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Sunstone Hotel Investors Inc. (NYSE:SHO)

Q4 2009 Earnings Call

February 23, 2010 5:00 pm ET

Executives

Bryan Giglia – Vice President of Corporate Finance

Arthur L. Buser – President, Chief Executive Officer & Director

Kenneth E. Cruse – Chief Financial Officer & Senior Vice President

Mark Hoffman – Senior Vice President & Head of Asset Management

Analysts

Jeffrey Donnelly – Wells Fargo

David Loeb – Robert W. Baird & Co., Inc.

Chris Woronka – Deutsche Bank Securities

William Crow – Raymond James

David Katz – Oppenheimer & Co.

Mike Salinsky – RBC Capital Markets

Bryan Mahr – Collins Stewart

Ryan Meliker – Morgan Stanley

Operator

Welcome to the Sunstone Hotel Investors fourth quarter 2009 earnings call. At this time all participants are in listen only mode. Following today’s prepared remarks instructions will be given for the question and answer session. (Operator Instructions) I would now like to turn the conference over to Mr. Bryan Giglia, Senior Vice President of Corporate Finance of Sunstone Hotel Investors. Please go ahead, Sir.

Bryan Giglia

Thank you. Good afternoon everyone and thank you for joining us today. By now you should have all received a copy of our earnings release which was released this afternoon. If you do not yet have a copy you can access it on the investor relations section of our website at www.SunstoneHotels.com.

Before we begin this conference I would like to remind everyone that this call contains forward-looking statements that are subject to risks and uncertainties including those described in our prospectuses, 10Qs, 10Ks and other filings with the SEC which could cause actual results to differ materially from those projected. We caution you to consider those factors in evaluating our forward-looking statements.

We also note that this call may contain non-GAAP financial information including EBITDA, adjusted EBITDA, FFO, adjusted FFO and hotel EBITDA margins. We are providing that information as a supplement to information prepared in accordance with generally accepted accounting principles.

With us today are Art Buser, President and Chief Executive Officer; Ken Cruse, Chief Financial Officer and Mark Hoffman, will be available to answer questions during the question and answer period. To begin our discussion today I would like to turn the call over to Art. Art please go ahead.

Arthur Buser

Thanks Bryan. Good afternoon everybody and thank you for joining us today. In today’s call I will review our fourth quarter and full-year performance and share some insights into the current operating environment. Following that, provide a status update on our acquisitions program and our Independent Hotel Management RFP process. Finally, Ken will provide additional detail on our finance initiatives including our proposed release of three properties from the Mass Mutual Portfolio and our decision to terminate the credit facility. Ken will also provide an update on corporate covenant compliance, impairment charges taken in the fourth quarter and provide some 2010 expense estimates.

Over the past year the Sunstone team accomplished a lot so I would like to start today’s call with a recap. If you look back to our 2008 fourth quarter call, a year ago we were in a very different situation. Our shares were trading at approximately $2. Common equity market cap was about $90 million. Sunstone owed $1.7 billion in debt and we held approximately $200 million in cash.

During 2009 we focused on improving our balance sheet, refining our portfolio and improving our operational efficiency. On the balance sheet front we took a number of positive steps during 2009. We capitalized on market conditions by repurchasing approximately $188 million of our exchangeable notes at an average discount to par of 38% resulting in a plus 20% yield to put and generated economic gain of nearly $70 million. We also amended our exchangeable notes debenture to provide for flexibility in restructuring our secured debt.

We equitized our balance sheet by issuing $269 million of common equity. We restructured our secured debt portfolio by addressing deficits among five of our nonrecourse mortgage loans collateralized by 15 hotels and totaling $470 million in indebtedness. As part of that we eliminated amortization for the next 2.5 years on the $105 million Baltimore Renaissance mortgage loan and we elected to deed back 11 hotels and are working to secure the release of three additional hotels which will result in the elimination or repayment of $366 million in mortgage debt.

In addition to deed backs we further refined our portfolio by selling three noncore hotels for net proceeds of $61.3 million. Finally on the operations side as a result of diligent efforts by our asset management team and our operators to redefine our hotel expense structure we drove profit save through of approximately 50% through the fourth quarter as well as for the full year. What that means is by making our hotels more efficient we met every dollar of lost revenue with $0.50 in cost reductions. That is remarkable. For the full year this resulted in a portfolio margin decline of only 470 basis points.

Where does that put us today? As a result of our 2009 initiatives as well as improving market conditions, Sunstone shares now trade at a little under $9. Our common equity market cap is approximately $900 million. We have less than $1.2 billion in well staggered debt, $181 million of which matures over the next five years. We hold nearly $400 million in cash and going forward we believe our new hotel level operating cost models will drive margin expansion as the growth phase of the cycle begins.

So I will switch to the current operations update. Unless noted, all RevPAR statistics we provide today reflect our 29 hotel portfolio which includes the three hotels we are seeking to release from the Mass Mutual loan.

