LASALLE HOTEL PROPERTIES - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

Commission file number 1-14045

LASALLE HOTEL PROPERTIES

(Exact name of registrant as specified in its charter)

Maryland

36-4219376

(State or other jurisdiction

of incorporation or organization)

(IRS Employer Identification No.)


4800 Montgomery Lane, Suite M25, Bethesda, MD		20814
(Address of principal executive offices)		(Zip Code)

(301) 941-1500

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act rule 12b-2).

Yes x No ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common and preferred shares as of the latest practicable date.


Class		Outstanding at October 19, 2004
Common Shares of Beneficial Interest ($0.01 par value)		28,124,279
10¹/4 % Series A Cumulative Redeemable Preferred Shares ($0.01 par value)		3,991,900
8³/8 % Series B Cumulative Redeemable Preferred Shares ($0.01 par value)		1,100,000

TABLE OF CONTENTS


		Page
PART I	Financial Information

Item 1.	Financial Statements	3

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	40

Item 4.	Controls and Procedures	42

PART II	Other Information

Item 1.	Legal Proceedings	42

Item 2.	Changes in Securities and Use of Proceeds	42

Item 3.	Defaults Upon Senior Securities	42

Item 4.	Submission of Matters to a Vote of Security Holders	42

Item 5.	Other Information	42

Item 6.	Exhibits and Reports on Form 8-K	42

	Signatures	44

PART I. Financial Information

Item 1.

Financial Statements.

LASALLE HOTEL PROPERTIES

Consolidated Balance Sheets

(Dollars in thousands, except share data)


	September 30, 2004			December 31, 2003
	*(Unaudited)*
Assets:
Investment in hotel properties, net (Note 2)	$	724,540		$	595,976
Property under development (Note 2)		22,034			14,743
Investment in joint venture (Note 2)		1,269			3,488
Cash and cash equivalents		4,250			34,761
Restricted cash reserves (Note 7)		7,654			21,988
Rent receivable		3,231			2,116
Hotel receivables (net of allowance for doubtful accounts of approximately $330 and $261, respectively)		15,341			10,593
Deferred financing costs, net		4,635			4,195
Deferred tax asset		11,519			10,424
Prepaid expenses and other assets		20,403			9,585
Assets sold, net (Note 3)		622			35

Total assets	$	815,498		$	707,904

Liabilities and Shareholders’ Equity:
Borrowings under credit facilities (Note 6)	$	3,370		$	—
Bonds payable (Note 6)		42,500			42,500
Mortgage loans (including unamortized premium of zero and $2,015, respectively) (Note 6)		212,565			187,157
Accounts payable and accrued expenses (Note 7)		35,897			26,842
Advance deposits		3,772			3,202
Accrued interest		1,006			705
Distributions payable		5,413			4,853
Liabilities of assets sold (Note 3)		599			61

Total liabilities		305,122			265,320
Minority interest in LaSalle Hotel Operating Partnership, L.P. (Note 8)		4,617			5,721
Minority interest in other partnerships		—			10
Commitments and contingencies (Note 7)		—			—
Shareholders’ Equity:
Preferred shares, $.01 par value, 20,000,000 shares authorized,
10 1/4 % Series A - 3,991,900 shares issued and outstanding at September 30, 2004 and December 31, 2003, respectively (Note 8)		40			40
8 3/8 % Series B - 1,100,000 shares issued and outstanding at September 30, 2004 and December 31, 2003, respectively (Note 8)		11			11
Common shares of beneficial interest, $.01 par value, 100,000,000 shares authorized and 28,118,014 and 24,140,855 shares issued and outstanding at September 30, 2004 and December 31, 2003, respectively (Note 8)		281			241
Additional paid-in capital, including offering costs of $29,438 and $28,461 at September 30, 2004 and December 31, 2003, respectively		562,691			485,724
Deferred compensation		(2,467	)		(3,394	)
Accumulated other comprehensive income		558			—
Distributions in excess of retained earnings		(55,355	)		(45,769	)

Total shareholders’ equity		505,759			436,853

Total liabilities and shareholders’ equity	$	815,498		$	707,904

The accompanying notes are an integral part of these consolidated financial statements.

LASALLE HOTEL PROPERTIES

Consolidated Statements of Operations

(Dollars in thousands, except per share data)

(Unaudited)


	For the three months ended September 30,						For the nine months ended September 30,
	2004			2003			2004			2003
Revenues:
Hotel operating revenues:
Room revenue	$	44,590		$	29,769		$	115,463		$	66,132
Food and beverage revenue		23,323			17,887			63,101			39,294
Other operating department revenue		6,918			6,035			17,436			11,969

Total hotel operating revenues		74,831			53,691			196,000			117,395
Participating lease revenue		7,135			6,958			15,562			17,454
Other income (Note 7)		18			110			110			906

Total revenues		81,984			60,759			211,672			135,755

Expenses:
Hotel operating expenses:
Room		10,750			7,040			28,755			17,510
Food and beverage		15,954			12,396			43,618			28,464
Other direct		3,762			3,192			10,193			6,637
Other indirect (Note 11)		20,003			14,626			54,765			34,375

Total hotel operating expenses		50,469			37,254			137,331			86,986
Depreciation and other amortization		9,977			7,891			28,700			23,485
Real estate taxes, personal property taxes and insurance		2,980			2,517			8,723			6,777
Ground rent (Note 7)		1,111			1,147			2,713			2,771
General and administrative		2,238			1,915			6,351			5,583
Amortization of deferred financing costs		590			575			1,657			1,731
Impairment of investment in hotel property		—			—			—			2,453
Contingent lease termination expenses (Note 7)		850			—			850			—
Other expenses		7			11			590			91

Total operating expenses		68,222			51,310			186,915			129,877

Operating income		13,762			9,449			24,757			5,878
Interest income		64			73			223			197
Interest expense		(3,338	)		(3,550	)		(9,909	)		(9,266	)

Income (loss) before income tax benefit (expense), minority interest, equity in earnings of unconsolidated entities and discontinued operations		10,488			5,972			15,071			(3,191	)
Income tax benefit (expense) (Note 12)		(558	)		55			807			2,857

Income (loss) before minority interest, equity in earnings of unconsolidated entities and discontinued operations		9,930			6,027			15,878			(334	)
Minority interest in LaSalle Hotel Operating Partnership, L.P.		(158	)		(108	)		(256	)		1

Income (loss) before equity in earnings of unconsolidated entities and discontinued operations		9,772			5,919			15,622			(333	)
Equity in earnings of unconsolidated entities (Note 2)		221			190			235			307

Income before discontinued operations		9,993			6,109			15,857			(26	)
Discontinued operations (Note 3):
Income (loss) from operations of property disposed of, including gain on disposal of assets		3,286			(325	)		4,745			37,748
Minority interest, net of tax		(51	)		7			(72	)		(806	)
Income tax benefit(expense) (Note 12)		(56	)		20			(180	)		(70	)

Net income (loss) from discontinued operations		3,179			(298	)		4,493			36,872

Net income		13,172			5,811			20,350			36,846
Distributions to preferred shareholders		(3,133	)		(2,557	)		(9,399	)		(7,672	)

Net income applicable to common shareholders	$	10,039		$	3,254		$	10,951		$	29,174

The accompanying notes are an integral part of these consolidated financial statements.

LASALLE HOTEL PROPERTIES

Consolidated Statements of Operations - Continued

(Dollars in thousands, except per share data)


	For the three months ended September 30,					For the nine months ended September 30,
	2004		2003			2004		2003
Earnings per Common Share - Basic:
Income (loss) applicable to common shareholders before discontinued operations and after dividends paid on unvested restricted shares	$	0.25	$	0.17		$	0.24	$	(0.41	)
Discontinued operations		0.11		(0.01	)		0.17		1.91

Net income applicable to common shareholders after dividends paid on unvested restricted shares	$	0.36	$	0.16		$	0.41	$	1.50

Earnings per Common Share - Diluted:
Income (loss) applicable to common shareholders before discontinued operations	$	0.24	$	0.16		$	0.24	$	(0.39	)
Discontinued operations		0.11		(0.01	)		0.17		1.87

Net income applicable to common shareholders	$	0.35	$	0.15		$	0.41	$	1.48

Weighted average number common shares outstanding:
Basic		27,805,183		20,738,660			26,087,859		19,254,958
Diluted		28,351,296		21,197,051			26,714,754		19,657,100

The accompanying notes are an integral part of these consolidated financial statements.

LASALLE HOTEL PROPERTIES

Consolidated Statements of Cash Flows

(Dollars in thousands, except per share data)

(Unaudited)


	For the nine months ended September 30,
	2004			2003
Cash flows from operating activities:
Net income	$	20,350		$	36,846
Adjustments to reconcile net income to net cash flow provided by operating activities:
Depreciation and other amortization		28,813			25,193
Amortization of deferred financing costs		1,657			2,843
Minority interest in LaSalle Hotel Operating Partnership, L.P.		328			805
Gain on sale of property disposed of		(2,643	)		(37,087	)
Loss on sale of property disposed of		—			291
Impairment of investment in hotel property		—			2,453
Gain on extinguishment of debt		(70	)		—
Gain on disposition of minority interest in other partnerships		(10	)		—
Income tax benefit		(627	)		(2,787	)
Deferred compensation		936			585
Equity in (income) of joint venture		(235	)		(307	)
Changes in assets and liabilities:
Rent receivable		(1,115	)		(396	)
Hotel receivables, net		(4,654	)		(6,558	)
Deferred tax asset		(468	)		(569	)
Prepaid expenses and other assets		(10,778	)		3,052
Mortgage loan premium		(75	)		2,173
Accounts payable and accrued expenses		4,643			(2,285	)
Advance deposits		553			2,820
Accrued interest		(195	)		(354	)

Net cash flow provided by operating activities		36,410			26,718

Cash flows from investing activities:
Improvements and additions to hotel properties		(22,578	)		(19,608	)
Acquisition of hotel properties		(163,767	)		(75,142	)
Distributions from joint venture		2,454			804
Purchase of office furniture and equipment		(84	)		(194	)
Repayment of notes receivable		—			750
Funding of restricted cash reserves		(7,211	)		(18,368	)
Proceeds from restricted cash reserves		21,545			14,764
Proceeds from sale of investment in hotel properties		28,596			50,001

Net cash flow used in investing activities		(141,045	)		(46,993	)

Cash flows from financing activities:
Borrowings under credit facilities		240,153			108,129
Repayments under credit facilities		(236,783	)		(117,438	)
Proceeds from mortgage loans		91,400			—
Repayments of mortgage loans		(63,977	)		(1,193	)
Mortgage loan premium		(1,870	)		—
Payment of deferred financing costs		(1,561	)		(5	)
Proceeds from exercise of stock options		11,999			374
Proceeds from issuance of preferred shares		—			25,000
Proceeds from issuance of common shares		62,400			33,069
Payment of preferred offering costs		—			(592	)
Payment of common offering costs		(978	)		(1,322	)
Distributions-preferred shares		(9,399	)		(7,672	)
Distributions-common shares		(17,260	)		(15,196	)

Net cash flow provided by financing activities		74,124			23,154

Net change in cash and cash equivalents		(30,511	)		2,879
Cash and cash equivalents, beginning of period		34,761			6,521

Cash and cash equivalents, end of period	$	4,250		$	9,400

The accompanying notes are an integral part of these consolidated financial statements.

LASALLE HOTEL PROPERTIES

Notes to Consolidated Financial Statements

(Dollars in thousands, expect per share data)

(Unaudited)

1.	Organization

LaSalle Hotel Properties (the “Company”), a Maryland real estate investment trust (“REIT”), buys, owns and leases primarily upscale and luxury full-service hotels located in convention, resort and major urban business markets. The Company is a self-administered and self-managed REIT as defined in the Internal Revenue Code of 1986, as amended (the “Code”). As a REIT, the Company generally is not subject to federal corporate income tax on that portion of its net income that is currently distributed to shareholders.

As of September 30, 2004, the Company owned interests in 18 hotels with approximately 6,100 suites/rooms located in 10 states and the District of Columbia. The Company owns 100% equity interests in 17 of the hotels and a non-controlling 9.9% equity interest in a joint venture that owns one hotel. Each hotel is leased under a participating lease that provides for rental payments equal to the greater of (i) base rent or (ii) participating rent based on hotel revenues. An independent hotel operator manages each hotel. Two of the hotels are leased to unaffiliated lessees (affiliates of whom also operate these hotels) and 15 of the hotels are leased to the Company’s taxable REIT subsidiary, LaSalle Hotel Lessee, Inc. (“LHL”), or a wholly owned subsidiary of LHL (see Note 11). Lease revenue from LHL and its wholly owned subsidiaries is eliminated in consolidation. The hotel that is owned by the joint venture that owns the Chicago Marriott Downtown is leased to Chicago 540 Lessee, Inc. in which the Company has a non-controlling 9.9% equity interest (see Note 2).

Substantially all of the Company’s assets are held by, and all of its operations are conducted through, LaSalle Hotel Operating Partnership, L.P. The Company is the sole general partner of the operating partnership. The Company owned approximately 98.7% of the operating partnership at September 30, 2004. At September 30, 2004, the remaining 1.3% is held by other limited partners who hold 383,090 limited partnership units. Limited partnership units are redeemable for cash, or at the option of the Company, for a like number of common shares of beneficial interest of the Company.

2.	Summary of Significant Accounting Policies

The accompanying unaudited interim consolidated financial statements and related notes have been prepared by management in accordance with the financial information and accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. The following notes to these interim financial statements highlight significant changes to the notes included in the December 31, 2003 audited financial statements included in the Company’s 2003 Annual Report on Form 10-K and present interim disclosures as required by the Securities and Exchange Commission (“SEC”). These unaudited consolidated financial statements, in the opinion of management, include all adjustments, (consisting of normal recurring adjustments) considered necessary for a fair presentation of the consolidated balance sheets, consolidated statements of operations, and consolidated statements of cash flows for the periods presented. Operating results for the three months and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004 due to seasonal and other factors. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted in accordance with the rules and regulations of the SEC. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. Certain prior period amounts have been reclassified to conform to the current period presentation.

Basis of Presentation

The consolidated financial statements include the accounts of the Company, the operating partnership, LHL and its subsidiaries and partnerships in which it has a controlling interest. All significant intercompany balances and transactions have been eliminated.

