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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005

OR

FOR THE TRANSITION PERIOD FROM              TO             

Commission file number 1-14045

LASALLE HOTEL PROPERTIES

(Exact name of registrant as specified in its charter)

(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.

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Part I. Financial Information

Item 1. Financial Statements

LASALLE HOTEL PROPERTIES

Consolidated Balance Sheets

(Dollars in thousands, except per share data)

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

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LASALLE HOTEL PROPERTIES

Consolidated Statements of Operations

(Dollars in thousands, except per share data)

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LASALLE HOTEL PROPERTIES

Consolidated Statements of Operations - Continued

(Dollars in thousands, except per share data)

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LASALLE HOTEL PROPERTIES

Consolidated Statements of Cash Flows

(Dollars in thousands, except per share data)

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

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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 March 31, 2005, the Company owned interests in 21 hotels with approximately 6,700 suites/rooms located in 10 states and the District of Columbia. The Company owns 100% equity interests in 20 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 18 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 “Operating Partnership”). The Company is the sole general partner of the Operating Partnership. The Company owned approximately 98.7% of the Operating Partnership at March 31, 2005. At March 31, 2005, 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, 2004. The following notes to these interim financial statements highlight significant changes to the notes included in the December 31, 2004 audited financial statements included in the Company’s 2004 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 ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005 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, 2004. 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.

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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.

Substantially all of the Company’s revenues and expense come 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 30 to 40 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

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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.

On November 2, 2004, the Chicago 540 Hotel Venture, in which the Company has a non-controlling 9.9% ownership interest, obtained a three and a half year commitment for a $5,750 credit facility to be used for partial funding of the costs related to upgrading the hotel’s furniture, fixtures and equipment (“FF&E”). The FF&E credit facility matures on the earlier of i) April 30, 2008, or ii) three years from the date on which the final borrowing is made. The borrower has an option to borrow amounts bearing interest with reference to the base rate or to LIBOR, and portions may be converted from one interest basis to another. Base rate will be the greater of i) the rate established by the lender as a base rate and which is designated by the lender as its U.S. prime rate, or ii) the Federal Funds Rate plus 0.50%. LIBOR rate will be set two business days before the start of an interest period. The Chicago 540 Hotel Venture purchased a cap on London InterBank Offered Rate capping the London InterBank Offered Rate at 7.5%. Interest expense for the three months end March 31, 2005 was $57. Consistent with our ownership interest, the Company is guaranteeing 9.9% of the credit facility. The company’s maximum exposure under the FF&E facility is $569, and the guarantee will expire at the maturity of the credit facility. In the event of default, any outstanding principal and accrued interest will be due and payable. As of March 31, 2005 and December 31, 2004, there was $5,749 and no outstanding borrowings under the FF&E credit facility, respectively.

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 the first quarter 2005 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 2005 and 2004 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 ended March 31, 2005 and 2004, respectively would approximate the pro forma amounts below (in thousands, except per share data).

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From time to time, the Company awards restricted shares under the 1998 share option and incentive plan to trustees, executive officers and employees, which vest over three or four years. The Company recognizes compensation expense for restricted shares on a straight-line basis over the vesting period based upon the fair market value of the shares on the date of grant.

Recently Issued Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment”, which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”. SFAS No. 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and amends SFAS No. 95, “Statement of Cash Flows”. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. The new standard will be effective for the Company in the first annual reporting period beginning after June 15, 2005. Adoption is not expected to have a material effect on the Company.

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 REIT 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 taxable 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 corporate rates.

3. Acquisition of Hotel Properties

On January 6, 2005, the Company acquired a 100% interest in the Hilton San Diego Gaslamp Quarter, a 282-room upscale full-service hotel located in the Gaslamp historic district in downtown San Diego, CA, for $85.0 million. The source of the funding for the acquisition was the Company’s senior unsecured bank facility. The property is leased to LHL, and Davidson Hotel Company was retained to manage the property.

