NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1. Business
Organization
Watermark Lodging Trust, Inc. (“WLT” or the “Company”), is a self-managed, publicly owned, non-traded real estate investment trust (“REIT”) that, together with its consolidated subsidiaries, invests in, manages and seeks to enhance the value of, interests in lodging and lodging-related properties in the United States.
Substantially all of our assets and liabilities are held by, and all of our operations are conducted through CWI 2 OP, LP (the “Operating Partnership”) and we are a general partner and a limited partner of, and owned a 99.0% capital interest in, the Operating Partnership, as of March 31, 2022. Watermark Capital Partners, LLC (“Watermark Capital”), which is 100% owned by Mr. Michael G. Medzigian, our Chief Executive Officer, held the remaining 1.0% in the Operating Partnership as of March 31, 2022.
We held ownership interests in 25 hotels as of March 31, 2022, including 24 hotels that we consolidated (“Consolidated Hotels”) and one hotel that we recorded as an equity investment (“Unconsolidated Hotels”).
Proposed Merger
On May 6, 2022, the Company, along with the Operating Partnership, entered into a definitive merger agreement with affiliates of private real estate funds managed by Brookfield (“Brookfield”) under which Brookfield will acquire all of the outstanding shares of common stock of the Company in an all-cash transaction. Completion of the transaction is subject to certain closing conditions, including the approval of our shareholders. The proposed transaction is expected to close in the fourth quarter of 2022. See Note 13 for further information.
COVID-19, Management’s Plans and Liquidity
The COVID-19 pandemic has had a material adverse effect on our business, results of operations, financial condition and cash flows and will continue to do so for the reasonably foreseeable future. As of May 12, 2022, all of our hotels are open but many are operating at significantly reduced levels of occupancy and staffing. Although results improved relative to 2021, we cannot estimate with certainty when travel demand will fully recover or how new variants of COVID-19 could impact recovery. We have generally seen improving demand at our properties as government-imposed restrictions and limitations on travel and large gatherings have loosened and as the vaccines have become more widely available. We expect the recovery to continue to occur unevenly across our portfolio, with hotels that cater to business travel recovering more slowly than resort properties. Governmental and business efforts to encourage or mandate vaccinations, and public adoption rates of vaccines, have impacted and continue to impact the recovery from the COVID-19 pandemic and have had and may continue to have disruptive effects on certain segments of the labor market. Individual ability or desire to travel and corporate travel policies will continue to be impacted by the COVID-19 pandemic and affect the recovery of our properties. The ultimate severity and duration of the COVID-19 pandemic and its effects, and the emergence of variants, are uncertain, including whether COVID-19 will become
Notes to Consolidated Financial Statements (Unaudited)
endemic or cyclical in nature. Given these uncertainties, we cannot estimate with reasonable certainty the impact on our business, financial condition or near- or long-term financial or operational results.
As of March 31, 2022, we had cash and cash equivalents of $178.7 million. As of March 31, 2022, the mortgage loans for our Consolidated Hotels had an aggregate principal balance totaling $2.0 billion outstanding, all of which is mortgage indebtedness and is generally non-recourse, subject to customary non-recourse carve-outs, except that we have provided certain lenders with limited corporate guaranties aggregating $25.0 million for items such as taxes, deferred debt service and amounts drawn from furniture, fixtures and equipment reserves to pay expenses, in connection with loan modification agreements. We have continued to work with our lenders to address loans with near-term mortgage maturities and have refinanced or extended the maturity date of four Consolidated Hotel mortgage loans, aggregating $285.4 million of indebtedness, during the three months ended March 31, 2022. Of the $2.0 billion aggregate principal balance indebtedness outstanding as of March 31, 2022, approximately $1.1 billion is scheduled to mature during the 12 months after the date of this Report, which included a total of $251.9 million that has been refinanced subsequent to March 31, 2022. If the Company is unable to repay, refinance or extend maturing mortgage loans, we may choose to market these assets for sale or the lenders may declare events of default and seek to foreclose on the underlying hotels or we may also seek to surrender properties back to the lender.
We cannot predict with reasonable certainty when our hotels will return to normalized levels of operations after the effects of the COVID-19 pandemic subside or whether hotels will be forced to shut down operations or impose additional restrictions due to a resurgence of COVID-19 cases in the future. Therefore, as a consequence of these unprecedented trends resulting from the impact of the COVID-19 pandemic, we are unable to estimate future financial performance with reasonable certainty.