Use of Estimates

Preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and the amounts of contingent assets and liabilities at the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

A significant portion of the Company’s revenues and expenses comes from the operations of the individual hotels. The Company uses revenues and expenses that are estimated and projected by the hotel operators to produce quarterly financial statements because the management contracts do not require the hotel operators to submit actual results within a time frame that permits the Company to use actual results when preparing its quarterly reports on Form 10-Q for filing by the deadline prescribed by the SEC. Generally, the Company uses actual revenue and expense amounts for the first two months of each quarter and revenue and expense estimates for the last month of each quarter. Each quarter, the Company reviews the estimated revenue and expense amounts provided by the hotel operators for reasonableness based upon historical results for prior periods and internal Company forecasts. The Company records any differences between recorded estimated amounts and actual amounts in the following quarter; historically these differences have not been material. The Company believes the aggregate estimate of quarterly revenues and expenses recorded on the Company’s consolidated statements of operations are materially correct.

Investment in Hotel Properties

Upon acquisition, the Company allocates the purchase price of assets to asset classes based on the fair value of the acquired real estate, furniture, fixtures and equipment and intangible assets. The Company’s investments in hotel properties are carried at cost and are depreciated using the straight-line method over estimated useful lives ranging from 27.5 to 30 years for buildings and improvements and three to five years for furniture, fixtures and equipment. Furniture, fixtures and equipment under capital leases are carried at the present value of the minimum lease payments.

The Company periodically reviews the carrying value of each hotel to determine if circumstances exist indicating impairment to the carrying value of the investment in the hotel or that depreciation periods should be modified. If facts or circumstances support the possibility of impairment, the Company will prepare an estimate of the undiscounted future cash flows, without interest charges, of the specific hotel and determine if the investment in such hotel is recoverable based on the undiscounted future cash flows. If impairment is indicated, an adjustment will be made to the carrying value of the hotel to reflect the hotel at fair value. The Company does not believe that there are any facts or circumstances indicating impairment of any of its investments in its hotels.

In accordance with the provisions of Financial Accounting Standards Board Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” a hotel is considered held for sale when a contract for sale is entered into or when management has committed to a plan to sell an asset, the asset is actively marketed and sale is expected to occur within one year.

Intangible Assets

The Company has an intangible asset for rights to build in the future at the Lansdowne Resort, which has an indefinite useful life. The Company does not amortize intangible assets with indefinite useful lives. The non-amortizable intangible asset is reviewed annually for impairment and more frequently if events or circumstances indicate that the asset may be impaired. If a non-amortizable intangible asset is subsequently determined to have a finite useful life, the intangible asset will be written down to the lower of its fair value or carrying amount and then amortized prospectively based on the remaining useful life of the intangible asset. The intangible asset for rights to build in the future is included in property under development in the accompanying consolidated balance sheets.

Investment in Joint Venture

Investment in joint venture represents the Company’s non-controlling 9.9% equity interest in each of (i) the joint venture that owns the Chicago Marriott Downtown and (ii) Chicago 540 Lessee, Inc., both of which are associated with the Chicago Marriott Downtown. The Carlyle Group owns a 90.1% controlling interest in both the joint venture that owns the Chicago Marriott Downtown and Chicago 540 Lessee, Inc. The Company accounts for its investment in joint venture using the equity method of accounting. The Company receives an annual preferred return in addition to its pro rata share of annual cash flow. The Company also has the opportunity to earn an incentive participation in net sale proceeds based upon the achievement of certain overall investment returns, in addition to its pro rata share of net sale or refinancing proceeds. Marriott International, Inc. operates the Chicago Marriott Downtown pursuant to a long-term incentive-based operating agreement.

Revenue Recognition

For properties not leased by LHL, the Company recognizes lease revenue on an accrual basis pursuant to the terms of the respective participating leases. Base rent and participating rent are recognized based on quarterly thresholds, pursuant to the lease agreements. For properties leased by LHL, the Company recognizes hotel operating revenue on an accrual basis consistent with the hotel operations.

For the Lansdowne Resort, the Company defers golf membership fees and recognizes revenue over the average expected life of an active membership (currently six years) on a straight-line basis. Golf membership, health club and executive club annual dues are recognized as earned throughout the membership year.

Stock-Based Compensation

Prior to 2003, the Company applied Accounting Principles Board Opinion No. 25 and related interpretations in accounting for the 1998 share option and incentive plan. Accordingly, no compensation costs were recognized for stock options granted to the Company’s employees, as all options granted under the plan had an exercise price equal to the market value of the underlying stock on the date of grant. Effective January 1, 2003, the Company adopted the fair value recognition provisions of Statement No. 123 prospectively for all options granted to employees and members of the Board of Trustees. No options were granted during 2003 or 2004.

Options granted under the 1998 share option and incentive plan vest over three to four years, therefore the costs related to stock-based compensation for 2004 and 2003 are less than that which would have been recognized if the fair value based method had been applied to all grants since the original effective date of Statement No. 123. Had compensation cost for all of the options granted under the Company’s 1998 share option and incentive plan been determined in accordance with the method required by Statement No. 123, the Company’s net income and net income per common share for the three months and nine months ended September 30, 2004 and 2003, respectively would approximate the pro forma amounts below (in thousands, except per share data).


	For the three months ended September 30,						For the nine months ended September 30,
	2004			2003			2004			2003
	Proforma			Proforma			Proforma			Proforma
Net income applicable to common shareholders	$	10,039		$	3,254		$	10,951		$	29,174
Stock-based employee compensation expense		(18	)		(22	)		(58	)		(66	)

Proforma net income	$	10,021		$	3,232		$	10,893		$	29,108

Proforma net income per common share:
basic (after dividends paid on unvested restricted shares)	$	0.36		$	0.15		$	0.41		$	1.50

diluted	$	0.35		$	0.15		$	0.41		$	1.48

The Company recognizes compensation cost for restricted shares issued based upon the fair market value of the common stock at the grant date. Compensation cost is recognized on a straight-line basis over the vesting period.

Income Taxes

The Company has elected to be taxed as a REIT under Sections 856 through 860 of the Code commencing with its taxable year ended December 31, 1998. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including a requirement that it currently distribute at least 90% of its adjusted taxable income to its shareholders. It is the Company’s current intention to adhere to these requirements and maintain the Company’s qualification for taxation as a REIT. As a REIT, the Company generally is not subject to federal corporate income tax on that portion of its net income that is currently distributed to shareholders. If the Company fails to qualify for taxation as a REIT in any taxable year, it will be subject to federal income taxes at regular corporate rates (including any applicable alternative minimum tax) and may not be able to qualify as a REIT for four subsequent taxable years. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income and property, and to federal income and excise taxes on its undistributed taxable income. In addition, taxable income from non-REIT activities managed through taxable REIT subsidiaries is subject to federal, state and local income taxes. As a wholly owned taxable-REIT subsidiary of the Company, LHL is required to pay income taxes at the applicable rates.

3.	Discontinued Operations

Effective January 16, 2004, the Company entered into an exclusive listing agreement for the sale of its Omaha property. The asset was classified as held for sale at that time because the property was being actively marketed and sale was expected to occur within one year; accordingly depreciation was suspended. Based on initial pricing expectations the Company expected to recognize a gain on the sale, therefore no impairment was recognized. Effective June 30, 2004, the Company entered into a purchase and sale agreement, which was amended on July 30, 2004 and August 23, 2004, to sell its Omaha property. The asset was sold on September 15, 2004 (see Note 4) with net sale proceeds of approximately $28,596. The Company believes that it can redeploy the capital into markets with better long-term fundamentals, thereby improving the return on its invested capital. Total revenues related to the asset of $2,863 and $9,829, comprised of primarily hotel operating revenues, and income before income tax expense related to the asset of $592 and $2,030 for the three months and nine months ended September 30, 2004, respectively, are included in discontinued operations. Revenues and expenses for the three months and nine months ended September 30, 2003 have been reclassified to conform to the current presentation.

The Company allocates interest expense to discontinued operations for debt that is to be assumed or that is required to be repaid as a result of the disposal transaction. The Company allocated no interest expense to discontinued operations for the three months and nine months ended September 30, 2004, respectively.

As of September 30, 2004, the Company had unsettled assets and liabilities of $622 and $599, respectively, related to the sale of the Omaha property. The Company expects all assets and liabilities to be settled by the end of first quarter of 2005. At September 30, 2004, the Company had no assets and liabilities for assets held for sale.

4.	Disposition of Hotel Property

On September 15, 2004, the Company sold the Omaha Marriott hotel for $28,500 resulting in a gain of approximately $2,643. The gain is recorded in discontinued operations in the accompanying consolidated financial statements. The asset was classified as held-for-sale effective January 16, 2004 at which time depreciation was suspended. Based on initial pricing expectations, the Company expected a gain on the sale of the asset, and, as such, no impairment of the asset was recorded.

5.	Acquisition of Hotel Properties

On February 10, 2004, the Company acquired a 100% interest in the Indianapolis Marriott Downtown, a 615-room, full-service hotel located in downtown Indianapolis, Indiana, for $106.0 million. The source of the funding for the acquisition was the Company’s senior unsecured bank facility, a portion of which was repaid when the Company entered into a mortgage agreement secured by the Indianapolis property in February 2004 (see Note 6). The property is leased to LHL, and White Lodging Services Corporation manages the property.

On May 28, 2004, the Company acquired a 100% interest in the Hilton Alexandria Old Town, a 241-room, upscale full-service hotel located in the heart of historic downtown Alexandria, Virginia, for $59.0 million. The source of the funding for the acquisition was the Company’s senior unsecured bank facility. The property is leased to LHL, and Sandcastle Resorts & Hotels manages the property.

6.	Long-Term Debt

Credit Facilities

The Company has a senior unsecured bank facility from a syndicate of banks that provides for a maximum borrowing of up to $300.0 million, which matures on December 31, 2006 and has a one-year extension option. On August 30, 2004, the Company, in accordance with bank facility terms, executed a commitment agreement expanding the commitment facility from $215.0 to $300.0 million. The senior unsecured bank facility contains certain financial covenants relating to debt service coverage, net worth and total funded indebtedness and contains financial covenants that, assuming no continuing defaults, allow the Company to make shareholder distributions which, when combined with the distributions to shareholders in the three immediately preceding fiscal quarters, do not exceed the greater of (i) funds from operations from the preceding four-quarter rolling period or (ii) the greater of (a) the amount of distributions required for the Company to maintain its status as a REIT or (b) the amount required to ensure the Company will avoid imposition of an excise tax for failure to make certain minimum distributions on a calendar year basis. As of September 30, 2004, the Company is in compliance with the financial covenants. Borrowings under the senior unsecured bank facility bear interest at floating rates equal to, at the Company’s option, either (i) London InterBank Offered Rate plus an applicable margin, or (ii) an “Adjusted Base Rate” plus an applicable margin. For the three months and nine months ended September 30, 2004, the weighted average interest rate for borrowings under the senior unsecured bank facility was approximately 3.9% and 3.6%, respectively. Interest expense for the three months and nine months ended September 30, 2004 was $453 and $1,633, respectively. The Company did not have any Adjusted Base Rate borrowings outstanding at September 30, 2004. Additionally, the Company is required to pay a variable unused commitment fee determined from a ratings or leverage based pricing matrix, currently set at 0.25% of the unused portion of the senior unsecured bank facility. The Company incurred an unused commitment fee of approximately $124 and $305 for the three months and nine months ended September 30, 2004, respectively. At September 30, 2004 and December 31, 2003, the Company had no outstanding borrowings under the senior unsecured bank facility.

the three months and nine months ended September 30, 2004, respectively was $94 and $156. Additionally, LHL is required to pay a variable unused commitment fee determined from a ratings or leverage based pricing matrix, currently set at 0.25% of the unused portion of the LHL credit facility. LHL incurred an unused commitment fee of approximately $5 and $16 for the three months and nine months ended September 30, 2004, respectively. At September 30, 2004 and December 31, 2003, the Company had $3.4 million and zero, respectively, outstanding borrowings under the LHL credit facility.

Bonds Payable

The Company is the obligor with respect to $37.1 million tax-exempt special project revenue bonds and $5.4 million taxable special project revenue bonds, both issued by the Massachusetts Port Authority (collectively, the “MassPort Bonds”). The MassPort Bonds which mature on March 1, 2018, bear interest based on a weekly floating rate and have no principal reductions prior to their scheduled maturities. The MassPort Bonds may be redeemed at any time at the Company’s option without penalty. The bonds are secured by letters of credit issued by GE Capital Corporation that expire in 2007 and are collateralized by the Harborside Hyatt Conference Center & Hotel and a $6.0 million letter of credit from the Company. If GE Capital Corporation fails to renew its letters of credit at expiration and an acceptable replacement provider cannot be found the Company may be required to pay off the bonds. The weighted average interest rate for the three months and nine months ended September 30, 2004 was 1.3% and 1.1%, respectively. Interest expense for the three months and nine months ended September 30, 2004, respectively was $137 and $363. In addition to the interest payments, the Company incurs a 2.0% annual maintenance fee, which is included in amortization of deferred financing costs. At both September 30, 2004 and December 31, 2003, the Company had outstanding bonds payable of $42.5 million.

Mortgage Loans

The Company, through a wholly owned partnership, is subject to a ten-year mortgage loan that is secured by the Sheraton Bloomington Hotel Minneapolis South, located in Bloomington, Minnesota and the Westin City Center Dallas, located in Dallas, Texas. The mortgage loan matures on July 31, 2009 and does not allow for prepayment prior to maturity without penalty. The mortgage loan bears interest at a fixed rate of 8.1% and requires interest and principal payments based on a 25-year amortization schedule. Interest expense for the three months and nine months ended September 30, 2004, respectively was $870 and $2,622. The loan agreement requires the partnership to hold funds in escrow sufficient for the payment of 50% of the annual insurance premiums and real estate taxes related to the two hotels that secure the loan. This mortgage loan had a principal balance of $42,884 and $43,515 at September 30, 2004 and December 31, 2003, respectively.