For the fourth quarter our total portfolio RevPAR was down 13.8% to the prior year. Occupancy was down 1.6 points to 66.4%. ADR was down 12.4% to $146.55. We continue to see moderation in the pace of decline in demand and in several markets we see positive occupancy trends which historically have been a leading indicator of improving demand conditions which in turn has driven increases in rate.

For the full year our total portfolio RevPAR was $102.09 which was down 18.2% to the prior year. Occupancy was down 7 points to 69.3% and rate was down 12.1% to $147.32. That level of occupancy makes me optimistic about prospects for increasing rate during the recovery. For the fourth quarter adjusted EBITDA was $44.8 million and adjusted FFO per share was $0.18. For the full year adjusted EBITDA was $168.6 million and adjusted FFO per share was $0.68, all of which are generally in line with or above the street’s consensus.

Now let’s talk about regional performance. Again for the 29 hotel portfolio during the fourth quarter our California properties were down 16.8% in RevPAR. L.A. and Orange County area hotels were down 18.6% when compared to 2008 while our San Diego area hotels were down 12.3%. Our East Region which includes Florida, Maryland, Massachusetts, New York, Pennsylvania, Virginia and the District of Columbia experienced a 10.4 RevPAR decline which is a reflection of the continued softness in Orlando and signs of improvement in New York, Boston and Baltimore.

Our Other West region was down 21.9%. Our Midwest region was down 12.3% to last year primarily as a result of weakness in our Chicago market. While we are bullish on Chicago’s long-term prospects we do expect Chicago to be one of the more challenged markets again this year due to continued assimilation of new supply and a weak convention calendar.

We continue to see signs that point to a recovery. In January 19 of 29 hotels had positive occupancy and 9 had positive RevPAR compared to January of 2009. That said, there are still a few assets in challenging markets such as Houston, Orlando and Chicago that we expect to lag our portfolio during 2010. It is also important to note that the impact of the inauguration on our D.C. assets. For the first quarter 2009, January RevPAR was down 14% for our 29 hotel portfolio. Excluding D.C. January RevPAR was down only 8% which was meaningfully better than our initial forecast.

We continue to see indications in a number of our markets that travelers are again willing to pay top dollar for hotel rooms on nights when markets compress. At our Hilton Times Square in January we saw 13 days with higher RevPAR than last year with 9 days that had higher ADR. Even more encouraging RevPAR for our Times Square so far in the month of February is up 14.8% relative to last year. It is unfortunate in a market with that much occupancy growth that some are still discounting.

Looking ahead we are continuing to see quality booking trends in our properties which is reflected in the pace improving from down 23 last month to down 18 currently. Consistency of approximately a 14% decline in occupancy and a 4% decline in rate. More importantly group bookings for our portfolio were up 30% in January compared to the prior year. Increasingly positive signs in terms of improving business and consumer sentiment point to a pending economic recovery setting the stage for a prolonged period of positive fundamentals in the lodging industry.

So let’s shift to acquisitions. We continue to believe that acquiring hotels now will likely create long-term value. While we review acquisition targets we will continue to take a measured and disciplined approach to acquisitions which may result in a more lengthy process than in the past but which we believe will result in the best execution for the company.

Now in the past we have often responded to questions about acquisitions by describing our pipeline volume. Given that so far none of the potential deals in our pipeline have translated into hard acquisitions we are going to spend less time discussions deals we are analyzing and more time discussing the general condition of the acquisitions market. After all, anybody can include the entire hotel market in their “pipeline.”

What we are seeing is currently there are more buyers than attractive opportunities. That does not make me any less optimistic about our ability to succeed in making accretive investments. I am as optimistic today as I was six months ago. However, what we are seeing suggests the volume of deals could be less than many expected. All that said, when we close on hotel acquisitions it will not be because we were more aggressive on our underwriting or more aggressive on our bidding. It will likely be because we have a unique ability to add value where others cannot, and thus generating more attractive returns.

As in the past we continue to prioritize our acquisition targets with the following criteria; First looking at discount valuation; that is targets are expected to trade at a discount relative to our current enterprise value per key and our EBITDA multiple. For the most part, opportunities we are seeing have lower cap rates and higher prices per key than current public company valuations.

We are also focusing on asset quality. Those are hotels that generate RevPAR in excess of the company’s current RevPAR and are higher EBITDA per key. Also focusing on value added opportunities where we are evaluating opportunities where selected renovation and repositioning work may add value as the costs of construction, renovation, labor and materials have declined from peak levels.

We are also looking for market concentration where we are targeting assets within our key markets because economies of scale, ownership efficiencies, improved pricing power and staff sharing may be realized by owning multiple hotels within the same market. We are looking for outperforming markets meaning we are targeting those markets we expect to outperform the U.S. average in terms of growth and lodging demand. Finally sourcing relationships. We are exploring preferred relationships with current owners of hotel real estate portfolios who may look to divest of such real estate in the future.

