Item 4. Controls and Procedures
Item 4. Controls and Procedures
As of the end of the period covered by this Quarterly Report on Form 10-Q, our management carried out an evaluation, under the supervision and with the participation of our President and Chief Executive Officer and our Chief Financial Officer and Treasurer, of the effectiveness of our disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our President and Chief Executive Officer and our Chief Financial Officer and Treasurer concluded that our disclosure controls and procedures are effective.
There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Warning Concerning Forward-Looking Statements
This Quarterly Report on Form 10-Q contains statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. Whenever we use words such as “believe,” “expect”, “anticipate,” “intend,” “plan,” “estimate,” “will,” “may” and negatives or derivatives of these or similar expressions, we are making forward-looking statements. These forward-looking statements are based upon our present intent, beliefs or expectations, but forward-looking statements are not guaranteed to occur and may not occur. Forward-looking statements in this Quarterly Report on Form 10-Q relate to various aspects of our business, including:
• The duration and severity of the economic downturn resulting from the COVID-19 pandemic and its impact on us and our operators and tenants,
• The implications of our termination of our IHG and Marriott agreements and our expectations about the ability of Sonesta to operate the hotels that may be transferred and rebranded to it from Wyndham, IHG and Marriott,
• Our expectations about our ability and the ability of our operators and tenants to operate throughout the COVID-19 pandemic and withstand the resulting economic downturn,
• The likelihood and extent to which our operators and tenants will be negatively impacted by the COVID-19 pandemic and its aftermath and their abilities and willingness to pay the contractual amounts of returns, rents or other obligations due to us,
• Our ability to maintain sufficient liquidity during the duration of the COVID-19 pandemic and resulting economic downturn,
• Potential defaults on, or non-renewal of, leases by our tenants,
• Decreased rental rates or increased vacancies,
• Our sales and acquisitions of properties,
• Our policies and plans regarding investments, financings and dispositions,
• Our ability to pay interest on and principal of our debt,
• Our ability to pay distributions to our shareholders and to sustain the amount of such distributions,
• Our ability to raise or appropriately balance the use of debt or equity capital,
• Our intent to make improvements to certain of our properties and the success of our hotel renovations,
• Our ability to engage and retain qualified managers and tenants for our hotels and net lease properties on satisfactory terms,
• Our ability to diversify our sources of rents and returns that improve the security of our cash flows,
• The future availability of borrowings under our revolving credit facility,
• Our credit ratings,
• Our expectation that we benefit from our relationships with RMR LLC and Sonesta,
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• Our qualification for taxation as a REIT,
• Changes in federal or state tax laws, and
• Other matters.
Our actual results may differ materially from those contained in or implied by our forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other factors, some of which are beyond our control. Risks, uncertainties and other factors that could have a material adverse effect on our forward-looking statements and upon our business, results of operations, financial condition, FFO, Normalized FFO, cash flows, liquidity and prospects include, but are not limited to:
• The impact of conditions in the economy, including the COVID-19 pandemic and the resulting economic downturn, and the capital markets on us and our operators and tenants,
• Competition within the real estate, hotel, transportation and travel center and other industries in which our tenants operate, particularly in those markets in which our properties are located,
• Compliance with, and changes to, federal, state and local laws and regulations, accounting rules, tax laws and similar matters,
• Limitations imposed on our business and our ability to satisfy complex rules in order for us to maintain our qualification for taxation as a REIT for U.S. federal income tax purposes,
• Acts of terrorism, outbreaks of pandemics, including the COVID-19 pandemic, or other manmade or natural disasters beyond our control, and
• Actual and potential conflicts of interest with our related parties, including our Managing Trustees, TA, Sonesta, RMR LLC, and others affiliated with them.
