred in connection with specified actions (other than any action brought by or in the right of the corporation), if they acted in good faith and in a manner they reasonably believed to be in and not opposed to the best interests of the corporation and, with respect to any criminal action or proceeding, had no reasonable cause to believe their conduct was unlawful. The same standard of conduct is applicable for indemnification in the case of derivative actions brought by or in the right of the corporation, except that in such cases the DGCL authorizes indemnification only for expenses (including attorneys' fees) incurred in connection with the defense or settlement of such cases. Moreover, the DGCL requires court approval before there can be any such indemnification where the person seeking indemnification has been found liable to the corporation in a derivative action. To the extent that a present or former director or officer has been successful in defense of any action, suit or proceeding, the DGCL provides for indemnification of such person for expenses (including attorneys' fees). The DGCL states expressly that the indemnification provided by or granted pursuant to the DGCL is not deemed exclusive of any non-statutory indemnification rights existing under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise. Host. Host's Certificate of Incorporation and Bylaws provide that every director, officer and employee of Host shall be indemnified against all expenses and liabilities, including counsel fees, reasonably incurred by or imposed upon him by reason of his being or having been a director, officer or employee of Host. Under Host's Certificate, no director shall be liable to Host or its shareholders for monetary damages, for breach of fiduciary duty as a director, except for liability (a) for any breach of the director's duty of loyalty to the corporation or its 69 shareholders, (b) for acts or omissions not in good faith or which involve intentional misconduct or knowing violation of law, (c) under section 174 of the DGCL (concerning unlawful payment of dividend or unlawful stock purchase or redemption), or (d) for any transaction from which the directors derived an improper personal benefit. MGCL. 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 (i) actual receipt of an improper benefit or profit in money, property or services or (ii) acts committed in bad faith or active and deliberate dishonesty established by a final judgment as being material to the cause of action; or (iii) in the case of any criminal proceeding, the director having reasonable cause to believe that an act or omission was unlawful. The MGCL further provides that a Maryland corporation may not indemnify for an adverse judgment in a suit by or in the right of the corporation. The MGCL expressly states that the indemnification or advancement of expenses authorized by the MGCL shall not be deemed exclusive of any other rights, by indemnification or otherwise, to which a director or officer may be entitled under the charter, the bylaws, a resolution of the stockholders or directors, an agreement or otherwise. Host REIT. The Host REIT Charter will provide that to the fullest extent permitted by Maryland statutory or decisional law, as amended or interpreted, no director or officer of Host REIT shall be personally liable to Host REIT or its stockholders for money damages. No amendment of the Host REIT Charter or repeal of its provisions will limit the benefits provided to directors and officers under this provision with respect to any act or omission which occurred prior to such amendment or repeal. The Host REIT Charter and Host REIT Bylaws will provide broad indemnification to directors and officers, whether serving Host REIT, or at its request, any other entity, to the fullest extent permitted under Maryland law. Host REIT will indemnify any present or former director and officer, (A) who has been successful, on the merits or otherwise, in defense of a proceeding to which he or she was made a party by reason of service in such capacity against reasonable expenses incurred by such officer or director in connection with the proceeding, and (B) 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 (i) the act or omission of the director or officer was material to the matter giving rise to the proceeding and (a) was committed in bad faith or (b) was the result of active and deliberate dishonesty, (ii) the director or officer actually received an improper personal benefit in money, property or services or (iii) in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. The Bylaws of Host REIT require Host REIT, as a condition to advancing expenses, to obtain (i) 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 (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 agreements indemnifying each of its directors and officers to the fullest extent permitted by Maryland law and to advance to its directors and officers all related expenses subject to reimbursement if it is subsequently determined that indemnification is not permitted. See "--Limitation of Liability and Indemnification of Directors and Officers" 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 Host REIT Charter. DECLARATION OF DIVIDENDS DGCL. Under the DGCL, a corporation is permitted to declare and pay dividends out of surplus (as defined in the DGCL) or, if there is no surplus, out of net profits for the fiscal year in which the dividend is declared and/or for the preceding fiscal year as long as the amount of capital of the corporation following the declaration and payment of the dividend is not less than the aggregate amount of the capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets. Dividends may be 70 paid in cash, property or shares of a corporation's capital stock. In addition, the DGCL generally provides that a corporation may redeem or repurchase its shares only if such redemption or repurchase would not impair the capital of the corporation. Host. The Host Bylaws provide that dividends upon the capital stock of Host, subject to the provisions of the Host Certificate, if any, may be declared by the Host Board at any regular or special meeting, pursuant to law. Dividends may be paid in cash, in property, or in shares of the capital stock, subject to the provisions of the Host Certificate. MGCL. Under the MGCL, if authorized by its board of directors, a Maryland corporation may declare and pay dividends subject to any restriction in its charter unless, after giving effect to the dividend, (i) the corporation would not be able to pay indebtedness of the corporation as the indebtedness becomes due in the usual course of business, or (ii) the corporation's total assets would be less than the sum of the corporation's total liabilities plus, unless the charter permits otherwise, the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of the stockholders whose preferential rights on dissolution are superior to those receiving the dividend. Host REIT. Under the Host REIT Bylaws, dividends upon the shares of stock of Host REIT may be authorized and declared by the directors, subject to the provisions of law and the Host REIT Charter. Under the Host REIT Charter, subject to the provisions of law and any preferences of any class of the capital stock of Host REIT, classified or reclassified, dividends (including dividends payable in shares of another class of Host REIT stock) will be able to be paid on Host REIT Common Stock at such time and in such amounts as the Board of Directors may deem advisable and the holders of Host REIT Common Stock shall share ratably in any such dividends, in proportion to the number of shares of Host REIT Common Stock held by them respectively, on a share for share basis. The Host REIT Bylaws provide that dividends and other distributions may be paid in cash, property, or shares of the Corporation, subject to Maryland law and the Charter. Host REIT and the Operating Partnership currently intend to pay regular quarterly distributions to holders of shares of Host REIT Common Stock and OP Units. For a discussion of Host REIT's distribution policy, see "Distribution and Other Policies--Distribution Policy." APPRAISAL RIGHTS DGCL. Under the DGCL, the right to receive the fair value of dissenting shares is made available to stockholders of a constituent corporation in a merger or consolidation effected under the DGCL. Dissenters' rights of appraisal are not available for the shares of any class or series of stock, which stock, or depository receipts in respect thereof, at the record date fixed to determine stockholders entitled to receive notice and vote on such transaction, were either (i) listed on a national securities exchange or designated as a national market system security on an interdealer quotation system by the National Association of Security Dealers, Inc. or (ii) held of record by more than 2,000 holders. Further, no appraisal rights are available for any shares of stock of the constituent corporation surviving a merger if the merger did not require for its approval the vote of the stockholders of the surviving corporation as provided by the DGCL. Notwithstanding the foregoing, appraisal rights under the DGCL are available for the shares of any class or series of stock of a constituent corporation if the holders thereof are required by the terms of an agreement of merger or consolidation pursuant to the DGCL to accept for such stock anything except (i) shares of stock of the corporation surviving or resulting from such merger or consolidation, or depository receipts in respect thereof, (ii) shares of stock of any other corporation, or depository receipts in respect thereof, which shares of stock (or depository receipts in respect thereof) will be either listed on a national securities exchange or designated as a national market system security on an interdealer quotation system by the National Association of Securities Dealers, Inc., or held of record by more than 2,000 holders, (iii) cash in lieu of fractional shares, or (iv) any combination of the shares of stock, depository receipts and cash in lieu of such fractional shares. 71 MGCL. Under the MGCL, a stockholder of a Maryland corporation has the right to demand and receive payment of the fair value of the stockholder's stock from the corporation if, among other things, the corporation consolidates or merges with another corporation. However, unless the transaction is governed by certain provisions specified by the MGCL, a stockholder may not demand the fair value of his stock and is bound by the terms of the transaction if (i) the stock is listed on a national securities exchange or is designated as a national market system security on an interdealer quotation system by the National Association of Securities Dealers, Inc.; (ii) the stock is that of the successor in a merger, unless (a) the merger alters the contract rights of the stock as expressly set forth in the charter, and the charter does not reserve the right to do so, or (b) the stock is to be changed or converted in whole or in part in the merger into something other than either stock in the successor or cash, scrip, or other rights or interests arising out of the provisions for the treatment of fractional shares of stock in the successor; or (iii) the stock is that of an open-end investment company registered with the SEC under the Investment Company Act of 1940 and the value placed on the stock in the transaction is its net asset value. MERGER, CONSOLIDATION, SHARE EXCHANGE AND TRANSFER OF ALL OR SUBSTANTIALLY ALL ASSETS DGCL. Under the DGCL, the principal terms of a merger or consolidation generally require the approval of the stockholders of each of the constituent corporations. Unless otherwise required in a corporation's certificate of incorporation, the DGCL does not require a stockholder vote of the surviving corporation in a merger if (i) the agreement of merger does not amend in any respect the certificate of incorporation of such constituent corporation, (ii) each share of stock of such constituent corporation outstanding immediately prior to the effective date of the merger is to be an identical outstanding or treasury share of the surviving corporation after the effective date of the merger, and (iii) either no shares of common stock of the surviving corporation and no shares, securities or obligations convertible into such stock are to be issued or delivered under the plan of merger, or the authorized unissued shares or the treasury shares of common stock of the surviving corporation to be issued or delivered under the plan of merger plus those initially issuable upon conversion of any other shares, securities or obligations to be issued or delivered under such plan do not exceed 20% of the shares of common stock of such constituent corporation outstanding immediately prior to the effective date of the merger. When a stockholder vote is required under the DGCL to approve a merger or consolidation, unless the certificate of incorporation provides otherwise, the affirmative vote of a majority of shares present in person or represented by proxy for each class of shares entitled to vote on the merger or consolidation shall be required to approve the merger or consolidation. If multiple classes of stock are entitled to vote on the merger or consolidation as separate classes, then a majority of each class entitled to vote to approve the merger or consolidation, voting separately as a class, shall be required to approve the merger or consolidation. Under the DGCL, a corporation may at any meeting of its board of directors or governing body, sell, lease or exchange all or substantially all of its property and assets, including its goodwill and its corporate franchises, upon such terms and conditions and for such consideration, which may consist in whole or in part of money or other property, including shares of stock in, and/or other securities of, any other corporation or corporations, as its board of directors or governing body deems expedient and for the best interests of the corporation, when and as authorized by a resolution adopted by the holders of a majority of the outstanding stock of the corporation entitled to vote thereon. Host. The Host Certificate provides that the affirmative vote of the holders of shares representing not less than 66 2/3% of the voting power of the corporation shall be required for the approval of any proposal for the corporation to reorganize, merge, or consolidate with any other corporation, or to sell, lease, or exchange substantially all of its assets or business. MGCL. The MGCL generally provides that mergers, consolidations, share exchanges or transfers of assets must first be approved by a majority of the board of directors and thereafter approved by stockholders 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 stockholder vote but not less than a majority of the number of votes entitled to be cast on the matter). However, under the MGCL, certain mergers may be accomplished without a vote of stockholders. For 72 example, no stockholder 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 stockholders 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 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 and by any other action required by its charter. 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 stockholders, 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. Host REIT. Pursuant to the Host REIT Charter, subject to the terms of any class or series of capital stock at the time outstanding, Host REIT will be able to merge with or into another entity, consolidate with one or more other entities, participate in a share exchange or transfer its assets within the meaning of the MGCL, but any such merger consolidation, share exchange or transfer of assets must be approved by the Board of Directors in the manner provided in the MGCL. The Host REIT Charter generally will provide for stockholder approval of such transactions by a two-thirds vote of all votes entitled to be cast (subject to the above enumerated statutory exceptions to a stockholder vote), 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 stockholders of Host REIT by the affirmative vote only of a majority of all the votes entitled to be cast on the matter, provided that (i) the stockholders of the trust immediately following the merger are the same as the stockholders of Host REIT immediately prior to the merger and (ii) the trust's declaration of trust contains amendment provisions substantially equivalent to those contained in specified provisions of the Host REIT Bylaws. CHANGES IN CONTROL PURSUANT TO DELAWARE/MARYLAND LAW DGCL. Section 203 of the DGCL provides that, subject to certain exceptions specified therein, a corporation will not engage in any business combination with any "interested stockholder" for a three-year period following the time that such stockholder becomes an interested stockholder unless (i) prior to such time the board of directors of the corporation approved either the business combination or the transaction which resulted in the stockholder becoming an interested stockholder, (ii) upon consummation of the transaction which resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced (excluding for purposes of determining the number of shares outstanding those shares owned by persons who are directors and also officers, and employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer), or (iii) at or subsequent to such time the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least 66 2/3% of the outstanding voting stock which is not owned by the interested stockholder. Except as specified in Section 203 of the DGCL, an interested stockholder is defined to include any person that (a) is the owner of 15% or more of the outstanding voting stock of the corporation, or (b) is an affiliate or associate of the corporation and was the owner of 15% or more of the outstanding voting stock of the corporation at any time within the 3-year period immediately prior to the date on which it is sought to be determined whether such person is an interested stockholder; and the affiliates and associates of such person. Section 203(b)(4) exempts from the restrictions in Section 203 a corporation that does not have a class of voting stock that is (i) listed on a national securities exchange, (ii) authorized for quotation on The NASDAQ Stock Market, or (iii) held of record by more than 2,000 stockholders, unless any of the foregoing results from action taken, directly or indirectly, by an interested stockholder or from a transaction in which a person becomes an interested stockholder. 73 Host. The Host Certificate provides that in addition to any affirmative vote required by law or by the Host Certificate, certain Business Combinations (as defined in the Host Certificate) involving "interested shareholders" (as defined below) require the affirmative vote of the holders of at least 66 2/3% of the Voting Stock, voting together as a single class unless the Business Combination is approved by a majority of the Disinterested Directors (as defined in the Host Certificate) or certain other conditions are satisfied. An "interested shareholder" is defined by the Host Certificate as any person (other than Host or any subsidiary of Host) who or which (i) is the beneficial owner, directly or indirectly, of more than 25% of the voting power of the outstanding Voting Stock, (ii) is an affiliate of Host (as defined in the Host Certificate) and at any time within the two-year period immediately prior to the date in question was the beneficial owner, directly or indirectly, of 25% or more of the voting power of the then outstanding Voting Stock, or (iii) is an assignee of or has otherwise succeeded to any shares of Voting Stock which were at any time within the two-year period immediately prior to the date in question beneficially owned by any "interested shareholder," if such assignment or succession shall have occurred in the course of a transaction or series of transactions not involving a public offering within the meaning of the Securities Act. MGCL. Under the MGCL, certain "business combinations" (including certain issuances of equity securities) between a Maryland corporation and any Interested Stockholder or an affiliate of the Interested Stockholder are prohibited for five years after the most recent date on which the Interested Stockholder becomes an Interested Stockholder. 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 those held by an Interested Stockholder unless, among other conditions, the corporation's common stockholders 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 Stockholder. A business combination that is approved by the board of directors of a Maryland corporation at any time before an Interested Stockholder first becomes an Interested Stockholder is not subject to the special voting requirements. Host REIT has not "opted-out" of the business combination provisions of the MGCL and, accordingly, will be subject to such provisions although Host REIT may elect to opt-out of these provisions in the future. The Board of Directors of Host REIT has adopted a resolution exempting from the operation of the "business combination" statute the acquisition of shares by Marriott International (together with its successors and permitted assignees, if any) pursuant to the terms of the Marriott International Purchase Right as well as any other transactions involving Host REIT, Marriott International, J.W. Marriott, Jr. and Richard E. Marriott; provided that any such transaction with Marriott International that is not in the ordinary course of business or with J.W. Marriott, Jr. or Richard E. Marriott must be approved by a majority of the directors of the Company present at a meeting at which a quorum is present, including a majority of the disinterested directors, in addition to any vote of stockholders required by other provisions of the MGCL. The MGCL further provides that "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, (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 stockholder approval. A "control share acquisition" means the acquisition of control shares, subject to certain exceptions. The Bylaws of Host REIT will contain an exemption from the control share acquisition provisions for any shares acquired by Marriott International (together with its successors and permitted assignees, if any) pursuant to the Marriott International Purchase Right, to the extent it is exercised. Host REIT. The Host REIT Charter will not contain a Fair Price Provision similar to the provision in the Host Certificate. Host REIT has not "opted- out" of the business combination or "control share" acquisition provisions of the MGCL, and, accordingly will be subject to such provisions. However, as permitted by the MGCL, Host REIT's Board of Directors may elect to opt out of these provisions in the future. 74 STOCKHOLDER RIGHTS PLAN Host. Host currently has in effect a stockholder rights plan pursuant to the Host Rights Agreement and it has preferred stock purchase rights attached to the Host Common Stock pursuant to such rights plan. Host REIT. Host REIT intends to adopt the Stockholder Rights Plan to replace the existing stockholder rights plan of Host. All shares of Host REIT Common Stock issued by Host REIT between the date of adoption of the Stockholder Rights Plan and the rights distribution date, or the date, if any, on which the preferred stock purchase rights are redeemed would have preferred stock purchase rights attached to them. See "Description of Host REIT Capital Stock--Certain Provisions of Maryland Law and the Host REIT Charter and Host REIT Bylaws--Stockholder Rights Plan." The Stockholder Rights Plan is expected to provide, among other things, that upon the occurrence of certain events, stockholders will be entitled to purchase from Host REIT a newly created series of junior preferred stock, subject to Host REIT's Ownership Limit. See "Description of Host REIT Capital Stock" and "Certain Provisions of Maryland Law and the Host REIT Charter and Bylaws." The discussion of the comparative rights of stockholders of Host and shareholders of Host REIT set forth above is not complete and is subject to and qualified in its entirety by reference to the DGCL and the MGCL and to the Host Certificate, Host Bylaws and the Host Rights Agreement and the Host REIT Charter, Host REIT Bylaws and the Shareholder Rights Plan. Copies of the Host REIT Charter and Host REIT Bylaws are attached as Exhibits B and C, respectively, to the Agreement, which is attached to this Proxy Statement/Prospectus as Appendix A. LIMITATION OF LIABILITY AND INDEMNIFICATION OF DIRECTORS AND OFFICERS 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 stockholders for money damages except for liability resulting from (a) actual receipt of an improper benefit or profit in money, property or services or (b) acts committed in bad faith or active and deliberate dishonesty established by a final judgment as being material to the cause of action. The Host REIT Charter will contain such a provision which limits such liability to the maximum extent permitted by Maryland law. The Host REIT Charter will authorize 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 Host REIT Bylaws 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 director, trustee, 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 Host REIT Charter and Host REIT 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 Host REIT 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, and permits a corporation to indemnify its present and former directors and officers, 75 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 a director or officer in a suit by or in the right of the corporation if such director or officer has been adjudged to be liable to the corporation. In accordance with the MGCL, the Host REIT Bylaws 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 Host REIT 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. Host REIT intends to enter into indemnification agreements with each of its directors and officers. The indemnification agreements 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 or officers all related expenses, subject to reimbursement if it is subsequently determined that indemnification is not permitted. The Partnership Agreement also provides for indemnification of Host REIT and its officers and directors to the same extent that indemnification is provided to officers and directors of Host REIT in the Host REIT 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 stockholders is limited under the Host REIT Charter. See "Description of the Partnership Agreement and OP Units--Exculpation and Indemnification of Host REIT." 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 Commission such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. 76 THE REIT CONVERSION The transactions summarized below, together with the Restructuring Transactions, collectively constitute the transactions pursuant to which Host will restructure its business so that it will qualify as a REIT. If the required corporate (Board and stockholder) 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 Restructuring Transactions are expected to occur at the final stage of the REIT Conversion, although certain of the transactions comprising the REIT Conversion (such as the Partnership Mergers, the Private Partnership Transactions and the Blackstone Acquisition) may occur after the Restructuring Transactions to the extent they are consummated. Although a number of the transactions comprising the REIT Conversion are expected to be consummated immediately prior to, or in certain instances immediately following, the Merger, the Merger will not be consummated unless the other conditions to the Merger have been satisfied or waived. In particular, Host's Board of Directors will have determined, among other things, that the transactions constituting the REIT Conversion which impact Host REIT's status as a REIT for federal income tax purposes have occurred or are reasonably likely to occur, and based on 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 prior to January 1, 1999). Consistent with the foregoing, Host intends to pursue the transactions constituting the REIT Conversion at least through the date of the Special Meeting of Host stockholders. If the Agreement is approved by Host stockholders at the Special Meeting, Host intends to continue pursuing those transactions constituting the REIT Conversion which have not yet been completed, including the Blackstone Acquisition (which is not expected to be consummated any earlier than December 29, 1998). In addition, if the Board of Directors has determined that the conditions to the Merger have been or likely will be satisfied or waived (and, in particular, that the transactions constituting the REIT Conversion which impact Host REIT's status as a REIT for federal income tax purposes have occurred or are reasonably likely to occur), the Board intends to declare the Initial E&P Distribution and enter into the Leases with the Lessees (which will be indirect, wholly-owned subsidiaries of Crestline). Under such circumstances, however, the Merger and other transactions comprising the REIT Conversion still might be delayed or possibly might never be consummated. Assuming the Agreement is approved by Host stockholders at the Special Meeting and the Host Board of Directors makes the determination described above, it is currently contemplated that the Merger would be consummated on or about December 29, 1998, subject to satisfaction or waiver of the remaining conditions. If, however, the Agreement is not approved by the Host stockholders at the Special Meeting or the Host Board of Directors does not make the requisite determinations, Host will continue to operate as a Delaware corporation, the REIT Conversion will not be completed at this time and the Initial E&P Distribution will not be made. 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 estimated cash distributions) and could cause the Blackstone Acquisition (which is conditioned, among other things, on consummation of the REIT Conversion by March 31, 1999 and Host REIT qualifying as a REIT for 1999) not to be consummated. In view of the complexity of the REIT Conversion, the number of transactions that must occur to complete the REIT Conversion and the time and expense involved, Host believes that it is advisable to complete the REIT Conversion, or as many of the transactions comprising the REIT Conversion as possible, as soon as practicable even if such completion is after January 1, 1999 (and, thus, a REIT election would not be effective until January 1, 2000). Moreover, completion of the REIT Conversion (or a significant number of the transactions comprising the REIT Conversion) could possibly facilitate another transaction (such as a merger into another entity) that would enable Host (or its successor) to elect to be treated as a REIT prior to January 1, 2000. 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 another transaction that would 77 permit it to commence a new taxable year and elect REIT status prior to January 1, 2000, although no assurance can be given that the Company will enter into or consummate such other transaction or otherwise qualify as a REIT 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, assuming it so qualified. THE INITIAL E&P DISTRIBUTION In order to qualify as a REIT for federal income tax purposes, among other things, Host REIT and/or Host, as its predecessor, must have distributed all of the accumulated E&P of Host to its stockholders in one or more taxable dividends prior to the end of the first full taxable year for which the REIT election of Host is effective, which currently is expected to be the taxable year commencing January 1, 1999 (but which might not be until the year beginning January 1, 2000). In an effort to help accomplish the requisite distributions of the accumulated E&P of Host, Host or Host REIT will make the Initial E&P Distribution, consisting of one or more taxable distributions, to its stockholders in connection with the REIT Conversion. Such taxable distributions would consist of shares of common stock of Crestline and cash or other consideration in an amount to be determined. Although there is no assurance as to what form such other consideration comprising the Initial E&P Distribution will take, it is currently contemplated that it will include the Special Dividend, payable, at each stockholder's election, in cash or Host Common Stock (or Host REIT Common Stock if the Merger has occurred). If the Special Dividend is declared, stockholders of record on the Special Dividend record date will be given approximately 20 days to decide whether to take cash, Host Common Stock (or Host REIT Common Stock if the Merger has occurred), or a combination of cash and stock in payment of the Special Dividend. It is anticipated that the cash/stock election will be available on a per-share basis and that, once made, stockholders' elections will be irrevocable. Stockholders entitled to the Special Dividend who fail to make a timely election will receive shares of Host Common Stock (or Host REIT Common Stock if the Merger has occurred), subject to the Ownership Limit, in payment of the Special Dividend. In any event, cash would be paid in lieu of fractional shares, and the Special Dividend payment would be made promptly following expiration of the election period. The aggregate value of the Crestline common stock and the cash or other consideration to be distributed to Host stockholders (and the Blackstone Entities) in connection with 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 stockholders), of which approximately $200 to $300 million (or approximately $.80 to $1.20 per share) is expected to be represented by the Special Dividend. The actual amount of the Initial E&P Distribution will be based in part upon the estimated amount of accumulated E&P of Host as of the last day of its taxable year ending on or immediately following completion of the REIT Conversion. To the extent that the Initial E&P Distribution is not sufficient to eliminate Host's accumulated E&P, Host REIT will make one or more additional taxable distributions to its stockholders (in the form of cash or securities) prior to the last day of Host REIT's first full taxable year as a REIT (currently expected to be December 31, 1999 but which instead might be December 31, 2000) in an amount intended to be sufficient to eliminate such E&P, 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. Limited Partners who elect to receive Host REIT Common Stock in exchange for OP Units in connection with the Partnership 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 stockholders of Host REIT (approximately 25 trading days after the effective date of the Partnership Mergers). However, following receipt of such shares of Host REIT Common Stock, such Limited Partners would participate as stockholders of Host REIT in other dividends or distributions by Host REIT to holders of Host REIT Common Stock, including any additional taxable distributions necessary to eliminate Host's accumulated E&P to the extent the Initial E&P Distribution is not sufficient to eliminate such accumulated E&P. The Limited Partners who elect to retain OP Units also will participate in such additional distributions because distributions by the Operating Partnership to its partners (including Host REIT) would be the source of such additional distributions. 78 No holder of Host Common Stock will be required to pay any cash or other consideration to Host or Host REIT for shares of Crestline common stock received in the Initial E&P Distribution or to surrender or exchange their Host Common Stock or Host REIT Common Stock in order to receive shares of Crestline common stock or other cash or securities as part of the Initial E&P Distribution. See "The REIT Conversion--The Initial E&P Distribution." In addition, following the Restructuring Transactions, the Blackstone Entities are entitled to receive a pro rata portion of the same consideration received by Host REIT's stockholders in connection with the Initial E&P Distribution, except to the extent the Blackstone Entities elected to receive additional OP Units in lieu thereof pursuant to the terms of the Blackstone Acquisition. The payment to the Blackstone Entities of Crestline common stock shares and other consideration is expected to be approximately $90 to $110 million of the aggregate Initial E&P Distribution of approximately $525 to $625 million if the REIT Conversion and the Blackstone Acquisition are consummated. See "Business and Properties--Blackstone Acquisition." Following the Initial E&P 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 Host REIT 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 non-competition arrangements) with respect to future acquisitions between Host REIT and Crestline and they expect stockholders 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. The Host Board believes that the distribution of Crestline common stock to Host stockholders as part of the Initial E&P Distribution will provide those Host stockholders who continue to hold Crestline common stock with a separate identifiable interest in a diversified company that generates revenue from both its senior living business and its leasing business. Even under circumstances where the Crestline common stock is distributed to Host stockholders as part of the Initial E&P Distribution but the Merger or other transactions comprising the REIT Conversion are delayed or possibly never consummated, the Host Board believes that having existing leasing arrangements in place with Crestline could facilitate any subsequent efforts by Host to qualify as a REIT for federal income tax purposes (including efforts to pursue a merger with another entity or another transaction that would permit it to commence a new taxable year and elect REIT status prior to January 1, 2000). OTHER TRANSACTIONS COMPRISING THE REIT CONVERSION In addition to the Restructuring Transactions and the Initial E&P Distribution, the REIT Conversion includes the following additional transactions: . Debt Refinancing. In August 1998, Host refinanced $1.55 billion of outstanding senior notes 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 Senior Note 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 Host REIT 79 Common Stock, 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, Host REIT will issue shares of Host REIT Common Stock, which will be delivered to such holder. Upon the issuance of such shares by Host REIT, the Operating Partnership will issue to Host REIT a number of OP Units equal to the number of shares of Host REIT Common Stock issued in exchange for the debentures. As a result of the distribution of Crestline common stock and any cash and other consideration to Host or Host REIT stockholders 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 "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." . The Partnership Mergers. Immediately following the Effective Date, each Partnership participating in the Partnership Mergers will merge with a subsidiary of the Operating Partnership. Such participating Partnerships will be the surviving entities of the Partnership Mergers and will continue in existence as indirect subsidiaries of the Operating Partnership. In the Partnership Mergers, each Limited Partner will receive a number of OP Units with a deemed value equal to the stated exchange value of his respective partnership interest. If a Limited Partner elects to receive Host REIT Common Stock or a Note in exchange for OP Units in connection with the Partnership 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 shares of Host REIT Common Stock or to the Operating Partnership in exchange for a Note with a specified principal amount. The general partners of the Partnerships, each of which is a wholly-owned, direct or indirect subsidiary of Host, and other subsidiaries of Host also will 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 Partnership 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 Partnership 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 that it receives from Host and its subsidiaries to a Non-Controlled Subsidiary. In addition, the Operating Partnership has reserved the right to exclude any Partnership from participation in the REIT Conversion (even if the requisite percentage of Limited Partners has voted to approve the Partnership Merger and each of the other conditions to such Partnership Merger has been satisfied or waived) if the Operating Partnership determines, in its sole discretion, that such exclusion is in the best interests of the Operating Partnership. Any such Partnership that is so excluded shall be treated as a Partnership that does not participate in a Partnership Merger, as described above, and its Limited Partners will continue to hold their respective interests in the Partnerships. . 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. 80 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 $12.50 per OP Unit):