Note 2. Basis of Presentation
Basis of Presentation
The unaudited consolidated financial statements and related notes have been prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and in conformity with the rules and regulations of the SEC applicable to financial information. The unaudited financial statements include all adjustments that are necessary, in the opinion of management, to fairly state the consolidated balance sheets, statements of operations, statements of comprehensive loss, statements of equity and statements of cash flows.
Our interim consolidated financial statements should be read in conjunction with our audited consolidated financial statements of and accompanying notes for the year ended December 31, 2021, as certain disclosures that would substantially duplicate those contained in the audited consolidated financial statements have not been included in this Report. Operating results for interim periods are not necessarily indicative of operating results for an entire year.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts and the disclosure of contingent amounts in our consolidated financial statements and the accompanying notes. Actual results could differ from those estimates.
Basis of Consolidation
Our consolidated financial statements reflect all of our accounts, including those of our controlled subsidiaries. The portions of equity in consolidated subsidiaries that are not attributable, directly or indirectly, to us are presented as noncontrolling interests. All significant intercompany accounts and transactions have been eliminated.
When we obtain an economic interest in an entity, we evaluate the entity to determine if it should be deemed a variable interest entity (“VIE”), and, if so, whether we are the primary beneficiary and are therefore required to consolidate the entity. There have been no significant changes in our VIE policies from what was disclosed in the 2021 Annual Report.
Notes to Consolidated Financial Statements (Unaudited)
As of both March 31, 2022 and December 31, 2021, we considered one entity to be a VIE, which we consolidated as we are considered the primary beneficiary. The following table presents a summary of selected financial data of the consolidated VIE included in the consolidated balance sheets (in thousands):
| | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
Net investments in hotels | $ | 263,692 | | | $ | 264,984 | |
Intangible assets, net | 28,655 | | | 28,819 | |
Total assets | 324,555 | | | 315,088 | |
| | | |
Non-recourse debt, net | $ | 177,450 | | | $ | 178,029 | |
Total liabilities | 202,439 | | | 201,557 | |
Cash, Cash Equivalents and Restricted Cash
The following table provides a reconciliation of cash and cash equivalents and restricted cash reported within the consolidated balance sheets to the consolidated statements of cash flows (in thousands):
| | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
Cash and cash equivalents | $ | 178,705 | | | $ | 249,478 | |
Restricted cash | 106,032 | | | 99,000 | |
Total cash and cash equivalents and restricted cash | $ | 284,737 | | | $ | 348,478 | |
Note 3. Net Investments in Hotels
Net investments in hotels are summarized as follows (in thousands):
| | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
Buildings | $ | 2,001,119 | | | $ | 2,002,614 | |
Land | 574,648 | | | 574,648 | |
Building and site improvements | 188,228 | | | 187,019 | |
Furniture, fixtures and equipment | 166,537 | | | 166,316 | |
Construction in progress | 32,060 | | | 26,332 | |
Hotels, at cost | 2,962,592 | | | 2,956,929 | |
Less: Accumulated depreciation | (407,282) | | | (383,337) | |
Net investments in hotels | $ | 2,555,310 | | | $ | 2,573,592 | |
During the three months ended March 31, 2022 and 2021, we retired fully depreciated furniture, fixtures and equipment aggregating $1.0 million and $5.9 million, respectively. During the three months ended March 31, 2022 and 2021, we recorded net write-offs of fixed assets resulting from property damage insurance claims of $1.6 million and $0.1 million, respectively. Depreciation expense was $25.3 million and $31.1 million for the three months ended March 31, 2022 and 2021, respectively.
As of March 31, 2022 and December 31, 2021, accrued capital expenditures were $1.8 million and $1.0 million, respectively, representing non-cash investing activity.
Note 4. Equity Investments in Real Estate
As of March 31, 2022, we owned an equity interest in one Unconsolidated Hotel with an unrelated third party. We did not control the venture that owns this hotel, but we exercised significant influence over it. We accounted for this investment under the equity method of accounting (i.e., at cost, increased or decreased by our share of earnings or losses, less distributions, plus contributions and other adjustments required by equity method accounting, such as basis differences from acquisition costs paid to our former advisor that we incur and other-than-temporary impairment charges, if any).