We continue to look at hotel acquisitions that meet the above criteria and we are also looking at other opportunities that would be additive such as assets that are not upper [upscale]. It could be those that are higher or lower quality. Also we are looking into investing in hotel debt where there is potential to gain ownership in the underlying asset. Debt investments can be very complicated and as we have previously stated if we make a debt investment it will likely be with a partner with significant expertise in this area. Looking at hotel debt, the best strategy is to proceed with extreme caution. It seems like every distressed asset fund is now a distressed debt fund and competition for debt is as intense for hotel assets and in some cases maybe even more.

Finally we continue to evaluate various portfolio transactions and we believe bulk purchases of quality hotels may prove to be the most productive for the company as there is seemingly over demand for single assets but limited demand for large portfolios, particularly those with near-term debt maturities.

Let me finish up by talking about the Management Agreement RFP and as we noted on our prior call, in December we initiated the process to analyze alternative operators for our 15 hotels currently operated by Sunstone Hotel Properties due to the division of Interstate Hotels and Resorts. We continue to make progress as we have narrowed the field down to a select few and continue our due diligence on each of the finalists.

We expect a final decision before the end of the second quarter. This process could result in one or several new managers or possibly no change at all. As we have previously stated our existing management agreements with Sunstone Hotel Properties are cancellable for a nominal fee and it is our responsibility to take that relatively free option to validate whether or not we have the best third-party manager in place for our hotels. If we find through this process that is not the case then we will make a change.

With that I would to turn the call over to Ken to provide an update on our finance initiatives. Ken, please go ahead.

Kenneth Cruse

Thanks Art. Good afternoon everyone. Thank you for joining us today. Today I will provide a status report on our finance initiatives including our proposed release of three hotels from the Mass Mutual loan. I will also discuss our decision to terminate our credit facility and summarize the one-time charges we recorded in the fourth quarter. Finally I will provide some information related to certain 2010 expense items and metrics.

The first topic is secured debt. As we have previously disclosed we are in the process of completing our secured debt restructuring program and we also previously noted we were proceeding with the deed back of all 11 hotels securing a $246 million loan with Mass Mutual. Recently we reached an agreement in principle with Mass Mutual to secure the release of three of the 11 hotels comprising the collateral pool.

The assets we are working to release are the 179 room Courtyard by Marriott Los Angeles, the 271 room [inaudible] Inn and Suites in Rochester, Minnesota and the 203 room Marriott Rochester, Minnesota, collectively representing a total of 653 rooms. We chose to retain these three assets because Sunstone is uniquely positioned to retain market efficiencies by keeping our Rochester and LAX portfolios intact. The remaining 8 hotels will be deeded back to Mass Mutual in satisfaction of the debt balance that will remain after the payment of a release price.

We expect this transaction to be completed in the first quarter but no assurances can be given at this time as to timing, final terms or if the transaction will close at all. Under the terms of our agreement with Mass Mutual we are unable to take questions on this transaction during today’s call. I would like to thank Mass Mutual and its co-lenders for their continued efforts to work with us towards the mutually beneficial resolution and for their professional and reasonable negotiations throughout this process.

On the other secured debt restructuring note we expect the appointment of a receiver for our Marriott Ontario Airport to occur during the first quarter at which point as we have previously discussed we will de-consolidate the Ontario Marriott for accounting purposes. Finally as noted on or prior call pending the conclusion of the Mass Mutual and Ontario deals our secured debt restructuring program is now concluded. That said, we will continue to act in the best interest of our stockholders so in the future we may seek to restructure additional secured loans if conditions warrant.

Next topic is our credit facility. Today we terminated our $85 million secured credit facility. We elected to terminate the credit facility because of the following; First, we have a very strong liquidity position. We finished the year with nearly $400 million of cash and cash equivalents that includes restricted cash which is more than 2 times all of our debt maturities within the next five years.

Second, we hold significant unencumbered asset base. With the termination of the credit facility and the pending release of three Mass Mutual hotels we will have ten unencumbered hotels. Third, our business plan does not contemplate the use of revolving credit for at least the next several quarters as other forms of capital are currently more attractive unless restricted. Finally, the termination of the credit facility will eliminate approximately $600,000 in fees and associated costs per annum and will further improve the company’s financial flexibility by eliminating restrictive corporate covenants and mortgage encumbrances on the five properties.

We will look to in terms of a new and appropriately sized and structured credit facility at some time in the future when we believe revolving credit would be additive to our business plan. We expect to accelerate approximately $1.6 million of non-cash deferred financing fees associated with the facility during the first quarter.

I would like to mention we are very appreciative of our various credit facility lenders and we look forward to continuing to work with our key banking relationships on a wide variety of investment banking and capital markets transactions. Sunstone continues to be very active in the capital markets and as in the past we expect to award our advisory and capital markets deals to those banks that support us with deal flow and with their balance sheets.

The next topic is corporate covenants. With the elimination of our credit facility our only remaining corporate level covenants are with our Series C perpetual preferred and with our 4.6% exchangeable senior notes. As of December 31, 2009 we were in compliance with all covenants related to the Series C preferred stock and our senior notes. This is a very positive step. As you may recall, in Q3 2009 we did not meet the Series C leverage covenant. I should point out that unless operations do improve we may again fail one or both of the Series C financial covenants at some point during 2010.