NEGOTIATED VALUE OF NUMBER OF PARTNERSHIP OP UNITS OP UNITS - ----------- ------------------- --------- HMC BN Limited Partnership..................... $20,600,000 1,648,000 Ivy Street Hotel Limited Partnership........... 4,050,000 324,000 Times Square Marquis Hotel, L.P................ 7,499,000 599,920 HMC/RGI Hartford Limited Partnership........... 10,500,000 840,000
. 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, the Blackstone Hotels. 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 pursuant to a Unit Redemption Right 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 issued in the Blackstone Acquisition will have registration rights under a shelf registration statement with respect to Host REIT Common Stock 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 Merger) 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 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 Host REIT Common Stock, 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 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 Host REIT 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 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. 81 . 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 FF&E 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 Partnership Mergers, certain of the Partnerships (assuming they participate in the Partnership Mergers) will sell to a Non- Controlled Subsidiary an estimated $180 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/Charitable 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 indirect income beneficiaries of the Host Employee/Charitable Trust will be employees of Host REIT eligible to participate in Host's Comprehensive Stock Incentive Plan (excluding Directors of Host REIT and certain other highly compensated employees). Upon termination of the Host Employee/Charitable Trust, the residual assets, if any, are to be distributed to a charitable organization designated in its charter. . Leases of Hotels. The Operating Partnership, its subsidiaries and its controlled partnerships, including the Partnerships participating in the Partnership Mergers, 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." 82 Following the REIT Conversion, assuming the Full Participation Scenario, the organizational structure of Host REIT is expected to be as follows: (1) Represents Limited Partners and others who retain OP Units and do not elect to receive shares of Host REIT Common Stock or Notes; excludes Host and its subsidiaries. (2) Also will include Limited Partners in the Partnership Mergers who elect to receive shares of Host REIT Common Stock in exchange for the OP Units received in the Partnership Mergers. Immediately following the Restructuring Transactions and the distribution by Host or Host REIT of Crestline common stock to its stockholders and receipt of Crestline common stock by the Blackstone Entities, the stockholders of Crestline will consist of the stockholders (other than Limited Partners who elect to receive Host REIT Common Stock in connection with the Partnership 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 Host REIT Common Stock or Notes in connection with the Partnership Mergers and that the price per share of Host REIT Common Stock is $12.50 for purposes of the Partnership Mergers. (4) The Operating Partnership will own all or substantially all of the equity interests in the Partnerships participating in the Partnership Mergers, 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 Partnerships that do not participate in the Partnership Mergers 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. 83 Ownership Interests in the Operating Partnership Following the Restructuring Transactions and the other transactions comprising the REIT Conversion. Following the Restructuring Transactions and the other transactions comprising the REIT Conversion, the Operating Partnership is expected to be owned as set forth below: OWNERSHIP OF THE OPERATING PARTNERSHIP
ENTITY PERCENTAGE INTEREST(1) ------ ---------------------- Host REIT............................................. 74.5% Limited Partners of the Partnerships.................. 8.4 Private Partnerships.................................. 1.2 Blackstone Entities................................... 15.9 ----- TOTAL............................................... 100.0% =====
- -------- (1) Assumes that all Partnerships participate in the Partnership Mergers, that the Blackstone Acquisition is consummated, that all Limited Partners in the Partnership Mergers elect to retain OP Units and that the price of an OP Unit is $12.50 per share for purposes of the Partnership 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 Host REIT Common Stock or Notes in exchange for their OP Units in connection with the Partnership Mergers or if the price per OP Unit in the Partnership Mergers is greater than $12.50. The percentage interest of Host REIT will decrease, and the percentage interest of the Limited Partners will increase, if the price per OP Unit in the Partnership Mergers is less than $12.50. 84 OPINION OF FINANCIAL ADVISOR OPINION OF BT WOLFENSOHN, FINANCIAL ADVISOR TO HOST BT Wolfensohn has acted as financial advisor to Host in connection with the REIT Conversion. On November , 1998, BT Wolfensohn delivered its written opinion to the Host Board of Directors to the effect that, as of the date of such opinion, based upon and subject to the assumptions made, matters considered and limits of the review undertaken by BT Wolfensohn, certain transactions to be effected by Host in connection with the conversion to a REIT described below, taken together, (the "REIT Transactions") were fair, from a financial point of view, to Host stockholders. For the purposes of BT Wolfensohn's opinion, the REIT Transactions mean (i) the contribution by Host of its wholly-owned full-service hotels, certain interests in hotel partnerships and certain other assets to the Operating Partnership in exchange for units of limited and general partnership interest in the Operating Partnership and the assumption of liabilities, (ii) the reincorporation of Host from the State of Delaware to the State of Maryland by merging Host into Host REIT, (iii) the taxable Initial E&P Distribution by Host to its stockholders which Host has advised BT Wolfensohn will consist of shares of common stock of Crestline and a special dividend of approximately $250 million in cash or, at the election of Host common stockholders, in Host REIT Common Stock, (iv) the assumption by the Operating Partnership of the debentures underlying the Convertible Preferred Securities and other indebtedness of Host and the related conversion price adjustment of such debentures, (v) the acquisition by merger of the Partnerships pursuant to the Partnership Mergers, (vi) the acquisition of partnership interests from unaffiliated partners of four limited partnerships that own one or more full- service hotels and that are partially but not wholly-owned by Host or one of its subsidiaries in exchange for OP Units, (vii) the Blackstone Acquisition, (viii) the creation and capitalization of the taxable Non-Controlled Subsidiaries, and (ix) the leasing of virtually all of the full-service hotels owned or controlled by the Operating Partnership for initial terms ranging generally from seven to ten years to the Lessees, whereby the Lessees will operate the hotels under the existing brand names and pursuant to their existing management agreements. The terms and conditions of the transactions comprising the REIT Transactions are more fully described in this Proxy Statement/Prospectus. THE FULL TEXT OF BT WOLFENSOHN'S WRITTEN OPINION, DATED NOVEMBER , 1998 (THE "BT WOLFENSOHN OPINION"), WHICH SETS FORTH, AMONG OTHER THINGS, THE ASSUMPTIONS MADE, MATTERS CONSIDERED AND LIMITS ON THE REVIEW UNDERTAKEN BY BT WOLFENSOHN IN CONNECTION WITH THE OPINION, IS ATTACHED AS APPENDIX B TO THIS PROXY STATEMENT/PROSPECTUS AND IS INCORPORATED HEREIN BY REFERENCE. HOST STOCKHOLDERS ARE URGED TO READ THE BT WOLFENSOHN OPINION IN ITS ENTIRETY. THE SUMMARY OF THE BT WOLFENSOHN OPINION SET FORTH IN THIS PROXY STATEMENT/PROSPECTUS IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE FULL TEXT OF THE BT WOLFENSOHN OPINION. In connection with BT Wolfensohn's role as financial advisor to Host, and in arriving at its opinion, BT Wolfensohn has, among other things, reviewed certain publicly available financial information and other information concerning Host and certain internal analyses and other information furnished to it by Host and Crestline. BT Wolfensohn also held discussions with the members of the senior management of Host and Crestline regarding the businesses and prospects of Host and Crestline. In addition, BT Wolfensohn (i) reviewed the reported prices and trading activity for the common stock of Host, (ii) compared certain financial and stock market information for Host with similar information for certain companies whose securities are publicly traded, (iii) reviewed certain public information of certain companies it deemed appropriate in analyzing Host and Crestline, and (iv) performed such other studies and analyses and considered such other factors as it deemed appropriate. BT Wolfensohn did not receive any instructions from Host or any affiliate of Host. In preparing its opinion, BT Wolfensohn did not assume responsibility for the independent verification of, and did not independently verify, any information, whether publicly available or furnished to it, concerning Host and Crestline, including, without limitation, any financial information, forecasts or projections, considered in connection with the rendering of its opinion. Accordingly, for purposes of its opinion, BT Wolfensohn assumed 85 and relied upon the accuracy and completeness in all material respects of all such information. BT Wolfensohn did not conduct a physical inspection of any of the properties or assets, and did not prepare or obtain any independent evaluation or appraisal of any of the assets or liabilities of Host and Crestline. With respect to the financial forecasts and projections made available to BT Wolfensohn and used in its analysis, BT Wolfensohn has assumed that they have been reasonably prepared on bases reflecting the best currently available estimates and judgments of the management of Host and Crestline as to the matters covered thereby. In rendering its opinion, BT Wolfensohn expressed no view as to the reasonableness of such forecasts and projections, or the assumptions on which they are based. The BT Wolfensohn Opinion was necessarily based upon economic, market and other conditions as in effect on, and the information made available to BT Wolfensohn as of, the date of such opinion. For purposes of rendering its opinion, BT Wolfensohn has assumed that the REIT Transactions will take place prior to or in connection with Host's election of REIT status in accordance with Sections 856 through 860 of the Code (the "REIT Rules"). For purposes of rendering its opinion, BT Wolfensohn has analyzed the REIT Transactions assuming alternatively that the Blackstone Acquisition is not consummated or is consummated in accordance with the terms of such transaction. BT Wolfensohn has also assumed that all material federal, state, local and other approvals and consents required in connection with the REIT Transactions will be obtained and that in connection with obtaining any necessary federal, state, local and other approvals and consents, or any amendments, modifications or waivers to any agreements, instruments or orders to which Host is a party or subject or by which it is bound, no limitations, restrictions or conditions will be imposed or amendments, modifications or waivers made that would have a material adverse effect on Host or Crestline or materially reduce the contemplated benefits of the REIT Transactions to Host. In addition, BT Wolfensohn has been advised by Host, and accordingly has assumed for purposes of its opinion, that the Initial E&P Distribution will be taxable to the Host stockholders. BT Wolfensohn has also assumed that upon consummation of the REIT Transactions, Host will qualify for treatment as a REIT under the REIT Rules no later than the full year beginning January 1, 2000 (and BT Wolfensohn understands that Host will obtain an opinion, which will be based on certain assumptions and representations of Host and subject to certain qualifications, to that effect from its outside counsel prior to consummation of the REIT Transactions). At the request of the Host Board of Directors, BT Wolfensohn has not solicited any proposals from any third parties for the acquisition of any of the assets of Host or Crestline nor made any determination as to whether any such proposals could be obtained if solicited. Set forth below is a brief summary of certain financial analyses performed by BT Wolfensohn in connection with its opinion. Comparable Company Trading Analysis. BT Wolfensohn performed a comparable company trading analysis to derive a range of implied future equity values per share for Host, assuming it retains its existing corporate structure, and for Host and Crestline after giving effect to the proposed REIT Transactions. BT Wolfensohn reviewed market statistics and financial and operating information with respect to selected publicly traded companies considered by BT Wolfensohn to be comparable in certain respects to Host and Crestline. BT Wolfensohn selected publicly traded companies organized as C-Corporations engaged in the lodging industry (Choice Hotels International, Inc., Four Seasons Hotels Inc., Hilton Hotel Corporation, John Q. Hammons Hotels, L.P., Marriott International, Inc., Meristar Hotels & Resorts, Inc., Prime Hospitality Corporation, Promus Hotel Corporation, Red Roof Inns, Inc., Servico, Inc. and ShoLodge, Inc.; the "Lodging C-Corp Peer Group"), publicly traded lodging REITs (Boykin Lodging Company, Equity Inns, Inc., FelCor Lodging Trust Incorporated, Hospitality Properties Trust, Innkeepers USA Trust, Jameson Inns, Inc., RFS Hotel Investors, Inc. and Winston Hotels, Inc.; the "Lodging REIT Peer Group") and publicly traded healthcare REITs (American Health Properties, Inc., Health Care Property Investors, Inc., Health Care REIT, Inc., Health & Retirement Properties Trust, LTC Properties, Inc., Nationwide Health Properties, Inc. and Omega Healthcare Investors, Inc.; the "Healthcare REIT Peer Group" and, together with the Lodging C-Corp Peer Group and the Lodging REIT Peer Group, the "BT Wolfensohn Peer Groups"). The business composition, market positions and capital 86 structures of these companies made them, in BT Wolfensohn's judgment, most closely comparable to Host and Crestline. In BT Wolfensohn's judgment, the Health Care REIT Peer Group is the most comparable set of companies for the purposes of valuing Crestline due to its ownership of senior living real estate assets. In using the Healthcare REIT Peer Group as a comparison, BT Wolfensohn took several differences into consideration, including that Crestline would be a taxable C-Corporation, that a significant portion of Crestline's earnings would be derived from leases on properties owned by Host, and that Crestline could potentially further diversify its revenue sources in the future. Based upon the market price of their common shares as of November 2, 1998 and the number of common shares outstanding, BT Wolfensohn calculated for each company in the BT Wolfensohn Peer Groups the market value of its common equity. For each C-Corporation engaged in the lodging industry, BT Wolfensohn added the market value of outstanding net debt, preferred stock instruments and capitalized leases (if applicable) in order to arrive at a total enterprise value ("TEV") for each company. BT Wolfensohn calculated the multiple 86--1 of each company's TEV to its historical earnings before interest, taxes, depreciation and amortization ("EBITDA") using publicly available information regarding each company's last twelve months of reported earnings. BT Wolfensohn also calculated the multiple of each company's stock price to its earnings per share ("EPS") for the latest twelve months and to its estimated earnings for calendar years 1998 and 1999 as reported by the Institutional Brokers Estimate System ("I/B/E/S"). I/B/E/S is a data service that monitors and publishes compilations of earning estimates by selected research analysts regarding companies of interest to institutional investors. BT Wolfensohn also calculated the current market value to current and projected Funds from Operations ratio for each company in the Lodging REIT Peer Group and Healthcare REIT Peer Group, using publicly available information regarding each company's latest twelve months Funds from Operations and Funds from Operations estimates for calendar years 1998 and 1999 as reported by I/B/E/S. Such multiples were then reviewed to determine the median, mean, high and low multiples for the BT Wolfensohn Peer Groups. BT Wolfensohn's analysis was not predicated upon a comparison of Host's stock price performance multiples to the BT Wolfensohn Peer Group multiples. In its professional opinion, BT Wolfensohn believed that Host's stock has been trading with the expectation that Host would convert to a REIT. BT Wolfensohn applied the resulting Lodging C-Corp Peer Group and Lodging REIT Peer Group multiple ranges (6.0x to 8.0x for EBITDA, 10x to 15x for earnings and 5.0x to 8.0x for Funds from Operations) to forecasted EBITDA, EPS and Funds from Operations of Host to determine a range of expected future equity values per share of Host under its existing corporate structure each year over the five-year period beginning January 1, 1999 and ending December 31, 2003. BT Wolfensohn also applied the resulting Lodging REIT Peer Group Funds from Operations multiple range (5.0x to 8.0x) to forecasted Funds from Operations of Host and the resulting Health Care REIT Peer Group Funds from Operations multiple range (5.0x to 8.0x) to forecasted Funds from Operations per share (less applicable corporate taxes) of Crestline to determine a range of expected future equity values per share of Host and Crestline each year over the five-year period beginning January 1, 1999 and ending December 31, 2003 after giving effect to the proposed REIT Transactions. In arriving at its conclusion as to the expected future trading values of Host and Crestline's stock, BT Wolfensohn also considered various factors affecting the trading values of specific members of the BT Wolfensohn Peer Groups as well as possible deviations from the indicated valuation range based upon specific factors related to Host and Crestline. IRR Analysis. Utilizing trading values calculated by BT Wolfensohn from the above Comparable Company Trading Analysis, BT Wolfensohn analyzed the internal rate of return ("IRR") to a Host stockholder buying one share of Host stock on December 31, 1998 ("Beginning Stock Price") at an assumed price of $15 per share and holding such share for a period of five years ending December 31, 2003 ("Ending Stock Price"), both under Host's existing corporate structure and after giving effect to the proposed REIT Transactions. The stock price on December 31, 2003 of Host under its existing corporate structure was computed using the methodology described above under Comparable Company Trading Analysis. The stock price on December 31, 2003 of Host based on the proposed REIT Transactions was computed using the methodology described above under Comparable Company Trading Analysis by adding the value of Host stock to the value of Crestline stock at such date. The IRR was then computed by taking into account the Beginning Stock Price, the Ending Stock Price, the assumed cash component of the Initial E&P Distribution and the annual dividends assumed to be received by a stockholder over the period. The analysis did not take into account taxes outside of corporate level taxes which would depend upon each individual shareholder's tax status. In each comparable case across a wide range of sensitivity analyses performed by BT Wolfensohn, the IRR giving effect to the REIT Transactions exceeded the IRR for Host under its existing corporate structure. The foregoing summary describes all analyses and factors that BT Wolfensohn deemed material in rendering its fairness opinion and each of such analyses supported BT Wolfensohn's opinion. In addition, BT Wolfensohn performed other analyses and considered other factors in connection with preparing its opinion. The preparation of a fairness opinion is a complex process involving the application of subjective business judgment in determining the most appropriate and relevant methods of financial analysis and the application of those methods to the particular circumstances and, therefore, is not readily susceptible to summary description. BT Wolfensohn believes that its analyses must be considered as a whole and that considering any portion of such analyses and of the factors considered without considering all analyses and factors could create a misleading 87 view of the process underlying the opinion. In arriving at its fairness determination, BT Wolfensohn did not assign specific weights to any particular analyses. In conducting its analyses and arriving at its opinion, BT Wolfensohn utilized a variety of generally accepted valuation methods. The analyses were prepared solely for the purpose of enabling BT Wolfensohn to provide its opinion to the Host Board of Directors as to the fairness to Host stockholders of the REIT Transactions and does not purport to be appraisals or necessarily reflect the prices at which businesses or securities actually may be sold, which are inherently subject to uncertainty. In connection with its analyses, BT Wolfensohn made, and was provided by Host and Crestline management with, numerous assumptions regarding 87--1 general market and economic trends and each company's estimated performance, much of which is beyond Host's and Crestline's control. The principal assumptions regarding Host's expected performance relate to occupancy rates, average daily rates ("ADRs") and the resulting revenue per available room ("REVPAR") for the period covered by the estimates. BT Wolfensohn assumed that demand would generally fall across the industry, resulting in a decline in occupancy rates of up to 100 basis points and a gradual decline of REVPAR growth from approximately 6% to 3% between 1999 and 2001. BT Wolfensohn also conducted a series of sensitivity analyses regarding the impact of market and economic performance variances on Host's and Crestline's businesses with occupancy rates, ADRs and REVPAR ranging between 75.1% to 78.6%, $138 to $172 and $108 to $133, respectively. Analyses based on estimates or forecasts of future results are not necessarily indicative of actual past or future values or results, which may be significantly more or less favorable than suggested by such analyses. Because such analyses are inherently subject to uncertainty, being based upon numerous factors or events beyond the control of Host and Crestline, or their respective advisors, neither Host nor Crestline nor BT Wolfensohn nor any other person assumes responsibility if future results or actual values are materially different from these forecasts or assumptions. The terms of the REIT Transactions were approved by the Host Board of Directors. Although BT Wolfensohn provided advice to Host during the course of these discussions, the decision to enter into the REIT Transactions was solely that of the Host Board of Directors. As described above, the opinion and presentation of BT Wolfensohn to the Host Board of Directors were only one of a number of factors taken into consideration by the Host Board of Directors in making its determination to approve the REIT Transactions. BT Wolfensohn's written opinion was provided to the Host Board of Directors to assist it in connection with its consideration of the REIT Transactions and does not constitute a recommendation to any holder of Host Common Stock as to how to vote with respect to the Merger. Host selected BT Wolfensohn as financial advisor in connection with the REIT Conversion based on BT Wolfensohn's qualifications, expertise, reputation and experience in mergers and acquisitions. BT Wolfensohn is engaged in the merger and acquisition and client advisory business of Bankers Trust (together with its affiliates, the "BT Group") and, for legal and regulatory purposes, is a division of BT Alex. Brown Incorporated, a registered broker dealer and member of the New York Stock Exchange. Since 1993, Host has paid BT Wolfensohn an annual retainer fee for providing ongoing merger, acquisition and corporate advisory services. This retainer fee totaled $500,000 in 1998. Host separately retained BT Wolfensohn pursuant to a letter agreement dated April 16, 1998 (the "Engagement Letter"). As compensation for BT Wolfensohn's services in connection with the REIT Conversion, Host has paid BT Wolfensohn a cash fee of $1 million and has agreed to pay an additional cash fee of $4 million if the REIT Conversion is consummated. This amount will be reduced by BT Wolfensohn's annual retainer fee received for 1998. Regardless of whether the REIT Conversion is consummated, Host has agreed to reimburse BT Wolfensohn for reasonable fees and disbursements of BT Wolfensohn's counsel and all of BT Wolfensohn's reasonable travel and other out-of-pocket expenses incurred in connection with the REIT Conversion or otherwise arising out of the retention of BT Wolfensohn under the Engagement Letter. Host has also agreed to indemnify BT Wolfensohn and certain related persons to the full extent lawful against certain liabilities, including certain liabilities under the federal securities laws arising out of its engagement or the REIT Conversion. The fee to be paid to BT Wolfensohn as Host's financial advisor was negotiated on an arms-length basis with Host's management. BT Wolfensohn is an internationally recognized investment banking firm experienced in providing advice in connection with mergers and acquisitions and related transactions. One or more members of the BT Group have, from time to time, provided investment banking, commercial banking (including extension of credit) and other financial services to Host or its affiliates for which it has received compensation. A member of the BT Group is the lead administrative agent for Host's $1.25 billion bank facility and was the co-administrative agent for Host's recent bond tender and subsequent $1.7 billion re-offering. The BT Group may actively trade securities of Host for its own account or the account of its customers and, accordingly, may from time to time hold a long or short position in such securities. 88 BUSINESS AND PROPERTIES BUSINESS OF THE COMPANY Host REIT was organized as a Maryland corporation on September 28, 1998 by Host to succeed to and continue the business of Host upon consummation of the Merger of Host with and into Host REIT pursuant to the Agreement. Host REIT has conducted no business to date other than that incident to the Merger and the other transactions comprising the REIT Conversion and has no material assets or liabilities. 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 the Company will be to (i) achieve long-term sustainable growth in Funds From Operations (as defined below) and cash flow per share of Host REIT Common Stock, (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 59,000 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 Company to the Lessees and will be managed on behalf of the Lessees by subsidiaries of Marriott International and other 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 Company will lease the Hotels, through its subsidiaries, to the Lessees under the Leases. See "--The Leases" below. The Lessees will pay rent to the Company 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 Company (although the obligation to pay such fees could adversely affect the ability of the Lessees to pay the required rent to the Company). The Leases, through the Percentage Rent provisions, are designed to allow the Company 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 Company 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 Company's Leases will provide the Company with the right to approve and finance major capital improvements. 89 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 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 Company's primary business objective is to increase its "Funds From Operations" or "FFO" (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 share of Host REIT Common Stock 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 Company's investment criteria, including entering into joint ventures when the Company 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 Company's investment criteria, employing transaction structures which mitigate risk to the Company. . 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 funding 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- 90 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 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 for 1997. 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. 91 . The Company intends to increase its pool of potential acquisition candidates by considering acquisitions of select non-Marriott and non- Ritz-Carlton hotels, subject to certain contractual limitations through October 8, 2000 imposed under the noncompetition agreement between Host and Marriott International (see "Certain Relationships and Related Transactions--Relationship Between Host and Marriott International-- Noncompetition Agreement"), 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 91--1 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 Company's only interest will be a mortgage loan), one Grand Hyatt, three Hyatt Regencies and four Swissotel properties. See "--Blackstone Acquisition." 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 Marriott Hotel Properties Limited Partnership, a Delaware limited partnership ("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 92 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. 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 the Gross Domestic Product ("GDP"), which recently has been growing at a rate of approximately 2% to 3%. 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% from 72.2% in 1996, 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. 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 changing slightly and room rates increasing at more than one and one-half times the rate of inflation in 1998. 93 While the supply/demand relationship has generally remained favorable in the upper upscale and luxury markets in which the Company's properties operate, a number of new construction projects have been announced or commenced in 1998, particularly in suburban and smaller metropolitan markets where the Company does not have a significant presence. This growth in new supply, together with slowing demand growth, have served to reduce the rate of REVPAR growth at the Company's properties from year earlier growth rates. In part, as a reaction to a concern regarding the potential for lodging industry overbuilding as well as general economic concerns which have been heightened by the Asian crisis and other factors, the availability of capital to the lodging industry has diminished greatly in the second half of 1998. While this condition is having a favorable effect by curtailing construction of a number of potentially competing hotel projects, it is also limiting the Company's ability to grow through acquisitions. The lodging industry is cyclical with operating results correlated highly to GDP. During recent months, a number of investment banks and economists have substantially reduced their estimates of growth in GDP through 1999. Should such estimates of diminished GDP growth prove accurate, the Company believes that REVPAR growth would be substantially reduced at its properties. 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. 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. 94 The following tables set forth certain information with respect to the operations of the Hotels to be owned by the Company following the REIT Conversion on a historical and pro forma basis for fiscal year 1997 and for the First Three Quarters 1998.