Notes to Consolidated Financial Statements (Unaudited)
Under the conventional approach of accounting for equity method investments, an investor applies its percentage ownership interest to the venture’s net income or loss to determine the investor’s share of the earnings or losses of the venture. This approach is inappropriate if the venture’s capital structure gives different rights and priorities to its investors. Therefore, we followed the hypothetical liquidation at book value (“HLBV”) method in determining our share of the ventures’ earnings or losses for the reporting period as this method better reflects our claim on the ventures’ book value at the end of each reporting period. Earnings for our equity method investments were recognized in accordance with each respective investment agreement and, where applicable, based upon the allocation of the investment’s net assets at book value as if the investment was hypothetically liquidated at the end of each reporting period.
The following table sets forth our ownership interest in our equity investment in real estate and its carrying value. The carrying value of this venture is affected by the timing and nature of distributions (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Unconsolidated Hotels | | State | | Number of Rooms | | % Owned | | Hotel Type | | Carrying Value at |
| | | | | March 31, 2022 | | December 31, 2021 |
Ritz-Carlton Philadelphia Venture (a) | | PA | | 301 | | | 60.0 | % | | Full-service | | $ | 11,425 | | | $ | 12,705 | |
___________
(a)We contributed $0.4 million to this investment during the three months ended March 31, 2022.
The following table sets forth our share of equity in losses from our Unconsolidated Hotels, which is based on the HLBV model, as well as certain amortization adjustments related to basis differentials from acquisitions of investments (in thousands):
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | | |
Unconsolidated Hotels | | 2022 | | 2021 | | | | |
Ritz-Carlton Philadelphia Venture | | $ | (1,670) | | | $ | (3,063) | | | | | |
Hyatt Centric French Quarter Venture (a) | | — | | | (857) | | | | | |
Total equity in losses of equity method investments in real estate, net | | $ | (1,670) | | | $ | (3,920) | | | | | |
___________
(a) On April 6, 2021, we acquired the remaining 20% interest in the Hyatt Centric French Quarter Venture from an unaffiliated third party. Upon completion of the acquisition, the Company owns 100% of this hotel and consolidates its real estate interest in this hotel therefore these amounts represent the equity in losses prior to the acquisition.
No other-than-temporary impairment charges were recognized during the three months ended March 31, 2022 or 2021.
As of March 31, 2022 and December 31, 2021, the unamortized basis difference on our equity investment was $1.4 million and $1.5 million, respectively. Net amortization of basis differences reduced the carrying values of our equity investments by less than $0.1 million during both the three months ended March 31, 2022 and 2021.
Note 5. Intangible Assets
Intangible assets are summarized as follows (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | March 31, 2022 | | December 31, 2021 |
| Amortization Period (Years) | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount |
Finite-Lived Intangible Assets | | | | | | | | | | | | | |
Villa/condo rental programs | 45 - 55 | | $ | 72,400 | | | $ | (11,411) | | | $ | 60,989 | | | $ | 72,400 | | | $ | (11,037) | | | $ | 61,363 | |
Trade name | 8 | | 9,400 | | | (2,314) | | | 7,086 | | | 9,400 | | | (2,024) | | | 7,376 | |
Other intangible assets | 5 - 17 | | 900 | | | (209) | | | 691 | | | 1,013 | | | (288) | | | 725 | |
Total intangible assets, net | | | $ | 82,700 | | | $ | (13,934) | | | $ | 68,766 | | | $ | 82,813 | | | $ | (13,349) | | | $ | 69,464 | |
Net amortization of intangibles was $0.7 million and $0.8 million for the three months ended March 31, 2022 and 2021, respectively. Amortization of intangibles is included in Depreciation and amortization and Property tax, insurance, rent and other in the consolidated financial statements.
Notes to Consolidated Financial Statements (Unaudited)
Note 6. Fair Value Measurements
The fair value of an asset is defined as the exit price, which is the amount that would either be received when an asset is sold or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The guidance establishes a three-tier fair value hierarchy based on the inputs used in measuring fair value. These tiers are: Level 1, for which quoted market prices for identical instruments are available in active markets, such as money market funds, equity securities and U.S. Treasury securities; Level 2, for which there are inputs other than quoted prices included within Level 1 that are observable for the instrument, such as certain derivative instruments, including interest rate caps and swaps; and Level 3, for securities that do not fall into Level 1 or Level 2 and for which little or no market data exists, therefore requiring us to develop our own assumptions.