The Company, through a wholly owned partnership, is subject to a ten-year mortgage loan that is secured by the Le Montrose Suite Hotel located in West Hollywood, California. The mortgage loan bears interest at a fixed rate of 8.08%, matures on July 31, 2010, and requires interest and principal payments based on a 27-year amortization schedule. Interest expense for the three months and nine months ended September 30, 2004, respectively was $291 and $871. The mortgage loan agreement requires the partnership to hold funds in escrow sufficient for the payment of 50% of the annual insurance premium and real estate taxes on the Le Montrose Suite Hotel. This mortgage loan had a principal balance of $14,097 and $14,231 at September 30, 2004 and December 31, 2003, respectively.

The Company, through a wholly owned partnership, is subject to a five-year mortgage that is secured by the San Diego Paradise Point Resort. The mortgage loan matures on February 1, 2009 and does not allow for prepayment prior to maturity without penalty. The mortgage loan bears interest at a fixed rate of 5.25% and requires interest and principal payments based on a 25-year amortization schedule. Interest expense for the three months and nine months ended September 30, 2004, respectively was $862 and $2,581. The loan agreement requires the Company to hold funds in escrow sufficient for the payment of 50% of the annual insurance premiums and real estate taxes related to the hotel that secures the loan. This mortgage loan had a principal balance of $64,184 and $65,000 at September 30, 2004 and December 31, 2003.

The Company, through a wholly owned partnership is subject to a three-year mortgage loan that is secured by the Indianapolis Marriott Downtown. The mortgage loan matures on February 9, 2007 and can be extended at the option of

the Company for two additional one-year terms. The loan agreement does not allow for prepayment without penalty prior to February 25, 2006. The mortgage loan bears interest at the London InterBank Offered Rate plus 1.0%. As of September 30, 2004, the interest rate was 2.3%. On February 27, 2004, the Company entered into a three-year fixed interest rate swap that fixes the London InterBank Offered Rate at 2.56% for the $57,000 balance outstanding on the Company’s mortgage loan secured by the Indianapolis hotel, and therefore fixes the mortgage interest rate at 3.56%. Monthly interest-only payments are due in arrears throughout the term. Interest expense for the three months and nine months ended September 30, 2004, respectively was $363 and $786 for the mortgage secured by the Indianapolis property plus an additional $149 and $433, respectively, for the interest rate swap. The mortgage loan had a principal balance of $57,000 and zero at September 30, 2004 and December 31, 2003, respectively.

The Company assumed a five-year mortgage loan of $62,845 secured by the Lansdowne Resort located in Lansdowne, Virginia when it acquired the property in June 2003. The mortgage loan had an interest rate floor of 7.5%. Interest expense for the three months and nine months ended September 30, 2004 was zero and $457, respectively. The mortgage loan permitted prepayment beginning on February 11, 2004, and on February 11, 2004 the Company paid in full the $62,326 balance of the mortgage loan. Under the terms of the purchase agreement, upon prepayment the seller was entitled to the $5,019 debt service reserve, less any prepayment penalty. On February 12, 2004, the Company paid the seller $3,149 in cash representing the $5,019 debt service reserve escrow less a $1,870 prepayment penalty. The source of funding for the prepayment was the Company’s senior unsecured bank facility. At the time of acquisition, the Company recorded the mortgage at its fair value resulting in the Company recognizing a gain on the debt extinguishment of $70.

On August 26, 2004, the Company, through LHO Alexandria One, L.L.C., entered into a five-year mortgage loan totaling $34,400 that is secured by the Hilton Alexandria Old Town Hotel located in Alexandria, Virginia. The mortgage loan matures on August 31, 2009 and does not allow for prepayment with out penalty prior to July 1, 2009. The mortgage loan bears interest at a fixed rate of 4.98% and requires interest and principal payments based on a 25-year amortization. Interest expense for both the three and nine months ended September 30, 2004 was $171. The mortgage loan had a principal balance of $34,400 and zero at September 30, 2004 and December 31, 2003, respectively.

7.	Commitments and Contingencies

Ground Leases

Four of the hotels, San Diego Paradise Point Resort, Harborside Hyatt Conference Center & Hotel, Sheraton Bloomington Hotel Minneapolis South (the parking lot only) and Indianapolis Marriott Downtown, are subject to ground leases under non-cancelable operating leases with terms ranging out to May 2099. Total ground lease expense for the three months and nine months ended September 30, 2004, respectively was $1,111 and $2,713.

Reserve Funds

The Company is obligated to maintain reserve funds for capital expenditures at the hotels (including the periodic replacement or refurbishment of furniture, fixtures and equipment) as determined pursuant to the operating agreements. The Company’s aggregate obligation under the reserve funds was approximately $18,600 at September 30, 2004. The reserve requirements for five hotels are contained in certain long-term operating/franchise agreements, which require the reserves to be maintained through furniture, fixtures and equipment restricted cash escrows. These five operating agreements require that the Company reserve restricted cash ranging from 3.0% to 5.5% of the individual hotel’s annual revenues. As of September 30, 2004, $5,299 was available in restricted cash reserves for future capital expenditures. Thirteen of the operating agreements require that the Company reserve funds of 4.0% of the individual hotel’s annual revenues but do not require the funds to be set aside in restricted cash. As of September 30, 2004, the total amount obligated for future capital expenditures but not set aside in restricted cash reserves was $13,301. Amounts will be recorded as incurred. As of September 30, 2004, purchase orders and letters of commitment totaling

approximately $21,651 have been issued for renovations at the hotels. The Company has committed to these projects and anticipates making similar arrangements with the existing hotels or any future hotels that it may acquire. Any unexpended amounts will remain the property of the Company upon termination of the operating agreements.

The joint venture operating agreement requires that the joint venture reserve restricted cash of 5.0% of the Chicago Marriott Downtown’s annual revenues; however, the joint venture is not consolidated in the Company’s financial statements and the amount of restricted cash reserves relating to the joint venture is not recorded on the Company’s books and records.

Restricted Cash Reserves

At September 30, 2004, the Company held $7,654 in restricted cash reserves. Included in such amounts are (i) $1,855 deposited in mortgage escrow accounts pursuant to mortgages to pre-fund a portion of certain hotel expenses, (ii) $5,299 of reserve funds relating to the hotels with operating agreements requiring the Company to maintain restricted cash to fund future capital expenditures and (iii) $500 for future renovations and conversion costs expected to be incurred related to the Bloomington, Minnesota property re-branding under the Sheraton brand affiliation.

Litigation

The Company has engaged Starwood Hotels & Resorts Worldwide, Inc. to manage and operate its Dallas hotel under the Westin brand affiliation. Meridien Hotels, Inc. (“Meridien”) affiliates had been operating the Dallas property as a wrongful holdover tenant, until the Westin brand conversion occurred on July 14, 2003 under court order.

On December 20, 2002, affiliates of Meridien abandoned the Company’s New Orleans hotel. The Company entered into a lease with a wholly owned subsidiary of LHL and an interim management agreement with Interstate Hotels & Resorts, Inc., and re-named the hotel the New Orleans Grande Hotel. The New Orleans property thereafter was sold on April 21, 2003 for $92.5 million.

In connection with the termination of the Meridien affiliates at these hotels, the Company is currently in litigation with Meridien and related affiliates. The Company believes its sole potential obligation in connection with the termination of the leases is to pay fair market value of the leases, if any. With respect to the Dallas hotel, the Company has obtained a judgment from the court that Meridien defaulted and that Meridien is not entitled to the payment of fair market value. With respect to the New Orleans hotel, the issue of default by the lessee, among other claims, is scheduled to go to trial in the fall of 2004. Arbitration of the fair market value of the New Orleans lease commenced in October 2002. On December 19, 2002, the arbitration panel determined that Meridien was entitled to an award of approximately $5.7 million in connection with the New Orleans property, subject to adjustment (reduction) by the courts to account for Meridien’s holdover. In order to dispute the arbitration decision, the Company was required to post a $7.8 million surety bond, which was secured by $5.9 million of restricted cash. The Company successfully challenged the award on appeal, and the dispute has been remanded to the trial court. Meridien’s request for rehearing was denied on March 31, 2004, and Meridien did not petition to the Louisiana Supreme Court. In June 2004, the $7.8 million surety bond was released and the $5.9 million restricted cash securing it was returned to the Company.

In 2002, the Company recognized a net $2.5 million contingent lease termination expense and reversed previously deferred assets and liabilities related to the termination of both the New Orleans property and Dallas property leases and recorded a corresponding contingent liability included in accounts payable and accrued expenses in the accompanying consolidated financial statements. The Company believes, however, it is owed holdover rent per the lease terms due to Meridien’s failure to vacate the properties as required under the leases. The contingent lease termination expense was therefore net of the holdover rent the Company believes it is entitled to for both properties. In the first, second and third quarters of 2003, the Company adjusted this liability by additional holdover rent of $395, $380 and $52, respectively, that it believes it is entitled to for the Dallas property. These amounts were recorded as other income in the accompanying consolidated financial statements. The contingent lease termination expense recognized cumulatively since 2002 is comprised of (dollars in thousands):


	Expense Recognized Quarter Ended December 31, 2002			Expense Recognized Quarter Ended September 30, 2004			Cumulative Expense Recognized From December 31, 2002 through September 30, 2004
Estimated arbitration award	$	5,749		$	—		$	5,749
Legal fees related to litigation		2,610			1,350			3,960
Holdover rent		(4,844	)		—			(4,844	)
Expected reimbursement of legal fees		(995	)		(500	)		(1,495	)

Net contingent lease termination expense	$	2,520		$	850		$	3,370

In September 2004, after evaluating the ongoing Meridien litigation, the Company accrued additional net legal fees of $850 due to litigation timeline changes in order to conclude this matter. As a result, the net contingent lease termination liability has a balance of approximately $2.4 million as of September 30, 2004, which is included in accounts payable and accrued expenses in the accompanying consolidated balance sheets. Based on the claims the Company has against Meridien, the Company is and will continue to challenge Meridien’s claim that it is entitled to the payment of fair market value, and will continue to seek reimbursement of legal fees and damages. These amounts may exceed or otherwise may be used to offset any amounts potentially owed to Meridien, and therefore ultimately may offset or otherwise reduce any contingent lease termination expense. Additionally, the Company cannot provide any assurances that the holdover rents will be collectible or that the amounts due will not be greater than the recorded contingent lease termination expense.

The Company maintained a lien on Meridien’s security deposit on both disputed properties with an aggregate value of approximately $3.3 million, in accordance with the lease agreements. The security deposits were liquidated in May 2003 with the proceeds used to partially satisfy Meridien’s outstanding obligations, including certain working capital notes and outstanding base rent.

Meridien also has sued the Company and one of the Company’s officers alleging that certain actions taken in anticipation of re-branding the Dallas and New Orleans hotels under the Westin brand affiliation constituted unfair trade practices, false advertising, trademark infringement, trademark dilution and tortious interference. The Company intends to vigorously challenge Meridien’s claims if and when this matter gets set for trial.

The Company does not believe that the amount of any fees or damages it may be required to pay on any of the litigation related to Meridien will have a material adverse effect on the Company’s financial condition or results of operations, taken as a whole. The Company’s management has discussed this contingency and the related accounting treatment with the audit committee of its Board of Trustees.

The Company is not presently subject to any other material litigation nor, to the Company’s knowledge, is any other litigation threatened against the Company, other than routine actions for negligence or other claims and administrative proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance and all of which collectively are not expected to have a material adverse effect on the liquidity, results of operations or business or financial condition of the Company.

8.	Shareholders’ Equity

Common Shares of Beneficial Interest

On January 15, 2004, the Company paid its December 2003 monthly distribution of $0.07 per share/unit on its common shares of beneficial interest and units of limited partnership interest to shareholders and unit holders of record as of December 31, 2003.

On January 15, 2004, the Company declared monthly cash distributions to shareholders of the Company and partners of the operating partnership in the amount of $0.07 per common share of beneficial interest/unit for each of the months of January, February and March 2004.

On February 13, 2004, the Company paid its January 2004 monthly distribution of $0.07 per share/unit on its common shares of beneficial interest and units of limited partnership interest to shareholders and unit holders of record as of January 31, 2004.

On March 15, 2004, the Company paid its February 2004 monthly distribution of $0.07 per share/unit on its common shares of beneficial interest and units of limited partnership interest to shareholders and unit holders of record as of February 29, 2004.

On March 19, 2004, holders of rights to purchase common shares of beneficial interest exercised 90,000 of those rights. The Company issued 90,000 common shares of beneficial interest in exchange for the rights; the transaction resulted in 74,187 treasury shares to the Company.

During the three months ended March 31, 2004, executives and employees of the Company exercised 491,919 options to purchase common shares of beneficial interest. The Company issued 460,727 common shares of beneficial interest and re-issued 31,192 treasury shares.

On April 2, 2004, holders of rights to purchase common shares of beneficial interest exercised 290,471 of those rights. The Company issued 216,284 common shares of beneficial interest and re-issued 74,187 treasury shares in exchange for the rights.

On April 12, 2004, holders of rights to purchase common shares of beneficial interest exercised 467,237 of those rights. The Company issued 467,237 common shares of beneficial interest; the holders of rights to purchase common shares surrendered some shares in order to pay the exercise price at the time of exercising, and the transaction resulted in 360,293 treasury shares to the Company.

On April 15, 2004, the Company declared monthly cash distributions to shareholders of the Company and partners of the operating partnership in the amount of $0.07 per common share of beneficial interest/unit for each of the months of April, May and June 2004.

On April 15, 2004, the Company paid its March 2004 monthly distribution of $0.07 per share/unit on its common shares of beneficial interest and units of limited partnership interest to shareholders and unit holders of record as of March 31, 2004.

On May 12, 2004, the Company completed an underwritten public offering of 2,700,000 common shares of beneficial interest, par value $0.01 per share. After deducting underwriting discounts and commissions and other offering costs, the Company raised net proceeds of approximately $55,350. The net proceeds were used to repay existing indebtedness under the Company’s senior unsecured credit facility. UBS Securities LLC acted as the sole underwriter for this transaction. The Company sold an additional 300,000 common shares on May 13, 2004, pursuant to an over allotment option for approximately $6,150 after deducting underwriting discounts and commissions.

On May 14, 2004, the Company paid its April 2004 monthly distribution of $0.07 per share/unit on its common shares of beneficial interest and units of limited partnership interest to shareholders and unit holders of record as of April 30, 2004.

On June 15, 2004, the Company paid its May 2004 monthly distribution of $0.07 per share/unit on its common

shares of beneficial interest and units of limited partnership interest to shareholders and unit holders of record as of May 31, 2004.