FISCAL YEAR 1997 ------------------------------------------- AVERAGE PARTNERSHIP NO. OF HOTELS NO. OF ROOMS HOTEL REVENUES OCCUPANCY DAILY RATE REVPAR - ----------- ------------- ------------ -------------- --------- ---------- ------- (IN THOUSANDS) Atlanta Marquis(1)(2)... 1 1,671 $ 85,397 69.8% $127.36 $ 88.95 Chicago Suites(2)....... 1 256 6,568 83.2 146.83 122.14 Desert Springs(2)(3).... 1 884 33,369 73.0 169.55 123.77 Hanover(2).............. 1 353 6,735 80.8 123.55 99.82 MDAH(2)................. 6 1,692 26,699 76.4 102.97 78.63 MHP(2)(4)............... 2 2,127 75,211 80.3 155.44 124.84 MHP2(2)(5).............. 4 3,411 69,014 80.7 133.75 107.91 PHLP(2)(6).............. 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)(7).... 95 45,718 946,726 78.4 133.74 104.84 Host (pro forma)(7)(8).. 127 59,118 3,601,866 77.7 132.73 103.09 FIRST THREE QUARTERS 1998 ---------------------------------------------------------------------- AVERAGE PARTNERSHIP NO. OF HOTELS NO. OF ROOMS HOTEL REVENUES OCCUPANCY DAILY RATE REVPAR - ----------- ------------- ------------ -------------- --------- ---------- ------- (IN THOUSANDS) Atlanta Marquis(1)(2)... 1 1,671 $ 58,625 68.9 $131.43 $ 90.51 Chicago Suites(2)....... 1 256 5,120 83.5 159.34 132.98 Desert Springs(2)(3).... 1 884 80,334 75.9 182.77 138.63 Hanover(2).............. 1 353 5,238 75.7 138.41 104.81 MDAH(2)................. 6 1,692 26,351 76.6 113.82 87.20 MHP(2)(4)............... 2 2,127 61,245 83.3 161.15 134.17 MHP2(2)(5).............. 4 3,411 29,513 83.7 150.16 125.76 PHLP(2)(6).............. 8 3,181 37,238 79.3 112.28 89.01 Blackstone Hotels....... 12 5,520 327,885 74.2 176.17 130.77 Host (historical)(7).... 101 49,019 921,864 79.1 139.48 110.33 Host (pro forma)(7)(8).. 127 59,118 2,665,023 78.4 141.61 111.05
- -------- (1) Atlanta Marquis has an 80% residual interest in the Atlanta Marriott Marquis Hotel. Revenues represents sales generated by the Hotel. (2) Partnership is participating in the "consent solicitation" relating to the Partnership Mergers. (3) Subsequent to November 25, 1997, revenues reflect gross hotel sales. Prior to that date, revenues reflected hotel rental income. (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 Desert Springs, Hanover, MHP and MHP2 for both fiscal year 1997 and First Three Quarters 1998 and Atlanta Marquis for First Three Quarters 1998 because the Company owned a controlling interest in such Partnerships for the periods indicated. Such Partnerships are part of the Partnership Mergers (if and to the extent consummated). (8) Includes the hotels owned by all Partnerships and Private Partnerships and the Blackstone Hotels, assuming the Full Participation Scenario (i.e., the transactions comprising the REIT Conversion, including the Blackstone Acquisition, occur, all Partnerships participate in the Partnership Mergers and no shares of Host REIT Common Stock or Notes are issued in the Partnership Mergers). 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 95 provided at intervals of five years, based on an annual review of the condition of each property. For the First Three Quarters 1998, First Three Quarters 1997, fiscal years 1997, 1996 and 1995, the Company spent $113 million, $86 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:
FIRST THREE 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.................... $ 141.68 $ 131.51 $134.49 $121.58 Occupancy percentage.................. 79.9% 79.8% 79.4% 78.0% REVPAR................................ $ 113.27 $ 105.00 $106.76 $ 94.84 REVPAR % change....................... 7.9% -- 12.6% --
- -------- (1) Consists of the 78 properties owned by the Company for the entire First Three Quarters 1998 and First Three 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. The chart below sets forth certain performance information for the Company's hotels:
FIRST THREE QUARTERS FISCAL YEAR ---------------------- ------------------------- 1998 1997 1997 1996 1995 ---------- ---------- ------- ------- ------- Number of properties........ 104 86 95 79 55 Number of rooms............. 50,064 41,171 45,718 37,210 25,932 Average daily rate(1)....... $ 139.48 $ 132.14 $133.74 $119.94 $110.30 Occupancy percentage(1)..... 79.1% 79.9% 78.4% 77.3% 75.5% REVPAR(1)................... $ 110.33 $ 105.57 $104.84 $ 92.71 $ 83.32
- -------- (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 96 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 Three Quarters 1998, REVPAR for comparable properties increased 7.9% as average room rates increased nearly 8% and average occupancy had no change. Sales for the First Three Quarters 1998 expanded at an 8% rate for comparable hotels and the house profit margin increased by one percentage point. REVPAR for the First Three Quarters of 1998 for all of the Company's properties increased 4.5% as average room rates increased nearly 6% 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. 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. 97 The following table presents full-service hotel information by geographic region for fiscal year 1997:
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 --
98 HOTEL PROPERTIES The following table sets forth, as of the date hereof, 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.
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...................................................... 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
LOCATION ROOMS - -------- ----- 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 Tennessee 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
99 HOTEL PROPERTIES (CONTINUED)
LOCATION ROOMS - -------- ------ Plaza San Antonio (6)(10).............................................. 252 San Antonio Rivercenter (4)(6)......................................... 999 San Antonio Riverwalk (6).............................................. 500 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 currently not consolidated by Host and are subject to the Partnership Mergers ("MDAH" refers to Marriott Diversified America Hotels, L.P., a Delaware limited partnership; "Chicago Suites" refers to Mutual Benefit Chicago Marriott Suite Hotel Partners, L.P., a Rhode Island limited partnership; and "PHLP" refers to Potomac Hotel Limited Partnership, a Delaware limited partnership):
HOTEL STATE ROOMS - ----- ----- ----- MDAH Fairview Park (6)......................................... Virginia 395 Dayton.................................................... Ohio 399 Research Triangle Park.................................... North Carolina 224 Detroit Marriott Southfield............................... Michigan 226
HOTEL STATE ROOMS - ----- ----- ----- Detroit Marriott Livonia.................................. Michigan 224 Fullerton (6)............................................. California 224 ----- 1,692 ----- 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 =====
Properties that are included in the Blackstone portfolio are as follows:
HOTEL STATE ROOMS - ----- ----- ----- Four Seasons, Atlanta (8).................................. Georgia 246 Four Seasons, Philadelphia (8)............................. Pennsylvania 365 Grand Hyatt, Atlanta (8)................................... Georgia 439 Hyatt Regency, Burlingame (8).............................. California 793 Hyatt Regency, Cambridge (8)............................... Massachusetts 469 Hyatt Regency, Reston (8).................................. Virginia 514 Swissotel, Atlanta (8)..................................... Georgia 348 Swissotel, Boston (8)...................................... Massachusetts 498 Swissotel, Chicago (8)..................................... Illinois 630 The Drake (Swissotel), New York (8)........................ New York 494 The Ritz-Carlton, Amelia Island (1)........................ Florida 449 The Ritz-Carlton, Boston (1)............................... Massachusetts 275 ----- TOTAL................................................................... 5,520 =====
- -------- (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. 100 (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. 1998 ACQUISITIONS In January 1998, the Company acquired an additional interest in Atlanta Marriott Marquis II Limited Partnership, a Delaware limited partnership, 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 Swissotel Management (USA) L.L.C., which operates five Swissotel hotels in the United States, from the Blackstone Entities, which the Company will transfer to Crestline in connection with the Initial E&P Distribution of Crestline common stock to the Company's stockholders 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 and was not based upon appraisals of the assets. Each OP Unit will be exchangeable for one share of Host REIT Common Stock (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). 101 At the closing of the Blackstone Acquisition, the Blackstone portfolio will be contributed to the Company 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 Company'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). 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 Company 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 reimbursed for the cost of providing these services subject to limitations in certain cases. 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 Three Quarters 1998, $4 million for the First Three 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 the date hereof, 88 of the Company's 104 hotel properties are managed 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 102 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. 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:
SEGMENT REPRESENTATIVE PARTICIPANTS ------- --------------------------- Luxury Full-Service................. Ritz-Carlton; Four Seasons Upscale Full-Service................ Crowne Plaza; Doubletree; Hyatt; Hilton; Marriott Hotels, Resorts andSuites; Radisson; Red Lion; Sheraton; Swissotel; Westin; Wyndham
RELATIONSHIP WITH HM SERVICES On December 29, 1995, the Company distributed to its stockholders through a special dividend (the "HMS 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 HMS 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 HMS Special Dividend provided Company stockholders with one share of common stock of HM Services for every five shares of Company common stock held by such stockholders 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 HMS 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 HMS Special Dividend and with respect to certain tax attributes of the Company after the HMS 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 stockholders 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 103 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. 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 Company 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 Restructuring Transactions and the other transactions comprising 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 104 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. 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 AMMLP 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. THE LEASES 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 105 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 stockholders at the time of the REIT Conversion, Host decided to enter into leases with subsidiaries of Crestline and distribute the stock of Crestline to Host's stockholders. 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. In Host's judgment, these factors make it more likely that Crestline and its subsidiaries will have the financial stability, access to capital and wherewithal to perform on an ongoing basis the substantial obligations as lessee under the Leases (which is critical both to the Leases being respected for federal income tax purposes and to a viable long-term lessor-lessee relationship between Host REIT and Crestline, particularly in light of the fact that Host REIT remains secondarily liable to pay the management fees if Crestline defaults on its obligations). 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 (including to Crestline and its subsidiaries) that has separate interests and economic objectives, Host believed that the advantages of the REIT Conversion substantially outweighed this disadvantage. 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 Proxy Statement/Prospectus 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 which will require the consent of both members. 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 of 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. Full-Service Lease Terms. Each full-service Hotel Lease will have a fixed term generally ranging 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 Leases upon Disposition of Full-Service 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 106 (which is described under "Personal Property Limitation" below). Any amounts other than Minimum Rent and Percentage Rent due to the Host REIT Lessor under the Hotel Leases are deemed to be "Additional Charges." The amount of Minimum Rent and the Percentage Rent thresholds will be adjusted each year (the "Annual Adjustment") based upon any increases in the Consumer Price Index ("CPI") and the Employment Cost Index 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 hotel 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 hotel Manager's accounting system. Rent payable for each Accounting Period will be the sum of (i) the excess (if any) of (x) the greater of cumulative Minimum Rent due and payable year-to-date or cumulative Percentage Rent due and payable year-to-date over (y) the total amount of Minimum Rent and Percentage Rent actually paid year-to-date plus (ii) any Additional Charges due ("Rent"). If the total amount of Minimum Rent and Percentage Rent actually paid year-to- date, as of any rent payment date, is greater than both cumulative Minimum Rent due and payable year-to-date and cumulative Percentage Rent due and payable year-to-date, then the Lessor will remit the difference to the Lessee. The full-service Hotel 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 Host REIT Lessor, as described below. Host REIT Lessor Expenses. The Host REIT Lessor will be responsible for the following expenses: real estate taxes, personal property taxes (to the extent the Host REIT 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 Host REIT Lessor will be required for any capital expenditures funded by the Lessee (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 Guarantees. Crestline and certain of its subsidiaries will enter into guarantees of the Lease obligations of each Lessee. For each of four identified "pools" of Hotels (determined on the basis of the term of the particular Lease with all leases having generally the same lease term placed in the same "pool"), the cumulative limit of Crestline's guaranty obligation will be the greater of 10% of the aggregate Rent payable for the immediately preceding Fiscal Year under all Leases in the pool or 10% of the aggregate Rent payable under all Leases in the pool for 1999 (with an agreed estimate of the 1999 Rent serving as the limit during 1999). For each pool, the subsidiary of Crestline that is the parent of the Lessees in the pool (a "Pool Parent") also will be a party to the guaranty of the Lease obligations for that pool. The obligations of the Pool Parent will not be limited in this manner. The obligations of the Pool Parent under each guaranty will be secured by all funds received by the applicable Pool Parent from the Lessees in the pool, and the Lessees in the pool will be required to distribute their excess cash flow to the Pool Parent for each Accounting Period, in certain events. These events include a decline in Crestline's tangible net worth or consolidated debt coverage ratio below specified levels, a payment 107 default under any Lease in the same pool or any other Lease, with respect to which a guaranty by Crestline is in effect, or a default under the lien or debt covenants under any Leases in the same pool, or a reduction in Crestline's obligation under a pool guaranty to zero. Funds received from the Lessees will be deposited in a cash collateral account and applied, to the extent of available funds, to pay any shortfalls in payment of Rent under any Lease in the Pool. If certain conditions are satisfied, any remaining funds will then be released to the Pool Parent. Otherwise, the remaining funds will be applied to make a payment to the Pool Parent in a specified amount for overhead expenses and to maintain a reserve equal to the amount of Crestline's liability under the applicable guaranty (subject to a specified minimum amount), and, if certain conditions are satisfied, any remaining funds will be released to the Pool Parent. In the event that Crestline's obligation under a guaranty is reduced to zero, the applicable Pool Parent can elect to terminate its guaranty and the pooling agreement for that pool by giving notice to the Operating Partnership. In that event, subject to certain conditions, the Pool Parent's guaranty will terminate six months after the effective date of such notice, subject to reinstatement in certain limited circumstances. Following termination of the Pool Parent's guaranty, the Host REIT Lessors in the applicable pool will have the right to terminate the Hotel Leases in the pool without payment of a termination fee, so long as the Hotel Leases are terminated within a year and all Hotel Leases in the pool are terminated. 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 Host REIT Lessor will sell the existing working capital (including Inventory and fixed asset supplies (which principally consist of linen and similar items) and net 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 (which shall be deemed to be book value after taking into account depreciation). 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 accrued 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 Host REIT Lessor the then existing working capital at a price equal to the value of such assets at that time (which shall be deemed to be book value after taking into account depreciation). The Host REIT Lessor will pay the purchase price of the working capital by offsetting against the outstanding principal balance of the working capital loan. To the extent that the value of the working capital delivered to the Host REIT Lessor exceeds or is less than the value of the working capital delivered by the Host REIT Lessor to the Lessee at the commencement of the Lease, the Host REIT Lessor, or the Lessee, as appropriate, shall pay to the other party an amount equal to the difference in cash. Termination of Leases upon Disposition of Full-Service Hotels. In the event the applicable Host REIT Lessor enters into an agreement to sell or otherwise transfer any full-service Hotel free and clear of the applicable Lease, the Host REIT 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 using a discount rate of 12%. Alternatively, the Host REIT Lessor will be entitled to (i) substitute a comparable Hotel or Hotels (in terms of economics and quality for the Host REIT 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 Host REIT Lessor's obligations under the Lease or is or controls or is controlled by a person convicted of a felony involving moral turpitude), without being required to pay a termination fee. Pursuant to the Lease, the Host REIT Lessor and the Lessee will each have the right to terminate the Lease without being required to pay any fee or other compensation as a result of such termination, provided that the termination rights of both the 108 Host REIT Lessor and the Lessee may only be exercised if the Host REIT Lessors and the Lessees under twelve of the other Hotel Leases have not already exercised their respective rights to terminate, and the Host REIT Lessor will only be permitted to exercise such right in connection with a sale of a Hotel 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 Hotel Leases upon Changes in Tax Laws. In the event that changes in the federal income tax laws allow the Host REIT Lessors, or subsidiaries or affiliates of the Host REIT Lessors, to directly operate the Hotels without jeopardizing Host REIT's status as a REIT, the Host REIT Lessors will have the right to terminate all, but not less than all, of the full-service Hotel Leases (excluding Leases for Hotels that must continue to be leased following the tax law change) in return for paying the Lessees the fair market value of the 108--1 remaining terms of the full-service Hotel Leases, valued in the same manner as provided above under "Termination of Leases upon Disposition of Full-Service Hotels." The payment will be payable in cash or, subject to certain conditions, shares of Host REIT Common Stock, at the election of Host REIT and the Host REIT Lessor. Host has been pursuing the enactment of such legislation for more than one year, but there is no such bill pending in Congress, and there can be no prediction as to whether such legislation would be enacted in the future. 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 Host REIT Lessor), the Lease of such Hotel shall automatically terminate and the insurance proceeds shall be retained by the Host REIT Lessor, except to the extent of any personal property owned by the Lessee and proceeds from 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 Host REIT Lessor), the Lessee, subject to the Host REIT 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 Host REIT Lessor shall fund any shortfall in insurance proceeds less than or equal to 5% of the estimated cost of repair. The Host REIT Lessor may fund, in its sole discretion, any shortfall in insurance proceeds greater than 5% of the estimated cost of the repair, provided that if the Host REIT Lessor elects not to fund such shortfall, the Lessee may terminate the Hotel Lease and the Host REIT Lessor shall pay to the Lessee a termination fee equal to the Lessee's Operating Profit for the immediately preceding Fiscal Year. Events of Default. Except as otherwise provided below, and subject to the notice and, in some cases, cure periods in the Hotel Lease, the Hotel Lease may be terminated without penalty by the applicable Host REIT 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 Hotel Lease (other than failure to pay Rent) for 30 days after notice from the Host REIT Lessor, including failure to properly maintain the Hotel (other than by reason of the failure of the Host REIT Lessor to perform its obligations under the Hotel 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 indirect parent of the Lessee (provided, however, that if 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 Host REIT Lessor must pay a termination fee equal to the Lessee's Operating Profit from the Hotel for the immediately preceding Fiscal Year if the Lease is terminated following such a change in control); or . The Lessee, Crestline or the Lessee's direct parent defaults under the assignment of the Management Agreement, the guarantees described above, the noncompetition agreement described below or certain other related agreements between the parties or their affiliates. Assignment of the Lease. A Lessee will be permitted to assign its interest under its Hotel Lease, without the consent of the Host REIT Lessor, to any wholly-owned and controlled single-purpose subsidiary of Crestline, 109 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 Host REIT Lessor. Subordination to Qualifying Mortgage Debt. The rights of each Lessee will be expressly subordinate to qualifying mortgage debt (which totaled approximately $2.9 billion on a pro forma basis at September 11, 1998 assuming all Partnerships participate and the Blackstone Acquisition is consummated) and any refinancing thereof. A default under the loan documents may result in the termination of the Hotel Lease by the lender. The lender will not be required to provide a non-disturbance agreement to the Lessee. The Host REIT 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 Full-Service Hotels" above, if the full-service Hotel 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 Host REIT 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 Host REIT Lessor will owe a termination fee as provided above. During any period of time that a cash flow sweep structure (or other similar cash management procedure) is in effect, the Host REIT Lessor will compensate the Lessee for any lost revenue resulting from such cash flow sweep. The Operating Pertnership will guarantee these obligations. Personal Property Limitation. If a Host REIT Lessor reasonably anticipates that the average tax basis of the items of the Host REIT 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 Host REIT 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 Host REIT 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 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 Hotel Lease would be reduced in accordance with a formula based on market recovery rates. Certain Actions under the Hotel Leases. The Leases prohibit the Lessee from taking the following actions with respect to the Management Agreement without notice to the Host REIT Lessor and, if the action would have a material adverse effect on the Host REIT Lessor, the consent of the Host REIT 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 Host REIT Lessor's rights or obligations under the Management Agreement for periods following the termination of the Hotel 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 Host REIT Lessor, which approval may not be unreasonably withheld. The 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 Host REIT Lessor, which consent may be withheld in the Host REIT Lessor's sole discretion. 110 THE MANAGEMENT AGREEMENTS General. The Lessees will lease the Hotels from the Partnerships and the Private Partnerships under the Management Agreements between the Operating Partnership 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 Company 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 Company's Hotels which will be leased to the Lessees, pursuant to the Management Agreements. Marriott International and its subsidiaries also will 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 as to contract compliance. Additionally, the possible desire of the Company 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 the Company 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 Company'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 Company or the Lessees. Nevertheless, the Company believes that there is sufficient mutuality of interest between the Company, 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 Partnership or Private Partnership currently, and that would exist between the Company'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 including the payment of fees due under the Management Agreement, other than certain retained obligations, including, without limitation, payment of property taxes, property casualty insurance and ground lease 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 a Lessee fails to perform any obligations, the Manager will be entitled to seek performance by or damages from the Lessor. The Lessees' obligation to pay the fees due under the Management Agreements, however, could adversely affect the ability of the Lessee to pay rent under the Leases, even though such amounts are otherwise due and owed to 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 111 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 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 generally 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, 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 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 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 Company, 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). Under each full-service Lease, Host REIT 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 Company and the Lessee 112 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 Company is required to pay any shortfall. 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. 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 non-payment 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 the failure 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 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 of 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 excluding the termination fee, if any, 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 Company. Restrictions on Sales and Other Transfers of Interests in Hotels. The Management Agreements prohibit the hotel owner from selling, leasing or otherwise transferring the hotels unless the transferees assume the Management Agreements and satisfy certain criteria, including having sufficient financial resources and liquidity to satisfy the owner's obligations under the Management Agreements, not being in control or controlled by persons who have been convicted of felonies and not being engaged in operating a branded hotel chain having 5,000 or more guest rooms in competition with Marriott International. The Management Agreements also prohibit the Lessees from subleasing all or any portion of the Leases and from assigning the Leases except to entities which are wholly-owned by Crestline and have organizational documents which are the same as those of the Lessees, in each case without the prior written consent of Marriott International. Restrictions on Lease Amendments. The Management Agreements prohibit the Lessees and the hotel lessors from entering in certain amendments of the Leases, including shortening the term of the Leases and 113 modifying the parties' respective rights and obligations with respect to FF&E, capital expenditures and approval of hotel budgets, in each case without the prior written consent of Marriott International. Marriott International's Right to Cause Termination of Leases. The Management Agreements provide that if the hotel lessors do not elect to terminate the Lease upon a "Change in Control," Marriott International may require the hotel lessors to exercise their termination rights if, as a result of such Change in Control, the Lessee is or is controlled by a person who has been convicted of a felony or who is engaged (or affiliated with persons who are engaged) in operating a branded hotel chain having 5,000 or more guest rooms in competition with Marriott International. NONCOMPETITION AGREEMENT Crestline, Host and the Non-Controlled Subsidiary which will lease to Crestline any Excess FF&E existing at the commencement of the Leases (the "Initial FF&E Lessor") will enter into a non-competition 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 or the date on which it is no longer a Lessee of more than 25% of the number of hotels owned by Host REIT at the time of the Initial E&P Distribution, it will not (i) own, acquire, develop or construct for ownership any full-service hotel (except for (a) investments which represent an immaterial portion of a merger or similar transaction, (b) a minimal portfolio investment or (c) the provision of limited financing); (ii) without the consent of Host or Host REIT in its sole discretion, manage or operate (other than through a third party manager) any limited-service or full-service hotel properties owned by Host or Host REIT; or (iii) conduct, participate in, engage in or have a financial interest in any person that engages in the ownership or operation of any single or multiple full-service hotel franchise system operating under one or more common name brands. The restrictions described in (i) and (iii) above do not apply to any activities of Crestline related to limited-service hotels. Crestline generally is permitted to act as a manager with respect to full-service hotels, subject to certain restrictions intended to preclude Crestline from using the management agreement relationship to take a disguised equity ownership position in full-service hotels. Crestline also generally is permitted to act as a lessee with respect to full-service hotels owned (i) by any party under an arrangement where Crestline also manages the hotel or (ii) by a REIT, whether or not Crestline also manages the hotel, subject in each case to certain restrictions intended to preclude Crestline from using those leasing arrangements to take significant disguised equity ownership positions in full-service hotels. Until the earlier of December 31, 2008 or the date upon which Crestline is not the lessee of more than 25% of the number of hotels owned by Host at the time of the Initial E&P Distribution, Host or Host REIT and the FF&E Lessor have agreed that they will not conduct, participate in, engage in or have a financial interest in any person that engages in the business of leasing, operating or franchising limited-service or full-service hotel properties; provided, however, that this restriction does not prevent Host or Host REIT or the FF&E Lessor from (i) managing, operating or franchising limited-service or full-service hotels with respect to matters incident to the operation of such properties (e.g., management services with respect to food and beverages, plant and equipment operation and maintenance, reservations, sales and marketing) on behalf of third parties or (ii) leasing full-service or limited- service hotels to and from each other or (iii) in the case of Host or Host REIT, leasing full-service or limited-service hotels from certain other related parties. Until December 31, 2003, Host or Host REIT and the FF&E Lessor have also agreed that they will not conduct, participate in, engage in or have a financial interest in any person that engages in the ownership, acquisition or operation of senior living communities (except for (a) investments which represent an immaterial portion of a merger or similar transaction, (b) a minimal portfolio investment or (c) the provision of limited financing). In addition, both Crestline and Host REIT will agree not to hire or attempt to hire any of the other company's other senior employees at any time prior to December 31, 2000. See "Business and Properties-- Noncompetition Agreement." Subject to the Marriott International hotel noncompetition agreement, which continues until October 2000, Crestline is free to pursue any and all activities with respect to limited service hotels (other than limited service hotels owned by Host), and it is permitted to operate full-service hotels as a third-party manager so long as it is not the owner of the brand or franchise under which such hotels are operated. 114 INDEBTEDNESS Senior Note 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 Marriott 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 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 Initial 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 Operating Partnership 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 Operating Partnership 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 11, 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 (7.5% at September 11, 1998). The New Credit Facility provides that in the event that the Operating Partnership 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 Operating Partnership elects to 115 exercise its one-year extensions, the Operating Partnership 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 Operating Partnership'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. While there are certain conditions to the termination of the guarantee of Host, the REIT Conversion has been structured so that such conditions will be satisfied. Termination does not otherwise require Lender approval. In addition, certain subsidiaries of Host 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 Operating Partnership. 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. The New Credit Facility includes financial and other covenants that require the maintenance of certain financial ratios and that restrict payment of distributions and investments, acquisitions and sales of assets by the Operating Partnership. The financial covenants impose the following requirements, among others, on the Operating Partnership: . the ratio of consolidated total debt to consolidated EBITDA must not exceed 5.5:1.0 through the end of the fiscal quarter ending on or about June 30, 1999, declining periodically to 4.5:1.0 at any time after the end of the fiscal quarter ending on or about June 30, 2000; . the ratio of consolidated secured debt to consolidated total debt must not exceed 0.57:1.0 through the end of the fiscal quarter ending on or about June 30, 1999, declining periodically to 0.40:1.0 at any time after the end of the fiscal quarter ending on or about December 31, 2001, with certain exceptions; . the ratio of EBITDA attributable to unencumbered properties of the Operating Partnership and its subsidiaries to consolidated EBITDA for any four fiscal quarters must not be less than 0.425:1.0 through the end of the fiscal quarter ending on or about March 31, 1999, increasing periodically to 0.60:1.0 for any four fiscal quarters ending on or after December 31, 2001; . the ratio of the consolidated EBITDA to consolidated interest expense for any four fiscal quarters must not be less than 2.25:1.0 through the end of the fiscal quarter ending on or about June 30, 1999, increasing periodically to 2.50:1.0 for any four fiscal quarters ending after the fiscal quarter that ends on or about June 30, 2000; . the ratio of EBITDA attributable to unencumbered properties of the Operating Partnership and its subsidiaries to consolidated unsecured debt for any four fiscal quarters must not be less than 2.0:1.0; . the ratio of consolidated EBITDA to total fixed charges (as defined in the New Credit Facility) for any four fiscal quarters must not be less than 1.5:1.0; and . the consolidated tangible net worth of the Operating Partnership must not be less than the sum of 75% of the tangible net worth on August 5, 1998 plus 75% of the aggregate net proceeds received from issuance of equity by the Operating Partnership after August 5, 1998. 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 Initial E&P Distribution. 116 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 Company. Upon consummation of the REIT Conversion, the Company'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 stockholders of Host REIT, 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 Host REIT Common Stock 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 stockholders an amount equal to 100% of Host REIT's 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. Host REIT 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 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. The Operating Partnership has estimated its pro forma 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 September 11, 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 estimate of cash available for distribution is 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: 117