Items Measured at Fair Value on a Recurring Basis
Derivative Assets and Liabilities — Our derivative assets, which are included in Other assets in the consolidated financial statements, are comprised of interest rate caps and our derivative liabilities, which are included in Accounts payable, accrued expenses and other liabilities in the consolidated financial statements, are comprised of interest rate swaps (Note 7).
The valuation of our derivative instruments is determined using a discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, as well as observable market-based inputs, including interest rate curves and implied volatilities. We incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative instruments for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings and thresholds. These derivative instruments were classified as Level 2 as these instruments are custom, over-the-counter contracts with various bank counterparties that are not traded in an active market.
We did not have any transfers into or out of Level 1, Level 2 and Level 3 category of measurements during the three months ended March 31, 2022 or 2021. Gains and losses (realized and unrealized) recognized on items measured at fair value on a recurring basis included in earnings are reported in Other income and (expense) in the consolidated financial statements.
Our non-recourse debt, net which we have classified as Level 3, had a carrying value of $2.0 billion as of both March 31, 2022 and December 31, 2021, and an estimated fair value of $2.0 billion as of both March 31, 2022 and December 31, 2021. We determined the estimated fair value using a discounted cash flow model with rates that take into account the interest rate risk. We also considered the value of the underlying collateral, taking into account the quality of the collateral and the then-current interest rate.
Our Series B preferred stock, which we have classified as Level 3, had a carrying value of $204.4 million and $201.7 million as of March 31, 2022 and December 31, 2021, respectively, and an estimated fair value of $242.8 million and $247.0 million as of March 31, 2022 and December 31, 2021, respectively.
Our Series A preferred stock, which we had classified as Level 3, had a carrying value of $55.1 million as of December 31, 2021 and an estimated fair value of $65.0 million as of December 31, 2021. On January 25, 2022, the Company redeemed the 1,300,000 shares of Series A Preferred Stock at the liquidation preference of $50.00 per share for a total of $65.0 million. See Note 12 for further discussion.
See Note 12 for information on the measurement of fair value of the Series A and Series B Preferred Stock and Warrants.
We estimated that our other financial assets and liabilities had fair values that approximated their carrying values as of both March 31, 2022 and December 31, 2021.
Notes to Consolidated Financial Statements (Unaudited)
Items Measured at Fair Value on a Non-Recurring Basis (Including Impairment Charges)
We periodically assess whether there are any indicators that the value of our real estate investments may be impaired or that their carrying value may not be recoverable. Where the undiscounted cash flows for an asset are less than the asset’s carrying value when considering and evaluating the various alternative courses of action that may occur, we recognize an impairment charge to reduce the carrying value of the asset to its estimated fair value. Further, when we classify an asset as held for sale, we carry the asset at the lower of its current carrying value or its fair value, less estimated cost to sell. We did not recognize any impairment charges during the three months ended March 31, 2022 or 2021.
Note 7. Risk Management and Use of Derivative Financial Instruments
Risk Management
In the normal course of our ongoing business operations, we encounter economic risk. There are two main components of economic risk that impact us: interest rate risk and market risk. We are primarily subject to interest rate risk on our interest-bearing assets and liabilities. Market risk includes changes in the value of our properties and related loans.
Derivative Financial Instruments
There have been no significant changes in our derivative financial instruments policies from what was disclosed in the 2021 Annual Report.
The following table sets forth certain information regarding our derivative instruments on our Consolidated Hotels (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Derivatives Designated as Hedging Instruments | | | | Asset Derivatives Fair Value at | | Liability Derivatives Fair Value at |
| Balance Sheet Location | | March 31, 2022 | | December 31, 2021 | | March 31, 2022 | | December 31, 2021 |
Interest rate caps | | Other assets | | $ | 3,835 | | | $ | 381 | | | $ | — | | | $ | — | |
Interest rate swaps | | Accounts payable, accrued expenses and other liabilities | | — | | | — | | | (406) | | | (2,023) | |
| | | | $ | 3,835 | | | $ | 381 | | | $ | (406) | | | $ | (2,023) | |
All derivative transactions with an individual counterparty are governed by a master International Swap and Derivatives Association agreement, which can be considered as a master netting arrangement; however, we report all our derivative instruments on a gross basis in our consolidated financial statements.