For example:
• Our ability to make future distributions to our shareholders and to make payments of principal and interest on our indebtedness depends upon a number of factors, including our future earnings, the capital costs we incur to acquire and maintain our properties and our working capital requirements. We may be unable to pay our debt obligations or to increase or maintain our current rate of distributions on our common shares and future distributions may be reduced or eliminated,
• We fully utilized the security deposit we held from IHG and IHG has defaulted on its payments to us. We fully utilized the security deposit we held and exhausted the $30.0 million limited guarantee to cover shortfalls in hotel cash flows available to pay the minimum returns due to us under the Marriott agreement. Under the Marriott agreement, if the security deposit and guaranty have been depleted, Marriott is required to fund shortfalls up to 80% of the minimum returns due to us to avoid termination. Marriott has not funded any of the required shortfalls in our minimum returns and we have terminated our Marriott agreement effective January 31, 2021. We expect to rebrand to Sonesta 102 of the 103 hotels under the IHG agreement and the 98 hotels, to the extent not sold, under the Marriott agreement. Transitioning hotels to another operator is disruptive to their operations and requires significant capital investments,
• We expect Sonesta to operate 257 of our 329 hotels, which constituted approximately 47.8% of our total historical real estate investments as of September 30, 2020, after we rebrand certain of our Wyndham, Marriott and IHG hotels to Sonesta in the fourth quarter of 2020 and the first quarter of 2021. Sonesta is a small privately held company with less resources and scale compared to Wyndham, IHG and Marriott. If Sonesta were to fail to provide quality services and amenities or to maintain a quality brand, our income from these properties may be adversely affected. There can be no assurance that Sonesta can operate the hotels rebranded from Wyndham, IHG and Marriott as effectively or for returns at levels that could otherwise be achieved by Wyndham, IHG or Marriott. Further, if we were required to replace Sonesta, we could experience significant disruptions in operations at the applicable properties, which could reduce our income and cash flows from, and the value of, those properties. We have no guarantee or security deposit under our Sonesta agreements. Accordingly, we may receive amounts from Sonesta that are less than the contractual minimum returns stated in our agreements with Sonesta or we may be requested to fund losses for our Sonesta hotels. Further, we own a 34% interest in Sonesta. If Sonesta experiences losses, or requires additional capital, Sonesta may request we fund our share through the contribution of additional capital.
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• We cannot be sure of the future financial performance of our properties and whether such performance will cover our minimum returns and rents, or regarding our managers’, tenants’ or guarantors’ future actions or their abilities or willingness to pay minimum returns and rents owed to us. If other operators do not honor their obligations, we may seek to terminate our arrangements with them or other actions to enforce our rights,
• Statements about improving trends experienced during the course of the 2020 third quarter in the level of requests for rent deferments or other relief and improving hotel occupancies may imply that the positive trend may continue. However, COVID-19 infections have recently increased in large parts of the United States and the U.S. economy is experiencing continued challenges. These positive trends could reverse and further deteriorate as a result,
• We have recently renovated certain hotels and are currently renovating additional hotels. Operating results at our hotels may decline as a result of having rooms out of service or other disruptions during renovations. Also, while our funding of these capital projects will cause our contractual minimum returns to increase, the hotels’ operating results may not increase or may not increase to the extent that the minimum returns increase. Accordingly, coverage of our minimum returns at these hotels may remain depressed for an extended period,
• If general economic activity in the country declines, the operating results of certain of our properties may decline, the financial results of our managers and our tenants may suffer and these managers and tenants may be unable to pay our returns or rents. Also, depressed operating results from our properties for extended periods may result in the operators of some or all of our properties becoming unable or unwilling to meet their obligations or their guarantees and security deposits we hold may be exhausted,
• Hotel and other competitive forms of temporary lodging supply (for example, Airbnb) have been increasing and may affect our hotel operators’ ability to grow ADR and occupancy, and ADR and occupancy could decline due to increased competition which may cause our hotel operators to become unable to pay our returns or rents,
• If the current level of commercial activity in the country declines including as a result of the current economic downturn in response to the COVID-19 pandemic, if the price of diesel fuel increases significantly, if fuel conservation measures are increased, if freight business is directed away from trucking, if TA is unable to effectively compete or operate its business, if fuel efficiencies, the use of alternative fuels or transportation technologies reduce the demand for products and services TA sells or for various other reasons, TA may become unable to pay current and deferred rents due to us,
• Cash flows generated by certain tenant businesses may not be sufficient for a tenant to meet its obligations to us. Our tenants’ failures to successfully operate their businesses could materially and adversely affect us,
• Our ability to grow our business and increase our distributions depends in large part upon our ability to buy properties that generate returns or can be leased for rents which exceed our operating and capital costs. We may be unable to identify properties that we want to acquire and we may fail to reach agreement with the sellers and complete the purchases of any properties we do want to acquire. In addition, any properties we may acquire may not generate returns or rents which exceed our operating and capital costs,
• We believe that our portfolio agreements include diverse groups of properties. Our portfolio agreements may not increase the security of our cash flows or increase the likelihood our agreements will be renewed as we expect,