I should also point out if we were to fail the covenants for four consecutive quarters a financial ratio violation would occur under the terms of the Series C which would trigger a 50 basis point per quarter increase in the dividend rate on that security as well as other control features until such time as the company went back into compliance with the Series C covenants. As we were in compliance with the Series C covenants as of the fourth quarter 2009 the first point at which a financial ratio violation may occur, if at all, would be in the first quarter of 2011.

The next topic is impairments and other charges. Before moving onto the detail of the Q4 impairments and other one-time charges I do want to point out that as we are now seeing market conditions stabilize and improve while we can give no assurances we do not expect to see meaningful impairment charges going forward.

There were three noteworthy charges in the fourth quarter. First, as previously disclosed in conjunction with our annual year-end impairment evaluation we recorded an impairment loss of $88.2 million in order to reduce the carrying values of six of the Mass Mutual portfolio hotels to their fair values as of December 31, 2009.

The six hotels along with two others are currently held for non-sale disposition in advance of being deeded back to Mass Mutual in satisfaction of their [subterfuted] debt. This is generally consistent with our prior disclosures related to this transaction.

Second, during the fourth quarter of 2009 our majority partner in our Doubletree Guest Suites Times Square joint venture recorded an impairment loss in order to reduce the carrying value of the hotel to its fair value. This impairment reduced the partner’s equity in the joint venture to a deficit. As the company has no guaranteed obligations to fund any losses of the partnership the company’s impairment loss was limited to its remaining $26 million investment in this partnership. This impairment charge was taken against equity and net losses of unconsolidated joint ventures, effectively reducing the company’s investment in the partnership to zero on its balance sheet as of December 31, 2009.

The final charge, in December of 2009 the company determined that a $5.6 million note received from the buyer of 13 hotels from the company in 2006 along with the related interest accrued on the note may be uncollectible. As such, the company recorded an allowance for bad debt of $5.6 million to reserve both the discounted note and the related interest receivable in full as of December 31, 2009.

My last topic is corporate expense benchmarks and metrics. While we are not giving guidance on our expectations for 2010 revenues and profits we would like to share with you some benchmarks for certain of our expenses. First of all, capital expenditures. During 2010 we expect to invest between $40-60 million in renovations of our existing portfolio. The final renovation investment amount will depend on a couple of pending decisions on the acceleration of certain projects.

If the positive operating trends we have seen in February continue we may accelerate rooms renovations for our Chicago Embassy Suites and our Renaissance D.C. which would push our 2010 CapEx program to the higher end of the range I just gave you. $30-40 million of our 2010 CapEx program will be routine with the balance of capital expended being ROI driven.

The next metric is interest expense. We expect cash interest expense to be down significantly in 2010 to approximately $64 million. Corporate overhead, we expect cash corporate overhead to be approximately $16.5-17 million in 2010. Finally, as we were active in the equity markets in 2009 our diluted share count for 2010 is expected to be 98 million.

To finish up my comments we are taking meaningful steps in our strategy to transform our company into an appropriately capitalized world class portfolio of well located, high quality, upper upscale hotel assets. 2009 was a challenging year and we are very proud of our accomplishments. More importantly we look forward to capitalizing on the impending recovery in 2010 and beyond from a position of strength.

Thank you. I will now turn the call back to Art to wrap up.

Arthur Buser

Thanks Ken. We are all looking forward to the next phase of this cycle and how. As I mentioned we are now seeing early signs of firming demand even as ongoing dysfunction in the property level mortgage markets might lead to attractive acquisition opportunities.

As a result, we believe we are moving to a phase of the cycle where well capitalized, proactive public companies may have opportunities to create significant value through acquisitions. We believe the backgrounds and skill set of the Sunstone team make us well qualified to capitalize on those emerging opportunities. Let me reiterate we continue to run our business with a single focus. We exist to outperform. It has been our strategy to create long-term stockholder value by capitalizing on cyclical opportunities and market inefficiencies.

As a result, we have made decisions which may have at the time appeared contrarian but which have proven to be correct. 2009 was a transformational year for Sunstone and we have set the bar even higher for ourselves in 2010.

Before I turn the call over to Q&A I would like to share with you how we would like you to think about Sunstone in 2010 and beyond. That is first, our company is poised for growth and outperformance from a position of strength. We have an exceptional high quality portfolio located in many of the top U.S. markets in addition to the growth potential already embedded in our existing portfolio we have approximately $400 million of cash providing fuel for growth.

With the conclusion of our secured debt restructuring program we can now focus more resources on acquisitions. I am very excited about the deals we are seeing and I am optimistic about our ability to succeed in acquiring hotels and overall Sunstone’s prospects for 2010 and beyond.

Two, we are comfortably leveraged to outperform. Over the past 18 months debt has been a four letter word, probably rightly so, as we experienced the bottoming of the cycle we see recovery with our 5.6% average fixed rate debt at an average term of over 7 years and no one is going to get those terms any time soon. Our equity is leveraged to provide out-sized performance in the recovery even before adding the growth from future acquisitions.