At both March 31, 2022 and December 31, 2021, no cash collateral had been posted nor received for any of our derivative positions.
We recognized unrealized gains of $4.0 million and $0.1 million in Other comprehensive income on derivatives in connection with our interest rate swaps and caps during the three months ended March 31, 2022 and 2021, respectively.
We reclassified $0.2 million and $0.1 million from Other comprehensive income on derivatives into Interest expense during the three months ended March 31, 2022 and 2021, respectively.
Amounts reported in Other comprehensive income related to our interest rate swap and caps will be reclassified to Interest expense as interest is incurred on our variable-rate debt. As of March 31, 2022, we estimated that an additional $0.8 million will be reclassified, resulting in a reduction to interest expense, during the next 12 months related to our interest rate swaps and caps.
Interest Rate Swaps and Caps
We are exposed to the impact of interest rate changes primarily through our borrowing activities. To limit this exposure, we attempt to obtain mortgage financing on a long-term, fixed-rate basis. However, from time to time, we or our investment partners may obtain variable-rate non-recourse mortgage loans and, as a result, may enter into interest rate swap or cap agreements with counterparties. Interest rate swaps, which effectively convert the variable-rate debt service obligations of a
Notes to Consolidated Financial Statements (Unaudited)
loan to a fixed rate, are agreements in which one party exchanges a stream of interest payments for a counterparty’s stream of cash flow over a specific period. The notional, or face, amount on which the swaps are based is not exchanged. An interest rate cap limits the effective borrowing rate of variable-rate debt obligations while allowing participants to share in downward shifts in interest rates. Our objective in using these derivatives is to limit our exposure to interest rate movements.
The interest rate swaps and caps that we had outstanding on our Consolidated Hotels as of March 31, 2022 and December 31, 2021 were designated as cash flow hedges and are summarized as follows (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Number of Instruments at | | Notional Amount at | | Fair Value at |
Interest Rate Derivatives | | March 31, 2022 | | December 31, 2021 | | March 31, 2022 | | December 31, 2021 | | March 31, 2022 | | December 31, 2021 |
Interest rate caps | | 12 | | | 10 | | | $ | 858,772 | | | $ | 627,955 | | | $ | 3,835 | | | $ | 381 | |
Interest rate swaps | | 2 | | | 2 | | | 185,295 | | | 185,295 | | | (406) | | | (2,023) | |
| | | | | | $ | 1,044,067 | | | $ | 813,250 | | | $ | 3,429 | | | $ | (1,642) | |
Credit Risk-Related Contingent Features
Some of the agreements we have with our derivative counterparties contain cross-default provisions that could trigger a declaration of default on our derivative obligations if we default, or are capable of being declared in default, on certain of our indebtedness. As of both March 31, 2022 and December 31, 2021, we had not been declared in default on any of our derivative obligations. The estimated fair value of our derivatives in a net liability position was $0.6 million and $2.3 million as of March 31, 2022 and December 31, 2021, respectively, which included accrued interest and any nonperformance risk adjustments. If we had breached any of these provisions as of March 31, 2022 or December 31, 2021, we could have been required to settle our obligations under these agreements at their aggregate termination value of $0.6 million and $2.3 million, respectively.
Note 8. Debt
Our debt consists of mortgage notes payable, which are collateralized by the assignment of hotel properties. The following table presents the non-recourse debt, net on our Consolidated Hotel investments (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | Carrying Amount at |
| | Interest Rate Range | | Current Maturity Date Range (a) | | March 31, 2022 | | December 31, 2021 |
Fixed rate | | 3.8% – 4.9% | | 06/21(b) – 08/23 | | $ | 870,478 | | | $ | 951,318 | |
Variable rate (c) | | 2.5% – 9.0% | | 08/22 – 01/25 | | 1,090,904 | | | 1,007,423 | |
| | | | | | $ | 1,961,382 | | | $ | 1,958,741 | |
___________
(a)Many of our mortgage loans have extension options, which are subject to certain conditions. The maturity dates in the table do not reflect the extension options.
(b)See discussion below on the Courtyard Times Square West mortgage loan, which matured on June 1, 2021.
(c)The interest rate range presented for these mortgage loans reflect the rates in effect as of March 31, 2022 through the use of an interest rate swap or cap, when applicable.