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On January 10, 2005, the Company acquired a 100% interest in the Grafton on Sunset, a 108-room, upscale full-service hotel located in West Hollywood, CA, for $25.5 million. The source of the funding for the acquisition was the Company’s senior unsecured bank facility. The property is leased to LHL, and Outrigger Lodging Services was retained to manage the property.

4. 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 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. Net loss from discontinued operations for the three months ended March 31, 2005, is a result of additional post-closing adjustments from the Omaha property sale. The loss includes an expense of $45 and is partly offset by the tax benefit of $19. For 2004, total revenues related to the asset of $3,167, comprised primarily of hotel operating revenues, were included in the net income of $496 from discontinued operations.

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 ended March 31, 2005 and 2004, respectively.

As of March 31, 2005, the Company had an unsettled liability of $202, related to the sale of the Omaha property. The Company expects all liabilities related to this hotel to be settled in the second quarter of 2005.

At March 31, 2005, the Company had no assets and liabilities for assets held for sale.

5. Disposition of Land

On March 15, 2005, the Company sold approximately 8 acres of land located at the Lansdowne Resort for $1,500, resulting in income of approximately $418, which is included in other income on the consolidated financial statements. At the time the Company purchased the Lansdowne Resort, the seller had entered into a contract with a third party for the sale of the 8 acres. The 8 acre contract was assigned to the Company at closing and the purchase/sale agreement related to the acquisition of the resort required the Company to pay the seller upon completion of the sale $1,080 of net sale proceeds which represented the expected sales price for the land. On March 21, 2005, the Company made the $1,080 payment to the seller resulting in the gain of $418.

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

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distributions on a calendar year basis. As of March 31, 2005, 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 ended March 31, 2005, the weighted average interest rate for borrowings under the senior unsecured bank facility was approximately 4.6%. Interest expense for the three months ended March 31, 2005 was $890. The Company did not have any Adjusted Base Rate borrowings outstanding at March 31, 2005. 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 $138 for the three months ended March 31, 2005. At March 31, 2005 and December 31, 2004, the Company had $90,900 and zero, respectively, of outstanding borrowings under the senior unsecured bank facility.

LHL has a $25.0 million unsecured revolving credit facility to be used for working capital and general corporate purposes that 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 three months ended March 31, 2005 was 4.4%. Interest expense for the three months ended March 31, 2005 was $215. 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 $4 for the three months ended March 31, 2005. At March 31, 2005 and December 31, 2004, the Company had $13,119 and zero, respectively, of outstanding borrowings under 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 ended March 31, 2005 was 2.0%. Interest expense for the three months ended March 31, 2005 was $209. 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 March 31, 2005 and December 31, 2004, the Company had outstanding bonds payable of $42,500.

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 ended March 31, 2005 was $861. 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 $42,441 and $42,666 at March 31, 2005 and December 31, 2004, 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 ended March 31, 2005 was $283. 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 $13,996 and $14,048 at March 31, 2005 and December 31, 2004, respectively.

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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 ended March 31, 2005 was $835. 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 $63,534 and $63,866 at March 31, 2005 and December 31, 2004, 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 loan 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 March 31, 2005, the interest rate was 3.8%. 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 ended March 31, 2005 was $512 for the mortgage secured by the Indianapolis property less $5 of income from the interest rate swap. The mortgage loan had a principal balance of $57,000 both at March 31, 2005 and December 31, 2004, respectively.

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 September 1, 2009 and does not allow for prepayment without 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 schedule. Interest expense for the three months ended March 31, 2005 was $425. The mortgage loan had a principal balance of $34,054 and $34,230 at March 31, 2005 and December 31, 2004, 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 expiring from 2016 to June 2099. In addition, one of the two golf courses, the Pines, at Seaview Marriott Resort and Spa, is subject to a ground lease, which expires on December 31, 2012. Total ground lease expense for the three months ended March 31, 2005 was $798.