During the three months ended September 30, 2004, executives and employees of the Company exercised 59,000 options to purchase common shares of beneficial interest. These common shares were issued under the 1998 share option and incentive plan.

On July 15, 2004, the Company declared monthly cash distributions to shareholders of the Company and partners of the operating partnership, increasing the amount from $0.07 per common share of beneficial interest/unit to $0.08 per common share of beneficial interest/unit for each of the months of July, August and September 2004.

On July 15, 2004, the Company paid its June 2004 monthly distribution of $0.07 per share/unit on its common shares of beneficial interest and units of limited partnership interest to shareholders and unit holders of record as of June 30, 2004.

On August 13, 2004, the Company paid its July 2004 monthly distribution of $0.08 per share/unit on its common shares of beneficial interest and units of limited partnership interest to shareholders and unit holders of record as of July 31, 2004.

On September 15, 2004, the Company paid its August 2004 monthly distribution of $0.08 per share/unit on its common shares of beneficial interest and units of limited partnership interest to shareholders and unit holders of record as of August 1, 2004.

Preferred Shares

On January 15, 2004, the Company paid its preferred distribution of $0.64 per Series A Preferred Share for the quarter ended December 31, 2003 to preferred shareholders of record at the close of business on January 1, 2004.

On January 15, 2004, the Company paid its preferred distribution of $0.52 per Series B Preferred Share for the quarter ended December 31, 2003 to preferred shareholders of record at the close of business on January 1, 2004.

On April 15, 2004, the Company paid its preferred distribution of $0.64 per Series A Preferred Share for the quarter ended March 31, 2004 to preferred shareholders of record at the close of business on April 1, 2004.

On April 15, 2004, the Company paid its preferred distribution of $0.52 per Series B Preferred Share for the quarter ended March 31, 2004 to preferred shareholders of record at the close of business on April 1, 2004.

On July 15, 2004, the Company paid its preferred distribution of $0.64 per Series A Preferred Share for the quarter ended June 30, 2004 to preferred shareholders of record at the close of business on July 1, 2004.

On July 15, 2004, the Company paid its preferred distribution of $0.52 per Series B Preferred Share for the quarter ended June 30, 2004 to preferred shareholders of record at the close of business on July 1, 2004.

Treasury Shares

Treasury shares are accounted for under the cost method. During the quarter ended March 31, 2004, the Company re-purchased 122,505 common shares of beneficial interest related to (i) executives and employees surrendering shares to pay taxes at the time restricted shares vested and (ii) holders of rights to purchase common shares of beneficial interest surrendering shares to pay the exercise price at the time of exercising their rights. The Company re-issued 48,318 treasury shares related to executives and employees exercising stock options and holders of rights to purchase common shares of beneficial interest exercising some rights.

During the quarter ended June 30, 2004, the Company repurchased 467,237 common shares of beneficial interest

related to holders of rights to purchase common shares of beneficial interest surrendering shares to pay the exercise price at the time of exercising their rights. The Company re-issued 541,424 common shares of beneficial interest related to (i) holders of rights to purchase common shares of beneficial interest exercising some rights, (ii) compensation to the Board of Trustees and (iii) the common share of beneficial interest equity offering in May 2004.

As of September 30, 2004, there were no common shares of beneficial interest in treasury.

Operating Partnership Units

As of September 30, 2004 and December 31, 2003, the operating partnership had 383,090 and 424,686 units outstanding, representing a 1.3% and 1.7% partnership interest held by the limited partners, respectively.

9.	Share Option and Incentive Plan

On January 23, 2004 and January 29, 2004, the Company issued an aggregate of 6,761 common shares of beneficial interest, including 5,448 deferred shares, to the independent members of its Board of Trustees for a portion of their 2003 compensation. The common shares of beneficial interest were issued in lieu of cash at the trustees’ election. These common shares of beneficial interest were issued under the 1998 share option and incentive plan.

On April 22, 2004, the Company granted an aggregate of 3,000 restricted common shares of beneficial interest to the Company’s Board of Trustees. These restricted shares vest over three years. The Company measures compensation cost for restricted shares based upon the fair market value of its common stock at the grant date. The fair market value of the common stock on the date of the grant was $21.22. Compensation expense recognized for the restricted shares issued April 22, 2004 and classified as general and administrative expense in the accompanying consolidated financial statements for the three and nine months ended September 30, 2004 was $5 and $9, respectively. These common shares were issued under the 1998 share option and incentive plan.

At September 30, 2004 and December 31, 2003, there were 236,870 and 283,302 common shares, respectively, available for future grant under the 1998 share option and incentive plan.

10.

Financial Instruments: Derivatives and Hedging

The Company uses interest rate swaps to hedge against interest rate fluctuations. Unrealized gains and losses are reported in other comprehensive income with no effect recognized in earnings as long as the characteristics of the swap and the hedged item are closely matched. On February 27, 2004, the Company entered into a three-year fixed interest rate swap that fixes the London InterBank Offered Rate at 2.56% for the $57,000 balance outstanding on the Company’s mortgage loan secured by the Indianapolis hotel, and therefore fixes the mortgage interest rate at 3.56%. As of September 30, 2004, there was $558 in unrealized gains included in accumulated other comprehensive income, a component of shareholders’ equity. The hedge is effective in offsetting the variable cash flows; therefore no gain or loss was realized in earnings during the three months and nine months ended September 30, 2004, respectively.

The following table summarizes the notional value and fair value of the Company’s derivative financial instrument. The notional value at September 30, 2004 provides an indication of the extent of the Company’s involvement in these instruments at that time, but does not represent exposure to credit, interest rate or market risks.

At September 30, 2004:


Hedge Type	Notional Value		Interest Rate		Maturity	Fair Value
Swap-Cash Flow	$	57,000	2.555	%	2/9/07	$	558

At September 30, 2004, the derivative instrument was reported at its fair value of $558 and is included within prepaid expenses and other assets in the accompanying consolidated financial statements.

Interest rate hedges that are designated as cash flow hedges hedge the future cash outflows on debt. Interest rate swaps that convert variable payments to fixed payments, interest rate caps, floors, collars, and forwards are cash flow

hedges. The unrealized gains/losses in the fair value of these hedges are reported on the balance sheet with a corresponding adjustment to either accumulated other comprehensive income/loss or in earnings depending on the type of hedging relationship and effectiveness. If the hedging transaction is a cash flow hedge, then the offsetting gains and losses are reported in accumulated other comprehensive income/loss. Over time, the unrealized gains and losses reported in accumulated other comprehensive income/loss will be reclassified to earnings. This reclassification is consistent with when the hedged items are also recognized in earnings. For the three months and nine months ended September 30, 2004, respectively, the Company reclassified $149 and $433 of accumulated other comprehensive loss to earnings as interest expense in conjunction with any interest rate swaps.

The Company hedges its exposure to the variability in future cash flows for transactions it anticipates entering into in the foreseeable future. During the forecast period, unrealized gains and losses in the hedging instrument will be reported in accumulated other comprehensive income/loss. Once the hedged transaction takes place, the hedge gains and losses will be reported in earnings during the same period in which the hedged item is recognized in earnings.

11.

LHL

A significant portion of the Company’s revenue is derived from operating revenues generated by the hotels leased by LHL.

Included in other indirect hotel operating expenses, including indirect operating expenses related to discontinued operations, are the following expenses incurred by the hotels leased by LHL:


	For the three months ended September 30,				For the nine months ended September 30,
	2004		2003		2004		2003
General and administrative	$	6,423	$	5,044	$	18,084	$	13,435
Sales and marketing		4,624		3,465		13,710		9,218
Repairs and maintenance		3,006		2,217		8,380		6,261
Utilities and insurance		2,936		2,408		7,815		5,709
Management and incentive fees		2,844		2,385		7,078		5,437
Other expenses		1,107		572		2,945		1,269

Total other indirect expenses	$	20,940	$	16,091	$	58,012	$	41,239

Effective March 16, 2004, LHL terminated its management agreement with Radisson Hotels and Resorts to manage the 565-room convention hotel in Bloomington, Minnesota. The hotel was re-flagged as the Sheraton Bloomington Hotel Minneapolis South. Starwood Hotels and Resorts Worldwide, Inc. was selected to manage the property as a Sheraton, Starwood’s upscale brand.

As of September 30, 2004, LHL leases the following 15 hotels owned by the Company:

•

Marriott Seaview Resort

•

LaGuardia Marriott

•

Harborside Hyatt Conference Center & Hotel

•

Hotel Viking

•

Topaz Hotel

•

Hotel Rouge

•

Hotel Madera

•

Hotel Helix

•

Holiday Inn on the Hill

•

Sheraton Bloomington Hotel Minneapolis South

•

Lansdowne Resort

•

Westin City Center Dallas

•

Hotel George

•

Indianapolis Marriott Downtown

•

Hilton Alexandria Old Town

All of the remaining hotels in which the Company owns an interest, excluding the joint venture that owns the Chicago Marriott Downtown, are leased directly to affiliates of the current hotel operators of those respective hotels.

12.

Income Taxes

Income tax benefit of $627 is comprised of state and local tax expense of $383 on the operating partnership’s income and federal, state and local tax benefit of $1,010 on LHL’s loss of $2,810 before income tax benefit.

The components of the LHL income tax benefit were as follows:


	For the nine months ended September 30,
	2004		2003
Federal:
Current	$	—	$	—
Deferred		813		2,504
State and local:
Current		—		—
Deferred		197		686

Total income tax benefit	$	1,010	$	3,190

The Company has estimated its income tax benefit using a combined federal and state rate of 41.5%. As of September 30, 2004, the Company had a deferred tax asset of $11,519 primarily due to past and current year’s tax net operating losses. These loss carryforwards will expire in 2021 thru 2024 if not utilized by then. Management believes that it is more likely than not that this deferred tax asset will be realized and has determined that no valuation allowance is required. Reversal of deferred tax asset in the subsequent year cannot be reasonably estimated.

13.

Earnings Per Common Share

The limited partners’ outstanding limited partnership units in the operating partnership (which may be converted to common shares of beneficial interest) have been excluded from the diluted earnings per share calculation as there would be no effect on the amounts since the limited partners’ share of income would also be added back to net income. The computation of basic and diluted earnings per common share is presented below:


	For the three months ended September 30,						For the nine months ended September 30,
	2004			2003			2004			2003
Numerator:
Net income (loss) applicable to common shareholders before discontinued operations and dividends paid on unvested restricted shares	$	6,860		$	3,552		$	6,458		$	(7,698	)
Discontinued operations		3,179			(298	)		4,493			36,872

Net income applicable to common shareholders before dividends paid on unvested restricted shares		10,039			3,254			10,951			29,174
Dividends paid on unvested restricted shares		(61	)		(47	)		(169	)		(140	)

Net income applicable to common shareholders, after dividends paid on unvested restricted shares	$	9,978		$	3,207		$	10,782		$	29,034

Denominator:
Weighted average number of common shares - basic		27,805,183			20,738,660			26,087,859			19,254,958
Effect of dilutive securities:
Unvested restricted shares		255,473			221,053			258,230			223,300
Common stock options		290,640			237,338			368,665			178,842

Weighted average number of common shares - diluted		28,351,296			21,197,051			26,714,754			19,657,100

Basic Earnings Per Common Share:
Net income (loss) applicable to common shareholders per weighted average common share before discontinued operations and after dividends paid on unvested restricted shares	$	0.25		$	0.17		$	0.24		$	(0.41	)
Discontinued operations		0.11			(0.01	)		0.17			1.91

Net income applicable to common shareholders per weighted average common share, after dividends paid on unvested restricted shares	$	0.36		$	0.16		$	0.41		$	1.50

Diluted Earnings Per Common Share:
Net income (loss) applicable to common shareholders per weighted average common share before discontinued operations	$	0.24		$	0.16		$	0.24		$	(0.39	)
Discontinued operations		0.11			(0.01	)		0.17			1.87

Net income applicable to common shareholders per weighted average common share	$	0.35		$	0.15		$	0.41		$	1.48

14.

Comprehensive Income

For the nine months ended September 30, 2004, comprehensive income was $11,509. As of September 30, 2004 and December 31, 2003 the Company’s accumulated other comprehensive income was $558 and zero, respectively. The change in accumulated other comprehensive income was entirely due to the Company’s unrealized gains on its interest rate derivative. For the three months and nine months ended September 30, 2004, respectively, the Company reclassified $149 and $433 of accumulated other comprehensive income to earnings as interest expense. Within the next twelve months the Company expects to reclassify $95 of the amount held in accumulated other comprehensive income to earnings as interest expense.

15.

Supplemental Information to Statements of Cash Flows


	For the nine months ended September 30,
	2004			2003
Interest paid, net of capitalized interest	$	10,104		$	11,298

Interest capitalized	$	496		$	148

Distributions payable (common shares)	$	2,280		$	4,018

Distributions payable (preferred shares)	$	3,133		$	2,557

Issuance of common shares for board of trustees compensation	$	37		$	36

Repurchase of common shares (treasury shares)	$	(10,641	)	$	—

Issuance of common shares from treasury	$	10,641		$	—

In conjunction with the hotel acquisitions, the Company assumed the following assets and liabilities:
Purchase of real estate	$	165,268		$	139,910
Mortgage loan assumed		—			(62,845	)
Other assets		822			6,813
Liabilities		(2,323	)		(8,736	)

Acquisition of hotel properties	$	163,767		$	75,142

In conjunction with the hotel disposition, the Company disposed the following assets and liabilities:
Sale of real estate	$	(25,755	)	$	(71,562	)
Mortgage loan assumed		—			58,072
Other assets		63			(624	)
Liabilities		(261	)		909
Gain on sale of property disposed of		(2,643	)		(36,796	)

Disposition of hotel properties	$	(28,596	)	$	(50,001	)

16.

Pro Forma Financial Information

The following condensed pro forma financial information is presented as if the Indianapolis Marriott Downtown and Hilton Alexandria Old Town acquisitions had been consummated and leased as of January 1, 2003.

The following condensed pro forma financial information is not necessarily indicative of what actual results of operations of the Company would have been assuming the acquisitions had been consummated and the hotels had been leased at the beginning of the respective periods presented, nor does it purport to represent the results of operations for future periods.