Pursuant to our mortgage loan agreements, our consolidated subsidiaries are subject to various operational and financial covenants, including minimum debt service coverage and debt yield ratios. Most of our mortgage loan agreements contain “lock-box” provisions, which permit the lender to access or sweep a hotel’s excess cash flow and could be triggered by the lender under limited circumstances, including the failure to maintain minimum debt service coverage ratios. If a lender requires that we enter into a cash management agreement, we would generally be permitted to spend an amount equal to our budgeted hotel operating expenses, taxes, insurance and capital expenditure reserves for the relevant hotel. The lender would then hold all excess cash flow after the payment of debt service in an escrow account until certain performance hurdles are met. As of March 31, 2022, we have effectively entered into cash management agreements with the lenders on 18 of our 24 Consolidated Hotel mortgage loans either because the minimum debt service coverage ratio was not met or as a result of a loan modification agreement. The cash management agreements generally permit cash generated from the operations of each hotel to fund the hotel’s operating expenses, debt service, taxes and insurance but restrict distributions of excess cash flow, if any, to the Company to fund corporate expenses.
Notes to Consolidated Financial Statements (Unaudited)
Financing Activity During 2022
On January 14, 2022, we refinanced the $81.4 million San Diego Marriott La Jolla non-recourse mortgage loan with a new mortgage loan of $97.7 million, of which $83.2 million was funded at closing, with the remaining balance available to fund planned renovations at the hotel. The loan has a floating annual interest rate, subject to an interest rate cap, and a maturity date of January 2025, with two one-year extension options, subject to certain conditions. We recognized a loss on extinguishment of debt of $4.1 million during the three months ended March 31, 2022.
On January 21, 2022, we refinanced the $87.1 million San Jose Marriott non-recourse mortgage loan and the $34.6 million Le Méridien Arlington non-recourse mortgage loan with a new mortgage loan of $135.5 million encumbering both hotels, of which $126.2 million was funded at closing, with the remaining balance available to fund planned renovations at the hotel. The hotels encumbered by the mortgage loan are cross-collateralized. The loan has a floating annual interest rate, subject to an interest rate cap, and a maturity date of January 2025, with two one-year extension options, subject to certain conditions. We recognized a loss on extinguishment of debt of less than $0.1 million during the three months ended March 31, 2022.
On March 14, 2022, the $80.0 million outstanding non-recourse mortgage loan on Renaissance Chicago Downtown was modified to extend the maturity date from July 1, 2022 to January 1, 2023 and included a principal paydown of $4.0 million. This extension was accounted for as a loan modification and no gain or loss was recognized.
Financing Activity During 2021
On March 5, 2021, we refinanced the $190.0 million Ritz-Carlton Key Biscayne non-recourse mortgage loan, which extended the maturity date of the loan from August 2021 to August 2023. The principal balance and interest rate remain unchanged. This refinancing was accounted for as a loan modification and no gain or loss was recognized.
On March 15, 2021, we refinanced the $45.5 million Equinox Golf Resort & Spa non-recourse mortgage loan, which extended the maturity date of the loan from March 2021 to March 2023. The principal balance and interest rate remain unchanged. This refinancing was accounted for as a loan modification and no gain or loss was recognized.
Courtyard Times Square West
The $59.2 million outstanding mortgage loan on Courtyard Times Square West matured on June 1, 2021 and we have not paid off the outstanding principal balance. The loan does not have any cross-default provisions with our other mortgage obligations. We are currently in the process of exploring various options as it relates to this asset, including but not limited to, surrendering the property back to the lender.
Scheduled Debt Principal Payments
Scheduled debt principal payments during the remainder of 2022 and each of the next four calendar years following December 31, 2022 are as follows (in thousands):
| | | | | | | | |
Years Ending December 31, | | Total |
2022 (remainder) | | $ | 910,965 | |
2023 | | 527,464 | |
2024 | | 329,910 | |
2025 | | 209,417 | |
2026 | | — | |
Total principal payments | | 1,977,756 | |
Unamortized deferred financing costs | | (10,401) | |
Unamortized fair value discount | | (5,973) | |
Total | | $ | 1,961,382 | |
Notes to Consolidated Financial Statements (Unaudited)
Note 9. Commitments and Contingencies
As of March 31, 2022, we were not involved in any material litigation. Various claims and lawsuits arising in the normal course of business are pending against us, including liens for which we may obtain a bond, provide collateral or provide an indemnity, but we do not expect the results of such proceedings to have a material adverse effect on our consolidated financial position, results of operations or cash flows.