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 $15,235 at March 31, 2005. The reserve requirements for four hotels, the hotels operated by Marriott International, Inc., White Lodging Services Corporation and Hyatt Corporation, are contained in certain long-term operating agreements, which require the reserves for the hotels operated by Marriott International, Inc. and Hyatt Corporation, to be maintained through furniture, fixtures and equipment restricted cash escrows. These four participating leases require that the Company reserve restricted cash ranging from 4.0% to 5.5% of the individual hotel’s annual revenues. As of March 31, 2005, $6,302 was available in restricted cash reserves for future capital expenditures. Sixteen 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 March 31, 2005, the total amount obligated for future capital expenditures but not set aside in restricted cash reserves was $8,933. Amounts will be recorded as incurred. As of March 31, 2005, purchase orders and letters of commitment totaling approximately $16,600 have been issued for renovations at the hotels.

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Any unexpended amounts will remain the property of the Company upon termination of the operating agreements.

The joint venture lease 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 March 31, 2005, the Company held $8,480 in restricted cash reserves. Included in such amounts are (i) $6,302 of reserve funds relating to the hotels with leases or operating agreements requiring the Company to maintain restricted cash to fund future capital expenditures, (ii) $500 for future renovations and conversion costs expected to be incurred related to the Bloomington, Minnesota property re-branding under the Sheraton brand affiliation and (iii) $1,678 deposited in mortgage escrow accounts pursuant to mortgage obligations to pre-fund a portion of certain hotel expenses.

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. The Company’s damage claims against Meridien went to trial in March 2005, and a decision is expected soon. With respect to the New Orleans hotel, 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, 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 had 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. The issue of default by the lessee and the Company’s wrongful holdover claim, as well as Meridien’s damage claims arising from the termination of its leasehold, among other claims, went to trial in February 2005. A decision has not yet been issued by the court.

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

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expense recognized cumulatively since 2002 is comprised of (dollars in thousands):

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 $1.6 million as of March 31, 2005, 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 or any damages will be collectible from Meridien 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, which are not expected to go to trial before Spring 2006.

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 initiated a lawsuit against Marriott Hotel Services, Inc. in the Supreme Court of the State of New York, County of New York, in connection with Marriott’s implementation of certain expenditures without the Company’s approval at the LaGuardia Airport Marriott. The Company is alleging breach of contract and breach of fiduciary duty, among other claims. Marriott Hotel Services, Inc. is seeking to refer the matter to arbitration, and alternatively has moved to dismiss the complaint. These preliminary matters are scheduled to go before the Court in second quarter of 2005. No trial date has been set.

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 1, 2005, the Company re-purchased 32,867 common shares of beneficial interest related to executives and employees surrendering shares to pay taxes at the time restricted shares vested. The Company re-issued these 32,867 treasury shares related to (i) compensation to the Board of Trustees and (ii) issuance of restricted common shares of beneficial interest to the Company’s executive officers.

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On January 1, 2005, the Company issued an aggregate of 1,071 common shares of beneficial interest, including 865 deferred shares, to the independent members of its Board of Trustees for their fourth quarter 2004 compensation. The common shares were issued in lieu of cash at the trustee’s election. These common shares were issued under the 1998 share option and incentive plan.

On January 14, 2005, 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 January, February and March 2005.

On January 14, 2005, the Company paid its December 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 December 31, 2004.

On January 25, 2005, the Company granted 40,917 restricted common shares of beneficial interest to the Company’s executive officers. The restricted shares granted vest over three years, starting January 1, 2007. These common shares were issued under the 1998 share option and incentive plan.

On February 15, 2005, the Company paid its January 2005 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 January 31, 2005.

On March 15, 2005, the Company paid its February 2005 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 February 28, 2005.

During the three months ended March 31, 2005, trustees, executives and employees of the Company exercised 76,134 options to purchase common shares of beneficial interest. These common shares were issued under the 1998 share option and incentive plan.

Treasury Shares

Treasury shares are accounted for under the cost method. During the quarter ended March 31, 2005, the Company re-purchased 32,867 common shares of beneficial interest related to executives and employees surrendering shares to pay taxes at the time restricted shares vested and acquired 1,082 common shares of beneficial interest related to the forfeiture of restricted shares by employees leaving the Company. The Company re-issued 33,949 treasury shares related to (i) restricted shares granted to executives in January 2005 and (ii) executives and employees exercising stock options.