(DOLLARS IN MILLIONS, EXCEPT PER OP UNIT AND SHARE AMOUNTS) -------------------- Pro forma income before extraordinary items for the fiscal year ended January 2, 1998............................... $ 26 Plus: Pro forma loss before extraordinary items for the First Three Quarters 1997.............................. 222 Less: Pro forma loss before extraordinary items for the First Three Quarters 1998........................... (204) ----- Pro forma income before extraordinary items for the Last Twelve Months............................................ 44 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).......... 333 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)......... 26 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)........... (4) ----- Pro forma cash from operations during the Last Twelve Months................................................... 404 Adjustments: FF&E reserves(6)........................................ (191) Principal repayments(7)................................. (69) ----- Estimated cash available for distribution of the Operating Partnership during the twelve months ending December 31, 1999........................................ 144 Adjustments: Estimated cash from contingent rents(8)................. 64 Estimated borrowings to make estimated initial annual cash distributions..................................... 23 ----- Total estimated initial annual cash distributions of the Operating Partnership during the twelve months ending December 31, 1999(9)(13)................................. $ 231 ===== Host REIT's share of total estimated initial annual cash distributions of the Operating Partnership during the twelve months ending December 31, 1999(10)(13)........... $ 172 ===== Estimated initial annual cash distributions per OP Unit during the twelve months ending December 31, 1999(11)(13)............................................. $0.84 ===== Estimated initial annual cash distributions per share of Host REIT Common Stock during the twelve months ending December 31, 1999(12)(13)................................ $0.84 =====
- ------- (1) Represents loss on sale of real estate for the last quarter 1997 of $15 million. (2) Represents pro forma real estate related depreciation and amortization for the fiscal year ended January 2, 1998 of $342 million minus pro forma real estate related depreciation and amortization for the First Three Quarters 1997 of $230 million plus pro forma real estate related depreciation and amortization for the First Three Quarters 1998 of $221 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 $30 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 Three Quarters 1997 of $16 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 Three Quarters 1998 of $12 million. (4) Represents pro forma one-time gain for the last quarter 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 Three Quarters 1997 of $8 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 Three Quarters 1998 of $3 million. (6) Represents FF&E reserves for the year ending December 31, 1999 of $191 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 $69 million based on the terms of the pro forma indebtedness at September 11, 1998. (8) The amount of contingent rent received but deferred pursuant to EITF 98- 9, "Accounting for Contingent Rents in Interim Financial Periods," at September 11, 1998 and September 12, 1997 was $320 million and $256 million, respectively. The difference of $64 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 thresholds under the leases are not met or exceeded. If the rental revenues represented by this 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 274.6 million OP Units outstanding on a pro forma basis after the Partnership Mergers (based upon an assumed price of $12.50 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 upon a total of 204.5 million OP Units to be owned by Host REIT on a pro forma basis after the Merger (based on a price of $12.50 per OP Unit). (11) Based on a total of 274.6 million OP Units outstanding on a pro forma basis after the Partnership Mergers (based upon an assumed price of $12.50 per OP Unit). (12) Based on a total of 204.5 million shares of Host REIT Common Stock outstanding on a pro forma basis after the Merger (based on an assumed price of $12.50 per share). (13) The actual initial cash distributions per OP Unit and per share of Host REIT Common Stock during the twelve months ending December 31, 1999 will be dependent upon the number of OP Units issued in the Partnership Mergers, which will be a function of the price of an OP Unit for purposes of the Partnership Mergers and which Partnerships participate in the Partnership Mergers. Does not include 29.6 million shares (or OP Units) which are issuable upon conversion of the convertible debentures underlying the Convertible Preferred Securities (based on the current conversion price of $18.604 per share), which does not take into account any anti-dilution adjustments which may result from certain effects of the REIT Conversion that cannot be determined at this time or any shares which are issuable upon exercise of outstanding stock options (6.8 million shares as of January 2, 1998), or any shares issued pursuant to the Special Dividend. Assuming a value of $2.50 per share for the Initial E&P Distribution (consisting of the distribution of Crestline common stock in an estimated amount equal to approximately $1.30 per share and the distribution of the Special Dividend in an estimated amount equal to approximately $1.20 per share), and a pre-distribution Host stock price of $15.00 per share (resulting in an assumed post distribution in Host stock price of $12.50 per share), the Company estimates that such anti- dilution adjustments would result in a decrease in the conversion price from $18.604 to approximately $15.50 and approximately 5.9 million additional shares becoming issuable upon conversion of the debentures and Convertible Preferred Shares following the Initial E&P Distribution. The actual adjustments may differ from this estimate and the differences may be material. 118 If Host's preliminary estimate of $231 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 were less than $144 million and estimated cash from contingent rents were only $64 million during the twelve months ending December 31, 1999, then the Operating Partnership would be required to borrow approximately $23 million (or $0.08 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 $64 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 stockholders per share of Host REIT Common Stock 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 stockholders 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 above 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 share of Host REIT Common Stock 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:
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNT) ----------------- Estimated cash distributions by the Operating Partnership for the twelve months ending December 31, 1999.................. $ 231 Less: Estimated cash distributions to OP Unitholders (other than Host REIT)............................................. (59) ----- Host REIT's share of estimated cash distributions by the Operating Partnership for the twelve months ending December 31, 1999.................................................... 172 Less: Estimated cash payments for federal and state income taxes (if Host REIT has not yet made REIT election)(1).. (65) ----- Estimated cash distributions by Host REIT (if Host REIT has not yet made a REIT election) for the twelve months ending December 31, 1999........................................... $107 ===== Estimated cash distributions per share of Host REIT Common Stock (if Host REIT has not yet made a REIT election) for the twelve months ending December 31, 1999(2)............... $0.53 =====
- -------- (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 204.5 million shares of Host REIT Common Stock 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 common or preferred stock by Host either prior to or following the Partnership 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 119 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 the holders of Host REIT Common Stock, see "Federal Income Tax Consequences--Taxation of Taxable U.S. Stockholders Generally," "--Taxation of Tax-Exempt Stockholders of Host REIT" and "--Taxation of Non-U.S. Stockholders." For a discussion of the annual distribution requirements applicable to REITs, see "Federal Income Tax Consequences--Federal Income Taxation of Host REIT Following the Merger-- Annual Distribution Requirements Applicable to REITs." 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 Company's investment objectives are to (i) achieve long-term sustainable growth in Funds From Operations per share of Host REIT Common Stock, (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 Company'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 Company may sell certain of its hotels. The Company 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 Company's equity interest in such property. Investments in Real Estate Mortgages. While the Company will emphasize equity real estate investments, it may, in its discretion, invest in mortgages and other similar interests. The Company 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 Company held two mortgages secured by hotels. In addition, the Company 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 Company also may invest in securities of other entities engaged in real estate activities or invest in securities of other issuers, including for the purpose of exercising control over such entities. The Company 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 Company'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. 120 FINANCING POLICIES The Operating Partnership's and Host REIT's organizational documents currently contain no restrictions on incurring debt. The Company, 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 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 Company 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 Company 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 Company's financing policy is subject to modification and change. The Company may waive or modify its borrowing policy without any vote of the stockholders of Host REIT. To the extent that the Board of Directors determines to seek additional capital, the Company 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 Company 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, the Company also may determine to issue securities senior to the Host REIT Common Stock or OP Units, including preferred shares and debt securities (either of which may be convertible into Host REIT Common Stock or OP Units or may be accompanied by warrants to purchase Host REIT Common Stock or OP Units). The Company 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 Company's objective is to reduce its reliance on secured indebtedness. LENDING POLICIES The Company 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 Company 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 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 121 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 also has 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 Host REIT 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 holders of Host REIT Common Stock and 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. 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 the Chairman of the Board and Chief Executive Officer 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 5.33% and 5.31%, respectively, of the outstanding shares of Crestline (but neither will serve as an officer or director thereof). Because they will serve as directors of Host REIT, as well as directors (and in the case of J.W. Marriott, Jr., the Chief Executive Officer) of Marriott International they may be subject to certain potential conflicts of interest in fulfilling their responsibilities to Host REIT and its stockholders. See "Risk Factors--Conflicts of Interest-- Relationships with Marriott International and Crestline." 122 POLICIES WITH RESPECT TO OTHER ACTIVITIES The Company 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 stockholders. 123 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 Three Quarters 1998 and First Three 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.
FIRST THREE QUARTERS FISCAL YEAR ---------------- ---------------------------------------------- 1998(1) 1997(1) 1997(1) 1996(2) 1995(3) 1994(1) 1993(1)(4) ------- ------- ------- ------- ------- ------- ---------- (UNAUDITED) (IN MILLIONS) INCOME STATEMENT DATA: Revenues............... $1,040 $ 768 $1,147 $ 732 $ 484 $ 380 $ 659 Operating profit....... 493 304 449 233 114 152 92 Interest expense....... 245 198 302 237 178 165 164 Income (loss) from con- tinuing operations.... 100 38 47 (13) (62) (13) 56 Net income (loss)(5)... (48) 43 50 (13) (143) (25) 50 OTHER OPERATING DATA: Cash from operations... 278 313 464 201 142 146 415 Cash used in investing activities............ (273) (497) (1,046) (504) (208) (178) (262) Cash provided by (used in) financing activi- ties.................. 23 391 389 806 200 26 (389) Comparative FFO(6) (un- audited).............. 282 202 295 164 136 N/A N/A Depreciation and amor- tization.............. 184 158 240 168 122 113 N/A RATIO DATA (UNAUDITED): Ratio of earnings to fixed charges(7)...... 1.7x 1.4x 1.3x 1.0x -- -- -- Deficiency of earnings to fixed charges(7)... -- -- -- -- 70 12 45 BALANCE SHEET DATA: Cash, cash equivalents and short-term marketable securities............ $ 575 $ 911 $ 865 $ 704 $ 201 $ 67 $ 73 Total assets........... 6,969 6,362 6,526 5,152 3,557 3,366 3,362 Debt................... 4,224 3,634 3,783 2,647 2,178 1,871 2,113
- -------- (1) In the First Three Quarters of 1998, Host recognized a $148 million extraordinary loss, net of taxes, on the extinguishment of certain debt. In the First Three 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 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 124 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 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 stockholders 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, 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. 125 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LACK OF COMPARABILITY FOLLOWING THE MERGER AND THE REIT CONVERSION Because substantially all of the Company's Hotels will be leased following the Merger and the REIT Conversion, the Company does not believe that the historical results of operations will be comparable to the results of operations of Host following the Merger and the REIT Conversion. For pro forma information giving effect to the Merger and the REIT Conversion (including the Leases), see "Pro Forma Financial Statements." 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 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 THREE QUARTERS 1998 COMPARED TO FIRST THREE 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 $272 million, or 35%, to $1,040 million for the First Three Quarters 1998 from $768 million for the First Three 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 11 full-service properties during the First Three 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 Three Quarters 1998. 126 Hotel revenues increased $186 million, or 25%, to $922 million for the First Three Quarters 1998 due to growth in REVPAR and the addition of 29 full- service properties acquired in 1997 and through the first three quarters of 1998. Hotel sales (gross hotel sales, including room sales, food and beverage sales, and other ancillary sales such as telephone sales) increased $449 million, or 24%, to over $2.3 billion in the First Three 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 7.9% to $113.27 for the First Three 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 nearly eight percent with no change in occupancy. Revenues generated from Host's 31 senior living communities totaled $58 million for the First Three Quarters 1998 compared to $16 million for the First Three Quarters 1997 (as the assets were purchased in the third quarter of 1997). For the First Three Quarters 1998, average occupancy was nearly 92% and the average per diem rate was $88.19. Senior living communities' sales totaled $166 million for the First Three 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, real and personal property taxes, ground, building and equipment rent, insurance and certain other costs. Operating costs and expenses increased $83 million to $547 million, primarily representing increased hotel and senior living communities operating costs. Hotel operating costs increased $69 million to $502 million for the First Three Quarters 1998, primarily due to the addition of 29 full-service hotel properties during 1997 and through the first three quarters of 1998 and increased management fees and rentals tied to improved property results. As a percentage of hotel revenues, hotel operating costs and expenses, from 63% and 59% of revenues for the First Three Quarters 1998, due to the significant increases in REVPAR discussed above, as well as the operating leverage as a result of a significant portion of the Company's hotel operating costs and expenses being fixed. The Company's senior living communities' operating costs and expenses were $31 million for the First Three Quarters 1998, compared to $9 million for the First Three Quarters 1998. As the senior living communities were purchased at the beginning of the 1997 third quarter, year-to-date operating costs and expenses are not comparable. Operating Profit. As a result of the changes in revenues and operating costs and expenses discussed above, the Company's operating profit increased $189 million, or 62%, to $493 million for the First Three Quarters 1998. For the First Three Quarters 1998, hotel operating profit increased $117 million, or 39%, to $420 million, or 46% of hotel revenues, for 1998 compared to $303 million, or 41% of hotel revenues, for 1997. Specifically, hotels in New York City, San Francisco, Toronto and Atlanta reported significant improvements for the 1998 third quarter over the third quarter of 1997. Minority Interest. Minority interest expense increased $12 million to $36 million for the First Three 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 1998. 127 Corporate Expenses. Corporate expenses increased $6 million to $33 million for the First Three Quarters 1998. As a percentage of revenues, corporate expenses decreased to 2.8% of revenues for the First Three Quarters 1998 from 1.1% in the First Three 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 and totaled $14 million for the First Three Quarters 1998. Interest Expense. Interest expense increased 24% to $245 million in the First Three Quarters 1998, primarily due to additional debt assumed in connection with the 1997 and 1998 full-service hotel and senior living community additions as well as the issuance of the New Senior Notes and the New Credit Facility. 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 decreased $1 million to $36 million for the First Three Quarters 1998, primarily reflecting the lower level of cash and marketable securities held in 1998 compared to 1997. Income before Extraordinary Item. Income before extraordinary item for the First Three Quarters 1998 was $100 million, compared to $38 million for the First Three Quarters 1997. Extraordinary Gain (Loss). In connection with the purchase of the Old Senior Notes, Host recognized an extraordinary loss of $148 million, which represents the bond premium and consent payments totaling approximately $175 million and the write-off of deferred financing fees of approximately $52 million related to the Old Senior Notes, net of taxes. 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 (Loss). The significant net loss for the First Three Quarters 1998 was due to the $148 million extraordinary loss on the extinguishment of debt. Net loss for the First Three Quarters 1998 was $48 million compared to net income of $43 million for the First Three Quarters 1997. Basic and diluted earnings (loss) per common share were $(.24) and $(.23), respectively, for 1998 and $.21 for the First Three Quarters 1997. 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 128 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. 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 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 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. 129 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 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. Net Income (Loss). The Company'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 130 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 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 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 the Company'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 Three Quarters 1998 to the First Three 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 Proxy Statement/Prospectus. The following discussion and analysis has been prepared assuming the following two scenarios: . All Partnerships participate in the Partnership Mergers and no Notes are issued ("100% Participation with No Notes Issued"). 131 . All Partnerships participate in the Partnership Mergers 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 Merger 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 Merger and the 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. The following table presents the results of operations for the First Three Quarters 1998 and the First Three Quarters 1997 on a pro forma basis under the scenarios discussed above:
100% PARTICIPATION 100% PARTICIPATION WITH NO NOTES ISSUED WITH NOTES ISSUED ---------------------- ---------------------- FIRST THREE QUARTERS FIRST THREE QUARTERS ---------------------- ---------------------- 1998 1997 1998 1997 ---------- ---------- ---------- ---------- (IN MILLIONS) Rental revenues................ $ 540 $ 521 $ 540 $ 521 Total revenues................. 542 528 542 528 Operating costs and expenses... 409 413 408 412 Operating profit before minority interest, corporate expenses and interest expense....................... 133 115 134 116 Minority interest.............. (14) (8) (14) (8) Corporate expenses............. (30) (29) (30) (29) Interest expense............... (328) (332) (340) (343) Interest income................ 24 20 24 20 ---------- ---------- ---------- ---------- Loss before income taxes....... (215) (234) (226) (244) Benefit (provision) for income taxes......................... 11 12 11 12 ---------- ---------- ---------- ---------- Loss before extraordinary items......................... $ (204) $ (222) $ (215) $ (232) ========== ========== ========== ==========
100% PARTICIPATION WITH NO NOTES ISSUED--FIRST THREE QUARTERS 1998 COMPARED TO FIRST THREE QUARTERS 1997 (PRO FORMA) 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 $14 million, or 2.7%, to $542 million for the First Three Quarters 1998 from $528 million for the First Three 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 for the substantial majority of the Company's leases in the First Three Quarters 1998 and First Three Quarters 1997. On a pro forma basis, the Company would have received rental payments of $860 million and $777 million, respectively, resulting in deferred revenue of $320 million and $256 million, respectively, for the First Three Quarters 1998 and First Three Quarters 1997. Hotel sales (gross hotel sales, including room sales, food and beverage sales, and other ancillary sales such as telephone sales) increased $194 million, or 7.8%, to over $2.6 billion in the First Three 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 8.1% to $111.05 for the First Three Quarters 1998. Average room rates increased 8.4%, while average occupancy decreased slightly to 78.4%. 132 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 $4 million to $409 million in the First Three Quarters 1998. As a percentage of rental revenues, hotel operating costs and expenses decreased to 73% of rental revenues in the First Three Quarters 1998 from 77% of rental revenues in the First Three 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 $18 million, or 16%, to $133 million for the First Three Quarters 1998. Hotel operating profit increased $24 million, or 20%, to $146 million, or 27% of rental revenues, for the First Three Quarters 1998 from $122 million, or 23% of rental revenues, for the First Three 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 reported significant improvements for the First Three 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 $6 million to $14 million for the First Three Quarters 1998, primarily reflecting improved lodging results. Corporate Expenses. Corporate expenses increased $1 million to $30 million for the First Three Quarters 1998 due to increased staffing levels and the impact of inflation. Interest Expense. Interest expense decreased $4 million to $328 million in the First Three Quarters 1998, primarily due to the impact of principal amortization on the Company's mortgage debt. Interest Income. Interest income increased $4 million to $24 million for the First Three Quarters 1998, primarily due to interest income from excess cash and marketable securities. Income before Extraordinary Items. The loss before extraordinary items for the First Three Quarters 1998 was $204 million, compared to $222 million for the First Three Quarters 1997. 100% PARTICIPATION WITH NOTES ISSUED--FIRST THREE QUARTERS 1998 COMPARED TO FIRST THREE QUARTERS 1997 (PRO FORMA) Revenues. Revenues increased $14 million, or 2.7%, to $542 million for the First Three Quarters 1998 from $528 million for the First Three Quarters 1997. Based on the structure of the Company's leases, only minimum rent was recorded for the substantial majority of the Company's leases in the First Three Quarters 1998 and First Three Quarters 1997. On a pro forma basis, the Company would have received rental payments of $860 million and $777 million, respectively, resulting in deferred revenue of $320 million and $256 million, respectively, for the First Three Quarters 1998 and First Three Quarters 1997. Hotel sales (gross hotel sales, including room sales, food and beverage sales, and other ancillary sales such as telephone sales) increased $194 million, or 7.8%, to over $2.6 billion in the First Three 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 8.1% to $111.05 for the First Three Quarters 1998. Average room rates increased 8.4%, while average occupancy decreased slightly to 78.4%. Operating Costs and Expenses. Operating costs and expenses decreased $4 million to $408 million in the First Three Quarters 1998. As a percentage of rental revenues, hotel operating costs and expenses decreased to 73% of revenues in the First Three Quarters 1998 from 76% of rental revenues in the First Three 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 $18 million, or 16%, to $134 million for the First Three Quarters 1998. Hotel operating profit increased $24 million, or 20%, to $147 million, or 27% of rental revenues, for the First Three Quarters 1998 from $123 million, or 24% of rental revenues, for the First Three Quarters 1997. Once again, the Company's hotels recorded significant improvements in comparable operating results; 133 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 Three 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 $6 million to $14 million for the First Three Quarters 1998, primarily reflecting improved lodging results. Corporate Expenses. Corporate expenses increased $1 million to $30 million for the First Three Quarters 1998 due to increased staffing levels and the impact of inflation. Interest Expense. Interest expense decreased $3 million to $340 million in the First Three Quarters 1998, primarily due to the impact of principal amortization on the Company's mortgage debt. Interest Income. Interest income increased $4 million to $24 million for the First Three Quarters 1998, primarily due to interest income from excess cash and marketable securities. Loss before Extraordinary Items. The loss before extraordinary items for the First Three Quarters 1998 was $215 million compared to $232 million for the First Three 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:
100% PARTICIPATION WITH 100% PARTICIPATION WITH NO NOTES ISSUED NOTES ISSUED ------------------------ ------------------------ FISCAL YEAR FISCAL YEAR ------------------------ ------------------------ 1997 1996 1997 1996 ----------- ----------- ----------- ----------- (IN MILLIONS) Rental revenues........... $ 1,135 $ 1,050 $ 1,135 $ 1,050 Total revenues............ 1,131 1,040 1,131 1,040 Operating costs and expenses................. 611 600 609 599 Operating profit before minority interest, corporate expenses and interest expense......... 520 440 522 441 Minority interest......... (10) (9) (10) (9) Corporate expenses........ (44) (39) (44) (39) Interest expense.......... (468) (481) (485) (498) Interest income........... 29 29 29 29 ----------- ----------- ----------- ----------- Income (loss) before income taxes............. 27 (60) 12 (76) Benefit (provision) for income taxes............. (1) 3 (1) 4 ----------- ----------- ----------- ----------- Income (loss) before extraordinary items...... $ 26 $ (57) $ 11 $ (72) =========== =========== =========== ===========
Revenues. Revenues increased $91 million, or 8.8%, to $1,131 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 $263 million, or 7.9%, to nearly $3.6 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 9.6% to $103.09 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 $611 million for 1997. As a percentage of rental revenues, hotel operating costs and expenses decreased to 53% of rental revenues for 1997, from 57% of rental revenues for 1996, reflecting the impact of increased 1997 rental revenues on relatively fixed operating costs and expenses. 134 Operating Profit. As a result of the changes in rental revenues and operating costs and expenses discussed above, the Company's operating profit increased $80 million, or 18%, to $520 million in 1997. Hotel operating profit increased $73 million, or 16%, to $535 million, or 47% of rental revenues, for 1997 compared to $462 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 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 unchanged at $29 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 $26 million, compared to a $57 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 $91 million, or 8.8%, to $1,131 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 $263 million, or 7.9%, to nearly $3.6 billion in 1997, reflecting increases in REVPAR. Improved results for the Company's full- service hotels were driven by strong increases in REVPAR of 9.6% to $103.09 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 $10 million to $609 million for 1997. As a percentage of rental revenues, hotel operating costs and expenses decreased to 54% of rental revenues for 1997, from 57% 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 $81 million, or 18%, to $522 million in 1997. Hotel operating profit increased $74 million, or 16%, to $537 million, or 47% of rental revenues, for 1997 compared to $463 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 135 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. 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 $29 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 $11 million, compared to a $72 million loss before extraordinary items for 1996 as a result of the items discussed above. PRO FORMA RESULTS IF NO PARTNERSHIPS PARTICIPATE IN THE REIT CONVERSION There is no requirement that any of the Partnerships participate in the REIT Conversion in order for the REIT Conversion to be consummated. Accordingly, the following discussion has been included assuming that no Partnerships participate in the REIT Conversion and compares the "No Partnership Participation" scenario to the 100% Participation with No Notes Issued scenario, both of which assume that the Blackstone Acquisition occurs. Revenues for the First Three Quarters 1998 and fiscal year 1997 would have been higher by $1 million and lower by $69 million, respectively, as a result of the Company not reporting rental revenues related to the 24 hotel properties owned by the Partnerships, partially offset by the Company reporting gross hotel sales for four of the Partnerships (Desert Springs, MHP, MHP2 and Hanover) that it will continue to consolidate for financial reporting purposes since these partnerships are controlled by Host. Operating profit would have been higher by $49 million for the First Three Quarters due to lower deferred rent under the No Partnership Participation scenario and lower by $42 million for fiscal year 1997 due to the operating profit generated by the Partnerships on a full year basis including the substantial impact of no rental revenues from the 24 properties, partially offset by a significant decrease in depreciation expense. Interest expense would have been lower by $24 million and $29 million, respectively, due to the reduction in overall debt levels by $426 million. The loss before extraordinary items for the First Three Quarters 1998 would have been lower by $65 million principally due to the changes in operating profit and interest expense discussed above and the impact on deferred rent. Income before extraordinary items for fiscal year 1997 would have been lower by $14 million, reflecting the net income generated by the Partnerships on a full year basis. PRO FORMA RESULTS IF HOST REIT'S ELECTION IS DELAYED UNTIL JANUARY 1, 2000 Host intends to use its best efforts 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, or at all. If the REIT Conversion does not occur in 1998, but the conditions to the REIT Conversion are otherwise satisfied, the effectiveness of Host REIT's election could be delayed to January 1, 2000, which could cause the Blackstone Acquisition (which is conditioned, among other things, on consummation of the REIT Conversion by March 31, 1999 and Host REIT qualifying as a REIT for 1999) not to be consummated. Accordingly, the following discussion compares the 100% Participation with No Notes Issued scenario with the "REIT 2000" scenario that 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 and no Notes are issued. 136 Revenues for the First Three Quarters 1998 and fiscal year 1997 would have been lower by $72 million and $137 million, respectively, due to the decrease in rental revenues as a result of the Company not completing the Blackstone Acquisition. Operating profit for the First Three Quarters 1998 and fiscal year 1997 would have been lower by $14 million and $50 million, respectively, due to the impact on rental revenues, of not completing the Blackstone Acquisition, net of the related operating costs and expenses (principally depreciation). Interest expense would have been lower by $36 million and $48 million, respectively, due to the reduction in overall debt levels of $600 million related to the Blackstone Acquisition. The loss before extraordinary items for the First Three Quarters 1998 would have been $26 million less and income before extraordinary items for fiscal year 1997 $4 million higher principally due to the changes in operating profit and interest expense discussed above. Note that the First Three Quarters 1998 is significantly impacted by $43 million of deferred revenue related to the Blackstone properties. 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 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 currently owns 72 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% (7.5% at September 11, 1998). The interest rate and commitment fee (0.35% at September 11, 1998) 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 11, 1998, $350 million was outstanding under the New Credit Facility. 137 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 $175 million. These costs, along with the write-off of deferred financing fees of approximately $52 million related to the Old Senior Notes and the Old Credit Facility, were recorded as a pre- tax extraordinary loss on the extinguishment of debt in the First Three Quarters 1998. Upon consummation of the REIT Conversion, the Company will be required to offer to repurchase the $127.4 million of 10 3/4% Senior Notes due 2008 issued by Courtyard by Marriott II Limited Partnership ("CBM2"). A subsidiary of the Company is the general partner of CBM2. Consummation of the REIT Conversion will constitute a "change of control" under the indenture relating to the notes. The Company must purchase any notes that are tendered for cash at a price equal to 101% of the principal amount plus accrued interest. The Company expects to borrow under the New Credit Facility to obtain any funds required to repurchase any such notes that are tendered. The Company will continue to hold any notes that are repurchased. Subject to market conditions, the Company is currently considering conducting a senior notes offering in the amount of approximately $300 to $500 million, the proceeds of which would be used to pay down other debt or pay other expenses of the REIT Conversion that would have been borrowed. 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 non-recourse 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 138 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 138--1 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 Operating Partnership 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, Host REIT will issue shares of Host REIT Common Stock, which will be delivered to such holder. Upon the issuance of such shares by Host REIT, the Operating Partnership will issue to Host REIT a number of OP Units equal to the number of shares of Host REIT Common Stock issued in exchange for the Debentures. 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. 139 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 Host's Courtyard properties and 18 of 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, Host 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 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. 140 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 875 units to these communities for approximately $88 million through an 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 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 141 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 and assisted living communities described above) to Host REIT's stockholders 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 equal to the accrued interest receivable on the notional amount of interest rate exchange agreements outstanding ($0 at January 2, 1998) 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 Three Quarters 1998 and First Three Quarters 1997 totaled $278 million and $313 million, respectively. 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 $273 million and $497 million for the First Three Quarters 1998 and the First Three 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 $317 million of short-term marketable securities in the First Three 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 from financing activities was $23 million and $391 million, respectively, for the First Three Quarters 1998 and First Three Quarters 1997. Host's cash from financing activities 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. 142 The ratio of earnings to fixed charges was 1.7 to 1.0, 1.4 to 1.0, 1.3 to 1.0, 1.0 to 1.0 and .7 to 1.0 for the First Three Quarters 1998, the First Three 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 stockholders 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 $80 million, or 40%, to $282 million in the First Three 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):