Hotel Management Agreements
As of March 31, 2022, our hotel properties were operated pursuant to long-term management agreements with nine different management companies, with initial terms ranging from five to 40 years. For hotels operated with separate franchise agreements, each management company receives a base management fee, generally ranging from 1.5% to 3.5% of hotel revenues. Eleven of our management agreements contain the right and license to operate the hotels under specified brands; no separate franchise agreements exist and no separate franchise fee is required for these hotels. The management agreements that include the benefit of a franchise agreement incur a base management fee ranging from 3.0% to 4.0% of hotel revenues. The management companies are generally also eligible to receive an incentive management fee, which is typically calculated as a percentage of operating profit, either (i) in excess of projections with a cap or (ii) after the owner has received a priority return on its investment in the hotel. We incurred management fee expense, including amortization of deferred management fees, of $6.4 million and $2.5 million for the three months ended March 31, 2022 and 2021, respectively.
Franchise Agreements
Eleven of our hotel properties operated under franchise or license agreements with national brands that are separate from our management agreements. As of March 31, 2022, we had eight franchise agreements with Marriott-owned brands, one with Hilton-owned brands, one with InterContinental Hotels-owned brands and one with a Hyatt-owned brand related to our hotels. Our typical franchise agreements have initial terms ranging from 15 to 25 years. Three of our hotels are not operated with a hotel brand so the hotels do not have franchise agreements. Generally, our franchise agreements provide for a license fee, or royalty, of 3.0% to 6.0% of room revenues and, if applicable, 2.0% to 3.0% of food and beverage revenue. In addition, we generally pay 1.0% to 4.0% of room revenues as marketing and reservation system contributions for the system-wide benefit of brand hotels. Franchise fees are included in sales and marketing expense in our consolidated financial statements. We incurred franchise fee expense, including amortization of deferred franchise fees, of $2.2 million and $0.9 million for the three months ended March 31, 2022 and 2021, respectively.
Capital Expenditures and Reserve Funds
With respect to our hotels that are operated under management or franchise agreements with major international hotel brands and for most of our hotels subject to mortgage loans, we are obligated to maintain furniture, fixtures and equipment reserve accounts for future capital expenditures sufficient to cover the cost of routine improvements and alterations at these hotels. The amount funded into each of these reserve accounts is generally determined pursuant to the management agreements, franchise agreements and/or mortgage loan documents for each of the respective hotels and typically ranges between 3.0% and 5.0% of the respective hotel’s total gross revenue. As of March 31, 2022 and December 31, 2021, $55.7 million and $58.7 million, respectively, was held in furniture, fixtures and equipment reserve accounts for future capital expenditures and is included in Restricted cash in the consolidated financial statements. In addition, due to the effects of the COVID-19 pandemic on our operations, we have been working with the brands, management companies and lenders and have used a portion of the available restricted cash reserves to cover operating costs at our properties, of which $1.3 million is subject to replenishment requirements as of March 31, 2022.
Notes to Consolidated Financial Statements (Unaudited)
Renovation Commitments
Certain of our hotel franchise and loan agreements require us to make planned renovations to our hotels. Additionally, from time to time, certain of our hotels may undergo renovations as a result of our decision to upgrade portions of the hotels, such as guestrooms, public space, meeting space, and/or restaurants, in order to better compete with other hotels and alternative lodging options in our markets. As of March 31, 2022, we had various contracts outstanding with third parties in connection with the renovation of certain of our hotels. The remaining commitments under these contracts as of March 31, 2022 totaled $54.9 million. Funding for a renovation will first come from our furniture, fixtures and equipment reserve accounts, to the extent permitted by the terms of the management agreement. Should these reserves be unavailable or insufficient to cover the cost of the renovation, we will fund all or the remaining portion of the renovation with existing cash resources or other sources of available capital, including cash flow from operations.
Leases
Lease Obligations
We recognize an operating right-of-use asset and a corresponding lease liability for ground lease arrangements, hotel parking leases and various hotel equipment leases for which we are the lessee. Our leases have remaining lease terms ranging from less than one year to 88 years (excluding extension options not reasonably certain of being exercised).