	For the three months ended September 30,				For the nine months ended September 30,
	2004		2003		2004		2003
Total revenues	$	85,892	$	74,976	$	228,155	$	176,241
Net income applicable to common shareholders	$	10,322	$	4,690	$	11,300	$	31,187
Net income applicable to common shareholders per weighted average common share:
basic (after dividends paid on unvested restricted shares)	$	0.37	$	0.22	$	0.43	$	1.61
diluted	$	0.36	$	0.22	$	0.42	$	1.59
Weighted average number of common shares outstanding:
basic		27,805,183		20,783,660		26,087,859		19,254,958
diluted		28,351,296		21,197,051		26,714,754		19,657,100

17.

Subsequent Events

On October 6, 2004, the Company granted 6,465 restricted common shares of beneficial interest to the Company’s employees. The restricted shares granted vest over three years, starting January 1, 2006. These common shares were issued under the 1998 share option and incentive plan.

On October 15, 2004, the Company declared monthly cash distributions to shareholders of the Company and partners of the operating partnership, in the amount of $0.08 per common share of beneficial interest/unit for each of the months of October, November and December 2004.

On October 15, 2004, the Company paid its September 2004 monthly distribution of $0.08 per share/unit on its common shares of beneficial interest and units of limited partnership interest to shareholders and unit holders of record as of September 30, 2004.

On October 15, 2004, the Company paid its preferred distribution of $0.64 per Series A Preferred Share for the quarter ended September 30, 2004 to preferred shareholders of record at the close of business on October 1, 2004.

On October 15, 2004, the Company paid its preferred distribution of $0.52 per Series B Preferred Share for the quarter ended September 30, 2004 to preferred shareholders of record at the close of business on October 1, 2004.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following should be read in conjunction with the consolidated financial statements and notes thereto appearing in Item 1 of this report.

Forward-Looking Statements

This report, together with other statements and information publicly disseminated by the Company, contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and includes this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe the Company’s future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. You should not rely on forward-looking statements since they involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond the Company’s control and which could materially affect actual results, performances or achievements. Factors that may cause actual results to differ materially from current expectations include, but are not limited to, the risk factors discussed in the Company’s Annual Report on Form 10-K. Accordingly, there is no assurance that the Company’s expectations will be realized. Except as otherwise required by the federal securities laws, the Company disclaims any obligations or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein (or elsewhere) to reflect any change in the Company’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

Overview

The third quarter was an improving quarter for the travel industry, the lodging business and the Company. Travel, in general, was positively affected by a number of factors including the improving economy, which resulted in higher occupancies and average daily rates at the hotels. In particular, business travel improved in the quarter. The Company’s

revenues come primarily from hotel operating revenues from its hotels. Hotel operating revenues include room revenue, food and beverage revenue and other ancillary revenue such as golf revenue at our two golf resorts, telephone and parking revenue.

For the third quarter of 2004, the Company had net income of $10.0 million, or $0.35 per diluted share. Funds from Operations (“FFO”) was $17.8 million, or $0.62 per diluted share/unit and earnings before interest, taxes, depreciation and amortization (“EBITDA”) was $28.3 million. Room revenue per available room (“RevPAR”) was $120.95. Management considers RevPAR and EBITDA to be key measures of the individual hotels’ performances. RevPAR for the total portfolio increased 11.7% for the quarter and EBITDA for the total hotel portfolio increased 13.8%. The RevPAR increase is attributable to an Average Daily Rate (“ADR”) increase of 5.0% to $161.11, and an occupancy improvement of 6.3% to 75.1%. The EBITDA increase is attributable to a 8.2% increase in revenues and a 152 basis point increase in EBITDA margin.

For the nine months ending September 30, 2004, the Company had net income of $11.0 million, or $0.41 per diluted share. FFO was $38.2 million, or $1.41 per diluted share/unit and earnings before interest, taxes, depreciation and amortization (“EBITDA”) was $61.7 million. Room revenue per available room (“RevPAR”) was $107.13. RevPAR for the total portfolio increased 12.2% over last year. EBITDA for the total hotel portfolio decreased 16.7%. The RevPAR increase is attributable to an Average Daily Rate (“ADR”) increase of 4.3% to $153.08, and an occupancy improvement of 7.6% to 70.0%. The EBITDA increase is attributable to a 9.6% increase in revenues and a 163 basis point increase in EBITDA margins.

The Company continuously uses these measures to evaluate each hotel’s contribution toward reaching the Company’s goal of maintaining a reliable stream of income and moderate growth to shareholders. The Company invests in capital improvements throughout the portfolio to continue to positively impact the competitiveness of its hotels and positively impact their financial performance. The Company actively seeks to acquire new hotel properties that meet its investment criteria. However, due to a high level of competitive capital resources the Company continues to face significant competition for acquisitions that meet its investment criteria.

Critical Accounting Estimates

Estimate of Hotel Revenues and Expenses

A significant portion of the Company’s revenues and expenses comes from the operations of the individual hotels. The Company uses revenues and expenses that are estimated and projected by the hotel operators to produce quarterly financial statements since the management contracts do not require the hotel operators to submit actual results within a time frame that permits the Company to use actual results when preparing its quarterly reports on Form 10-Q for filing with the SEC by the filing deadline prescribed by the SEC. Generally, the Company uses actual revenue and expense amounts for the first two months of each quarter and revenue and expense estimates for the last month of each quarter. Each quarter, the Company reviews the estimated revenue and expense amounts provided by the hotel operators for reasonableness based upon historical results for prior periods and internal Company forecasts. The Company records any differences between recorded estimated amounts and actual amounts in the following quarter; historically these differences have not been material. The Company believes the aggregate estimate of quarterly revenues and expenses recorded on the Company’s consolidated statements of operations are materially correct.

An estimated contingent lease liability related to the Company’s litigation with Meridien Hotels, Inc. is reported in accounts payable and accrued expenses in the accompanying consolidated financial statements.

The Company’s management has discussed the policy of using estimated hotel operating revenues and expenses with its audit committee of its Board of Trustees. The audit committee has reviewed the Company’s disclosure relating to the estimates in this Management’s Discussion and Analysis of Financial Conditions and Results of Operations section.

Comparison of the Three Months Ended September 30, 2004 to the Three Months Ended September 30, 2003

Hotel operating revenues

Hotel operating revenues from the hotels leased to LHL (15 hotels), including room revenue, food and beverage revenue and other operating department revenues (which includes golf, telephone, parking and other ancillary revenues) increased approximately $21.1 million, from $53.7 million in 2003 to $74.8 million in 2004. This increase includes amounts that are not comparable year-over-year as follows:

•

$10.4 million increase from the Indianapolis Marriott Downtown, which was purchased in February 2004;

•

$3.5 million increase from the Hilton Alexandria Old Town, which was purchased in May 2004;

•

$1.5 million increase from the Hotel George, which was purchased in September 2003; and

•

$1.1 million increase from the Westin City Center Dallas, which lease was transferred to LHL in July 2003.

The remaining change is an increase of $4.6 million, or 8.6%, which is attributable to an 11.7% increase in RevPAR and a 26.4% increase in other non-room revenues, primarily attributable to increased occupancy, for our other properties leased to LHL. The increase in RevPAR is attributable to increases in average daily rates and higher occupancies primarily from stronger business travel.

Overall, travel levels improved in the third quarter, when the industry benefited from continued relatively strong leisure demand and significant increases in demand from business travelers. On a year-over-year basis, overall industry demand for hotel rooms significantly outpaced supply growth this quarter, with occupancies for the Company’s portfolio up an average of 6.3% in the quarter. With demand improving during the quarter, continuing to reflect the early stage of an industry recovery, room rates also improved, but to a lesser degree. Both the leisure traveler and the business traveler, group and transient, continue to be price sensitive, utilizing an aggressive negotiation posture and internet sites to shop for the lowest rates. Additionally, the business is more competitive now because transient guests tend to book their rooms closer to their time of stay than in the past, and transient rooms get priced lower than they otherwise would have. Despite these rate challenges, many of the Company’s hotels experienced ADR increases during the quarter, especially at our urban hotels.

Participating lease revenue

Participating lease revenue from hotels leased to third party lessees increased $0.1 million from $7.0 million in 2003 to $7.1 million in 2004. Participating lease revenue includes (i) base rent and (ii) participating rent based on fixed percentages of hotel revenues pursuant to the respective participating lease. This increase includes amounts that are not comparable year-over-year as follows:

•

$0.1 million decrease from the Westin City Center Dallas, which lease was transferred to LHL in July 2003.

The remaining change is an increase of $0.2 million, or 2.9%, and is a result of a slight overall increase in average daily rate at the hotels leased to third party lessees.

Hotel operating expenses

Hotel operating expenses increased approximately $13.2 million from $37.3 million in 2003 to $50.5 million in 2004. This increase includes amounts that are not comparable year-over-year as follows:

•

$6.9 million increase from the Indianapolis Marriott Downtown, which was purchased in February 2004;

•

$1.9 million increase from the Hilton Alexandria Old Town, which was purchased in May 2004;

•

$0.9 million increase from the Hotel George, which was purchased in September 2003; and

•

$0.7 million increase from the Westin City Center Dallas, which lease was transferred to LHL in July 2003.

The remaining change is an increase of $2.8 million, or 7.5%, a result of higher occupancies at the hotels as well as

above inflation increases in payroll and related employee costs and benefits, sales and marketing, insurance and energy costs.

Depreciation and other amortization

Depreciation and other amortization expense increased by approximately $2.1 million from $7.9 million in 2003 to $10.0 million in 2004. This increase includes amounts that are not comparable year-over-year as follows:

•

$1.3 million increase from the Indianapolis Marriott Downtown, which was purchased in February 2004;

•

$0.5 million increase from the Hilton Alexandria Old Town, which was purchased in May 2004;

•

$0.2 million increase from the Hotel George, which was purchased in September 2003.

Real estate taxes, personal property taxes, insurance and ground rent

Real estate taxes, personal property taxes, insurance and ground rent expenses increased approximately $0.4 million from $3.7 million in 2003 to $4.1 million in 2004. This increase includes amounts that are not comparable year-over-year as follows:

•

$0.4 million increase from the Indianapolis Marriott Downtown, which was purchased in February 2004; and

•

$0.1 million increase from the Hilton Alexandria Old Town which was purchased in May 2004.

The remaining real estate taxes, personal property taxes, insurance and ground rent remained approximately equivalent for the third quarter 2004 compared to the third quarter 2003.

General and administrative expenses

General and administrative expense increased approximately $0.3 million from $1.9 million in 2003 to $2.2 million in 2004 primarily as a result of increases in audit fees and payroll related expenses to executives and employees.

Interest expense

Interest expense decreased by approximately $0.3 million from $3.6 million in 2003 to $3.3 million in 2004 due to a decrease in the weighted average interest rate offset by an increase in the Company’s weighted average debt outstanding and an increase in capitalized interest. The Company’s weighted average debt outstanding related to continuing operations increased from $265.1 million in 2003 to $290.0 million in 2004, which includes, (i) additional borrowings under the Company’s bank facility to finance other capital improvements during 2003 and 2004 (ii) additional borrowings to purchase the Hotel George in September 2003, (iii) additional borrowings to purchase the Indianapolis Marriott Downtown in February 2004 and (iv) $59.0 million additional borrowings to purchase the Hilton Alexandria Old Town in May 2004, offset by: (v) a $26.9 million net pay down in September 2003 on the Company’s bank facility with proceeds from the September 2003 Series B Preferred Share offering, (vi) $50.0 million net pay down on the Company’s bank facility with proceeds from the November 2003 common stock offering, (vii) $61.5 million net pay down on the Company’s bank facility with proceeds from the May 2004 common stock offering, (viii) pay-off of the mortgage secured by the Lansdowne Resort in February 2004, (ix) an $18.0 million and $8.0 million paydown on the company’s bank facility and the LHL facility, respectively, with proceeds from the sale of Omaha Marriott on September 15, 2004, and (x) additional pay downs on the Company’s bank facility with operating cash flows. The Company’s weighted average interest rate related to continuing operations decreased from 5.6% in 2003 to 4.8% in 2004. Capitalized interest increased by approximately $0.1 million from $0.1 million in 2003 to approximately $0.2 million in 2004.

Income taxes

Income tax expense increased approximately $0.6 million from an immaterial benefit in 2003 to $0.6 million expense in 2004. For the three months ended September 30, 2004, the REIT incurred state and local income tax

expense of approximately $0.1 million. LHL’s net income before income tax expense increased by approximately $1.5 million from a $0.3 million loss in 2003 to $1.2 million income in 2004. Accordingly, for the three months ended September 30, 2004, LHL recorded a federal income tax expense of approximately $0.4 million (using an estimated tax rate of 30.8%) and a state and local tax expense of approximately $0.1 million (using an estimated tax rate of 10.7%). Additionally, LHL recorded estimated state tax payments of less than $0.1 million. The portion of LHL’s income tax benefit/expense relating to the Omaha property, the New Orleans property and the Key West property has been reclassified to discontinued operations. The following table summarizes the income tax (benefit) expense (dollars in thousands):


	For the three months ended September 30,
	2004			2003
REIT state and local tax expense	$	56		$	56
LHL federal, state and local tax (benefit) expense		558			(131	)

Total tax (benefit) expense		614			(75	)

Less: LHL federal, state and local tax expense (benefit) related to discontinued operations		(56	)		20

Total continuing operations tax (benefit) expense	$	558		$	(55	)

As of September 30, 2004, the Company had a deferred tax asset of $11,519 primarily due to past and current year’s tax net operating losses. These loss carryforwards will expire in 2021 thru 2024 if not utilized by then. Management believes that it is more likely than not that this deferred tax asset will be realized and has determined that no valuation allowance is required. The deferred tax asset is classified as non-current because the reversal in the subsequent year cannot be reasonably estimated.

Minority interest

Minority interest in the operating partnership represents the limited partners’ proportionate share of the equity in the operating partnership. Income is allocated to minority interest based on the weighted average percentage ownership throughout the year. For the three months ended September 30, 2004, the weighted average aggregate partnership interest held by the limited partners in the operating partnership was approximately 1.5%.