FIRST THREE QUARTERS FISCAL YEAR ---------------- ------------ 1998 1997 1997 1996 ------- ------- ----- ----- Income before extraordinary items.......... $ 100 $ 38 $ 47 $ (13) Real estate related depreciation and amortization.............................. 184 158 240 168 Other real estate activities............... (53) 1 6 7 Partnership adjustments.................... (9) (6) (13) 1 REIT Conversion expenses................... 14 -- -- -- Deferred taxes............................. 46 11 15 1 ------- ------- ----- ----- Comparative FFO............................ $ 282 $ 202 $ 295 $ 164 ======= ======= ===== =====
Host 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. On October 13, 1998, Host issued a press release reporting Comparative FFO and other financial information for the 1998 third quarter. The press release contained a statement to the effect that Host remained comfortable with industry analysts' consensus Comparative FFO per share estimate for 1998 (which implied diluted Comparative FFO of approximately $425 million for 1998) and further stated that for 1999, given the broad range of forecasts of gross domestic product for such year, that Host believed that the range of Comparative FFO per share estimates for 1999 (which implied a diluted Comparative FFO range for 1999 of approximately $700 million to $730 million) was appropriate at such time. In making such statement, Host intended to indicate its comfort level with industry analysts' Comparative FFO estimates for 1999. Host's comments on its comfort with analysts' Comparative FFO estimates for 1999 (which reflect estimated activities of Host REIT and Crestline together on a combined basis) were based on a number of factors, including the following principal assumptions: (i) the REIT Conversion would be effective as of January 1, 1999 on terms expected at such time; (ii) REVPAR would increase by approximately 4% in 1999 compared to 1998; (iii) $375 143 million of hotel properties would be acquired during 1999; (iv) construction of one new hotel property and expansion of three properties would be continued, which projects requiring 1999 outlays of funds of $160 million would reach completion in 1999 and would not generate earnings in 1999; (v) approximately $100 million of hotel dispositions would be consummated during 1999; (vi) net borrowings would be made in the third and fourth quarters of 1999 in the aggregate amount of $235 million at an assumed average interest rate of 7.20%; (vii) new bond debt of $1.2 billion would be issued at an assumed average interest rate of 8.10% in the first two quarters of 1999 to refinance existing mortgage debt with the remainder used for general corporate purposes; (viii) a limited number of OP Units would be issued in connection with hotel acquisitions; and (ix) conversion in full of the debentures and the Convertible Preferred Shares. As indicated in the press release, certain matters discussed in the press release, as well as those set forth in the preceding paragraph, including the statements with respect to the range of analysts' estimates for 1999 Comparative FFO, constitute forward-looking statements within the meaning of the Private Litigation Reform Act of 1995. Host's actual Comparative FFO for 1999 could differ materially and adversely from that stated or implied by such forward-looking statements due to a number of factors, many of which are beyond Host's control. In particular, some of the assumptions relied on by Host in commenting upon the range of analysts' estimates for 1999 Comparative FFO inevitably will not be accurate and unanticipated events may occur subsequent to the date thereof which may cause the actual Comparative FFO for 1999 to vary materially from that set forth in such statements. The assumptions upon which Host based its comments on the range of analysts' estimates for 1999 Comparative FFO reflected conditions it expected to exist and courses of action it expected to take during 1999 and required Host to make estimates and assumptions as to significant matters affecting Comparative FFO, including certain matters beyond the control of Host and/or which are inherently difficult to predict. For example, in making comments on the range of analysts' estimates for 1999 Comparative FFO, Host assumed that a certain level of rates and occupancy could be achieved by its properties during 1999 and that financing would be available on terms consistent with anticipated market conditions; that certain acquisition opportunities would be available during 1999 consistent with those available during 1998; and that the costs of construction of new properties and of expansion of existing hotel properties would not change materially in 1999 from those experienced during 1998. There can be no assurance that events will not occur which will cause these or other factors affecting Comparative FFO to change, which events or factors may cause Comparative FFO for 1999 to be materially different from that presented in the press release and in the immediately preceding paragraph. Factors which might cause such a difference include, but are not limited to, those discussed under "Forward-Looking Statements" on page 1 of this Proxy Statement/Prospectus, "Risk Factors" commencing on page 32 of this Proxy Statement/Prospectus and under "Distribution and Other Policies" commencing on page 117 of this Proxy Statement/Prospectus. Moreover, if the REIT Conversion is consummated, Host REIT and Crestline will be operated as separated public companies, and their results will not be reported together. Because of these and other factors, there is no assurance that the consensus estimates for 1999 Comparative FFO will be realized or that actual Comparative FFO for 1999 will not vary materially from that presented above. Host and Host REIT disclaim any responsibility to update the information contained in the press release or the foregoing paragraphs. 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 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 for 1995. 143--1 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 PROBLEM Year 2000 issues have arisen because many existing computer programs and chip-based embedded technology systems use only the last two digits to refer to a year, and therefore do not properly recognize a year that begins with "20" instead of the familiar "19". If not corrected, many computer applications could fail or create erroneous results. The following disclosure provides information regarding the current status of the Company's Year 2000 compliance program. The Company has adopted the compliance program because it recognizes the importance of minimizing the number and seriousness of any disruptions that may occur as a result of the Year 2000 issue. The Company's compliance program includes an assessment of the Company's hardware and software computer systems and embedded systems, as well as an assessment of the Year 2000 issues relating to third parties with which the Company has a material relationship or whose systems are material to the operations of the Company's hotel properties. The Company's efforts to ensure that its computer systems are Year 2000 compliant have been segregated into two separate phases: in-house systems and third-party systems. Following the REIT Conversion, Crestline, as the Lessee of the Company's hotels, will deal directly with Year 2000 matters material to the operation of the Hotels, and Crestline has agreed to adopt and implement the program outlined below with respect to third-party systems for all Hotels for which it is Lessee. In-House Systems. Since the distribution of Marriott International on October 8, 1993, the Company has invested in the implementation and maintenance of accounting and reporting systems and equipment that are intended to enable the Company to provide adequately for its information and reporting needs and which are also Year 2000 compliant. Substantially all of the Company's in-house systems have already been certified as Year 2000 compliant through testing and other mechanisms and the Company has not delayed any systems projects due to the Year 2000 issue. The Company is in the process of engaging a third party to review its Year 2000 in-house compliance. Management believes that future costs associated with Year 2000 issues for its in-house systems will be insignificant and therefore not impact the Company's business, financial condition and results of operations. The Company has not developed, and does not plan to develop, a separate contingency plan for its in-house systems due to their current Year 2000 compliance. 144 Third-Party Systems. The Company relies upon operational and accounting systems provided by third parties, primarily the managers and operators of its hotel and senior living properties, to provide the appropriate property- specific operating systems (including reservation, phone, elevator, security, HVAC and other systems) and to provide it with financial information. Based on discussion with the third parties that are critical to the Company's business, including the managers and operators of its hotels, the Company believes that these parties are in the process of studying their systems and the systems of their respective vendors and service providers and, in many cases, have begun to implement changes, to ensure that they are Year 2000 compliant. However, the Company has not received any oral or written assurances that these third parties will be Year 2000 compliant on time. To the extent these changes impact property-level systems, the Company may be required to fund capital expenditures for upgraded equipment and software. The Company does not expect these charges to be material, but is committed to making these investments as required. To the extent that these changes relate to a third party manager's centralized systems (including reservations, accounting, purchasing, inventory, personnel and other systems), the Company's management agreements generally provide for these costs to be charged to the Company's properties subject to annual limitations, which costs will be borne by Crestline following the REIT Conversion. The Company and Crestline expect that the third party managers will incur Year 2000 costs in lieu of costs for its centralized systems related to system projects that otherwise would have been pursued and therefore, its overall level of centralized systems charges allocated to the properties will not materially increase as a result of the Year 2000 compliance effort. The Company and Crestline believe that this deferral of certain system projects will not have a material impact on its future results of operations, although it may delay certain productivity enhancements at its properties. The Company (and, following the REIT Conversion, Crestline) will continue to monitor the efforts of these third parties to become Year 2000 compliant and will take appropriate steps to address any non-compliance issues. The Company believes that in the event of material Year 2000 non- compliance, the Company will have the right to seek recourse against the manager under its third party management agreements. The management agreements, however, generally do not specifically address the Year 2000 compliance issue. Therefore, the amount of any recovery in the event of Year 2000 non-compliance at a property, if any, is not determinable at this time (and if the REIT Conversion occurs, only a portion of such recovery would accrue to the Company, through increased lease rental payments from Crestline). The Company (and, following the REIT Conversion, Crestline) will work with the third parties to ensure that appropriate contingency plans will be developed to address the most reasonably likely worst case Year 2000 scenarios, which may not have been identified fully. In particular, the Company has had extensive discussions regarding the Year 2000 problem with Marriott International, the manager of a substantial majority of its hotel properties and all of its senior living communities. Due to the significance of Marriott International to the Company's business, a detailed description of Marriott International's state of readiness follows. Marriott International has adopted an eight-step process toward Year 2000 readiness, consisting of the following: (i) Awareness: fostering understanding of, and commitment to, the problem and its potential risks; (ii) Inventory: identifying and locating systems and technology components that may be affected; (iii) Assessment: reviewing these components for Year 2000 compliance, and assessing the scope of Year 2000 issues; (iv) Planning: defining the technical solutions and labor and work plans necessary for each particular system; (v) Remediation/Replacement: completing the programming to renovate or replace the problem software or hardware; (vi) Testing and Compliance Validation: conducting testing, followed by independent validation by a separate internal verification team; (vii) Implementation: placing the corrected systems and technology back into the business environment; and (viii) Quality Assurance: utilizing a dedicated audit team to review and test significant projects for adherence to quality standards and program methodology. Marriott International has grouped its systems and technology into three categories for purposes of Year 2000 compliance: (i) information resource applications and technology (IT Applications)--enterprise-wide systems supported by Marriott International's centralized information technology organization ("IR"); (ii) Business-initiated Systems ("BIS")--systems that have been initiated by an individual business unit, and 145 that are not supported by Marriott International's IR organization; and (iii) Building Systems--non-IT equipment at properties that use embedded computer chips, such as elevators, automated room key systems and HVAC equipment. Marriott International is prioritizing its efforts based on how severe an effect noncompliance would have on customer service, core business processes or revenues, and whether there are viable, non-automated fallback procedures (System Criticality). Marriott International measures the completion of each phase based on documented and quantified results, weighted for System Criticality. As of the end of the 1998 third quarter, the awareness and inventory phases were complete for IT Applications and nearly complete for BIS and Building Systems. For IT Applications, the Assessment, Planning and Remediation/Replacement phases were each over 80 percent complete, and Testing and Compliance Validation had been completed for a number of key systems, with most of the remaining work in its final stage. For BIS and Building Systems, Assessment and Planning were in the mid-to-upper-range of completion, with a substantial amount of work in process, while the progress level for Remediation/Replacement and Testing and Compliance Validation had not yet been documented and quantified. Quality Assurance is also in progress for IT Applications and is scheduled to begin for BIS and Building Systems in the near future. Marriott International's goal is to substantially complete the Remediation/Replacement and Testing phases for its System Critical IT Applications by the end of 1998, with 1999 reserved for unplanned contingencies and for Compliance Validation and Quality Assurance. For System Critical BIS and Building Systems, the same level of completion is targeted for June 1999 and September 1999, respectively. Marriott International has initiated Year 2000 compliance communications with its significant third party suppliers, vendors and business partners, including its franchisees. Marriott International is focusing its efforts on the business interfaces most critical to its customer service and revenues, including those third parties that support the most critical enterprise-wide IT Applications, franchisees generating the most revenues, suppliers of the most widely used Building Systems and BIS, the top 100 suppliers, by dollar volume, of non-IT products, and financial institutions providing the most critical payment processing functions. Responses have been received from a majority of the firms in this group. A majority of these respondents have either given assurances of timely Year 2000 compliance or have identified the necessary actions to be taken by them or Marriott International to achieve timely Year 2000 compliance for their products. Marriott International is also establishing a common approach for testing and addressing Year 2000 compliance issues for its managed and franchised properties. This includes a guidance protocol for operated properties, and a Year 2000 "Toolkit" for franchisees containing relevant Year 2000 compliance information. Marriott International is also utilizing a Year 2000 best- practices sharing system. Risks. There can be no assurances that Year 2000 remediation by the Company or third parties will be properly and timely completed, and failure to do so could have a material adverse effect on the Company, its business and its financial condition. The Company cannot predict the actual effects to it of the Year 2000 problem, which depends on numerous uncertainties such as: (i) whether significant third parties properly and timely address the Year 2000 issue; and (ii) whether broad-based or systemic economic failures may occur. Moreover, following the REIT Conversion, the Company will be reliant upon Crestline to interface with third parties in addressing the Year 2000 issue at the hotels leased by Crestline. The Company is also unable to predict the severity and duration of any such failures, which could include disruptions in passenger transportation or transportation systems generally, loss of utility and/or telecommunications services, the loss or disruption of hotel reservations made on centralized reservation systems and errors or failures in financial transactions or payment processing systems such as credit cards. Due to the general uncertainty inherent in the Year 2000 problem and the Company's dependence on third parties (including Crestline following the REIT Conversion), the Company is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on the Company. The Company's Year 2000 compliance program, and Crestline's adoption thereof following the REIT Conversion are expected to significantly reduce the level of uncertainty about the Year 2000 problem and management believes that the possibility of significant interruptions of normal operations should be reduced. Accounting Standards. Host adopted Statement of Financial Accounting Standard ("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 146 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 1995 of $47 million, which was reflected in discontinued operations. In the fourth quarter of 1996, Host 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 Three Quarters 1998 and First Three Quarters 1997, Host's other comprehensive loss was $3 million and $8 million, respectively. As of September 11, 1998 and January 2, 1998, Host's accumulated other comprehensive income was approximately $7 million and $10 million, respectively. On November 20, 1997, the Emerging Issues Task Force ("EITF") of the Financial Accounting Standards Board reached a consensus of 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 Three Quarters 1998, First Three Quarters 1997 and Fiscal Years 1997, 1996 and 1995 would have increased both revenues and operating expenses by approximately $1,501 million, $1,161 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. EIFT 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. 147 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 Merger and the other transactions comprising 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.
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.... 79 Director John G. Schreiber....... 52 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............... 51 Senior Vice President, General Counsel and Corporate Secretary Donald D. Olinger....... 39 Senior Vice President and Corporate Controller
- -------- (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 stockholders. 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 stockholders. 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 Directors of Bucknell 148 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 stockholders. 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 stockholders. 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 stockholders. 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 stockholders. 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 stockholders. 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 stockholders. 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. 149 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 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. 150 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 Host REIT Common Stock 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 stockholders' 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 the Plans (to the extent such Director is eligible) and/or Host REIT's Non- Employee Directors' Deferred Stock Compensation Plan. Directors also will 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 Directors 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").
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 Board 1996 262,951 105,180 114,969(7) 0 0 21,439(8) 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
151 - -------- (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 stockholders 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 Host Marriott Corporation Executive 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 stockholder 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 Host Marriott Corporation (HMC) Retirement and Savings Plan and the Host Marriott Corporation Executive Deferred Compensation Plan. In 1997, the amounts attributable to the Host Marriott Corporation (HMC) 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 Host Marriott Corporation Executive 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 Host Marriott Corporation Executive Deferred Compensation Plan following his retirement and (ii) common stock due to be distributed to him under the Host Marriott Corporation 1997 Comprehensive Stock Incentive Plan (formerly called the Host Marriott Corporation 1993 Comprehensive Stock Incentive Plan) following his retirement. In connection with this waiver, Host entered into an 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 Host Marriott Corporation Executive Deferred Compensation Plan and the stock distributions under the Host Marriott Corporation 1997 Comprehensive Stock Incentive Plan (formerly called the Host Marriott Corporation 1993 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 $96,842 for Mr. Nassetta. 152 AGGREGATED STOCK OPTION EXERCISES AND YEAR-END VALUE The table below sets forth, on an aggregated basis, (i) information regarding the exercise during fiscal year 1997 of options to purchase Host Common Stock (and shares of the common stock of other companies which Host has previously spun off) by each of the executive officers listed on the Executive Compensation table above, and (ii) the value on January 2, 1998 of all unexercised options held by such individuals. Host did not grant any options to the executive officers listed on the following table in fiscal year 1997. Terence C. Golden and Christopher J. Nassetta do not have any options to purchase stock in any of the companies listed in the following table. AGGREGATED STOCK OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
VALUE OF UNEXERCISED IN- NUMBER OF SHARES THE UNDERLYING UNEXERCISED MONEY OPTIONS AT OPTIONS AT FISCAL YEAR END FISCAL YEAR END (2) (#) ($) ----------------------------------- ------------------------- SHARES ACQUIRED ON VALUE EXERCISE REALIZED NAME COMPANY(1) (#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- ---------- ----------- -------- --------------- -------------- ----------- ------------- R. E. Marriott.......... HM 35,000 421,379 55,700(3) 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
- -------- (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 1997 Comprehensive Stock Incentive Plan (formerly called 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 1997 Comprehensive Stock Incentive Plan (formerly called the Host Marriott Corporation 1993 Comprehensive Stock Incentive 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. (3) In order to facilitate the REIT Conversion, Mr. Marriott has agreed to the cancellation of such options upon consummation of the Merger in exchange for a grant of an equal number of stock appreciation rights payable in cash that are economically equivalent to the options that are canceled. 153 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
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
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 the 1998 Employee Benefits Allocation Agreement which 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 certain liabilities relating to covered benefits and labor matters with respect to individuals who are employed by Host REIT or its affiliates on or 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 also is 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"), 154 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. 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. Outstanding awards of Host Common Stock issued or reserved under the Comprehensive Stock Incentive Plan are expected to be exchanged for Host REIT Common Stock and Crestline common stock, according to the terms of the 1998 Employee Benefits Allocation Agreement. Under the terms of the Comprehensive Stock Incentive Plan, an eligible full- time employee may receive an award of (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 awards under the Comprehensive Stock Incentive Plan will be for Host REIT Common Stock. Options granted to officers and key employees 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 no later than 15 years after the date of grant. Under the terms of the Comprehensive Stock Incentive Plan, an eligible full- time employee may receive an award of deferred shares of Host Common Stock. Deferred shares may be granted as part of a bonus award or deferred stock agreement. After the REIT Conversion, an award of deferred shares under the Comprehensive Stock Incentive Plan will be for Host REIT Common Stock. 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. After the REIT Conversion, an award of restricted shares under the Comprehensive Stock Incentive Plan will be for Host REIT Common Stock. Under the terms of the Comprehensive Stock Incentive Plan, an eligible full- time employee may receive a bonus award. 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 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, all bonus awards will be for shares of Host REIT Common Stock. The Comprehensive Stock Incentive Plan authorizes the grant of stock appreciation rights ("SARs") 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 on the Host Common Stock, cash or other form or combination form of payout. After the REIT Conversion, SARs awarded under the Comprehensive Stock Incentive Plan will be tied to the appreciation in the value of Host REIT Common Stock. 155 Under the Comprehensive Stock Incentive Plan, an eligible full-time employee may receive 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, Special Recognition Awards will be for Host REIT Common Stock. 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 Stock Purchase Plan is expected to be adopted by the Operating Partnership as part of the REIT Conversion. 401(K) PLAN Host sponsors the Host Marriott Corporation (HMC) Retirement and Saving Plan (the "401(k) Plan"). The 401(k) Plan has received a favorable ruling from the Internal Revenue Service ("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 Merger, all shares of Host Common Stock held under the 401(k) Plan are expected to be converted to Host REIT Common Stock and shares of Crestline common stock. It is expected that after the REIT Conversion, 401(k) Plan participants will be able to elect to invest all or part of their plan benefits in Host REIT Common Stock. NON-EMPLOYEE DIRECTOR PLAN Host sponsors the Host Marriott Corporation Non-Employee Directors' Deferred Stock Compensation Plan (the "Non-Employee Director Plan") for purposes of attracting and retaining qualified non-employee Directors. Under the terms of the Non-Employee Director 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 Non-Employee Director 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 Non- Employee Director Plan are treated as if invested in 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 treat Directors' fees deferred under the Non-Employee Director Plan as if invested in Host REIT Common Stock. Non-Employee Directors may elect to receive payment of their benefits under the Non-Employee Director Plan in Host Common Stock in lump sum or installment payments. After the REIT Conversion, Host REIT expects to allow participants of the Non-Employee Director Plan to elect to receive their benefits in Host REIT Common Stock in lump sum or installment payments. DEFERRED COMPENSATION PLAN Host maintains the Host Marriott Corporation Executive Deferred Compensation Plan (the "Deferred Compensation Plan") for the benefit of select executives and directors. A participant may elect to defer part of 156 his compensation or director's fees in the case of non-employee directors pursuant to the Deferred Compensation Plan. The Deferred Compensation Plan will be adopted by the Operating Partnership as part of the REIT Conversion. LIMITATION OF LIABILITY AND INDEMNIFICATION The Host REIT Charter and Host REIT Bylaws contain provisions limiting the liability of Host REIT's present and former directors and officers to the corporation and its stockholders and obligating Host REIT to indemnify present and former directors and officers all in accordance with Maryland law. See "The Restructuring Transactions--Limitation of Liability and Indemnification of Directors and Officers." INDEMNIFICATION AGREEMENTS Host REIT intends to enter into indemnification agreements with each of its directors and officers. The indemnification agreements 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. 157 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 "Lodging/Service Management Business"). (On December 29, 1995, Host distributed the Host/Travel Plazas Business to the stockholders of HM Services; 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 Lodging/Service 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 could 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 158 Merger as to the Host REIT Common Stock, subject to the following limitations intended to protect 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), 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 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, in the event the Operating Partnership is or would be considered a "publicly traded partnership" within the meaning of the Code, the Marriott International Purchase Right will be exercisable only if such acquisition and ownership of Host REIT Common Stock 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 (taking into account the applicable attribution rules and any stock of Crestline that the Operating Partnership is deemed to own under the attribution rules by reason of the ownership of an interest in the Operating Partnership by the Blackstone Entities). 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 Common Stock will face the possibility that its ability to exercise control would be impaired by the exercise of the Marriott International 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 Host REIT Common Stock 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. 159 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 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, subject to certain exceptions. 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. 160 (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 160--1 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 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 2007. 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. Shares of Crestline, which will own the senior living communities business, will be distributed to Host's stockholders as part of the Initial E&P Distribution in connection with the REIT Conversion. (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 Sodexho 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 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. 161 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, 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 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 various agreements, in addition to the Leases as described below. The descriptions of such agreements are qualified in their entirety by reference to the agreements, the forms of which (other than the Distribution Agreement and the Corporate Transitional Services Agreement) are included as exhibits to the Registration Statement of which this Proxy Statement/Prospectus is a part. 162 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; (iv) the transfer to Crestline of the 25% interest in the Swissotel management company to be acquired in the Blackstone Acquisition; (v) the return to Crestline of those shares of Crestline common stock held for delivery to the Blackstone Entities in the Blackstone Acquisition if that transaction does not occur prior to January 1, 1999, subject, however, to the right of Host to cause Crestline to sell such 18% of the common stock of Crestline to the Blackstone Entities at fair market value if the Blackstone Acquisition is consummated at a later date; and (vi) certain other agreements governing the relationship between Crestline and Host following the Initial E&P Distribution. Crestline also will grant Host REIT a contingent right to purchase Crestline's interest in Swissotel Management (USA) L.L.C. at fair market value in the event the tax laws are changed so that Host REIT could own such interest without jeopardizing its status as a REIT. 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 Distribution, financial responsibilities for liabilities arising out of or in connection with the business of the senior living communities. 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 through 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 Host will enter into an asset management agreement (the "Asset Management Agreement") with Crestline and at least one Non-Controlled Subsidiary, pursuant to which Crestline will agree to provide review and advice on the management and operation of the hotels. Generally, Crestline will provide the following consulting services: (i) review of operating and financial results (including site visits) and meet with Host and the Non-Controlled Subsidiaries, as applicable, 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) review of revenue and capital spending projections; (iv) administration of approvals relating to the operation of the hotel required under any related loan documents; (v) advice relating to any changes to the hotel management agreements; (vi) review of market conditions and competition for each of the hotels; (vii) monitoring and negotiating with governmental agencies in connection with any condemnation proceedings against the hotels; and (viii) monitoring and negotiating with insurance companies and contractors following a casualty at a hotel. Crestline will be paid a fee not to exceed $4.5 million for each calendar year for its consulting services under the Asset Management Agreements, which will be allocated between Host REIT and the Non-Controlled Subsidiary. The Asset Management Agreements will have a term of two years with an automatic one year renewal, unless earlier terminated by either party in accordance with the terms thereof. 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. Such services will be provided, as needed, at cost (including a reasonable overhead allocation) on a time and materials basis. The charges associated with such services are not expected to be material. 163 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--Noncompetition Agreements." 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." Guarantee and Pooling Agreements Crestline and certain of its subsidiaries will enter into guarantees of the Lease obligations of each Lessee. See "Business and Properties--The Leases." 164 PRINCIPAL STOCKHOLDERS The following table sets forth, as of July 31, 1998, the beneficial ownership of Host REIT Common Stock and OP Units of (i) each person who is expected to hold more than a 5% interest in Host REIT or the Operating Partnership, (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 Stock and OP Units" represents the number of shares of Host REIT Common Stock and OP Units the person is expected to hold immediately after the REIT Conversion, as a percentage of the total number of shares of Host REIT Common Stock 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.