With the result of our secure debt restructuring program we can pay for 100% of our debt maturities for the next five years with about half of our cash on hand. There is not many companies of any industry that can say that. While the world continues to wring its hands over debt our advantage is being comfortable with an appropriate amount of leverage and therefore willing to acquire hotels that may carry debt.

Finally it is our belief that he who wants it the most and has the best talent wins. We have left the cycle where money was made in the hotel space by financial wizardry. We are now back in the space of back to basics where high performing companies not only have hotels in the best markets but have the best quality talent, in particular at the hotel level especially in sales. History has shown the best time to acquire talent and take market share is when the market bottoms.

While in the seminary I learned that the meek shall inherit the earth. I believe in the current hotel cycle the best and most aggressive talent will outperform. This underscores our key process and our company culture. With that I would like to open the call up to questions. Operator please go ahead.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Jeffrey Donnelly – Wells Fargo.

Jeffrey Donnelly – Wells Fargo

You talked about some of the markets that present some challenges in 2010. How are you thinking about New York City this year? There is a lot of supply growth in Manhattan that comes on the heels of a good chunk of supply growth last year. Do you think New York City is one of the markets that maybe could be a best performing this year or do you think it maybe has higher risk that will keep it maybe middle of the pack?

Arthur Buser

The former. While New York City is often treated as a market, the Times Square sub-market historically has been the highest performer in terms of occupancy. So it feels like as New York City recovers our Times Square markets are going to recover first and we see that in occupancy. While the overall market might not have robust numbers we are fairly bullish and particularly when you hear RevPAR numbers of up over 14% year-over-year in February, listen half a month doesn’t make a month nor a year, but it certainly seems like that sub-market within New York should be an outperformer.

Jeffrey Donnelly – Wells Fargo

A bit more broad, there is a lot of talk on the benefit of a mix shift and maybe driving rates this year. Can you hazard a guess on the percentage mix of your overall portfolio in 2009 between leisure and corporate and group and where you think those percentages would move to in 2010?

Arthur Buser

I am going to dish it to Mark. Historically we have been a 70% transient house, 30% group. I don’t think that is going to change much over the 200 basis points. Mark?

Mark Hoffman

What is going to happen is you are filling in a lot of the transient these days is filling in with discount transient as expected. We do expect to see improvement in our group portfolio but I don’t think it will make a meaningful shift because it takes a lot of percentage to change that. We should continue to see strengthening in group and what we hope to see is a lessening of the opaque’s and a lessening of the discounts in the transient sector.

Arthur Buser

What I would add to that is what we are bullish on is historical recovery show that companies with a lower percentage of group which might have been booked in the future at a lower rate are going to have higher [bade] in the recovery because you are filling up and the market is going to take the last rates available.

Jeffrey Donnelly – Wells Fargo

Maybe to ask that a bit differently, within that transient category the focus is the thinking may be if 2009 was full of airline crews, [low rated] online business, in 2010 you are going to see a swing back to a higher priced corporate traveler. Are you able to kind of talk a bit about that split between leisure and corporate in 2009 and your thinking in 2010? Or do you think that will be fairly constant too?

Kenneth Cruse

I am pretty sure that would be constant. I don’t have that number at my fingertips but we can call you back with that.

Jeffrey Donnelly – Wells Fargo

I recognize that you said you won’t take questions on this but I am going to try and ask them anyways. The three hotels you said you were contemplating holding back from Mass Mutual, I guess I’d think of that as in effect you are sort of repurchasing them from Mass Mutual?

Kenneth Cruse

Yes.

Jeffrey Donnelly – Wells Fargo

Are you going to at least give us some rough indication of the magnitude of the payment you are contemplating? Separate from Mass Mutual you did own and operate those last year, are you able to give us some indication on what those three hotels did in 2009 for EBITDA and whether or not they will be cash flow positive in 2010?

Kenneth Cruse

I wish I could. I would say stay tuned. Things are moving well with Mass Mutual so we expect to be in a position where we can report the final outcome of this transaction here in the next month or so.

Jeffrey Donnelly – Wells Fargo

I know you didn’t give specific earnings guidance but in some past quarters you have commented on what you have thought about analyst consensus EBITDA and earnings per share estimates. Do you have any thoughts on where consensus is standing today?

Kenneth Cruse

Why don’t we just be consistent with our last couple of calls and say we think that the analysts may prove to be overly optimistic this year although we are very early in the process.

Arthur Buser

Before you jump off, back to that 70%, of that 70 35% or about half is business traveler. Leisure is about 20%, government is about 5% and contract and other are 10%. We would expect that to be the same kind of 2009 to 2010.

Operator

The next question comes from the line of David Loeb – Robert W. Baird & Co., Inc.

David Loeb – Robert W. Baird & Co., Inc.

Before I bring up the forbidden topic I thought it was appropriate to comment Art on the [inaudible] by your comp. We don’t see very many CEOs who earned bonuses refusing them. I think your shareholders are appreciative of that.

Arthur Buser

Thanks.