Discontinued operations

Net income from discontinued operations is a result of the sale of the Omaha property, the Holiday Inn Beachside Resort property and the New Orleans property in September 2004, July 2003 and April 2003, respectively. Net income from discontinued operations increased by approximately $3.5 million from a loss of $0.3 million in 2003 to a net income of $3.2 million in 2004. The following table summarizes net income from discontinued operations from 2004 and 2003 (dollars in thousands):


	For the three months ended September 30,
	2004			2003
Net lease income from Omaha property	$	508		$	283
Net operating income from Omaha property		135			98
Net lease loss from New Orleans property		—			(8	)
Net operating loss from New Orleans property		—			(78	)
Net lease loss from Key West property		—			(258	)
Net operating loss from Key West property		—			(67	)
Gain on sale of Omaha property		2,643			—
Loss on sale of New Orleans property		—			(295	)
Minority interest related to Omaha property		(51	)		(7	)
Minority interest related to New Orleans property		—			1
Minority interest related to Key West property		—			13
Income tax expense related to Omaha property		(56	)		(40	)
Income tax benefit related to New Orleans property		—			32
Income tax benefit related to Key West property		—			28

Net income (loss) from discontinued operations	$	3,179		$	(298	)

Distributions to preferred shareholders

Distributions to preferred shareholders increased $0.5 million from $2.6 million in 2003 to $3.1 million in 2004. The Series B Preferred Shares were issued on September 30, 2003. Distributions were paid for the Series B Preferred Shares for the entire third quarter of 2004, but there were no Series B Preferred Shares distributions in the third quarter of 2003. Distributions on the Series A Preferred Shares were paid for the entire third quarter of 2004 and 2003.

Comparison of the Nine Months Ended September 30, 2004 to the Nine Months Ended September 30, 2003

Hotel operating revenues

Hotel operating revenues from the hotels leased to LHL (15 hotels), including room revenue, food and beverage revenue and other operating department revenues (which includes golf, telephone, parking and other ancillary revenues) increased approximately $78.6 million, from $117.4 million in 2003 to $196.0 million in 2004. This increase includes amounts that are not comparable year-over-year as follows:

•

$27.6 million increase from the Indianapolis Marriott Downtown, which was purchased in February 2004;

•

$15.9 million increase from the Lansdowne Resort, which was purchased in June 2003;

•

$9.2 million increase from the Westin City Center Dallas, which lease was transferred to LHL in July 2003;

•

$5.5 million increase from the Hotel George, which was purchased in September 2003; and

•

$5.0 million increase from the Hilton Alexandria Old Town, which was purchased in May 2004.

The remaining change is an increase of $15.4 million, or 13.1%, which is attributable to a 12.2% increase in RevPAR and a 57.1% increase in other non-room revenues, primarily attributable to increased occupancy, for our other properties leased to LHL. While ADR was up 4.3%, the increase in RevPAR is primarily attributable to higher occupancies from stronger business travel.

Overall, travel levels improved in the first three quarters, when the industry benefited from continued relatively strong leisure demand and significant increases in demand from business travelers. On a year-over-year basis, overall industry demand for hotel rooms significantly outpaced supply growth during the first nine months, with occupancies for the Company’s portfolio up an average of 7.6% during 2004. With demand improving during 2004, continuing to reflect the early stage of an industry recovery, the Company is beginning to find it easier to achieve increased ADRs. Nevertheless, both the leisure traveler and the business traveler, group and transient, continue to be price sensitive, utilizing an aggressive negotiation posture and internet sites to shop for the lowest rates. Additionally, the business is more competitive now because transient guests tend to book their rooms closer to their time of stay than in the past, and transient rooms get priced lower than they otherwise would have. Despite these rate challenges, many of the Company’s hotels experienced ADR increases during the first three quarters, especially at our urban hotels.

Participating lease revenue

Participating lease revenue from hotels leased to third party lessees (two hotels) decreased $1.9 million from $17.5 million in 2003 to $15.6 million in 2004. Participating lease revenue includes (i) base rent and (ii) participating rent

based on fixed percentages of hotel revenues pursuant to the respective participating lease. This decrease includes amounts that are not comparable year-over-year as follows:

•

$1.6 million decrease from the Westin City Center Dallas, which lease was transferred to LHL in July 2003.

The remaining change is a decrease of $0.3 million, or 1.7%, and is a result of a decrease in RevPAR at the hotels leased to third party lessees. The lower RevPAR resulted from decreased ADR from weak group and leisure demand and the difficult comparison to last year’s first quarter that included the significant benefits of the Super Bowl.

Hotel operating expenses

Hotel operating expenses increased approximately $50.3 million from $87.0 million in 2003 to $137.3 million in 2004. This increase includes amounts that are not comparable year-over-year as follows:

•

$18.0 million increase from the Indianapolis Marriott Downtown, which was purchased in February 2004;

•

$11.1 million increase from the Lansdowne Resort, which was purchased in June 2003;

•

$6.8 million increase from the Westin City Center Dallas, which lease was transferred to LHL in July 2003;

•

$3.2 million increase from the Hotel George, which was purchased in September 2003; and

•

$2.8 million increase from the Hilton Alexandria Old Town, which was purchased in May 2004.

The remaining change is an increase of $8.4 million, or 9.6%, and is a result of higher occupancies at the hotels as well as above inflation increases in payroll and related employee costs and benefits, sales and marketing, insurance and energy costs.

Depreciation and other amortization

Depreciation and other amortization expense increased by approximately $5.2 million from $23.5 million in 2003 to $28.7 million in 2004. This increase includes amounts that are not comparable year-over-year as follows:

•

$3.5 million from the Indianapolis Marriott Downtown, which was purchased in February 2004;

•

$1.5 million from the Lansdowne Resort, which was purchased in June 2003;

•

$0.7 million from the Hilton Alexandria Old Town, which was purchased in May 2004,

•

$0.6 million from the Hotel George, which was purchased in September 2003.

The remaining change is a decrease of $1.1 million because certain furniture, fixture and equipment assets were fully depreciated during 2003 and 2004.

Real estate taxes, personal property taxes, insurance and ground rent

Real estate taxes, personal property taxes, insurance and ground rent expenses increased approximately $1.9 million from $9.5 million in 2003 to $11.4 million in 2004. This increase includes amounts that are not comparable year-over-year as follows:

•

$0.9 million increase from the Indianapolis Marriott Downtown, which was purchased in February 2004;

•

$0.4 million increase from the Lansdowne Resort, which was purchased in June 2003;

•

$0.3 million increase from the Hotel Viking, San Diego Paradise Point and Holiday Inn on the Hill;

•

$0.2 million increase from the Hotel George, which was purchased in September 2003;

•

$0.1 million increase from the Hilton Alexandria Old Town, which was purchased in May 2004.

The remaining real estate taxes, personal property taxes, insurance and ground rent remained approximately equivalent for the first three quarters of 2004 compared to the first three quarters of 2003.

General and administrative expenses

General and administrative expense increased approximately $0.8 million from $5.6 million in 2003 to $6.4 million in 2004 primarily as a result of increases in audit fees and payroll related expenses to executives and employees.

Interest expense

Interest expense increased by approximately $0.6 million from $9.3 million in 2003 to $9.9 million in 2004 due to an increase in the Company’s weighted average debt outstanding, offset by a decrease in the weighted average interest rate and an increase in capitalized interest. The Company’s weighted average debt outstanding related to continuing operations increased from $261.9 million in 2003 to $289.0 million in 2004, which includes (i) assumption of a $65.2 million mortgage loan (including a $2.4 million mortgage premium) in conjunction with the purchase of the Lansdowne Resort in June 2003, (ii) additional borrowings under the Company’s bank facility to finance other capital improvements during 2003 and 2004, (iii) additional borrowings to purchase the Hotel George in September 2003, (iv) additional borrowings to purchase the Indianapolis Marriott Downtown in February 2004, (v) additional borrowings to purchase the Hilton Alexandria Old Town in May 2004, offset by: (vi) a $32.0 million pay down in June 2003 on the Company’s bank facility with proceeds from the June 2003 common stock offering and (vii) a $26.9 million net pay down in September 2003 on the Company’s bank facility with proceeds from the September 2003 Series B Preferred Share offering, (viii) $50.0 million net pay down on the Company’s bank facility with proceeds from the November 2003 common stock offering, (ix) $61.5 million net pay down on the Company’s bank facility with proceeds from the May 2004 common stock offering, (x) pay-off of the mortgage secured by the Lansdowne Resort in February 2004, (xi) an $8.0 million and $18.8 million paydown on the LHL Credit facility and the company’s bank facility, respectively, with proceeds from the sale of Omaha Marriott on September 15, 2004, and (xii) additional pay downs on the Company’s bank facility with operating cash flows. The Company’s weighted average interest rate related to continuing operations decreased from 5.6% in 2003 to 4.8% in 2004. Capitalized interest increased by approximately $0.4 million from $0.1 million in 2003 to $0.5 million in 2004.

Income taxes

Income tax benefit decreased approximately $2.1 million from $2.9 million in 2003 to $0.8 million in 2004. For the nine months ended September 30, 2004, the REIT incurred state and local income tax expense of approximately $0.4 million. LHL’s net loss before income tax benefit decreased by approximately $5.3 million from $8.1 million in 2003 to $2.8 million in 2004. Accordingly, for the nine months ended September 30, 2004, LHL recorded a federal income tax benefit of approximately $0.8 million (using an estimated tax rate of 30.8%) and a state and local tax benefit of approximately $0.3 million (using an estimated tax rate of 10.7%). Additionally, LHL recorded estimated tax payments of approximately $0.1 million. The portion of LHL’s income tax benefit relating to the Omaha property, the New Orleans property and the Key West property has been reclassified to discontinued operations. The following table summarizes the income tax (benefit) expense (dollars in thousands):


	For the nine months ended September 30,
	2004			2003
REIT state and local tax expense	$	383		$	403
LHL federal, state and local tax benefit		(1,010	)		(3,190	)

Total tax benefit		(627	)		(2,787	)

Less: LHL federal, state and local tax expense related to discontinued operations		(180	)		(70	)

Total continuing operations tax benefit	$	(807	)	$	(2,857	)

Minority interest

Minority interest in the operating partnership represents the limited partners’ proportionate share of the equity in the operating partnership. Income is allocated to minority interest based on the weighted average percentage ownership throughout the year. At September 30, 2004, the aggregate weighted average partnership interest held by the limited partners in the operating partnership was approximately 1.59%. The following table summarizes the change in minority interest (dollars in thousands):


	For the nine months ended September 30,
	2004			2003
Net income before minority interest	$	20,678		$	37,651
Weighted average minority interest percentage		1.59	%		2.14	%

Minority interest		328			805
Less: minority interest related to discontinued operations		(72	)		(806	)

Total continuing operations minority interest	$	256		$	(1	)

Discontinued operations

Net income from discontinued operations is a result of the sale of the Omaha property, the Holiday Inn Beachside Resort and the New Orleans property in September 2004, July 2003 and April 2003, respectively. Net income from discontinued operations decreased by approximately $32.4 million from $36.9 million in 2003 to $4.5 million in 2004. The following table summarizes net income from discontinued operations from 2004 and 2003 (dollars in thousands):


	For the nine months ended September 30,
	2004			2003
Net lease income from Omaha property	$	1,668		$	640
Net operating income from Omaha property		434			391
Net lease loss from New Orleans property		—			(122	)
Net operating income from New Orleans property		—			72
Net lease income from Key West property		—			270
Net operating loss from Key West property		—			(299	)
Gain on sale of Omaha property		2,643			—
Gain on sale of New Orleans property		—			36,796
Minority interest related to Omaha property		(72	)		(19	)
Minority interest related to New Orleans property		—			2
Minority interest related to Key West property		—			(789	)
Income tax expense related to Omaha property		(180	)		(166	)
Income tax expense related to New Orleans property		—			(31	)
Income tax benefit related to Key West property		—			127

Net income from discontinued operations	$	4,493		$	36,872

Distributions to preferred shareholders

Distributions to preferred shareholders increased $1.7 million from $7.7 million in 2003 to $9.4 million in 2004. The Series B Preferred Shares were issued on September 30, 2003. Distributions were paid for the Series B Preferred Shares for the entire first, second and third quarters of 2004, but there were no Series B Preferred Shares distributions in the first, second and third quarters of 2003. Distributions on the Series A Preferred Shares were paid for the entire first, second and third quarters of 2004 and 2003.

Non-GAAP Financial Measures

Funds From Operations

The Company considers the non-GAAP measure of funds from operations (“FFO”) to be a key supplemental measure of the Company’s performance and should be considered along with, but not as an alternative to, net income as a measure of the Company’s operating performance. Historical cost accounting for real estate assets implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, most industry investors consider supplemental measurements of performance to be helpful in evaluating a real estate company’s operations. The Company believes that excluding the effect of gains or losses from debt restructuring, extraordinary items, real estate-related depreciation and amortization, and the portion of these items related to unconsolidated entities, all of which are based on historical cost accounting and which may be of limited significance in evaluating current performance, can facilitate comparisons of operating performance between periods and between REITs, even though FFO does not represent an amount that accrues directly to common shareholders. However, FFO may not be helpful when comparing the Company to non-REITs.

The White Paper on FFO approved by NAREIT in April 2002 defines FFO as net income or loss (computed in accordance with GAAP), excluding gains or losses from debt restructuring, sales of properties and items classified by GAAP as extraordinary, plus real estate-related depreciation and amortization (excluding amortization of deferred finance costs) and after comparable adjustments for the Company’s portion of these items related to unconsolidated entities and joint ventures. The Company computes FFO in accordance with standards established by NAREIT, which may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently than the Company.

FFO does not represent cash generated from operating activities determined by GAAP and should not be considered as an alternative to net income, cash flow from operations or any other operating performance measure prescribed by GAAP. FFO is not a measure of the Company’s liquidity, nor is it indicative of funds available to fund the Company’s cash needs, including its ability to make cash distributions. FFO does not reflect cash expenditures for long-term assets and other items that have been and will be incurred. FFO may include funds that may not be available for management’s discretionary use due to functional requirements to conserve funds for capital expenditures, property acquisitions, and other commitments and uncertainties. To compensate for this, management considers the impact of these excluded items to the extent they are material to operating decisions or evaluation of the Company’s operating performance.