NUMBER OF PERCENT PERCENT OF PERCENT OF SHARES OF PERCENT OF OF ALL ALL COMMON NUMBER OF ALL OP COMMON COMMON COMMON STOCK AND NAME OP UNITS UNITS(1) STOCK(2) STOCK(3) STOCK(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)........... 18,135 * 13,275,014 6.50% 6.51% 4.85% Richard E. Marriott(6)(8)(9)...... 15,314 * 13,203,209 6.47 6.47 4.82 Ann Dore McLaughlin..... 0 * 9,500 * * * John G. Schreiber(11)... 875,000 1.25% 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 62.31 0 * 17.63 15.93 Dresdner RCM Global Investors LLC(13)...... 0 * 13,595,975 6.66 6.66 4.96 FMR Corp.(14)........... 0 * 22,532,574 11.03 11.03 8.21 Southeastern Asset Management, Inc.(15)... 0 * 36,758,000 18.00 18.00 13.40 ALL DIRECTORS AND EXECUTIVE OFFICERS AS A GROUP (11 PERSONS)(6)(10)........ 908,449 1.30% 24,209,204 11.86% 12.25% 9.16%
- -------- * 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 (70.1 million OP Units), assuming a value of $12.50 per OP Unit. (2) Consists of Host REIT Common Stock received in the REIT Conversion as a result of ownership of Host. (3) Represents the number of shares of Host REIT Common Stock held by the person as a percentage of the total number of shares of Host REIT Common Stock expected to be outstanding immediately following the REIT Conversion (204.2 million shares of Host REIT Common Stock). (4) Assumes that all OP Units held by the person are redeemed for Host REIT Common Stock. The total number of shares of Host REIT Common Stock outstanding used in calculating this percentage (204.2 million shares of Host REIT Common Stock 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 Host REIT Common Stock. (5) Assumes that all OP Units held by the person are redeemed for Host REIT Common Stock. The total number of shares of Host REIT Common Stock and OP Units outstanding used in calculating this percentage (274.3 million) assumes that all of the OP Units held by other persons also are redeemed for Host REIT Common Stock. (6) Includes (i) the shares of unvested restricted stock granted under Host's Comprehensive Stock Incentive Plan, 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 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. In order to facilitate the REIT Conversion, J.W. Marriott, Jr. and Richard E. Marriott have agreed to the cancellation of 326,568 options and 55,700 options held by them, respectively, upon consummation of the Merger in exchange for a grant of an equal number of stock appreciation rights payable in cash that are economically equivalent to the options that are canceled. 165 (7) Host REIT Common Stock 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 stockholder; 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.; 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) Host REIT Common Stock 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 stockholder; does not include shares held by the adult children of Richard E. Marriott; Richard E. Marriott disclaims beneficial ownership of all such shares. (10) Host REIT Common Stock 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, the Host Marriott Corporation (HMC) 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 Directors 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 and shared dispositive power over 14,968,300 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. 166 DESCRIPTION OF HOST REIT CAPITAL STOCK The summary description 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 Host REIT Charter and Host REIT Bylaws, to be effective upon completion of the Merger, attached as Exhibits B and C, respectively, to the Agreement, which is attached to this Proxy Statement/Prospectus as Appendix A. GENERAL The Host REIT 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 shares of Host REIT Common Stock and 50,000,000 shares of Host REIT Preferred Stock. The Board of Directors is authorized, without a vote of stockholders, 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 November 13, 1998, 100 shares of Host REIT Common Stock were issued and outstanding. HOST REIT COMMON STOCK Subject to the preferential rights of any other classes or series of shares of capital stock and to the provisions of the Host REIT Charter regarding restrictions on transfers of shares of capital stock, holders of Host REIT Common Stock 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 stockholders 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. See "Distribution and Other Policies." Subject to the provisions to be contained in the Host REIT Charter regarding restrictions on the transfer of shares of capital stock, each outstanding share of Host REIT Common Stock will entitle the holder to one vote on all matters submitted to a vote of stockholders, 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 shares of Host REIT Common Stock 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 Host REIT Common Stock can elect all of the directors then standing for election. Holders of shares of Host REIT Common Stock will have no preferences, conversion, sinking fund, redemption rights or preemptive rights to subscribe for any securities of Host REIT. Subject to the provisions to be contained in the Host REIT Charter regarding restrictions on transfer of capital stock, shares of Host REIT Common Stock will 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 stockholders 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 the Host REIT Charter, any merger, consolidation, share exchange or transfer of its assets will need to be approved (i) by the Board of Directors in the manner provided in the MGCL and (ii) by stockholders to the extent required under the MGCL. The Host REIT Charter generally will provide for stockholder 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 stockholders 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 stockholders. For example, no stockholder 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 will not need to be approved by stockholders of a Maryland successor corporation if the merger does not reclassify or change the outstanding shares or otherwise amend the charter, and the number 167 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 will need to be approved by a Maryland successor only by its Board of Directors. Any amendments to the provisions contained in the Host REIT Charter relating to restrictions on transferability of stock, the classified Board and fixing the size of the Board within the range set forth in the Host REIT 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 stockholders 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 Host REIT Charter may be effected by requisite action of the Board of Directors and approval by stockholders by the affirmative vote of not less than a majority of the votes entitled to be cast on the matter. The Host REIT Charter will authorize the Board of Directors to reclassify any unissued shares of Host REIT Common Stock into other classes or series of capital stock, including preferred stock, 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 STOCK The Host REIT Charter initially will authorize the Board of Directors to issue 50 million shares of Host REIT Preferred Stock and to classify or reclassify any unissued preferred shares into one or more classes or series of capital stock, including Host REIT Common Stock. Prior to issuance of shares of any class or series of stock other than Host REIT Common Stock, the Board of Directors is required, under the MGCL, to set, subject to the provisions of the Host REIT 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 shares of Host REIT Common Stock or otherwise be in their best interest. As of the date hereof, no shares other than Host REIT Common Stock 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 Stockholders 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 shares of Host REIT Common Stock or otherwise be in their best interest. POWER TO ISSUE ADDITIONAL HOST REIT COMMON STOCK AND PREFERRED STOCK Host REIT believes that the power of the Board of Directors to issue additional authorized but unissued shares of Host REIT Common Stock or Host REIT Preferred Stock and to classify or reclassify unissued Host REIT Common Stock or Host REIT Preferred Stock 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 Host REIT Common Stock, will be available for issuance without further action by Host REIT's stockholders, 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 certain entities) during the last half of a taxable year (other than the first year for which an election to be treated 168 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 Host REIT Charter will provide that, subject to certain exceptions, no person or persons acting as a group 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 shares of Host REIT Common Stock outstanding 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 stock, subject to (a) an exception for a holder of shares of Host REIT Common Stock solely by reason of the Merger in excess of the Ownership Limit so long as such holder would not own, directly or by attribution under the Code, more than 9.9% by value of the outstanding capital stock of Host REIT as of the Special Merger Ownership Limit Effective Time, and (b) a limitation on the application of the "group" limitation (but no other element of the Ownership Limit) to any "group" that otherwise would exceed the Ownership Limit at the Effective Time solely by reason of its status as a "group." The Ownership Limit will prohibit 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 will grant an exception (pursuant to the applicable provisions of the Host REIT Charter) that will 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 Host REIT Common Stock 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 of less than 9.8% of the Host REIT Common Stock (or the acquisition or ownership of an interest in an entity that owns, actually or constructively, Host REIT Common Stock) 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 Host REIT Common Stock and thus subject such Host REIT Common Stock 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 Host REIT Common Stock 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. PURSUANT TO THE TERMS OF THE HOST REIT CHARTER, THE OWNERSHIP LIMIT WILL BECOME EFFECTIVE TO ALL HOST REIT STOCKHOLDERS AS OF THE EFFECTIVE TIME (SUBJECT TO THE LIMITED EXCEPTIONS DESCRIBED ABOVE). The Board of Directors of Host REIT will have the authority to increase the Ownership Limit from time to time, but will not have the authority to do so to the extent that after giving effect to such increase, five beneficial owners of Host REIT Common Stock could beneficially own in the aggregate more than 49.5% of the outstanding Host REIT Common Stock. 169 The Host REIT Charter will further prohibit (i) any person from actually or constructively owning shares of Host REIT Common Stock 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 Host REIT capital stock if such transfer would result in shares Host REIT capital stock being owned by fewer than 100 persons. Any person who acquires or attempts or intends to acquire actual or constructive ownership of shares of Host REIT capital stock 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 Host REIT capital stock or any other event would otherwise result in any person violating the Ownership Limit or the other restrictions in the Host REIT 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 Host REIT 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. The Host REIT Charter will provide that, 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 transfer of the excess shares will be void. In addition, shares of Host REIT stock 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. 170 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. TO AVOID THE ADVERSE EFFECTS OF THE OWNERSHIP LIMIT, ANY HOLDER OF HOST COMMON STOCK WHO WOULD OWN SHARES OF HOST REIT COMMON STOCK IN EXCESS OF THE OWNERSHIP LIMIT AT THE EFFECTIVE TIME SHOULD DISPOSE OF SUCH EXCESS SHARES PRIOR TO THE EFFECTIVE TIME. SEE "THE RESTRUCTURING TRANSACTIONS--TERMS OF THE MERGER." ANY SHARES OF HOST REIT COMMON STOCK HELD AT THE EFFECTIVE TIME AND NOT SUBSEQUENTLY TRANSFERRED PRIOR TO THE SPECIAL MERGER OWNERSHIP LIMIT EFFECTIVE TIME, OR ACQUIRED OR OTHERWISE HELD AT ANY TIME AFTER THE EFFECTIVE TIME 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 EXCESS SHARES OF HOST REIT COMMON STOCK WILL NOT BE ENTITLED TO ANY DISTRIBUTIONS THEREON OR TO VOTE SUCH EXCESS SHARES OF HOST REIT COMMON STOCK. THE HOLDER OF ANY SUCH EXCESS SHARES OF HOST REIT COMMON STOCK WILL RECEIVE THE LESSER OF THE VALUE OF SUCH EXCESS SHARES AS OF THE EFFECTIVE TIME OR THE CASH PROCEEDS OF THE SALE OF SUCH EXCESS SHARES OF HOST REIT COMMON STOCK BY THE TRUSTEE OF THE TRUST. 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. The Host REIT Charter also will provide that "Benefit Plan Investors" (as defined in the Host REIT Charter) may not hold, individually or in the aggregate, 25% or more of the value of any class or series of shares of capital stock of Host REIT to the extent such class or series does not constitute "Publicly Offered Securities" (as defined in the Host REIT Charter). All certificates representing shares of Host REIT 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 Host REIT capital stock must give a written notice to the Company within 30 days after the end of each taxable year. In addition, each stockholder 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 Host REIT 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 Host REIT Common Stock might receive a premium for their Host REIT Common Stock 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 Host REIT Common Stock will be First Chicago Trust Company of New York. 171 CERTAIN PROVISIONS OF MARYLAND LAW AND THE HOST REIT CHARTER AND BYLAWS The following summary of certain provisions of Maryland law and of the Host REIT Charter and Host REIT Bylaws 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 Host REIT Charter and Host REIT Bylaws to be effective upon completion of the Merger copies of which are attached as Exhibits B and C, respectively, to the Agreement attached to this Proxy Statement/Prospectus as Appendix A. The Host REIT Charter and Host REIT Bylaws will contain certain provisions that could make more difficult an acquisition or change in control of the Company 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 persons 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 "--Anti-Takeover Effect of Certain Provisions of Maryland Law and the Host REIT Charter and Bylaws." NUMBER OF DIRECTORS; CLASSIFICATION AND REMOVAL OF BOARD OF DIRECTORS; OTHER PROVISIONS The Host REIT 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 Host REIT Bylaws, provided that the total number of directors may not be fewer than three nor more than thirteen. Pursuant to the Host REIT Bylaws, the number of directors shall be fixed by the Board of Directors within the limits set forth in the Host REIT Charter. Further, the Host REIT 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 stockholders; the term of the second class of directors will expire at the 2000 annual meeting of stockholders; and the term of the third class of directors will expire at the 2001 annual meeting of stockholders. At each annual meeting of stockholders, 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 stockholders will have no right to cumulative voting for the election of directors, at each annual meeting of stockholders the holders of a majority of the outstanding Host REIT Common Stock will be able to elect all of the successors to the class of directors whose term expires at that meeting. The Host REIT Charter also will provide that, except for any directors who may be elected by holders of a class or series of capital stock other than the Host REIT Common Stock, directors may be removed only for cause only by the affirmative vote of stockholders 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 (except in the event of a vacancy on the Board of Directors among the directors elected by a class or series of stock other than Host REIT Common Stock, in which case such vacancy may be filled by a majority of the remaining directors elected by that class or series, or by the stockholders of that class or series unless otherwise provided in the articles supplementary for that series) and, in the case of a vacancy resulting from the removal of a director by the stockholders, by the stockholders 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 stockholders. A vote of stockholders 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 stockholders, 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 stock 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 Host REIT 172 Common Stock. 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 "The Restructuring Transactions--Limitation of Liability and Indemnification of Directors and Officers" 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 Host REIT Charter. CHANGES IN CONTROL PURSUANT TO MARYLAND LAW Maryland Business Combination Law. Under the MGCL, unless an exemption is available, certain "business combinations" (including certain issuances of equity securities) between a Maryland corporation and any Interested Stockholder or an affiliate of the Interested Stockholder, are prohibited for five years after the most recent date on which the Interested Stockholder becomes an Interested Stockholder. Thereafter, any such business combination must be recommended by the board of directors and approved by the affirmative vote of at least (i) 80% of all the votes entitled to be cast by holders of the outstanding shares of voting stock and (ii) two-thirds of the votes entitled to be cast by holders of voting stock other than voting stock held by the Interested Stockholder who will (or whose affiliate will) be a party to the business combination or any affiliate or associate of the Interested Stockholder, voting together as a single voting group, unless, among other conditions, the corporation's common stockholders 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 Stockholder for its shares. A business combination that is approved by the board of directors of a Maryland corporation at any time before an Interested Stockholder first becomes an Interested Stockholder is not subject to the special voting requirements. 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. The Board of Directors of Host REIT has adopted a resolution exempting from the operation of the "business combination" statute the acquisition of shares by Marriott International (together with its successors and permitted assignees, if any) pursuant to the terms of the Marriott International Purchase Right as well as any other transactions involving Host REIT, Marriott International, J.W. Marriott, Jr. and Richard E. Marriott; provided that any such other transaction with Marriott International or its affiliates or associates that is not in the ordinary course of business or with J.W. Marriott, Jr. or Richard E. Marriott must be approved by a majority of the directors of Host REIT present at a meeting at which a quorum is present, including a majority of disinterested directors, in addition to any vote of stockholders required by other provisions of the MGCL. 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 stockholder approval. A "control share acquisition" means the acquisition of control shares, subject to certain exceptions. A person who has made or proposes to make a control share acquisition, 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 stockholders 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 stockholders 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) 173 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 stockholders at which the voting rights of such shares are considered and not approved. If voting rights for control shares are approved at a stockholders meeting and the acquiror becomes entitled to vote a majority of the shares entitled to vote, all other stockholders 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 (i) shares acquired in a merger, consolidation or share exchange if the corporation is a party to the transaction or (ii) 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. The Host REIT Bylaws will contain an exemption from the control share acquisition provisions for any shares acquired by Marriott International (together with its successors and permitted assignees, if any) pursuant to the Marriott International Purchase Right, to the extent it is exercised. ADVANCE NOTICE OF DIRECTOR NOMINATIONS AND NEW BUSINESS The Host REIT Bylaws provide that (i) with respect to an annual meeting of stockholders, subject to the rights of holders of any class or series of stock having a preference over the Host REIT Common Stock as to dividends or upon liquidation to elect directors under specified circumstances, nominations of persons for election to the Board of Directors and the proposal of business to be considered by stockholders may be made only (A) pursuant to Host REIT's notice of meeting, (B) by or at the direction of the Board of Directors or (C) by a stockholder who was a stockholder of record both at the time of giving notice provided for in the Host REIT Bylaws and at the time of the annual meeting, and who is entitled to vote at the meeting and has complied with the advance notice procedures set forth in the Host REIT Bylaws and (ii) with respect to special meetings of the stockholders, only the business specified in Host REIT's notice of meeting may be brought before the meeting of stockholders and except as otherwise provided for or fixed by or pursuant to the provisions of the Host REIT Charter relating to the rights of the holders of any class or series of stock having a preference over the Host REIT Common Stock as to dividends or upon liquidation to elect directors under specified circumstances, nominations of persons for election to the Board of Directors may be made only (X) pursuant to Host REIT's notice of the meeting, (Y) by or at the direction of the Board of Directors or (Z) provided that the Board of Directors has determined that directors shall be elected at such meeting, by a stockholder who was a stockholder of record both at the time of giving notice provided for in the Host REIT Bylaws and at the time of the special meeting, and who is entitled to vote at the meeting and has complied with the advance notice provisions set forth in the Host REIT Bylaws. The advance notice provisions contained in the Host REIT Bylaws generally require nominations and new business proposals by stockholders to be 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 first mailed its proxy materials for the prior year's annual meeting of stockholders. MEETINGS OF STOCKHOLDERS; CALL OF SPECIAL MEETINGS; STOCKHOLDER ACTION IN LIEU OF MEETING BY UNANIMOUS CONSENT The Host REIT Bylaws provide that annual meetings of stockholders 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 stockholders 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 stockholders on the written request of stockholders entitled to cast a majority of all the votes entitled to be cast at the meeting. The Host REIT Bylaws further provide that special stockholder meetings may be called by the holders of any class or series of stock having a preference over the Host REIT Common Stock as to dividends or upon liquidation in the manner specified in articles supplementary filed as part of the Host REIT Charter. Pursuant to the MGCL and the Host REIT Bylaws, any action required or permitted to be taken by the stockholders must be effected at a duly called annual or special meeting of stockholders and may not be effected by any consent in writing by stockholders, unless such consent is unanimous. 174 MERGER, CONSOLIDATION, SHARE EXCHANGE AND TRANSFER OF ASSETS OF HOST REIT Pursuant to the Host REIT Charter, subject to the terms of any class or series of 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, 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. 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 stockholders 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 stockholder vote but not less than a majority of the number of votes entitled to be cast on the matter). The Host REIT Charter generally will provide for stockholder 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 stockholders of Host REIT by the affirmative vote only of a majority of all the votes entitled to be cast on the matter provided that (i) the stockholders of the trust immediately following the merger are the same as the stockholders of Host REIT immediately prior to the merger and (ii) the trust's declaration of trust contains amendment provisions substantially equivalent to those contained in specified provisions of the Host REIT Bylaws. Under the MGCL, certain mergers may be accomplished without a vote of stockholders. For example, no stockholder 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 stockholders 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 stockholders, 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. AMENDMENTS TO THE HOST REIT 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 stockholders for their consideration either at an annual or special meeting of stockholders. Thereafter, the proposed amendment must be approved by stockholders 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 to be contained in the Host REIT Charter relating to restrictions on transferability of Host REIT Common Stock, the classified Board and fixing the size of the Board within the range set forth in the Host REIT 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 stockholders 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 Host REIT Charter generally may be effected by requisite action of the Board of Directors and approval by stockholders 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 Host REIT Bylaws provide that directors have the exclusive right to amend the Host REIT 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 THE HOST REIT CHARTER AND BYLAWS The business combination and control share provisions of the MGCL, the provisions of the Host REIT Charter on the classification of the Board of Directors, fixing the size of the Board of Directors within a specified 175 range and removal of directors, the provisions authorizing the Board of Directors, without a vote of stockholders, to classify or reclassify any unissued shares of stock into one or more classes or series of stock, the provisions relating to mergers, consolidations, share exchanges and transfers of assets, the provisions for amending certain provisions of the Host REIT Charter and for amending the Host REIT Bylaws, the advance notice provisions of the Host REIT Bylaws and the limitations on the ability of stockholders 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 Host REIT Common Stock or otherwise be in their best interests. The stock transfer restrictions that will be contained in the Host REIT 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 Host REIT Common Stock or otherwise be in their best interests. MARRIOTT INTERNATIONAL PURCHASE RIGHT In connection with Host's spin-off 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 Merger (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 Stock 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. STOCKHOLDER RIGHTS PLAN Host currently has in effect a stockholder rights plan pursuant to the Host Rights Agreement, and it has preferred stock purchase rights attached to its common stock pursuant to such rights plan. Prior to the completion of the Merger, the Board of Directors intends to adopt a Stockholder Rights Plan pursuant to a rights agreement (the "Host REIT Rights Agreement") to replace the existing Host Rights Agreement and declare a dividend of one Host REIT Right, consisting of one preferred stock purchase right for each outstanding share of Host REIT Common Stock. All shares of Host REIT Common Stock issued by Host REIT between the date of adoption of the Host REIT Rights Agreement and the Rights Distribution Date (as defined below), or the date, if any, on which the Host REIT Rights are redeemed would have Host REIT Rights attached to them. It is expected that the Host REIT Rights will expire ten years after adoption of the Host REIT Rights Agreement, unless earlier redeemed or exchanged. Each Host REIT Right, when exercisable, would entitle the holder to purchase upon payment of the purchase price a fraction of a share of a newly created series of junior participating preferred stock. Until a Host REIT Right is exercised, the holder thereof, as such, would have no rights as a stockholder of Host REIT including, without limitation, the right to vote or to receive dividends. The Host REIT Rights Agreement is expected to provide that the Host REIT Rights initially attach to all certificates representing Host REIT Common Stock then outstanding. The Host REIT Rights would separate from the Host REIT Common Stock and a distribution of Host REIT Rights certificates would occur (a "Rights 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 Host REIT Common Stock (the "Stock 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 Host REIT Common Stock. For the purposes of determining the 20% threshold amount, shares of Host REIT Common Stock that can be acquired by Marriott International pursuant to the Marriott International Purchase Right will be deemed exempt shares under the Host REIT Rights Agreement and will not be included in any determination of the number of shares of Host REIT 176 Common Stock beneficially owned by Marriott International. The following additional shares of Host REIT Common Stock also will be deemed exempt shares under the Host REIT Rights Agreement: (i) shares of Host REIT Common Stock that are received pursuant to the Merger in exchange for shares of Host Common Stock which such person beneficially owned on February 3, 1989 and owned continuously thereafter until the Merger; (ii) certain shares of Host REIT Common Stock which were acquired by a person pursuant to a gift, bequest, inheritance or distribution from a trust or from a corporation controlled by such person where such shares of Host REIT Common Stock were exempt shares immediately prior to such acquisition; and (iii) shares of Host REIT Common Stock acquired by a person as a result of a stock dividend, stock distribution or other recapitalization, in respect to exempt shares only. Until the Rights Distribution Date, the Host REIT Rights would be evidenced by the Host REIT Common Stock certificates, and would be transferred with, and only with, the Host REIT Common Stock certificates. It is expected that, if a Person becomes the beneficial owner of 20% or more of the then outstanding Host REIT Common Stock (except pursuant to an offer for all outstanding Host REIT Common Stock which the directors by a two-thirds vote determine to be fair to and otherwise in the best interests of Host REIT and its stockholders), each holder of a Host REIT Right would, after the end of a redemption period, have the right (subject to the Ownership Limit and the other ownership restrictions to be contained in the Host REIT Charter) to exercise the Host REIT Right by purchasing shares of Host REIT Common Stock (or, in certain circumstances, cash, property or other securities of Host REIT) having a value equal to two times the purchase price of the Host REIT Right, subject to the Ownership Limit. If at any time following the Stock 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 Host REIT 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 Host REIT Right. It is expected that, in general, the Board of Directors of Host REIT may redeem the Host REIT Rights at a nominal price per Host REIT Right at any time until ten days after an Acquiring Person has been identified as such. If the decision to redeem the Host REIT Rights occurs after a person becomes an Acquiring Person, the decision will require the concurrence of directors by a two-thirds vote. The Host REIT Rights would have certain anti-takeover effects. The Host REIT Rights would cause substantial dilution to a person or group that attempts to acquire Host REIT. The Host REIT 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 Host REIT Rights Agreement to exempt the person from the Host REIT Rights Agreement. 177 DESCRIPTION OF THE PARTNERSHIP AGREEMENT AND OP UNITS The following is a summary of the material terms of the Partnership Agreement and the OP Units to be issued in connection with the Partnership Mergers and the REIT Conversion. Following the REIT Conversion, OP Units will be owned by the following groups: Host REIT; the Blackstone Entities; the Limited Partners who participate in the Partnership Mergers; and partners in four Private Partnerships participating in the Private Partnership Transactions. Following the REIT Conversion, Host REIT will be the sole general partner of the Operating Partnership, and following consummation of the other transactions comprising the REIT Conversion, the Operating Partnership will carry on the business formerly conducted by Host. See "The REIT Conversion." 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 shares of Host REIT Common Stock outstanding, each OP Unit generally will receive distributions in the same amount paid on each share of Host REIT Common Stock. 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 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 is expected to hold a substantial amount of the interests in the Operating Partnership. Of the interests in the Operating Partnership 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 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 stockholders 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 178 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. 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 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. "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 and 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). 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. In addition, 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). 179 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 stockholders 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. 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 180 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. To the extent that the indemnification provisions purport to include indemnification for liabilities arising under the Securities Act, in the opinion of the Commission, such indemnification is contrary to public policy and therefore unenforceable. 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 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 Host REIT Common Stock, (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. 181 CERTAIN VOTING RIGHTS OF HOLDERS OF OP UNITS DURING THE FIRST YEAR FOLLOWING THE EFFECTIVE DATE OF THE PARTNERSHIP MERGERS During the first year following the effective date of the Partnership Mergers, if a vote of the stockholders 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 Host REIT Common Stock representing 20% or more of the outstanding Host REIT Common Stock which would require stockholder 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 stockholders vote. In addition, during the one-year period following the effective date of the Partnership Mergers, any taxable sale or sales of Hotels representing more than 10% of the aggregate appraised value (as determined by an independent hotel valuation and financial advisory firm) of the Hotels previously owned by 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 Partnership 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 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 effective date of the Partnership 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 182 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 effective date of the Partnership 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 share of Host REIT Common Stock 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 Host REIT Common Stock 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 Host REIT Common Stock, 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. 