David Loeb – Robert W. Baird & Co., Inc.

Of the three assets you are not going to talk about I also was thinking this was essentially a repurchase so I am glad Jeff brought that up. Can you talk a little about the accounting? Have you got all of the debt in the non-sale disposition line or have you parsed that out as well?

Kenneth Cruse

Good question. The way we have accounted for the Mass Mutual Portfolio is based on its contractually allocated debt amounts. So you will see about $60 million of debt that is on continuing debt related to the three assets. That is by no means reflective of the release price for these assets. If you look at the last page of the press release you will see the existing debt that is in place net of all debt associated with the secured debt restructuring program. That is the $1.145 billion total. Again if you look at the 10K you will see a total amount of basically $1.2 billion and again that is inclusive of the allocated loan amounts for those three, not the amount we are negotiating to pay as a release price.

David Loeb – Robert W. Baird & Co., Inc.

From a theoretical perspective how do you look at acquiring three hotels for example two in Rochester and one in L.A.? How would you look to value those three hotels? Is that negotiation or that analytical process any different because of the fact you are negotiating with Mass Mutual and I guess as part of that would you consider or would they consider leaving some debt in place?

Arthur Buser

Again, I can’t speak and shouldn’t speak for the lender but our approach to evaluating those assets is the same as if we were buying them. Looking at what RevPAR growths were and flow through and there is clearly as Ken pointed out synergy between those assets that has to be considered.

Kenneth Cruse

Our plan would be to own those assets with no debt in place at this point.

David Loeb – Robert W. Baird & Co., Inc.

What I am hearing if I am reading between the lines correctly is $60 million is the attributable debt. You will have to pay that down and probably pay something in excess of that in order to carve those out of the agreement. Is that fair?

Arthur Buser

That is fair.

David Loeb – Robert W. Baird & Co., Inc.

The note payable write off or the note receivable write off, was that taken through the corporate overhead line?

Kenneth Cruse

Yes.

David Loeb – Robert W. Baird & Co., Inc.

You talked about the 50% save through. When you start seeing hotels having positive revenue gains, first question is how much revenue gain does there need to be on a property by property basis for you to actually start seeing EBITDA grow. The second question is once you are in the growth phase what do you think the flow through would be from incremental revenues?

Arthur Buser

Historically to the first part of the question is a 2-3% increase in RevPAR is generally where you see some growth but then you take a look at our Renaissance D.C. that had a reduction in revenue and an increase in EBITDA. I can’t say that is true for all of the hotels but when you get the cost model right you would assume that is possible that other hotels with flat to shrinking revenue could see some EBITDA growth.

In terms of flow through going forward, I am going to give you the popular answer. It depends a lot of that on how much of that is rate and how much of that is occupancy. Let’s assume kind of 50/50 and so you would see flow throughs of 60% thereabout to 80%. Again it really depends a lot market by market and what the mix is. I wouldn’t hold anybody to that number because as we have seen hotel by hotel it varies a lot. In particular, this year we see increases in occupancy and declines in rate, it is going to be difficult to preserve margins.

David Loeb – Robert W. Baird & Co., Inc.

So looking ahead to 2011 and 2012 you think that as the mix changes to the equivalent rate and occupancy thereabout it should be over 50%?

Arthur Buser

One should expect that is the case. That is a reasonable expectation. It is certainly ours.

Operator

The next question comes from the line of Chris Woronka – Deutsche Bank Securities.

Chris Woronka – Deutsche Bank Securities

When we kind of drill down and read through some of the regional data we get weekly and monthly it looks as though the recovery is unfolding a little bit faster across the east coast relative to the west. You obviously have exposure to both coasts. I am curious as to what some of the dynamics driving that are. Also not that you have a ton of group accounts but do you think Las Vegas is impacting some of the other group markets?

Arthur Buser

To the last part of the question unsure. I have read a lot and we have heard a lot about kind of Vegas and it may keep rates down for awhile going forward. We don’t have anecdotal data from our hotels that they say we are losing group rooms particularly in D.C. and other markets where they are more locationally driven.

In terms of the markets, it is really a function of convention calendar and supply. So when I look at the west coast versus the east coast New York is clearly having a good run up. Then there is anomalies like D.C. with the inauguration. You had two college bowls in the L.A. area in January and so you had some hotels really outperform there. I think it is kind of early in the year where there is a lot of anomalies. I agree with you in one way. I do think we are going to come out of this where some markets are going to greatly outperform others and there is only so much you can do about that.

Chris Woronka – Deutsche Bank Securities

Shifting gears over to the asset side, it looks like we have picked up in the last couple of weeks in some situations banks are starting to actually get a little bit more aggressive in terms of pursuing action on these distressed assets. Is that your opinion as well? I heard you comment earlier about maybe not seeing quite as many opportunities as you initially thought. Where is the middle ground? What are some of the really big sticky issues on why things aren’t moving a little bit quicker than a lot of us might have thought?