At March 31, 2005, there were no common shares of beneficial interest in treasury.

Preferred Shares

The Series A Preferred Shares and Series B Preferred Shares rank senior to the common shares of beneficial interest and on parity with each other with respect to payment of distributions; the Company will not pay any distributions, or set aside any funds for the payment of distributions, on its common shares of beneficial interest unless it has also paid (or set aside for payment) the full cumulative distributions on the Series A Preferred Shares and Series B Preferred Shares for the current and all past dividend periods. Neither the Series A Preferred Shares nor the Series B Preferred Shares have any maturity date, and neither the Series A Preferred Shares nor the Series B Preferred Shares are subject to mandatory redemption. There is no difference between the carrying value and the redemption amount of the Series A Preferred Shares and Series B Preferred Shares. In addition, the Company is not required to set aside funds to redeem the Series A Preferred Shares or Series B Preferred Shares. Also, the Company may not optionally redeem the Series A Preferred Shares prior to March 6, 2007, or the Series B Preferred Shares

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prior to September 30, 2008, except in limited circumstances relating to the Company’s continuing qualification as a REIT. After those dates, the Company may, at its option, redeem the Series A Preferred Shares or Series B Preferred Shares, respectively, in whole or from time to time in part, by payment of $25.00 per share, plus any accumulated, accrued and unpaid distributions to and including the date of redemption. Accordingly, the Series A Preferred Shares and Series B Preferred Shares will remain outstanding indefinitely unless the Company decides to redeem them.

On January 14, 2005, the Company paid its preferred distribution of $0.64 per Series A Preferred Share for the quarter ended December 31, 2004 to preferred shareholders of record at the close of business on January 1, 2005.

On January 14, 2005, the Company paid its preferred distribution of $0.52 per Series B Preferred Share for the quarter ended December 31, 2004 to preferred shareholders of record at the close of business on January 1, 2005.

Operating Partnership Units

As of both March 31, 2005 and December 31, 2004, the operating partnership had 383,090 units outstanding, representing a 1.3% partnership interest held by the limited partners, respectively.

9. Share Option and Incentive Plan

On January 1, 2005, the Company issued an aggregate of 1,071 common shares of beneficial interest, including 865 deferred shares, to the independent members of its Board of Trustees for a portion of their 2004 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.

At March 31, 2005 and December 31, 2004, there were 231,602 and 272,306 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 March 31, 2005, there was $1,524 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 ended March 31, 2005.

The following table summarizes the notional value and fair value of the Company’s derivative financial instrument. The notional value at March 31, 2005 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 March 31, 2005:

At March 31, 2005, the derivative instrument was reported at its fair value of $1,524 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

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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 ended March 31, 2005, the Company reclassified $5 of accumulated other comprehensive income to earnings as an offset to 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:

As of March 31, 2005, LHL leases the following 18 hotels owned by the Company:

The two 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 third-party hotel operators of those respective hotels.

On March 11, 2005, the Company notified Marriott International (“Marriott”) that it was terminating the management agreement at the Marriott Seaview Resort due to Marriott’s failure to meet certain hotel operating performance thresholds as defined in the management agreement. Pursuant to the management agreement, Marriott has the right to avoid termination by making payment of approximately $2,394 within 60 days of notification, which Marriott may recoup in the event certain future operating performance thresholds are attained.

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12. Income Taxes

Income tax benefit of $2,724 is comprised of a state and local tax refund of $136, state and local tax expense of $83 on the operating partnership’s income and federal, state and local tax benefit of $2,671 on LHL’s loss of $6,572 before income tax benefit.

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

The provision for income taxes differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate to pretax income as a result of the following differences:

For the three months ended March 31, 2005, LHL recorded an income tax benefit of $2,671 that is included in the accompanying consolidated financial statements. The Company has estimated its income tax benefit using a combined federal and state rate of 41.5%. As of March 31, 2005, the Company had a deferred tax asset of $17,224 primarily due to past and current year’s tax net operating losses. These loss carryforwards will expire in 2021 through 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.