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 Host REIT Common Stock would be prohibited either under the provisions of the Host REIT Charter relating to restrictions on ownership and transfer of Host REIT Common Stock or under applicable federal or state securities laws as long as the Host REIT Common Stock are publicly traded. See "Description of Host REIT Capital Stock--Restrictions on Ownership and Transfer." In the event that the Host REIT Common Stock 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 Host REIT Common Stock are not publicly traded and there is no Parent Entity with 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 183 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 Host REIT Common Stock 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. Except under circumstances involving the purchase of OP Units by Host REIT with proceeds from the exercise of Host REIT Rights, 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 25% 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. 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 184 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 stockholders, 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 stockholders, Host REIT will furnish to each limited partner, no later than the date on which Host REIT mails such reports to its stockholders, 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 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 185 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 Aspects of Host REIT's Ownership of OP Units." 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. 186 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 Host REIT Common Stock 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 Host REIT Common Stock 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 Host REIT Common Stock 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 Host REIT Common Stock. 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 percentage of the Operating Partnership that the Blackstone Entities will own immediately following the REIT Conversion, and certain other factors, 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 issuance or transfer of OP Units if such issuance or transfer would result in benefit plan investors owning more than 25%. 187 FEDERAL INCOME TAX CONSEQUENCES INTRODUCTION The following discussion summarizes the federal income tax consequences reasonably anticipated to be material to a Host stockholder in connection with the Merger, the Initial E&P Distribution, the OP Contribution, and the ownership and disposition of Host REIT Common Stock. The following discussion is intended to address only those federal income tax consequences that are generally relevant to all Host stockholders. Accordingly, it does not discuss all aspects of federal income taxation that might be relevant to a specific Host stockholder in light of his particular investment or tax circumstances. Therefore, it is imperative that a Host stockholder 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 Merger, the Initial E&P Distribution, the OP Contribution, and the subsequent ownership and disposition of Host REIT Common Stock. 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 a Host stockholder 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 headings "Federal Income Tax Consequences of the Initial E&P Distribution--Tax Consequences of the Initial E&P Distribution to Tax-Exempt Host Stockholders" and "Taxation of Tax-Exempt Stockholders 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 headings "Federal Income Tax Consequences of the Initial E&P Distribution--Tax Consequences of the Initial E&P Distribution to Non-U.S. Stockholders" and "Taxation of Non-U.S. Stockholders"). 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. Except as described under "--Federal Income Tax Consequences of the OP Contribution," neither Host nor Host REIT has requested or plans to request any rulings from the IRS concerning the tax consequences of the OP Contribution, the Merger, the Initial E&P Distribution, and the subsequent ownership and disposition of Host REIT Common Stock. Hogan & Hartson L.L.P. ("Hogan & Hartson"), counsel to Host, Host REIT and the Operating Partnership, has delivered to Host and Host REIT an opinion to the effect that the discussion herein under the heading "Federal Income Tax Consequences," to the extent that it contains descriptions of applicable federal income tax law, is correct in all material respects (see Appendix C for this opinion). The opinion, however, does not purport to address the tax consequences of the Merger, the Initial E&P Distribution, the OP Contribution, and the subsequent ownership and disposition of Host REIT Common Stock to any particular Host stockholder 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 will have a material adverse impact on the income tax positions of Host REIT stockholders. The opinion is 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. 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. 188 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 opinion (which does not bind the IRS or the courts) will not be challenged by the IRS or will be sustained by a court if so challenged. The following discussion is not intended to be, and should not be construed by a Host stockholder as, tax advice. THE SPECIFIC TAX ATTRIBUTES OF A PARTICULAR HOST STOCKHOLDER COULD HAVE A MATERIAL IMPACT ON THE TAX CONSEQUENCES OF THE MERGER, THE INITIAL E&P DISTRIBUTION, THE OP CONTRIBUTION AND/OR THE SUBSEQUENT OWNERSHIP AND DISPOSITION OF HOST REIT COMMON STOCK. THEREFORE, IT IS ESSENTIAL THAT EACH HOST STOCKHOLDER CONSULT WITH HIS OWN TAX ADVISORS WITH REGARD TO THE APPLICATION OF THE FEDERAL INCOME TAX LAWS TO SUCH STOCKHOLDER'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. FEDERAL INCOME TAX CONSEQUENCES OF THE MERGER The Merger is intended to qualify as a reorganization under Section 368(a) of the Code, and the federal income tax consequences summarized below are based on the assumption that the Merger will so qualify. Hogan & Hartson, counsel for Host and Host REIT, has delivered to Host and Host REIT an opinion to the effect that the Merger will be treated for federal income tax purposes as a reorganization under Section 368(a) of the Code (see Appendix C for this opinion). The opinion, however, does not purport to address the tax consequences of the Merger to any particular Host REIT stockholder in light of his particular circumstances. It is based on (i) certain factual assumptions and representations made by Host and Host REIT, and (ii) the Code and Treasury Regulations in effect on the date hereof, current administrative interpretations and positions of the IRS and existing court decisions. 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 opinion (which does not bind the IRS or the courts) will not be challenged by the IRS or will be sustained by a court if so challenged. No ruling will be sought from the IRS regarding the Merger. Because the Merger will qualify as a reorganization under the Code, no gain or loss will be recognized by Host or Host REIT as a result of the Merger. In addition, no gain or loss will be recognized by a Host stockholder (other than certain Host stockholders who are not considered "U.S. persons" for purposes of the Code and who own (or have owned) in excess of 5% of Host Common Stock) upon the conversion of such holder's shares of Host Common Stock into Host REIT Common Stock pursuant to the Merger. The initial tax basis of the Host REIT Common Stock received by such a former Host stockholder pursuant to the Merger should be the same as the stockholder's adjusted tax basis in the shares of Host Common Stock being converted pursuant to the Merger (subject to any adjustment resulting from the Initial E&P Distribution). The holding period of the Host REIT Common Stock received by such a former Host stockholder pursuant to the Merger should include the holder's holding period with respect to the shares of Host Common Stock being converted pursuant to the Merger, provided that such Host Common Stock is held as a capital asset as of the Effective Time. See also "Federal Income Tax Consequences of the Initial E&P Distribution." Certain Host stockholders that are nonresident alien individuals, foreign corporations, foreign partnerships or foreign estates or trusts (collectively, "Non-U.S. Stockholders") could recognize gain or loss pursuant to the Merger. In particular, because Host is a "U.S. real property holding company" for the purposes of the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA"), but Host REIT anticipates qualifying as a "domestically controlled REIT" for purposes of FIRPTA, a Non-U.S. Stockholder who at any time during the 189 five-year period ending on the Effective Date owned more than 5% of the Host Common Stock would recognize gain to the extent that the fair market value of the Host REIT Common Stock he receives in the Merger exceeds his adjusted tax basis in his Host Common Stock. Any such Non-U.S. Stockholder would be subject to regular United States income tax with respect to such gain in the same manner as a "U.S. person" for purposes of the Code (subject to any applicable alternative minimum tax, a special alternative minimum tax in the case of nonresident alien individuals and the possible application of a 30% branch profits tax in the case of foreign corporations). See "Taxation of Non-U.S. Stockholders--Sales of Host REIT Common Stock" for a related discussion of the impact of the application of FIRPTA. FEDERAL INCOME TAX CONSEQUENCES OF THE INITIAL E&P DISTRIBUTION As described more fully above in "The REIT Conversion--The Initial E&P Distribution," Host stockholders will receive in the Initial E&P Distribution Crestline common stock and cash or other consideration. Host currently contemplates that such other consideration will be in the form of the Special Dividend, which is payable, at each Host stockholder's election, in cash or Host Common Stock (or, if the Merger has occurred, Host REIT Common Stock). Although no assurance can be provided that such other consideration will take this form, the following discussion is based on the assumption that it will. The Initial E&P Distribution will assist Host REIT to meet the requirement that it distribute to its stockholders its accumulated pre-REIT E&P. For a detailed discussion of this requirement, see "--Federal Income Taxation of Host REIT Following the Merger--Requirements for Qualification," below. Tax Consequences of the Initial E&P Distribution to U.S. Stockholders. As used herein, the term "U.S. Stockholder" means a Host stockholder who (for United States federal income tax purposes) is (i) a citizen or resident of the United States, (ii) a corporation, partnership or other entity created or organized in or under the laws of the United States or of any political subdivision thereof, (iii) an estate or trust the income of which is subject to United States federal income taxation regardless of its source, or (iv) a trust whose administration is subject to the primary supervision of a United States court and which has one or more United States persons who have the authority to control all substantial decisions of the trust. A U.S. Stockholder will include the fair market value of his share of the Initial E&P Distribution in gross income as ordinary income to the extent that the Initial E&P Distribution is made out of the U.S. Stockholder's share of the portion of the current and accumulated E&P of Host and Host REIT allocable to the Initial E&P Distribution. The income attributable to the distribution of the Crestline common stock will be recognized when the Host stockholders become the owners of that stock, which is currently anticipated to occur in 1998. In addition, although the law is not entirely clear, Host intends to take the position that the income attributable to the Special Dividend will be recognized in 1999 when it is determined what a Host stockholder will receive (i.e., cash or stock, and if stock, the value thereof) and such cash or stock is payable to the Host stockholders. Under this approach, the fair market value of a U.S. Stockholder's share of the Initial E&P Distribution would equal the sum of (i) the fair market value (on the distribution date, which currently is expected to be in 1998) of the Crestline common stock that he receives in the Initial E&P Distribution, (ii) the amount of cash he receives in lieu of fractional shares of Crestline common stock, (iii) the amount of cash or the fair market value of the stock he receives pursuant to the Special Dividend, plus (iv) the amount of any other cash and fair market value of any other consideration he receives in the Initial E&P Distribution. Thus, insofar as a U.S. Stockholder receives cash pursuant to the Special Dividend, the income recognized would include the amount of the cash he so receives. With respect to a U.S. Stockholder that receives Host (or Host REIT) stock pursuant to the Special Dividend, the law is not entirely clear, but Host intends to take the position that the fair market value of the consideration he receives will equal the sum of (i) fair market value of the stock as of the end of the period during which the election under the Special Dividend can be made, plus (ii) the amount of any cash he receives in lieu of fractional shares of such stock. No assurance can be provided, however, that the IRS would not challenge this position regarding the taxation of the cash or stock received pursuant to the Special Dividend (for example, contending that the ability to make the election provided for under the Special Dividend is property that must be valued as of the record date of the Special Dividend or possibly the date on which notice of the Special Dividend is distributed to 190 the Host stockholders) and included in income on such date, which currently is expected to be in 1998), or that such an IRS challenge would not be sustained by a court. In determining whether the Initial E&P Distribution is made out of the current and accumulated E&P of Host and Host REIT, such E&P will be allocated pursuant to complex rules under the Code in the following order: first, to the portion of the Initial E&P Distribution that is distributed on the distribution date (which Host intends to take the position consists only of the Crestline common stock), and second, to the portion of the Initial E&P Distribution that is distributed after the distribution date (which, although the law is not entirely clear, Host intends to take the position will include the cash and stock distributed pursuant to the Special Dividend). Host currently estimates that the Initial E&P Distribution will be approximately $2.10 to $2.50 per share of Host Common Stock (of which approximately $0.80 to $1.20 per share would be attributable to the Special Dividend, assuming that a Host stockholder were to elect to receive cash). No assurance can be provided, however, that this estimate will be accurate. If the value of the Initial E&P Distribution is greater than Host's current estimate (for example, because the value of the Crestline common stock received is higher than currently estimated or because a stockholder receives stock pursuant to the Special Dividend and the value of such stock is higher than the dollar amount of the cash that could have been received pursuant thereto), then a U.S. Stockholder will include such additional amount in gross income as ordinary income to the extent of the U.S. Stockholder's share of the portion of the current and accumulated E&P of Host and Host REIT allocable to the Initial E&P Distribution. A U.S. Stockholder will have a basis in the Crestline common stock he receives in the Initial E&P Distribution equal to the fair market value of such stock on the distribution date and his holding period in such stock will begin on the day after the distribution date. Although the law is not entirely clear, consistent with the approach outlined in the preceding paragraph, Host intends to take the position that a U.S. Stockholder who elects to receive Host REIT Common Stock pursuant to the Special Dividend would have a basis in such stock equal to the fair market value of such stock on the day after the final day of the election period under the Special Dividend, and his holding period in such stock would begin on that day. Host currently believes that the substantial majority, if not all, of the Initial E&P Distribution will be considered made out of the portion of Host and Host REIT's current and accumulated E&P allocable to the Initial E&P Distribution. The calculation of such E&P, however, will be very complex. The amount will include (i) the allocated consolidated E&P of Host (including each of its predecessors) accumulated from 1929, the first year that the predecessor of Host was a "C" corporation, through and including Host's 1998 taxable year, (ii) the current E&P of Host and Host REIT in 1998, and (iii) to the extent the Initial E&P Distribution occurs in 1999, the current E&P of Host and Host REIT in 1999. In addition, the calculation depends upon a number of factual and legal interpretations related to the activities and operations of Host and its corporate affiliates during its entire corporate existence and is subject to review and challenge by the IRS. There can be no assurance that Host and Host REIT's calculation of this E&P will be respected by the IRS or that a challenge to such calculations by the IRS would not be sustained by a court. Hogan & Hartson will express no opinion as to the amount of the current and accumulated E&P of Host and Host REIT. To the extent that the sum of the amount of the Initial E&P Distribution received by a U.S. Stockholder exceeds his share of the portion of Host and Host REIT's current and accumulated E&P allocable to the Initial E&P Distribution, it will be treated first as a tax-free return of capital to such U.S. Stockholder, reducing the adjusted basis in his Host Common Stock by the amount of such excess (but not below zero) and then, if such basis is reduced to zero and there is remaining excess, as capital gain to the extent of such remaining excess (provided that such Host Stockholder has held the Host Common Stock as a capital asset). Backup Withholding for the Initial E&P Distribution. Under the backup withholding rules, a U.S. Stockholder may be subject to backup withholding at the rate of 31% with respect to the Initial E&P Distribution paid unless such holder (a) is a corporation or comes within certain other exempt categories and, when required, demonstrates this fact or (b) provides a taxpayer identification number, certifies as to no loss of exemption from backup withholding and otherwise complies with applicable requirements of the backup withholding rules. See "--Taxation of Non-U.S. Stockholders." 191 Tax Consequences of the Initial E&P Distribution to Tax-Exempt Host Stockholders. Provided that a tax-exempt Host stockholder (except certain tax- exempt Host stockholders described in the following sentence) has not held its Host Common Stock as "debt financed property" within the meaning of the Code and such Host Common Stock is not otherwise used in a trade or business, the Initial E&P Distribution will not constitute unrelated business taxable income ("UBTI"). For a tax-exempt Host stockholder that is a social club, voluntary employee benefit association, supplemental unemployment benefit trust or qualified group legal services plan exempt from federal income taxation under Code Sections 501 (c)(7), (c)(9), (c)(17) or (c)(20), respectively, the Initial E&P Distribution will constitute UBTI unless the organization is properly able to deduct amounts set aside or placed in reserve for certain purposes so as to offset the income generated by its investment in Host. Such Host stockholders should consult their own tax advisors concerning these "set aside" and reserve requirements. Tax Consequences of the Initial E&P Distribution to Non-U.S. Stockholders. A Non-U.S. Stockholder will treat the fair market value of the Initial E&P Distribution as ordinary income to the extent of the Non-U.S. Stockholder's share of the current and accumulated E&P of Host REIT allocable to the Initial E&P Distribution. For a discussion regarding the fair market value of the Initial E&P Distribution and the extent to which the Initial E&P Distribution will be attributable to such E&P, see "--Tax Consequences of the Initial E&P Distribution to U.S. Stockholders" above. For Non-U.S. Stockholders, the Initial E&P Distribution will be subject to withholding of United States federal income tax on a gross basis (that is, without allowance of deductions) at a 30% rate or such lower rate as may be specified by an applicable income tax treaty, unless it is treated as effectively connected with the conduct by the Non-U.S. Stockholder of a United States trade or business. Certain certification and disclosure requirements must be satisfied to be exempt from withholding under the effectively connected income exemption. If the Initial E&P Distribution is effectively connected with such a trade or business, a Non-U.S. Stockholder will be subject to tax on the Initial E&P Distribution on a net basis (that is, after allowance of deductions) at graduated rates, in the same manner as U.S. Stockholders are taxed with respect to the Initial E&P Distribution, and generally will not be subject to withholding. A Non-U.S. Stockholder that is a corporation may also be subject to an additional branch profits tax on the Initial E&P Distribution at a 30% rate or such lower rate as may be specified by an applicable income tax treaty. See "--Taxation of Non-U.S. Stockholders," below. To the extent that the sum of the fair market value of the Initial E&P Distribution received by a Non-U.S. Stockholder exceeds his share of the portion of Host and Host REIT's current and accumulated E&P allocable to the Initial E&P Distribution, it will be treated first as a tax-free return of capital to such Non-U.S. Stockholder, reducing the adjusted basis in his Host Common Stock (or Host REIT Common Stock, to the extent the Initial E&P Distribution occurs after the Merger) by the amount of such excess (but not below zero). If such basis is reduced to zero and there is remaining excess, the Initial E&P Distribution will give rise to gain from the sale or exchange of such stock. For a discussion of the federal income tax consequences of a sale or exchange of Host REIT Common Stock by a Non-U.S. Stockholder, see "-- Taxation of Non-U.S. Stockholders--Sales of Host REIT Common Stock," below. As a result of a legislative change made by the Small Business Job Protection Act of 1996, it appears that Host would be required to withhold 10% of any distribution in excess of Host and Host REIT's current and accumulated E&P. Consequently, although Host currently intends to withhold at a rate of 30% on the entire amount of any distribution (or a lower applicable treaty rate), to the extent that Host does not do so, any portion of the Initial E&P Distribution not subject to withholding at a rate of 30% (or a lower applicable treaty rate) will be subject to withholding at a rate of 10%. However, a Non-U.S. Stockholder may seek a refund of such amounts from the IRS if it subsequently determined that the Initial E&P Distribution was, in fact, in excess of such E&P, and the amount withheld exceeded the Non-U.S. Stockholder's United States tax liability, if any, with respect to the Initial E&P Distribution. To the extent that withholding tax is owed with respect to any Non-U.S. Stockholder with respect to Crestline common stock received in the Initial E&P Distribution and any Host (or Host REIT) stock received pursuant to the Special Dividend, Host anticipates that the Transfer and Exchange Agent would sell in the market 192 a portion of the shares of stock distributable to such Non-U.S. Stockholder to pay such withholding taxes and the actual number of shares of Crestline common stock and any Host (or Host REIT) stock received pursuant to the Special Dividend exercise of the Election Rights would be net of any shares sold to pay such withholding taxes. Tax Consequences to Host of the Distribution of Crestline Common Stock. Generally, a corporation that distributes property (other than its own stock) to its shareholders will recognize any gain realized on that distribution, but will not recognize any loss realized. Accordingly, Host would recognize gain on the distribution of the Crestline common stock to the extent that the fair market value of the Crestline common stock were to exceed Host's adjusted basis in the stock. Conversely, Host would not be able to recognize any loss if the fair market value of the Crestline common stock were to be less than Host's adjusted tax basis in that stock. Based on its current estimate of the fair market value of the Crestline common stock, which estimate is described above, Host currently believes that it will not recognize gain on the distribution of the Crestline common stock, but that it may realize a loss, which loss cannot be recognized for federal income tax purposes. Similar considerations apply with respect to the delivery of Crestline common stock to the Blackstone Entities. Host will not recognize any gain or loss in connection with any distribution of Host Common Stock, Host REIT Common Stock or cash as part of the Special Dividend. FEDERAL INCOME TAX CONSEQUENCES OF THE OP CONTRIBUTION As described more fully above in "The Restructuring Transactions--The OP Contribution," Host will contribute certain of its assets (excluding the Crestline common stock, cash and other consideration to be distributed pursuant to 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 OP Units, preferred partnership interests in the Operating Partnership (if Host has outstanding any preferred stock), and the assumption by the Operating Partnership of all liabilities of Host (other than liabilities of Crestline). Host has obtained an opinion of Hogan & Hartson to the effect that the discussion in this section, to the extent it contains descriptions of federal income tax law, is correct in all material respects, but Host is not obtaining an opinion of outside counsel as to the actual tax consequences to it of the OP Contribution. Section 721 of the Code provides that no gain or loss is recognized in the case of a contribution of property to a partnership in exchange for an interest in the partnership. Accordingly, Section 721 generally would apply to prevent the recognition of gain by Host in the OP Contribution. However, there are several potential exceptions to the availability of nonrecognition treatment under Section 721 that could result in Host recognizing gain in connection with the OP Contribution. First, the assumption by the Operating Partnership of Host liabilities would result in a deemed distribution of cash to Host in an amount equal to the excess, if any, of such liabilities over Host's share of the liabilities of the Operating Partnership immediately after the OP Contribution and the Partnership Mergers. To the extent any such deemed distribution of cash exceeds Host's adjusted tax basis in the assets it transfers to the Operating Partnership, Host will recognize gain in the OP Contribution. However, based upon the amount of its liabilities outstanding and the adjusted tax basis of its various assets, Host currently believes that immediately after the OP Contribution and the Partnership Mergers it will not be deemed to have received a deemed cash distribution that would result in the recognition of gain in the OP Contribution. Second, the OP Contribution would not be tax free to Host to the extent that it were treated as a "disguised sale" of all or a portion of the assets Host contributes to the Operating Partnership 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. For purposes of these rules, assumptions of certain liabilities are treated as transfers of money or other property from the partnership to the partner which may give rise to a disguised sale. In addition, the Disguised Sale Regulations provide generally that transfers of money or other 193 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. One exception to "disguised sale" treatment in the Disguised Sale Regulations relates to the assumption of "qualified liabilities" in connection with a contribution of property to a partnership. A second exception to "disguised sale" treatment relates to distributions of "operating cash flow," which are presumed not to be a part of a sale of property to a partnership unless the facts and circumstances clearly establish that such distributions are part of a sale. A third exception to "disguised sale" treatment relates to distributions made to partners to reimburse them for certain "preformation" capital expenditures. The application of these and other exceptions to the Disguised Sale Regulations are highly complex and depend on a number of factual determinations and other outside events which may or may not occur, but Host currently believes that even if a portion of the OP Contribution were treated as a disguised sale under the Disguised Sale Regulations, Host would not recognize a material amount of gain in the OP Contribution. Third, if the OP Contribution were considered to be a transfer to an "investment company," as defined in the Treasury Regulations, gain would be recognized on such transfer under Section 721 of the Code. In the case of a transfer of property to a partnership, the Code and the Treasury Regulations provide that such transfer would be treated as having been made to an investment company if the transfer results in a diversification of the interests of two or more transferors, and the transferee is a partnership more than 80% of the value of whose assets are "stock and securities." Although the OP Contribution (when considered together with the Partnership Mergers) will result in the diversification of the interests of two or more transferors, no significant portion of the Operating Partnership's assets will constitute "stock and securities" as defined in the Code. Accordingly, Host currently believes that the transfers to the Operating Partnership will not constitute transfers to an "investment company," as defined in the current Treasury Regulations. It should be noted in this regard, however, that the Operating Partnership might not meet the IRS's guidelines for obtaining an advance ruling with respect to this issue. Although the application of the foregoing exceptions to nonrecognition treatment is extremely complex, Host currently believes that such application will not result in the recognition by Host of a material amount of gain in connection with the OP Contribution. However, even if Host does not recognize material gain in the OP Contribution, there are a variety of subsequent events and transactions including (i) the sale or other taxable disposition of appreciated assets contributed by Host to the Operating Partnership in the OP Contribution (including one or more of the Hotels contributed by Host), (ii) the refinancing or repayment of certain liabilities secured by one or more of the Hotels contributed to the Operating Partnership by Host in the OP Contribution, (iii) the issuance of additional OP Units, including in connection with 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 one or more of the Hotels contributed to the Operating Partnership by Host in the OP Contribution resulting from capital expenditures and (v) the elimination over time of the disparity between the current tax basis of one or more of the Hotels contributed to the Operating Partnership by Host in the OP Contribution and the "book basis" of such assets (based upon their fair market value at the time of the OP Contribution) that could cause Host REIT to recognize part or all of the taxable gain that otherwise has been deferred pursuant to the OP Contribution. It should be noted that Host REIT, as general partner of the Operating Partnership, will have control over whether the Operating Partnership will undertake specific transactions. Because of the numerous transactions that comprise the OP Contribution and the REIT Conversion and the inherently factual nature of a number of the critical determinations relevant to the tax consequences to Host of the OP Contribution and the REIT Conversion, Host has not sought (and likely could not obtain) an opinion of outside counsel as to the tax consequences to it (in terms of the actual amount of income and gain that would be recognized) of the OP Contribution and the other transactions comprising the REIT Conversion (other than the Merger). Host believes, based upon its knowledge of the relevant facts and advice that it has received from various professional advisers (including both attorneys and accountants on its staff and outside attorneys and 194 accountants) as to the applicable general principles of law, that it will not recognize a material amount of income and gain as a result of the OP Contribution and the other transactions comprising the REIT Conversion. Host, however, will recognize some income and gain in connection with these various transactions, and there can be no assurance that under the relevant facts and circumstances such income and gain would not be material. If Host were to recognize a material amount of income and gain as a result of these various transactions, the resulting income tax liability could be material to Host, and the increase in E&P resulting from such income and gain could materially increase the amount that Host must distribute to its stockholders in order to qualify as a REIT, all of which could have adverse consequences to Host REIT and its stockholders. FEDERAL INCOME TAXATION OF HOST REIT FOLLOWING THE MERGER General. Host REIT plans to make an election to be taxed as a REIT under Sections 856 through 859 of the Code, effective for its first taxable year commencing after the REIT Conversion is completed (which Host currently expects to be the year beginning January 1, 1999, but which might not be until the year beginning January 1, 2000). (This election is made with the filing of Host REIT's federal income tax return for the first taxable year for which the election is effective.) Host REIT intends that, commencing with such first taxable year, it will be organized and will operate in such a manner as to qualify for taxation as a REIT under the Code, and Host REIT 194--1 intends to continue to operate in such a manner, but no assurance can be given that it in fact will continue to operate in such a manner so as to qualify or remain qualified. The sections of the Code and the corresponding Treasury Regulations that govern the federal income tax treatment of a REIT and its stockholders are highly technical and complex. The following sets forth a summary of the material aspects of these rules, which summary, however, is qualified in its entirety by the applicable Code provisions, rules and regulations promulgated thereunder, and administrative and judicial interpretations thereof. Hogan & Hartson has acted as counsel to Host REIT in connection with the REIT Conversion and Host REIT's election to be taxed as a REIT. Hogan & Hartson has provided to Host REIT and the Operating Partnership an opinion to the effect that, beginning with Host REIT's first full taxable year commencing after the REIT Conversion is completed, Host REIT will be organized 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 (see Appendix D for this opinion). It must be emphasized that this opinion is conditioned upon completion of the REIT Conversion in the manner described in this Proxy Statement/Prospectus and upon certain assumptions and representations made by Host REIT and the Operating Partnership as to factual matters relating to the organization and operation of Host REIT, the Operating Partnership, the Partnerships and Private Partnerships, the Subsidiary Partnerships, the Non-Controlled Subsidiaries, the Host Employee/Charitable Trust and Crestline and the Lessees, including the economic and other terms of each Lease and the expectations of Host REIT and the Lessees with respect thereto. In addition, this opinion is based upon the factual representations of Host REIT concerning its business and properties as described in this Proxy Statement/Prospectus and assumes that all of the transactions and other actions described under "The Restructuring Transactions" and "The REIT Conversion" and related portions of this Proxy Statement/Prospectus and under "Federal Income Tax Consequences" are completed in a timely fashion (which means prior to the first day of the first taxable year for which Host REIT's election to be taxed as a REIT will be effective, except where the description thereof clearly contemplates completion of such action subsequent thereto). If Host REIT desires to be a REIT for the taxable year commencing January 1, 1999, that means all of the transactions and other actions referred to above would need to be completed prior to that date; otherwise, Host REIT might not qualify to be taxed as a REIT until its taxable year commencing January 1, 2000 (assuming that all such transactions and other actions are completed prior to that later date). Moreover, such qualification and taxation as a REIT depends upon Host REIT's ability to meet on an ongoing basis (through actual annual operating results, distribution levels and diversity of share ownership) the various qualification tests imposed under the Code discussed below, the results of which will not be reviewed by Hogan & Hartson. Accordingly, no assurance can be given that the actual results of Host REIT's operations for any particular taxable year will satisfy such requirements. Further, the anticipated income tax treatment described in this Proxy Statement/Prospectus may be changed, perhaps retroactively, by legislative, administrative or judicial action at any time. See "--Failure of Host REIT to Qualify as a REIT" below. If Host REIT qualifies for taxation as a REIT, it generally will not be subject to federal corporate income taxes on its net income that is currently distributed to its stockholders. This treatment would substantially eliminate the "double taxation" (at the corporate and stockholder levels) that generally results from investment in a regular corporation. However, Host REIT will be subject to federal income tax as follows: 1. Host REIT will be taxed at regular corporate rates on any undistributed "REIT taxable income," including undistributed net capital gains (provided, however, that properly designated undistributed capital gains will effectively avoid taxation at the stockholder level). A REIT's "REIT taxable income" is the otherwise taxable income of the REIT subject to certain adjustments, including a deduction for dividends paid. 2. Under certain circumstances, Host REIT may be subject to the "alternative minimum tax" on its items of tax preference. 