The following is a reconciliation between net income applicable to common shareholders and FFO for the three months and nine months ended September 30, 2004 and 2003 (dollars in thousands, except share data):


	For the three months ended September 30,						For the nine months ended September 30,
	2004			2003			2004			2003
Funds From Operations (FFO):
Net income applicable to common shareholders	$	10,039		$	3,254		$	10,951		$	29,174
Depreciation		9,949			8,192			28,732			25,106
Equity in depreciation of joint venture		265			255			790			758
Amortization of deferred lease costs		11			11			34			38
Minority interest:
Minority interest in LaSalle Hotel Operating Partnership, L.P.		158			108			256			(1	)
Minority interest in discontinued operations		51			(7	)		72			806
Net (gain) loss on sale of property disposed of		(2,643	)		295			(2,643	)		(36,796	)

FFO	$	17,830		$	12,108		$	38,192		$	19,085

Weighted average number of common shares and units outstanding:
Basic		28,223,539			21,163,346			26,510,419			19,679,643
Diluted		28,769,652			21,621,737			27,137,314			20,081,786

EBITDA

The Company considers the non-GAAP measure of earnings before interest, taxes, depreciation and amortization (“EBITDA”) to be a key measure of the Company’s performance and should be considered along with, but not as an alternative to, net income as a measure of the Company’s operating performance. Most industry investors consider EBITDA a measurement of performance that is helpful in evaluating a REIT’s operations. The Company believes that excluding the effect of non-operating expenses and non-cash charges, and the portion of these items related to unconsolidated entities, all of which are based on historical cost accounting and which may be of limited significance in evaluating current performance, can help eliminate the accounting effects of depreciation and amortization, and financing decisions and facilitate comparisons of core operating profitability between periods and between REITs, even though EBITDA does not represent an amount that accrues directly to common shareholders.

EBITDA does not represent cash generated from operating activities determined by GAAP and should not be considered as an alternative to net income, cash flow from operations or any other operating performance measure prescribed by GAAP. EBITDA is not a measure of the Company’s liquidity, nor is it indicative of funds available to fund the Company’s cash needs, including its ability to make cash distributions. EBITDA does not reflect cash expenditures for long-term assets and other items that have been and will be incurred. EBITDA may include funds that may not be available for management’s discretionary use due to functional requirements to conserve funds for capital

expenditures, property acquisitions, and other commitments and uncertainties. To compensate for this, management considers the impact of the excluded items to the extent they are material to operating decisions or evaluation of the Company’s operating performance.

The following is a reconciliation between net income applicable to common shareholders and EBITDA for the three months and nine months ended September 30, 2004 and 2003 (dollars in thousands, except share data):


	For the three months ended September 30,					For the nine months ended September 30,
	2004		2003			2004			2003
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA):
Net income applicable to common shareholders	$	10,039	$	3,254		$	10,951		$	29,174
Interest		3,338		3,605			9,909			10,944
Equity in interest expense of joint venture		130		148			391			441
Income tax (benefit) expense:
Income tax (benefit) expense		558		(55	)		(807	)		(2,857	)
Income tax (benefit) expense from discontinued operations		56		(20	)		180			70
Depreciation and other amortization		9,977		8,222			28,813			25,193
Equity in depreciation/amortization of joint venture		286		283			879			841
Amortization of deferred financing costs		590		836			1,657			2,843
Minority interest:
Minority interest in LaSalle Hotel Operating Partnership, L.P.		158		108			256			(1	)
Minority interest in discontinued operations		51		(7	)		72			806
Distributions to preferred shareholders		3,133		2,557			9,399			7,672

EBITDA	$	28,316	$	18,931		$	61,700		$	75,126

Off-Balance Sheet Arrangements

The Company is a party to a joint venture arrangement with The Carlyle Group, an institutional investor that controls the joint venture that owns the 1,192-room Chicago Marriott Downtown in Chicago, Illinois. The Company owns a non-controlling 9.9% equity interest in the joint venture that owns the Chicago Marriott Downtown. The Company receives an annual preferred return in addition to its pro rata share of annual cash flow. The Company also has the opportunity to earn an incentive participation in net sale proceeds based upon the achievement of certain overall investment returns, in addition to its pro rata share of net sale or refinancing proceeds. The Chicago Marriott Downtown is leased to Chicago 540 Lessee, Inc., in which the Company also owns a non-controlling 9.9% equity interest. The Carlyle Group owns a 90.1% controlling interest in both the joint venture that owns the Chicago Marriott Downtown and Chicago 540 Lessee, Inc. Marriott International, Inc. operates the Chicago Marriott Downtown pursuant to a long-term incentive-based operating agreement. As the controlling owner, The Carlyle Group may elect to dispose of the Chicago Marriott Downtown without the Company’s consent. The Company accounts for its non-controlling 9.9% equity interest in each of the joint venture that owns the Chicago Marriott Downtown and Chicago 540 Lessee, Inc. under the equity method of accounting.

The joint venture that owns the Chicago Marriott Downtown and in which the Company holds a non-controlling 9.9% ownership interest was subject to two mortgage loans for an aggregate amount of $120.0 million. The mortgage loans had two-year terms, and were due to expire in July 2004. On April 6, 2004, the joint venture that owns the Chicago Marriott Downtown refinanced its existing two mortgage loans with a new mortgage loan for an aggregate amount of $140.0 million. Upon refinancing, the Company received approximately $1.8 million in cash representing its prorated share of the additional proceeds. The new mortgage loan has a two-year term, expires in April 2006, and can be extended at the option of the joint venture for three additional one-year terms. The mortgage bears interest at the London InterBank Offered Rate plus 2.25%. The joint venture has purchased a cap on the London InterBank Offered Rate capping the London InterBank Offered Rate at 7.25%, effectively limiting the rate on the mortgage to 9.5%. As of

September 30, 2004, the interest rate on this mortgage was 4.1%. Monthly interest-only payments are due in arrears throughout the term. The Chicago Marriott Downtown secures the mortgage. The Company’s pro rata share of the loan is approximately $13.9 million and is included in the Company’s liquidity and capital resources discussion and in calculating debt coverage ratios under the Company’s credit facility. No guarantee exists on behalf of the Company for this mortgage.

The Company is obligated to maintain reserve funds for capital expenditures at the hotels (including the periodic replacement or refurbishment of furniture, fixtures and equipment) as determined pursuant to the operating agreements. The Company’s aggregate obligation under the reserve funds was approximately $18.6 million at September 30, 2004. Five of the operating/franchise agreements require that the Company reserve restricted cash ranging from 3.0% to 5.5% of the individual hotel’s annual revenues. As of September 30, 2004, $5.3 million was available in restricted cash reserves for future capital expenditures. Thirteen of the operating agreements require that the Company reserve funds of 4.0% of the individual hotel’s annual revenues but do not require the funds to be set aside in restricted cash. As of September 30, 2004, the total amount obligated for future capital expenditures but not set aside in restricted cash reserves was $13.3 million. Amounts will be recorded as incurred. As of September 30, 2004, purchase orders and letters of commitment totaling approximately $21.7 million have been issued for renovations at the hotels. The Company has committed to these projects and anticipates making similar arrangements with the existing hotels or any future hotels that it may acquire. Any unexpended amounts will remain the property of the Company upon termination of the operating agreements.

The Company has no other off-balance sheet arrangements.

Liquidity and Capital Resources

The Company’s principal source of cash to meet its cash requirements, including distributions to shareholders, is its pro rata share of hotel operating cash flow distributed by LHL and the operating partnership’s cash flow from the participating leases. The partnership agreement for the operating partnership provides that distributions of available cash “shall be distributed” at least quarterly. Available cash is generally defined as net income plus any reduction in reserves and minus interest and principal payments on debt, capital expenditures, and additions to reserves and other adjustments. The Company’s senior unsecured bank facility contains certain financial covenants relating to debt service coverage, net worth and total funded indebtedness and contains financial covenants that, assuming no continuing defaults, allow the Company to make shareholder distributions (see below). There are currently no other contractual or other arrangements limiting payment of distributions by the operating partnership. Similarly, LHL is a wholly owned subsidiary of the operating partnership. Payments to the operating partnership are required pursuant to the terms of the lease agreements between LHL and the operating partnership relating to the properties owned by the operating partnership and leased by LHL. Except for the security deposits required under the participating leases for the two hotels not leased by LHL, the lessees’ obligations under the participating leases are unsecured and the lessees’ abilities to make rent payments to the operating partnership, and the Company’s liquidity, including its ability to make distributions to shareholders, is dependent on the lessees’ abilities to generate sufficient cash flow from the operations of the hotels.

weighted average interest rate for borrowings under the senior unsecured bank facility was approximately 3.6%. Interest expense for the nine months ended September 30, 2004 was $1.6 million. The Company did not have any Adjusted Base Rate borrowings outstanding at September 30, 2004. Additionally, the Company is required to pay a variable unused commitment fee determined from a ratings or leverage based pricing matrix, currently set at 0.25% of the unused portion of the senior unsecured bank facility. The Company incurred an unused commitment fee of approximately $0.3 million for the nine months ended September 30, 2004. At September 30, 2004 and December 31, 2003, the Company had no outstanding borrowings against the senior unsecured bank facility.

On August 30, 2004, LHL amended and increased its three-year $13.0 million unsecured revolving credit facility to allow for maximum borrowings of $25.0 million. The LHL credit facility is to be used for working capital and general corporate purposes and is due to mature on December 31, 2006. Borrowings under the LHL credit facility bear interest at floating rates equal to, at LHL’s option, either (i) London InterBank Offered Rate plus an applicable margin, or (ii) an “Adjusted Base Rate” plus an applicable margin. The weighted average interest rate under the LHL credit facility for the nine months ended September 30, 2004 was 3.5%. Interest expense for the nine months ended September 30, 2004 was less than $0.2 million. Additionally, LHL is required to pay a variable unused commitment fee determined from a ratings or leverage based pricing matrix, and currently set at 0.25% of the unused portion of the LHL credit facility. LHL incurred an immaterial unused commitment fee for the nine months ended September 30, 2004. At September 30, 2004 and December 31, 2003, respectively, the Company had outstanding borrowings against the LHL credit facility of $3.4 million and zero.

The Company is the obligor with respect to a $37.1 million tax-exempt special project revenue bond and $5.4 million taxable special project revenue bond, both issued by the Massachusetts Port Authority (collectively, the “MassPort Bonds”). The MassPort Bonds which mature on March 1, 2018, bear interest based on a weekly floating rate and have no principal reductions prior to their scheduled maturities. For the nine months ended September 30, 2004, the weighted average interest rate on the MassPort bonds was 1.1%. The MassPort Bonds may be redeemed at any time at the Company’s option without penalty. The bonds are secured by letters of credit issued by GE Capital Corporation that expire in 2007 and are collateralized by the Harborside Hyatt Conference Center & Hotel and a $6.0 million letter of credit from the Company. If GE Capital Corporation fails to renew its letters of credit at expiration and an acceptable replacement provider cannot be found, the Company may be required to pay-off the bonds. Interest expense for the nine months ended September 30, 2004 was $0.4 million. At both September 30, 2004 and December 31, 2003, the Company had outstanding bonds payable of $42.5 million.

The Company, through a wholly owned partnership, is subject to a ten-year mortgage loan that is secured by the Sheraton Bloomington Hotel Minneapolis South, located in Bloomington, Minnesota and the Westin City Center Dallas, located in Dallas, Texas. The mortgage loan matures on July 31, 2009 and does not allow for prepayment prior to maturity without penalty. The mortgage loan bears interest at a fixed rate of 8.1% and requires interest and principal payments based on a 25-year amortization schedule. Interest expense for the nine months ended September 30, 2004 was $2.6 million. The loan agreement requires the partnership to hold funds in escrow sufficient for the payment of 50% of the annual insurance premiums and real estate taxes related to the two hotels that secure the loan. The principal balance of this mortgage loan was $42.9 million and $43.5 million at September 30, 2004 and December 31, 2003, respectively.

The Company, through a wholly owned partnership, is subject to a ten-year mortgage loan that is secured by the Le Montrose Suite Hotel located in West Hollywood, California. This loan is subject to a fixed interest rate of 8.08%, matures on July 31, 2010, and requires interest and principal payments based on a 27-year amortization schedule. Interest expense for the nine months ended September 30, 2004 was $0.9 million. The mortgage loan agreement requires the partnership to hold funds in escrow sufficient for the payment of 50% of the annual insurance premium and real estate taxes on the Le Montrose Suite Hotel. The principal balance of this mortgage loan was $14.1 million and $14.2 million at September 30, 2004 and December 31, 2003, respectively.

The Company, through a wholly owned partnership, is subject to a five-year mortgage loan that is secured by the San Diego Paradise Point Resort. The mortgage loan matures on February 1, 2009 and does not allow for prepayment prior to maturity without penalty. The mortgage loan bears interest at a fixed rate of 5.25% and requires interest and

principal payments based on a 25-year amortization schedule. Interest expense for the nine months ended September 30, 2004 was $2.6 million. The loan agreement requires the Company to hold funds in escrow sufficient for the payment of 50% of the annual insurance premiums and real estate taxes related to the hotel that secures the loan. The principal balance of this mortgage loan was $64.2 million and $65.0 million at September 30, 2004 and December 31, 2003, respectively.

The Company, through a wholly owned partnership, is subject to a three-year mortgage loan that is secured by the Indianapolis Marriott Downtown. The mortgage loan matures on February 9, 2007 and can be extended at the option of the Company for two additional one-year terms. The mortgage does not allow for prepayment without penalty prior to February 25, 2006. The mortgage bears interest at the London InterBank Offered Rate plus 1.0%. As of September 30, 2004, the interest rate was 2.3%. On February 27, 2004, the Company entered into a three-year fixed interest rate swap that fixes the London InterBank Offered Rate at 2.56% for the $57.0 million balance outstanding on this mortgage loan, and therefore fixes the mortgage interest rate at 3.56%. Monthly interest-only payments are due in arrears throughout the term. Interest expense for the nine months ended September 30, 2004 was $0.8 million for the mortgage secured by the Indianapolis property plus an additional $0.4 million for the interest rate swap. The principal balance of this mortgage loan was $57.0 million and zero at September 30, 2004 and December 31, 2003, respectively.