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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:

14. Comprehensive Income

For the three months ended March 31, 2005, comprehensive income was $559. As of March 31, 2005 and December 31, 2004 the Company’s accumulated other comprehensive income was $1,524 and $965, 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 ended March 31, 2005, the Company reclassified $5 of accumulated other comprehensive income to earnings as an offset to interest expense. Within the next twelve months the Company expects to reclassify $646 of the amount held in accumulated other comprehensive income to earnings as an offset to interest expense.

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15. Supplemental Information to Statements of Cash Flows

16. Pro Forma Financial Information

The following condensed pro forma financial information is presented as if the Indianapolis Marriott Downtown, Hilton Alexandria Old Town, Chaminade Resort and Conference Center, Hilton San Diego Gaslamp Quarter and Grafton on Sunset acquisitions had been consummated and leased as of January 1, 2004.

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.

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17. Subsequent Events

On April 15, 2005, the Company declared monthly distributions to shareholders of the Company and partners of the operating partnership, in the amount of $0.08 per common shares of beneficial interest/unit for each of the months of April, May and June 2005.

On April 15, 2005, the Company paid its March 2005 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 March 31, 2005.

On April 15, 2005, the Company paid its preferred distribution of $0.64 per Series A Preferred Share for the quarter ended March 31, 2005 to preferred shareholders of record at the close of business on April 1, 2005.

On April 15, 2005, the Company paid its preferred distribution of $0.52 per Series B Preferred Share for the quarter ended March 31, 2005 to preferred shareholders of record at the close of business on April 1, 2005.

On April 19, 2005, the Company granted 2,785 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 of beneficial interest were issued under the 1998 share option and incentive plan.

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 Company intends to acquire upscale, full-service hotels in convention, resort and major urban business markets where the Company perceives strong demand growth or significant barriers to entry. The Company measures hotels performance by evaluating financial metrics such as unleveraged internal rates of return, revenue per available room (“RevPAR”), funds from operations (“FFO”) and earnings before interest, taxes, depreciation and amortization (“EBITDA”).

The Company continuously evaluates the hotels in its portfolio and potential acquisitions using the measures discussed above to evaluate each hotel’s contribution toward reaching its goal of maintaining a reliable stream of income and moderate growth to shareholders. The Company invests in capital improvements throughout its 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, because of the high level of competitive capital resources and a relatively limited number of hotels on the market, there continues to be relatively few hotels that meet our criteria priced to provide the Company the returns it requires.

The first quarter of 2005 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 first quarter of 2005, we had a net loss of $2.9 million, or $0.10 per diluted share. FFO was $8.3 million, or $0.27 per diluted share/unit and EBITDA was $13.5 million. RevPAR was $97.80. We consider RevPAR and EBITDA to be key measures of the individual hotels’ performance. RevPAR for the total portfolio increased 10.3% for the first quarter of 2005. The RevPAR increase is attributable to an Average Daily Rate (“ADR”) increase of 8.9% to $152.43, while occupancy improved by 1.3% to 64.2%. EBITDA at the corporate level increased 82.0% due to an increase in revenues from the purchases of several hotels in 2004 and 2005, partly offset by the sale of Omaha Marriott. At the hotel level, EBITDA increased 22% due to higher ADR and occupancy. Additionally, first quarter EBITDA margin across the Company’s portfolio was 19.2% representing a 202 basis points improvement over the same period in 2004.

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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 March 31, 2005 to the Three Months Ended March 31, 2004

Hotel operating revenues

Hotel operating revenues from the hotels leased to LHL (18 hotels), including room revenue, food and beverage revenue and other operating department revenues (which includes golf, telephone, parking and other ancillary revenues) increased approximately $21.7 million, from $47.2 million in 2004 to $68.9 million in 2005. This increase includes amounts that are not comparable year-over-year as follows:

The remaining change is an increase of $4.3 million, or 9.1%, and is attributable to increases in RevPAR, and associated Food & Beverage and Other revenue for our other properties leased to LHL. The increase in RevPAR was primarily attributable to an increase in ADR of 8.9%.