3. If Host REIT has (i) net income from the sale or other disposition of "foreclosure property" which is held primarily for sale to customers in the ordinary course of business or (ii) other nonqualifying income from foreclosure property, it will be subject to tax at the highest corporate rate on such income. 195 4. If Host REIT has net income from "prohibited transactions" (which are, in general, certain sales or other dispositions of property held primarily for sale to customers in the ordinary course of business other than foreclosure property), such income will be subject to a 100% tax. 195--1 5. If Host REIT should fail to satisfy the 75% gross income test or the 95% gross income test (as discussed below), but has nonetheless maintained its qualification as a REIT because certain other requirements have been met, it will be subject to a 100% tax on an amount equal to (a) the gross income attributable to the greater of the amount by which Host REIT fails the 75% or 95% test multiplied by (b) a fraction intended to reflect Host REIT's profitability. 6. If Host REIT should fail to distribute during each calendar year at least the sum of (i) 85% of its REIT ordinary income for such year, (ii) 95% of its REIT capital gain net income for such year and (iii) any undistributed taxable income from prior periods, Host REIT would be subject to a 4% excise tax on the excess of such required distribution over the sum of amounts actually distributed and amounts retained but with respect to which federal income tax was paid. 7. If Host REIT acquires any asset from a "C" corporation (i.e., generally a corporation subject to full corporate-level tax) in a transaction in which the basis of the asset in the hands of Host REIT is determined by reference to the basis of the asset in the hands of the "C" corporation (a "Built-In Gain Asset"), and Host REIT recognizes gain on the disposition of such asset during the ten-year period beginning on the date on which such asset was acquired by Host REIT (the "Recognition Period"), then, to the extent of the asset's "Built-In Gain" (i.e., the excess of (a) the fair market value of such asset over (b) Host REIT's adjusted basis in the asset, determined when Host REIT acquired the asset), such gain will be subject to tax at the highest regular corporate rate applicable. Host REIT will own an indirect interest in appreciated assets that Host held before the REIT Conversion. Such appreciated assets will have a "carryover" basis and thus will be "Built-In Gain Assets" with respect to Host REIT. Under IRS Notice 88-19, unless Host REIT were to elect to be subject to corporate income tax on any Built-In Gain recognized with respect to such Built-In Gain Assets during the Recognition Period commencing on the first day of Host REIT's first taxable year as a REIT, Host would have to pay federal corporate income tax on the Built-In Gain at the time of the REIT Conversion. In connection with the REIT Conversion, Host REIT will make the election provided for in Notice 88-19 with respect to all of Host's assets that will be owned by the Operating Partnership subsequent to the REIT Conversion. As a result of this election, if such appreciated property is sold within the ten-year period following the REIT Conversion, Host REIT will generally be subject to regular corporate tax on that gain to the extent of the Built-In Gain in that property at the time of the REIT Conversion. The total amount of gain on which Host REIT can be taxed is limited to its net Built-In Gain (defined for these purposes as the excess of the aggregate fair market value of its assets at the time it became a REIT over the adjusted tax bases of those assets at that time) at the time of the REIT Conversion. This tax could be very material, however, and may result in the Operating Partnership and Host REIT seeking to avoid a taxable disposition of any significant assets owned by Host at the time of the REIT Conversion for the ten taxable years following the REIT Conversion (even though such disposition might otherwise be in the best interests of Host REIT). Notwithstanding Host REIT's status as a REIT, it is likely that substantial deferred liabilities of Host will be recognized over the next ten years (including, but not limited to, tax liabilities attributable to Built-In Gain Assets and deferred tax liabilities attributable to taxable income for which neither Host REIT nor the Operating Partnership will receive corresponding cash). In addition, 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 Operating Partnership will pay (or reimburse Host REIT for) all taxes incurred by Host REIT (except for taxes imposed on Host REIT by reason of its failure to qualify as a REIT or to distribute to its stockholders an amount equal to its "REIT taxable income," including net capital gains). This obligation by the Operating Partnership would include any federal corporate income tax imposed on Built-In Gain. 196 Requirements for Qualification. The Code defines a REIT as a corporation, trust or association (i) which is managed by one or more directors or trustees; (ii) the beneficial ownership of which is evidenced by transferable shares or by transferable certificates of beneficial interest; (iii) which would be taxable as a domestic corporation, but for Sections 856 through 859 of the Code; (iv) which is neither a financial institution nor an insurance company subject to certain provisions of the Code; (v) the beneficial ownership of which is held by 100 or more persons; (vi) during the last half of each taxable year not more than 50% in value of the outstanding stock of which is owned, actually or constructively, by five or fewer individuals (as defined in the Code to include certain entities) (the "not closely held" requirement); and (vii) which meets certain other tests, described below, regarding the nature of its income and assets. The Code provides that conditions (i) to (iv), inclusive, must be met during the entire taxable year and that condition (v) must be met during at least 335 days of a taxable year of twelve months, or during a proportionate part of a taxable year of less than twelve months. Conditions (v) and (vi) will not apply until after the first taxable year for which Host REIT makes the election to be taxed as a REIT. For purposes of conditions (v) and (vi), pension funds and certain other tax-exempt entities are treated as individuals, subject to a "look-through" exception in the case of condition (vi). Compliance with condition (v) shall be determined by disregarding the ownership of Host REIT shares by any person(s) who: (1) acquired such Host REIT shares as a gift or bequest or pursuant to a legal separation or divorce; (2) is the estate of any person making such transfer to the estate; or (3) is a company established exclusively for the benefit of (or wholly-owned by) either the person making such transfer or a person described in (1) or (2). In connection with condition (vi), Host REIT is required to send annual letters to its stockholders requesting information regarding the actual ownership of its shares. If Host REIT complies with this requirement, and it does not know, or exercising reasonable diligence would not have known, whether it failed to meet condition (vi), then it will be treated as having met condition (vi). If Host REIT fails to send such annual letters, it will be required to pay either a $25,000 penalty or, if the failure is intentional, a $50,000 penalty. The IRS may require Host REIT, under those circumstances, to take further action to ascertain actual ownership of its shares, and failure to comply with such an additional requirement would result in an additional $25,000 (or $50,000) penalty. No penalty would be assessed in the first instance, however, if the failure to send the letters is due to reasonable cause and not to willful neglect. Host REIT believes that it will meet conditions (i) through (iv). In addition, Host REIT believes that it will have outstanding (commencing with its first taxable year as a REIT) Host REIT Common Stock with sufficient diversity of ownership to allow it to satisfy conditions (v) and (vi). With respect to condition (vi), Host REIT intends to comply with the requirement that it send annual letters to its stockholders requesting information regarding the actual ownership of its shares. In addition, the Host REIT Charter will provide for restrictions regarding the transfer and ownership of Host REIT Common Stock, which restrictions are intended to assist Host REIT in continuing to satisfy the share ownership requirements described in (v) and (vi) above. Such ownership and transfer restrictions are described in "Description of Host REIT Capital Stock--Restrictions on Ownership and Transfer." These restrictions, together with compliance with the annual stockholder letter requirement described above, however, may not ensure that Host REIT will, in all cases, be able to satisfy the share ownership requirements described above. If Host REIT fails to satisfy such share ownership requirements, Host REIT's status as a REIT will terminate. See "-- Failure of Host REIT to Qualify as a REIT." A corporation may not elect to become a REIT unless its taxable year is the calendar year. Although Host currently has adopted a 52-53 week year ending on the Friday closest to January 1, Host REIT will adopt a calendar year taxable year in connection with the REIT Conversion. Distribution of "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 earnings and profits to distribute such E&P. In connection with the REIT Conversion, Host REIT intends to make the Initial E&P Distribution. The aggregate amount of the Initial E&P Distribution is currently expected to be in the range of $525 to $625 million and is intended to eliminate the substantial majority, 197 if not all, of Host's undistributed E&P. For a more detailed discussion of the Initial E&P Distribution, see "The REIT Conversion--The Initial E&P Distribution," above. For a discussion of the federal income tax consequences of the Initial E&P Distribution, see "--Federal Income Tax Consequences of the Initial E&P Distribution," above. To the extent, however, that Host has any such undistributed E&P at the time of the REIT Conversion (including E&P resulting from either transactions undertaken in contemplation of the REIT Conversion or the REIT Conversion itself), such E&P (the "Acquired Earnings") will carry over to Host REIT and will be treated as accumulated earnings and profits of a REIT attributable to non-REIT years. Host REIT will be required to distribute such 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, although such REIT election may not be effective until taxable year 2000). Failure to do so would result in disqualification of Host REIT as a REIT at least for taxable year 1999. If Host REIT should be so disqualified for taxable year 1999, subject to the satisfaction by Host REIT of certain "deficiency dividend" procedures described below in "--Annual Distribution Requirements Applicable to REITs" and assuming that Host REIT otherwise satisfies the requirements for qualification as a REIT, Host REIT should qualify as a REIT for taxable year 2000 and thereafter. Host REIT believes that the Initial E&P Distribution, together with any subsequent distributions of Acquired Earnings made prior to December 31, 1999, will be sufficient to distribute all of the Acquired Earnings as of December 31, 1999, but there are substantial uncertainties relating to the estimate of the Acquired Earnings, as described below, and the value of noncash consideration to be distributed as part of the Initial E&P Distribution, and, thus, there can be no assurance this requirement will be met. The estimated amount of the Acquired Earnings will be based on the allocated consolidated earnings and profits of Host (including each of its predecessors) accumulated from 1929, the first year that the predecessor of Host was a "C" corporation, through and including Host's 1998 taxable year (and taking into account the allocation, as a matter of law, of 81% of Host's accumulated E&P to Marriott International on October 8, 1993 in connection with the Marriott International Distribution), determined based on the available tax returns and certain assumptions with respect to both such returns and other matters. The calculation of the Acquired Earnings, however, depends upon a number of factual and legal interpretations related to the activities and operations of Host and its corporate affiliates during its entire corporate existence and is subject to review and challenge by the IRS. There can be no assurance that the IRS will not examine the tax returns of Host and its affiliates for all years prior to and including the REIT Conversion and propose adjustments to increase their taxable income. The impact of such proposed adjustments, if any, may be material. If the IRS were to examine Host's calculation of its E&P (and thus the amount of Acquired Earnings, if any), the IRS can consider all taxable years of Host, its affiliates and its predecessors as open for review for purposes of such determination. Hogan & Hartson will express no opinion as to the amount of E&P of Host and its predecessors and, accordingly, for purposes of its opinion as to the qualification of Host REIT as a REIT following the REIT Conversion, Hogan & Hartson is relying upon a representation from Host REIT that by the end of 1999 it will have eliminated all Acquired Earnings. Qualified REIT Subsidiary. If Host REIT owns a corporate subsidiary that is a "qualified REIT subsidiary," that subsidiary will be disregarded for federal income tax purposes, and all assets, liabilities and items of income, deduction and credit of the subsidiary will be treated as assets, liabilities and items of Host REIT itself. Generally, a qualified REIT subsidiary is a corporation all of the capital stock of which is owned by one REIT. Host REIT anticipates owning one or more qualified REIT subsidiaries for purposes of holding de minimis indirect interests in the Hotel Partnerships. A "qualified REIT subsidiary" will not be subject to federal corporate income taxation, although it may be subject to state and local taxation in certain jurisdictions. Ownership of Partnership Interests by a REIT. In the case of a REIT which is a partner in a partnership, Treasury Regulations provide that the REIT will be deemed to own its proportionate share of the assets of the partnership and will be deemed to be entitled to the income of the partnership attributable to such share. In addition, the character of the assets and gross income of the partnership shall retain the same character in the hands of the REIT for purposes of Section 856 of the Code (including satisfying the gross income tests and the 198 asset tests). Thus, Host REIT's proportionate share of the assets and items of income of the Operating Partnership (including the Operating Partnership's share of such items of the Partnerships, Private Partnerships and any other subsidiaries that are partnerships or LLCs) will be treated as assets and items of income of Host REIT for purposes of applying the requirements described herein. A summary of the rules governing the federal income taxation of partnerships and their partners is provided below in "--Tax Aspects of Host REIT's Ownership of OP Units." As the sole general partner of the Operating Partnership, Host REIT will have direct control over the Operating Partnership and indirect control over the Hotel Partnerships and the partnerships in which the Operating Partnership or the Hotel Partnerships have a controlling interest and intends to operate these entities consistent with the requirements for qualification of Host REIT as a REIT. Income Tests Applicable to REITs. In order to maintain qualification as a REIT, Host REIT annually must satisfy two gross income requirements. First, at least 75% of Host REIT's gross income (excluding gross income from "prohibited transactions") for each taxable year must be derived directly or indirectly from investments relating to real property or mortgages on real property (including "rents from real property" and, in certain circumstances, interest) or from certain types of temporary investments. Second, at least 95% of Host REIT's gross income (excluding gross income from "prohibited transactions") for each taxable year must be derived from such real property investments, dividends, interest, certain hedging instruments and gain from the sale or disposition of stock or securities, including certain hedging instruments (or from any combination of the foregoing). Rents paid pursuant to the Leases (together with dividends and interest received from the Non-Controlled Subsidiaries) will constitute substantially all of the gross income of Host REIT. Several conditions must be satisfied in order for rents received by Host REIT, including the rents received pursuant to the Leases, to qualify as "rents from real property" in satisfying the gross income requirements for a REIT described in the preceding paragraph. First, the amount of rent must not be based in whole or in part on the income or profits of any person. However, an amount received or accrued generally will not be excluded from the term "rents from real property" solely by reason of being based on a fixed percentage or percentages of receipts or sales. Second, rents received from a tenant will not qualify as "rents from real property" in satisfying the gross income tests if Host REIT, or an actual or constructive owner of 10% or more of Host REIT, actually or constructively owns 10% or more of such tenant (a "Related Party Tenant"). Third, if rent attributable to personal property, leased in connection with a lease of real property, is greater than 15% of the total rent received under the lease, then the portion of rent attributable to such personal property will not qualify as "rents from real property" (the "15% Personal Property Test"). Finally, if (i) Host REIT operates or manages a property or furnishes or renders services to the tenants at the property other than through an independent contractor from whom Host REIT derives no revenue, excluding for these purposes services "usually or customarily rendered" in connection with the rental of real property and not otherwise considered "rendered to the occupant," and (ii) the greater of (a) the income derived from such services or (b) 150% of the cost of providing such services (the "Impermissible Tenant Service Income") exceeds one percent of the total amount received by Host REIT with respect to the property (or, if such services are not available to all tenants at a property, possibly with respect to each tenant to whom the services are made available), then no amount received by Host REIT with respect to the property (or, where possibly applicable, such tenant) will qualify as "rents from real property." If the Impermissible Tenant Service Income is one percent or less of the total amount received by the REIT with respect to the property (or, where possibly applicable, such tenant), then only the Impermissible Tenant Service Income will not qualify as "rents from real property." To the extent that services other than those customarily furnished or rendered in connection with the rental of real property are rendered to the tenants of the property by an independent contractor, the cost of the services must be borne by the independent contractor. The Operating Partnership and each Partnership and Private Partnership that owns Hotels (together with certain other subsidiaries of the Operating Partnership that may own Hotels) will enter into a Lease with a Lessee that is a Crestline subsidiary, pursuant to which the owner of such Hotels will lease the Hotels that it owns to the 199 Lessee for a term of years (ranging generally from seven to ten years, depending upon the particular Hotel) commencing on or before the January 1, 1999 (assuming the Merger occurs prior to that date, otherwise as soon as practicable following the distribution of the Crestline common stock as part of the Initial E&P Distribution). In addition, the Operating Partnership will lease to the Lessees, on similar terms, the Hotels contributed by the Blackstone Entities. Each Lease will provide for thirteen payments per annum of the specified Base Rent plus, to the extent that it would exceed the Base Rent, Percentage Rent, which Percentage Rent will be calculated based upon the gross sales of the Hotels subject to the particular Lease, plus certain other amounts. See "Business and Properties--The Leases." Neither Host REIT nor the Operating Partnership intends to (i) provide any services to the Lessees with respect to the operation of the Hotels; (ii) charge rent for any Hotel that is based in whole or in part on the income or profits of any person (except by reason of being based on a percentage of receipts or sales, as described above); (iii) rent any Hotel to a Related Party Tenant (unless the Board of Directors determines in its discretion that the rent received from such Related Party Tenant is not material and will not jeopardize Host REIT's status as a REIT); or (iv) derive rental income attributable to personal property other than personal property leased in connection with the lease of real property, the amount of which is less than 15% of the total rent received under the lease (unless the Board of Directors determines in its discretion that the amount of such rent attributable to personal property is not material and will not jeopardize Host REIT's status as a REIT). In order for the rent paid pursuant to the Leases to constitute "rents from real property," (i) the Lessees must not be regarded as Related Party Tenants; and (ii) the Leases must be respected as true leases for federal income tax purposes and not treated as service contracts, joint ventures or some other type of arrangement. A Lessee will be regarded as a Related Party Tenant only if Host REIT and/or one or more actual or constructive owners of 10% or more of Host REIT, actually or constructively, own 10% or more of such Lessee through an ownership interest in Crestline. In order to help preclude the Lessees from being regarded as Related Party Tenants, (i) the Articles of Incorporation of Crestline will expressly prohibit any person (or persons acting as a group), including Host REIT (and/or any 10% or greater stockholder of Host REIT), from owning more than 9.8% of the lesser of the number or value of the shares of capital stock of Crestline; (ii) the Host REIT Charter will expressly prohibit any person (or persons acting as a group) or entity from owning, actually and/or constructively, more than 9.8% of the lesser of the number or value of Host REIT Common Stock (subject to a limited exception for a holder of shares of Host REIT Common Stock solely by reason of the Merger in excess of the Ownership Limit so long as the holder thereof would not own, directly or by attribution under the Code, more than 9.9% in value of the outstanding shares of capital stock of Host REIT as of the Special Merger Ownership Limit Effective Time) or any other class or series of shares of Host REIT; and (iii) the Partnership Agreement will expressly prohibit any person (or persons acting as a group) or entity (other than Host REIT and Blackstone) from owning more than 4.9% by value of any class of interests in the Operating Partnership. Each of these prohibitions will contain self-executing enforcement mechanisms. Assuming that these prohibitions are enforced at all times (and no waivers thereto are granted), the Lessees should not be regarded as Related Party Tenants. There can be no assurance, however, that the ownership restrictions described herein will be enforced in accordance with their terms in all circumstances or otherwise will ensure, in all cases, that the Lessees will not be regarded as Related Party Tenants. The determination of whether the Leases are true leases depends upon an analysis of all the surrounding facts and circumstances. In making such a determination, courts have considered a variety of factors, including the following: (i) the intent of the parties; (ii) the form of the agreement; (iii) the degree of control over the property that is retained by the property owner (e.g., whether the lessee has substantial control over the operation of the property or whether the lessee was required simply to use its best efforts to perform its obligations under the agreement); and (iv) the extent to which the property owner retains the risk of loss with respect to the property (e.g., whether the lessee bears the risk of increases in operating expenses or the risk of damage to the property) or the potential for economic gain (e.g., appreciation) with respect to the property. In addition, Section 7701(e) of the Code provides that a contract that purports to be a service contract (or a partnership agreement) is treated instead as a lease of property if the contract is properly treated as such, taking 200 into account all relevant factors, including whether or not: (i) the service recipient is in physical possession of the property; (ii) the service recipient controls the property; (iii) the service recipient has a significant economic or possessory interest in the property (e.g., the property's use is likely to be dedicated to the service recipient for a substantial portion of the useful life of the property, the recipient shares the risk that the property will decline in value, the recipient shares in any appreciation in the value of the property, the recipient shares in savings in the property's operating costs or the recipient bears the risk of damage to or loss of the property); (iv) the service provider does not bear any risk of substantially diminished receipts or substantially increased expenditures if there is nonperformance under the contract; (v) the service provider does not use the property concurrently to provide significant services to entities unrelated to the service recipient; and (vi) the total contract price does not substantially exceed the rental value of the property for the contract period. Since the determination of whether a service contract should be treated as a lease is inherently factual, the presence or absence of any single factor may not be dispositive in every case. The Leases have been structured with the intent to qualify as true leases for federal income tax purposes. For example, with respect to each Lease (i) the Operating Partnership (or, where appropriate, the applicable Partnership or Private Partnership or other lessor entity) and the Lessee intend for their relationship to be that of a lessor and lessee and such relationship is documented by a lease agreement, (ii) the Lessee has the right to exclusive possession and use and quiet enjoyment of the Hotels covered by the Lease during the term of the Lease, (iii) the Lessee bears the cost of, and will be responsible for, day-to-day maintenance and repair of the Hotels (other than the cost of certain capital expenditures), and will dictate (through the Managers, who work for the Lessees during the terms of the Leases) how the Hotels are operated and maintained, (iv) the Lessee bears all of the costs and expenses of operating the Hotels (including the cost of any inventory used in their operation) during the term of the Lease (other than the cost of certain furniture, fixtures and equipment, and certain capital expenditures), (v) the Lessee benefits from any savings (and bears the burdens of any increases) in the costs of operating the Hotels during the term of the Lease, (vi) in the event of damage or destruction to a Hotel, the Lessee is at economic risk because it will bear the economic burden of the loss in income from operation of the Hotels subject to the right, in certain circumstances, to terminate the Lease if the lessor does not restore the Hotel to its prior condition, (vii) the Lessee has indemnified the Operating Partnership (or, where appropriate, the applicable Partnership or Private Partnership or other lessor entity) against all liabilities imposed on the Operating Partnership (or, where appropriate, the applicable Partnership or Private Partnership or other lessor entity) during the term of the Lease by reason of (A) injury to persons or damage to property occurring at the Hotels or (B) the Lessee's use, management, maintenance or repair of the Hotels, (viii) the Lessee is obligated to pay, at a minimum, substantial Base Rent for the period of use of the Hotels under the Lease, (ix) the Lessee stands to incur substantial losses (or reap substantial gains) depending on how successfully it (through the Managers, who work for the Lessees during the terms of the Leases) operates the Hotels, and (x) Host REIT and the Operating Partnership believe that each Lessee reasonably expects to derive a meaningful profit, after expenses and taking into account the risks associated with the Lease, from the operation of the Hotels during the term of its Leases. Moreover, upon termination of a Lease, each Hotel is expected to have a remaining useful life equal to at least 20% of its expected useful life on the date of the consummation of the REIT Conversion, and a fair market value equal to at least 20% of its fair market value on the date of the consummation of the REIT Conversion. Based upon representations made by Host REIT and the Operating Partnership (including representations as to the matters described in the previous paragraph and as to economic and other terms of the Leases), Hogan & Hartson, counsel to Host REIT, has provided to Host REIT an opinion letter to the effect that the Leases will be respected as leases for federal income tax purposes. As noted previously, however, an opinion of counsel does not bind the IRS or the courts. Moreover, there are no controlling Treasury Regulations, published IRS rulings or judicial decisions involving leases with terms substantially the same as the Leases that discuss whether such leases constitute true leases for federal income tax purposes and that this issue, more so than many others, is likely to turn on the surrounding facts and underlying economic circumstances. Hogan & Hartson is not expressing any opinion as to the economic terms of the Leases, the commercial reasonableness thereof, whether the actual economic relationships created thereby are such that the Leases will be respected for federal income 201 tax purposes or whether the rental and other terms of the Leases conform with normal business practice (and are not being used as a means to base the rent paid on the income or profits of the Lessees). Therefore, there can be no assurance that the IRS will not assert a contrary position or that such position will be sustained by a court if so challenged. If the Leases were recharacterized as service contracts or partnership agreements, rather than true leases, or disregarded altogether for tax purposes, all or part of the payments that the Operating Partnership receives from the Lessees would not be considered rent or would not otherwise satisfy the various requirements for qualification as "rents from real property." In that case, Host REIT very likely would not be able to satisfy either the 75% or 95% gross income tests and, as a result, would lose its REIT status. As indicated above, "rents from real property" must not be based in whole or in part on the income or profits of any person. Payments made pursuant to the Leases should qualify as "rents from real property" since they will be based on either a fixed dollar amount (i.e., Base Rent) or specified percentages of gross sales (i.e., Percentage Rents) which percentages will be fixed at the time the Leases are entered into. The foregoing assumes that the Leases (i) are not renegotiated during their term in a manner that has t