• We were in the process of marketing certain hotels for sale in order to reduce our leverage. Current market conditions have forced us to suspend efforts to sell certain of these properties. We may not complete the sales of any additional hotels we plan to sell, and we may determine to sell fewer, additional or other assets than those we may target for sale. Also, we may sell assets at prices that are less than we expect and less than their carrying values and we may incur losses on these sales or with respect to these assets, or may not ultimately use any proceeds we may receive to reduce debt leverage,
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• At September 30, 2020, we had $47,847 of cash and cash equivalents, $919,914 available under our $1,000,000 revolving credit facility, guarantees covering some of our minimum returns and rents and executed on $74,735 of property sales and are under agreement to sell additional properties for an aggregate of $218,800. These statements may imply that we have sufficient working capital and liquidity to meet our obligations for the next twelve months. We used $400,000 of the availability under our revolving credit facility to repay our outstanding term loan on November 5, 2020. Certain tenants have requested and we have granted certain rent relief and these requests could increase. In addition, our managers and tenants may not be able to fund minimum returns and rents due to us from operating our properties or from other resources. In the past and currently, certain of our tenants and managers have in fact not paid the minimum amounts due to us from their operations of our leased or managed properties. Also, certain of the security deposits and guarantees we have to cover any such shortfalls are limited in amount and duration, and any security deposits we apply for such shortfalls do not result in additional cash flows to us. Our properties require, and we have agreed to provide, significant funding for capital improvements, renovations and other matters. Accordingly, we may not have sufficient working capital or liquidity,
• We may be unable to repay our debt obligations when they become due,
• We intend to conduct our business activities in a manner that will afford us reasonable access to capital for investment and financing activities. However, we may not succeed in this regard and we may not have reasonable access to capital, including due to the COVID-19 pandemic and the resulting economic downturn. If challenging market conditions, including due to the COVID-19 pandemic and the resulting economic downturn, last for a long period or worsen, our operators and tenants may experience liquidity constraints and as a result may be unable or unwilling to pay returns or rents to us and our ability to operate our business effectively may be challenged,
• Continued availability of borrowings under our revolving credit facility is subject to our satisfying certain financial covenants and other credit facility conditions. If our operating results and financial condition are significantly negatively impacted by the current economic conditions or otherwise, we may fail to satisfy covenants and conditions under our credit agreement or fail to satisfy our public debt covenants. We expect the ratio of income available from debt service to debt service coverage could fall below the 1.5x requirement under our public debt covenants in the first quarter of 2021. We will not be allowed to incur additional debt while this ratio is below 1.5x.
• Actual costs under our revolving credit facility or other floating rate debt will be higher than LIBOR plus a premium because of fees and expenses associated with such debt,
• The premiums used to determine the interest rate and facility fee payable on our revolving credit facility are based on our credit ratings. Changes in our credit ratings may cause the interest and fees we pay to increase,
• We have the option to extend the maturity date of our revolving credit facility upon payment of a fee and meeting other conditions; however, the applicable conditions may not be met,
• The business and property management agreements between us and RMR LLC have continuing 20 year terms. However, those agreements permit early termination in certain circumstances. Accordingly, we cannot be sure that these agreements will remain in effect for continuing 20 year terms, and
• We believe that our relationships with our related parties, including RMR LLC, RMR Inc., TA, Sonesta and others affiliated with them may benefit us and provide us with competitive advantages in operating and growing our business. However, the advantages we believe we may realize from these relationships may not materialize.
Currently unexpected results could occur due to many different circumstances, some of which are beyond our control, such as pandemics, acts of terrorism, natural disasters, changes in our managers’ or tenants’ revenues or expenses, changes in our managers’ or tenants’ financial conditions, the market demand for hotel rooms or the goods and services provided at our properties or changes in capital markets or the economy generally.
The information contained elsewhere in this Quarterly Report on Form 10-Q and in our 2019 Annual Report or in our other filings with the SEC, including under the caption “Risk Factors,” or incorporated herein or therein, identifies other important factors that could cause differences from our forward-looking statements. Our filings with the SEC are available on the SEC’s website at www.sec.gov.
You should not place undue reliance upon our forward-looking statements.
Except as required by law, we do not intend to update or change any forward-looking statements as a result of new information, future events or otherwise.
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Statement Concerning Limited Liability
The Amended and Restated Declaration of Trust establishing Service Properties Trust dated August 21, 1995, as amended and supplemented, as filed with the State Department of Assessments and Taxation of Maryland, provides that no trustee, officer, shareholder, employee or agent of Service Properties Trust shall be held to any personal liability, jointly or severally, for any obligation of, or claim against, Service Properties Trust. All persons dealing with Service Properties Trust in any way shall look only to the assets of Service Properties Trust for the payment of any sum or the performance of any obligation.
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Part II Other Information