Arthur Buser

Pricing optimism. I would ask you to take a poll of yourself, how do you feel today versus October or November and most people feel maybe though guarded a little more optimistic with that optimism. I think many people in the business community have already changed their RevPAR predictions for the rest of this year after just one month. If you take year one and you increase RevPAR by a couple of hundred basis points and flow that over four years you are going to have a pretty significant increase in calculated price. So I think it is the optimism that ebbs and flows and then works in a calculated value that is really the difference.

Operator

The next question comes from the line of William Crow – Raymond James.

William Crow – Raymond James

You are [inaudible], I think you pointed out in the call. Is this a better time to sell than to buy?

Arthur Buser

Based on the number of buyers allegedly lining up there we have asked ourselves the same question. If somebody was going to pay us significantly more than we thought an asset would be worth we should consider it. That doesn’t go unnoticed by us. We are not actively selling assets. We respond to inbound calls. I think you have caught on something that might be true here and there for some companies.

William Crow – Raymond James

I was interested in your comments about Chicago. You think it is a very good long-term market. Isn’t Chicago kind of on the precipice of potentially going through a secular change where the environment for conventions has gotten so harsh or unattractive they are losing auto conventions? I am trying to see what your longer term view is.

Arthur Buser

When I worked at the Chicago Hilton in 1994 it was similar. Chicago has kind of gone through these cycles where the leverage of whether the buying or selling community feels a little more robust then clearly the buying community now feels that they can push around some cities and maybe rightly so. I think San Francisco has a bit of this as well because it is an expensive city to operate in. So Chicago is at kind of a tipping point where there is a lot of shows, RSNA, NRA, the Restaurant Show and some others, the toy show that have been there forever that are bidding out in other cities. The question is are they doing that just to get the best deal or are they really intent on moving?

If some of those major shows pulled out of October and some of those even go around kind of the Thanksgiving period Chicago as a city would never be able to fill those and if you are figuring you are going to lost 10-15 nights that were otherwise 100% occupancy you could say that Chicago is forever lost three points in occupancy city wide or thereabouts. I would say there is that potential. But Chicago and other markets have been there before. I think Chicago is the sort of market that realizes that and is probably marshalling all of their resources on both sides of the aisle to find a way to make things work.

Operator

The next question comes from the line of David Katz – Oppenheimer & Co.

David Katz – Oppenheimer & Co.

In the commentary there was some notion that competition for portfolios is somewhat less than either for debt or I guess individual properties. Can you elaborate on that a bit as to why that is and why you are seeing that?

Arthur Buser

Two reasons, people are risk averse so they want to take on transactions that are smaller in scale. You look at the size of the funds and cash available no one is going to use all of that on one deal. Those are really the two drivers as to why people are looking smaller. We just left an environment where in 2005, 2006 and 2007 a lot of people said if it not to be [inaudible] I am not going to look at it. I think they learned the dangers of that. The last reason is larger deals probably by definition have a lot of debt and debt people have a great aversion to, particularly if the maturities are two years out how does one reserve sufficient cash or a deal with maturities two years out? If you hold that cash today it certainly is a drag on your IRR. I think those are the three reasons that really we notice make less competition.

David Katz – Oppenheimer & Co.

The $5.6 million note, have you told us who that is with?

Arthur Buser

No we haven’t.

David Katz – Oppenheimer & Co.

I assume that is intentional, that is not disclosable?

Arthur Buser

That is correct.

Kenneth Cruse

I take that back. In our release in 2006 we did reveal who that was with and it was with Trinity Hotel Investors.

Operator

The next question comes from the line of Mike Salinsky – RBC Capital Markets.

Mike Salinsky – RBC Capital Markets

On the line of credit you terminated, how close were you in proximity to the covenants on that? It sounds like you are freeing up substantial capacity by terminating that. I just wondered how much capacity and how close you were?

Kenneth Cruse

Good question. We do expect that during the course of 2010 we would have bumped up against one or more of the covenants in the facility. There was a one-time fixed charge coverage ratio limit that was probably going to see the company bumping into that at some point.

Mike Salinsky – RBC Capital Markets

In the press release you provide a good amount of detail on the portfolio assets of Mass Mutual. I am just curious as to what the margins actually would look like if you go back and exclude that from the portfolio?

Kenneth Cruse

We have a pro forma analysis for you that shows the EBITDA after the portfolio. This is in the back of the press release. Look at page 11.

Mike Salinsky – RBC Capital Markets

I will check on that. Switching over to the Doubletree, with the impairment during the quarter is that hotel still compliant with its debt covenants then? Also, when is the debt maturity on that?

Kenneth Cruse

The hotel has about $300 million worth of secured debt in place. It is in a cash sweep so the partnership is not taking money out. There are no covenants beyond that. It is a sweeping loan that matures in 2012.

Mike Salinsky – RBC Capital Markets

It sounds like you are pretty much done with the repositioning of the balance sheet. You seem to have a pretty good handle on where your operations are. Why not provide guidance at this point? What is the additional things that could add a lot of volatility?