The Company, through LHO Alexandria One, L.L.C., is subject to a five-year mortgage loan that is secured by the Hilton Alexandria Old Town Hotel located in Alexandria, Virginia. The mortgage loan matures on August 31, 2009 and does not allow for prepayment without penalty prior to July 1, 2009. The mortgage bears interest at fixed rate of 4.98% and requires interest and principal payments based on a 25-year amortization. Monthly interest and principal payments are due in arrears throughout the term. Interest expense for the nine months ended September 30, 2004 was $0.2 million. The principal balance of this mortgage loan was $34.4 million and zero at September 30, 2004 and December 31, 2003, respectively.

At September 30, 2004, the Company had approximately $4.3 million of cash and cash equivalents and approximately $7.4 million of restricted cash reserves.

Net cash provided by operating activities was approximately $36.4 million for the nine months ended September 30, 2004, primarily due to the distribution of available hotel operating cash by LHL and participating lease revenues, which were offset by payments for real estate taxes, personal property taxes, insurance and ground rent.

Net cash used in investing activities was approximately $141.0 million for the nine months ended September 30, 2004, primarily due to the purchases of the Indianapolis Marriott Downtown and the Hilton Alexandria Old Town, outflows for improvements and additions at the hotels, and the funding of restricted cash reserves, offset by proceeds from restricted cash reserves and proceeds from the sale of the Omaha Marriott.

Net cash provided by financing activities was approximately $74.1 million for the nine months ended September 30, 2004, comprised of borrowings under the senior unsecured bank facility, proceeds from mortgage loans, proceeds from the exercise of stock options and proceeds from the May 2004 common stock offering, offset by repayments of borrowings under the senior unsecured bank facility, repayments of mortgage loans, payment of distributions to the common shareholders and unit holders and payments of distributions to preferred shareholders.

The Company has considered its short-term (one year or less) liquidity needs and the adequacy of its estimated cash flow from operations and other expected liquidity sources to meet these needs. The Company believes that its principal short-term liquidity needs are to fund normal recurring expenses, debt service requirements, distributions on the preferred shares and the minimum distribution required to maintain the Company’s REIT qualification under the Code. The Company anticipates that these needs will be met with cash flows provided by operating activities and using availability under the senior unsecured bank facility. The Company also considers capital improvements and property acquisitions as short-term needs that will be funded either with cash flows provided by operating activities, utilizing availability under the senior unsecured bank facility, the issuance of other indebtedness, or the issuance of additional equity securities.

The Company expects to meet long-term (greater than one year) liquidity requirements such as property acquisitions, scheduled debt maturities, major renovations, expansions and other nonrecurring capital improvements utilizing availability under the senior unsecured bank facility, estimated cash flows from operations, the issuance of long-term unsecured and secured indebtedness and the issuance of additional equity securities. The Company expects to acquire or develop additional hotel properties only as suitable opportunities arise, and the Company will not undertake acquisition or development of properties unless stringent acquisition/development criteria have been achieved.

Reserve Funds

The Company is obligated to maintain reserve funds for capital expenditures at the hotels (including the periodic replacement or refurbishment of furniture, fixtures and equipment) as determined pursuant to the operating agreements. The Company’s aggregate obligation under the reserve funds was approximately $18.6 million at September 30, 2004. Five of the operating/franchise agreements require that the Company reserve restricted cash ranging from 3.0% to 5.5% of the individual hotel’s annual revenues. As of September 30, 2004, $5.3 million was available in restricted cash reserves for future capital expenditures. Thirteen of the operating agreements require that the Company reserve funds of 4.0% of the individual hotel’s annual revenues but do not require the funds to be set aside in restricted cash. As of September 30, 2004, the total amount obligated for future capital expenditures but not set aside in restricted cash reserves was $13.3 million. Amounts will be recorded as incurred. As of September 30, 2004, purchase orders and letters of commitment totaling approximately $21.7 million have been issued for renovations at the hotels. The Company has committed to these projects and anticipates making similar arrangements with the existing hotels or any future hotels that it may acquire. Any unexpended amounts will remain the property of the Company upon termination of the operating agreements.

The joint venture operating agreement requires that the joint venture reserve restricted cash of 5.0% of the Chicago Marriott Downtown’s annual revenues; however, the joint venture is not consolidated in the Company’s financial statements and, therefore, the amount of restricted cash reserves relating to the joint venture is not recorded on the Company’s books and records.

The Hotels

The following table sets forth historical comparative information with respect to occupancy, average daily rate (“ADR”) and room revenue per available room (“RevPAR”) for the total hotel portfolio owned as of September 30, 2004, for the three months and nine months ended September 30, 2004, respectively and 2003, respectively.


	For the three months ended September 30,						For the nine months ended September 30,
	2004		2003		Variance		2004		2003		Variance
Total Portfolio
Occupancy	75.1	%	70.6	%	6.3	%	70.0	%	65.0	%	7.6	%
ADR	161.11		153.36		5.0	%	153.08		146.79		4.3	%
RevPAR	120.95		108.31		11.7	%	107.13		95.47		12.2	%

Inflation

The Company’s revenues come primarily from its pro rata share of the operating partnership’s cash flow from the participating leases and the LHL hotel operating revenues, thus the Company’s revenues will vary based on changes in the underlying hotels’ revenues. Therefore, the Company relies entirely on the performance of the hotels and the lessees’ abilities to increase revenues to keep pace with inflation. The hotel operators can change room rates quickly, but competitive pressures may limit the lessees’ and hotel operators’ abilities to raise rates faster than inflation or even at the same rate, as has been the case for the period from the second quarter of 2001 through the first quarter of 2004.

The Company’s expenses (primarily real estate taxes, property and casualty insurance, administrative expenses and LHL hotel operating expenses) are subject to inflation. These expenses are expected to grow with the general rate of

inflation, except for energy, liability insurance, property tax rates, employee benefits, and some wages, which are expected to increase at rates higher than inflation, and except for instances in which the properties are subject to periodic real estate tax reassessments.

Seasonality

The hotels’ operations historically have been seasonal. The hotels maintain higher occupancy rates during the second and third quarters, including the Marriott Seaview Resort and Lansdowne Resort, which generate a portion of their revenues from golf-related business and, as a result, their revenues also fluctuate according to the season and the weather. These seasonality patterns can be expected to cause fluctuations in the Company’s quarterly lease revenue under the participating leases with third-party lessees and hotel operating revenue from LHL.

Litigation


	Expense Recognized Quarter Ended December 31, 2002			Expense Recognized Quarter Ended September 30, 2004			Cumulative Expense Recognized From December 31, 2002 through September 30, 2004
Estimated arbitration award	$	5,749		$	—		$	5,749
Legal fees related to litigation		2,610			1,350			3,960
Holdover rent		(4,844	)		—			(4,844	)
Expected reimbursement of legal fees		(995	)		(500	)		(1,495	)

Net contingent lease termination expense	$	2,520		$	850		$	3,370

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

The Company is exposed to market risk from changes in interest rates. The Company’s interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs. To achieve these objectives, the Company borrows at a combination of fixed and variable rates. As of September 30, 2004, approximately $59.7 million of aggregate indebtedness (21.9% of total indebtedness), including the Company’s $13.9 million pro rata portion of indebtedness relating to the Company’s joint venture investment in the Chicago Marriott Downtown hotel, was subject to variable interest rates.

At September 30, 2004, the Company had no outstanding borrowings under the senior unsecured bank facility. Borrowings under the senior unsecured bank facility bear interest at variable market rates. The weighted average interest rate under the facility for the nine months ended September 30, 2004, respectively was 3.6%. A 0.25% annualized change in interest rates would have changed interest expense by less than $0.1 million for the nine months ended September 30, 2004. This change is based on the weighted average borrowings under the senior unsecured bank facility for the nine months ended September 30, 2004 of $59.6 million.

At September 30, 2004, the Company had $3.4 million outstanding borrowings under the LHL credit facility. Borrowings under the LHL credit facility bear interest at variable market rates. The weighted average interest rate under the facility for the nine months ended September 30, 2004 was approximately 3.5%. A 0.25% annualized change in interest rates would have changed interest expense by an immaterial amount for the nine months ended September 30, 2004. This change is based on the weighted average borrowings under the LHL credit facility for the nine months ended September 30, 2004 of $5.8 million.

At September 30, 2004, the Company had outstanding bonds payable of $42.5 million. The bonds bear interest based on weekly floating rates and have no principal reductions for the life of the bonds. The weighted average interest rate for the nine months ended September 30, 2004 was 1.1%. A 0.25% annualized change in interest rates would have changed interest expense by less than $0.1 million for the nine months ended September 30, 2004. This change is based on the weighted average borrowings under the bonds for the nine months ended September 30, 2004 of $42.5 million.

At September 30, 2004, the mortgage loan that is collateralized by the Sheraton Bloomington Hotel Minneapolis South and the Westin City Center Dallas had a balance of $42.9 million. At September 30, 2004, the carrying value of this mortgage loan approximated its fair value as the interest rate associated with the borrowing approximated current market rates available for similar types of borrowing arrangements. This loan is subject to a fixed interest rate of 8.1%, matures on July 31, 2009 and requires interest and principal payments based on a 25-year amortization schedule.

At September 30, 2004, the mortgage loan that is collateralized by the Le Montrose Suite Hotel located in West Hollywood, California had a balance of $14.1 million. At September 30, 2004, the carrying value of this mortgage approximated its fair value as the interest rate associated with the borrowing approximated current market rate available for similar types of borrowing arrangements. This loan is subject to a fixed interest rate of 8.08%, matures on July 31, 2010, and requires interest and principal payments based on a 27-year amortization schedule.

At September 30, 2004, the mortgage loan that is collateralized by the San Diego Paradise Point Resort had a principal balance of $64.2 million. At September 30, 2004, the carrying value of this mortgage approximated its fair value as the interest rate associated with the borrowing approximated the current market rate available for similar types of borrowing arrangements. This loan is subject to a fixed interest rate of 5.25%, matures on February 1, 2009, and requires interest and principal payments based on a 25-year amortization schedule.

At September 30, 2004, the mortgage loan that is collateralized by the Indianapolis Marriott Downtown had a principal balance of $57.0 million. This mortgage loan bears interest at a floating rate that is reset monthly. However, the Company is party to a fixed interest rate swap agreement that fixes the London InterBank Offered rate at 2.56% for the $57.0 million balance outstanding on the Company’s mortgage loan secured by the Indianapolis hotel, and therefore fixes the mortgage interest rate at 3.56%. At September 30, 2004, the carrying value of the mortgage loan approximated its fair value as the interest rate associated with the borrowings approximated the current market rate available for similar borrowing arrangements. This loan matures on February 9, 2007, can be extended at the option of the Company for two additional one-year terms and requires interest-only payments monthly throughout the term of the loan.

At September 30, 2004, the mortgage loan that is collateralized by the Hilton Alexandria Old Town Hotel had a principal balance of $34.4 million. At September 30, 2004, the carrying value of this mortgage approximated its fair value as the interest rate associated with the borrowing approximated the current market rate available for similar types of borrowing arrangements. This loan is subject to a fixed interest rate of 4.98%, matures on August 31, 2009, and requires interest and principal payments based on a 25-year amortization schedule.

Item 4.

Controls and Procedures

Based on the most recent evaluation, the Company’s Chief Executive Officer and Chief Financial Officer believe the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) were effective as of September 30, 2004. There were no changes to the Company’s internal controls over financial reporting during the third quarter ended September 30, 2004, that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II. Other Information

Item 1.

Legal Proceedings.

Neither the Company nor LaSalle Hotel Operating Partnership, L.P. is currently involved in any litigation of which the ultimate resolution, in the opinion of the Company, is expected to have a material adverse effect on the financial position, operations or liquidity of the Company and the operating partnership.

Item 2.

Changes in Securities and Use of Proceeds.

None.

Item 3.

Defaults Upon Senior Securities.

None.

Item 4.

Submission of Matters to a Vote of Security Holders.

None.

Item 5.

Other Information.

None.

Item 6.

Exhibits and Reports on Form 8-K.

(a)

Exhibits.


Exhibit Number		Description of Exhibit

31.1		Certifications Pursuant to Rule 13a-14(a)/15d-14(a).

31.2		Certifications Pursuant to Rule 13a-14(a)/15d-14(a).

32.1		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b)

Reports on Form 8-K.

The Company filed seven current reports on Form 8-K during the quarter ended September 30, 2004. Information regarding items reported is as follows:


Date		Items Reported On

July 1, 2004		Item 2 – Acquisition or Disposition of Assets

		Item 7 – Financial Statements, Pro forma Financial Information and Exhibits

		On July 1, 2004, the Company reported additional financial information regarding the acquisition of the Hilton Alexandria Old Town in Alexandria, VA, which was reported on the Form 8-K, filed May 28, 2004.

July 13, 2004		Item 9 – Regulation FD Disclosure

		On July 13, 2004, the Company issued a press release announcing it would report its financial results for the second quarter of 2004 on July 21, 2004 after the close of the market and conduct its quarterly conference call on Thursday, July 22, 2004.

July 15, 2004		Item 7 – Financial Statements, Pro forma Financial Information and Exhibits

		Item 9 – Regulation FD Disclosure

		On July 15, 2004, the Company issued a press release announcing an increase in its monthly dividend to $0.08 per common share of beneficial interest for each of the months of July, August, and September 2004.

July 21, 2004		Item 7 – Financial Statements, Pro forma Financial Information and Exhibits

		Item 12 – Results of Operations and Financial Condition

		On July 21, 2004, the Company issued a press release announcing its results for the three months and six months ended June 30, 2004, and its outlook for the remainder of 2004.

August 26, 2004		Item 7.01 – Regulation FD Disclosure

		Item 9.01 – Financial Statements and Exhibits

		On August 26, 2004, the Company issued a press release announcing the successful execution of a $34.4 million secured loan with Wells Fargo Bank at a fixed rate of 4.98 percent.

August 30, 2004		Item 7.01 – Regulation FD Disclosure

		Item 9.01 – Financial Statements and Exhibits

		On August 30, 2004, the Company issued a press release announcing it had successfully increased its senior unsecured credit facility to $300.0 million from $215.0 million.

September 15, 2004		Item 7.01 – Regulation FD Disclosure

		Item 9.01 – Financial Statements and Exhibits

		On September 15, 2004, the Company issued a press release announcing the sale of the 299-room Omaha Marriott for $28.5 million.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		LASALLE HOTEL PROPERTIES

Dated: October 20, 2004	BY:	/s/ HANS S. WEGER
		Hans S. Weger Executive Vice President, Treasurer and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)