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Overall, travel levels improved in the first 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 up an average of 1.3% in the quarter. With demand improving during 2005, continuing to reflect the early stage of an industry recovery, the industry is experiencing an opportunity to raise prices. However, 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 quarter, especially at its urban and convention hotels.

Participating lease revenue

Participating lease revenue from hotels leased to third party lessees (two hotels) increased $0.3 million from $3.6 million in 2004 to $3.9 million in 2005. 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 is due to a $0.3 million increase from the San Diego Paradise Point due to a 13.8% increase in RevPar in 2005.

Hotel operating expenses

Hotel operating expenses increased approximately $14.5 million from $38.2 million in 2004 to $52.7 million in 2005. This increase includes amounts that are not comparable year-over-year as follows:

The remaining change is an increase of $2.7 million, or 7.1%, 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 $1.9 million from $9.0 million in 2004 to $10.9 million in 2005. This increase includes amounts that are not comparable year-over-year as follows:

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

Real estate taxes, personal property taxes, insurance and ground rent expenses increased approximately $0.9 million from $3.5 million in 2004 to $4.4 million in 2005. This increase includes amounts that are not comparable year-over-year as follows:

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In addition, the real estate taxes, personal property taxes, insurance and ground rent expenses for the three months ended March 31, 2004 included a $0.1 million tax assessment reduction refund for the New Orleans Grande Hotel, which was sold in April 2003.

The remaining real estate taxes, personal property taxes, insurance and ground rent remained approximately the same for the first quarter 2005 compared to the first quarter 2004.

General and administrative expenses

General and administrative expense increased approximately $0.7 million from $2.1 million in 2004 to $2.8 million in 2005 primarily as a result of increases in payroll related expenses, audit fees, legal fees and other professional fees.

Interest expense

Interest expense increased by approximately $0.7 million from $3.3 million in 2004 to $4.0 million in 2005 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 $234.4 million in 2004 to $350.2 million in 2005, which includes increases from (i) a secured loan financing on the Hilton Alexandria Old Town in August 2004 of $34.4 million, (ii) additional borrowings to purchase the Chaminade Resort and Conference Center in November 2004, (iii) additional borrowings to purchase the Hilton San Diego Gaslamp Quarter in January 2005, (iv) additional borrowings to purchase the Grafton on Sunset in January 2005, and (iv) additional borrowings under the Company’s bank facility to finance other capital improvements during 2005, offset by (i) 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, (ii) a $54.9 million net paydown on the Company’s bank facility with proceeds from the November 2004 common stock offering, and (iii) 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 4.7% in 2004 to 4.6% in 2005. Capitalized interest increased by approximately $0.3 million from $0.1 million in 2004 to $0.4 million in 2005, primarily due to 2005 capital expenditures related to the Lansdowne Resort development project.

Income taxes

Income tax benefit decreased approximately $0.2 million from $2.9 million in 2004 to $2.7 million in 2005. For the three months ended March 31, 2005, the REIT incurred state and local income tax expense of approximately $0.1 million. LHL’s net loss before income tax benefit decreased by approximately $0.6 million from $7.2 million in 2004 to $6.6 million in 2005. Accordingly, for the three months ended March 31, 2005, LHL recorded a federal income tax benefit of approximately $2.3 million (using an estimated tax rate of 34.5%) and a state and local tax benefit of approximately $0.4 million (using an estimated tax rate of 7.0%, net of the federal income tax effect). Additionally, LHL recorded estimated tax payments of approximately $0.1 million. The portion of LHL’s income tax benefit relating to the Omaha property has been reclassified to discontinued operations. The following table summarizes the income tax (benefit) expense (dollars in thousands):

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As of March 31, 2005, the Company had a deferred tax asset of $17,224 primarily due to past and current year’s tax net operating losses. These loss carryforwards will expire in 2021 through 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.

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 March 31, 2005, the aggregate weighted average partnership interest held by the limited partners in the operating partnership was approximately 1.27%. The following table summarizes the change in minority interest (dollars in thousands):