Arthur Buser

Our belief is we should provide guidance when we are getting numbers we can rely on. In December we sat around and had our 2010 budget presentations. In the vast majority of hotels I think all but one beat their budgets for January. So we are continuing to see here we aren’t getting numbers we can rely on. I think when we get numbers we can rely on we are going to do that. I think the variance to budget was double digit, maybe 15% and that was only a month later. So I think it doesn’t serve a lot of purpose to give you numbers and a month later say the view has changed.

Here is my anecdotal comment for this, 1.5 years ago as things started to drop off and Ken personally noticed this, people were overly optimistic and operations were well below expectations. Now that we have had over a year run down people are more pessimistic and they are projecting off a tangent and so they are still somewhat pessimistic in their view while their operations get better. Our jobs as owners is to push them from a revenue standpoint to say listen we think it is going to be better, start to yield towards higher occupancy and higher rates. So when we get numbers we can rely on and are accurate we will share those.

Operator

The next question comes from the line of Bryan Mahr – Collins Stewart.

Bryan Mahr – Collins Stewart

The credit facility, what was the breakage cost on that?

Kenneth Cruse

We are expensing out $1.6 million. Those are deferred financing charges though. Those are costs associated with the initiation of the facility. There is really no cost to terminate the facility.

Bryan Mahr – Collins Stewart

On the Doubletree and I don’t want to beat a dead horse here but can you tell us what the new valuation is on that property according to the partner?

Kenneth Cruse

No we cannot.

Bryan Mahr – Collins Stewart

Can you tell us what the initial investment by Sunstone in the property was?

Kenneth Cruse

Yes, we made a $40 million investment in the deal. Our investment prior to the write down was $26 million so we took…that was after money we had taken out.

Bryan Mahr – Collins Stewart

When was the $40 million made?

Kenneth Cruse

2006.

Bryan Mahr – Collins Stewart

Is there any chance you could lose the hotel like it could just be taken away?

Kenneth Cruse

The Doubletree Times Square?

Bryan Mahr – Collins Stewart

Yes.

Kenneth Cruse

As we have noted, we have written our investment to zero in the partnership.

Bryan Mahr – Collins Stewart

But you had hedged further upside if everything improves. So there is upside there and there is no real downside. I want to see if there is any potential upside if you lose the note?

Kenneth Cruse

You can take the fact that we have written it down to zero to mean there is a chance the hotel would go away. For our purposes it has gone away. I think you can also take there is a potential that as you said this hotel could revalue and you could see a nice recovery in the New York market and there could actually be value there.

Operator

The next question comes from the line of Ryan Meliker – Morgan Stanley.

Ryan Meliker – Morgan Stanley

Getting back to market mix, can you give us any color on the percentage of your group demand or what you are expecting for 2010 that is currently on the books and what that rate is relative to 2009?

Arthur Buser

In terms of what the pace is?

Ryan Meliker – Morgan Stanley

Do you have 70% of your group on the books right now. What are you looking for in 2010 on the books and is that rate at the same level as 2009?

Kenneth Cruse

Right now for group, pace is down 18% with 14% reduction in occupied rooms and a 4% reduction in rate but what we need to caution you with is the rooms that were on the books that we are comping against for last year are what we would characterize as much softer. We saw a great deal of attrition against the rooms that were on the books last year as the market continued to be soft or maybe it just didn’t materialize the way they were booked. This year we think the quality of the bookings is considerably better.

Arthur Buser

I would add to that generally we turn the year with over half of the business on the books. We were in a similar place but as we pointed out on the call the activity in January was 30% higher than the previous January. So it seems like the amount of the bookings are increasing and how that is to be played out is to be seen.

Ryan Meliker – Morgan Stanley

Along those lines, maybe I am wrong but if I am just correct me, you don’t seem to be in a deteriorating rate environment and the group bookings that would be occurring now would probably be coming in at rates lower than the ones that were booked over the past year or two. If that is correct, looking at January was a very strong month for group bookings for you guys, how much of a discount in January did group bookings get versus what you have on the books right now?

Arthur Buser

It varies greatly. It varies a lot by time as well. 4% overall is where the discount in terms of rate.

Operator

The next question comes from the line of David Loeb – Robert W. Baird & Co., Inc.

David Loeb – Robert W. Baird & Co., Inc.

In that original release on the Times Square asset you had mentioned a $28.5 million mezzanine loan that was part of the initial $68.5 million investment. Was that also either paid off or refi’d out or refi’d in to debt?

Kenneth Cruse

Actually we sold that for a profit shortly after we closed on the deal.

David Loeb – Robert W. Baird & Co., Inc.

So the net investment was just the $40 million preferred equity investment and you pulled some cash out of that as well?

Kenneth Cruse

Yes.

Operator

I am showing no further questions in the queue. Please continue.

Arthur Buser

We appreciate everybody’s time today as well as your continued interest. It looks like about 105 people logged in today. We look forward to speaking with you at our mid-quarter update call in April and a variety of conferences we will be attending in the next month. Thank you again for your support of Sunstone.

Operator

Ladies and gentlemen this concludes the Sunstone Hotel Investors fourth quarter 2009 earnings call. You may now disconnect. Thank you for your participation.

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