Lease Cost
Certain information related to the total lease cost for operating leases is as follows (in thousands):
| | | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | | |
| 2022 | | 2021 | | | | | |
Fixed lease cost | $ | 3,474 | | | $ | 2,850 | | | | | | |
Variable lease cost (a) | 84 | | | 28 | | | | | | |
Total lease cost | $ | 3,558 | | | $ | 2,878 | | | | | | |
___________
(a)Our variable lease payments consist of payments based on a percentage of revenue.
Note 10. Loss Per Share and Equity
Loss Per Share
The following table presents loss per share (in thousands, except share and per share amounts):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2022 | | Three Months Ended March 31, 2021 |
| Basic and Diluted Weighted-Average Shares Outstanding | | Allocation of Loss | | Basic and Diluted Loss Per Share | | Basic and Diluted Weighted-Average Shares Outstanding | | Allocation of Loss | | Basic and Diluted Loss Per Share |
Class A common stock | 167,689,164 | | | $ | (29,382) | | | $ | (0.18) | | | 167,466,809 | | | $ | (55,367) | | | $ | (0.33) | |
Class T common stock | 61,095,773 | | | (10,705) | | | (0.18) | | | 61,099,580 | | | (20,200) | | | (0.33) | |
Net loss attributable to Common Stockholders | | | $ | (40,087) | | | | | | | $ | (75,567) | | | |
The allocation of net loss attributable to common stockholders is calculated based on the weighted-average shares outstanding for Class A common stock and Class T common stock for the period.
Notes to Consolidated Financial Statements (Unaudited)
Noncontrolling Interest in the Operating Partnership
We consolidate the Operating Partnership, which is a majority-owned limited partnership that has a noncontrolling interest. As of both March 31, 2022 and December 31, 2021, the Operating Partnership had 231,202,933 OP Units outstanding, of which 99.0% of the outstanding OP Units were owned by the Company, and the noncontrolling 1.0% ownership interest was beneficially owned by Mr. Medzigian as of both period ends.
As of both March 31, 2022 and December 31, 2021, Mr. Medzigian indirectly owned 2,417,996 OP Units. The outstanding OP Units indirectly held by Mr. Medzigian are exchangeable on a one-for-one basis into shares of WLT Class A common stock. Additionally, we had 16,778,446 Warrant Units outstanding as of both March 31, 2022 and December 31, 2021. The noncontrolling interest is included in noncontrolling interest on the consolidated balance sheet.
Reclassifications Out of Accumulated Other Comprehensive Income (Loss)
The following table presents a reconciliation of changes in Accumulated other comprehensive income (loss) by component for the periods presented (in thousands):
| | | | | | | | | | | | | | |
| | Three Months Ended March 31, |
Gains on Derivative Instruments | | 2022 | | 2021 |
Beginning balance | | $ | 148 | | | $ | (724) | |
Other comprehensive income before reclassifications | | 3,978 | | | 90 | |
Amounts reclassified from accumulated other comprehensive income to: | | | | |
Interest expense | | 171 | | | 149 | |
Total | | 171 | | | 149 | |
Net current period other comprehensive income | | 4,149 | | | 239 | |
Net current period other comprehensive income attributable to noncontrolling interests | | — | | | (2) | |
Ending balance | | $ | 4,297 | | | $ | (487) | |
Note 11. Income Taxes
We elected to be treated as a REIT and believe that we have been organized and have operated in such a manner to maintain our qualification as a REIT for federal and state income tax purposes. As a REIT, we are generally not subject to corporate level federal income taxes on earnings distributed to our stockholders. Since inception, we have distributed at least 100% of our taxable income annually and intend to do so for the tax year ending December 31, 2022, if applicable. Accordingly, we have not included any provisions for federal income taxes related to the REIT in the accompanying consolidated financial statements for the three months ended March 31, 2022. We conduct business in various states and municipalities within the United States, and, as a result, we or one or more of our subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. As a result, we are subject to certain state and local taxes and a provision for such taxes is included in the consolidated financial statements.
Certain of our subsidiaries have elected taxable REIT subsidiary (“TRS”) status. A TRS may provide certain services considered impermissible for REITs and may hold assets that REITs may not hold directly.
The accompanying consolidated financial statements include an interim tax provision for our TRSs for the three months ended March 31, 2022 and 2021. Current income tax expense was $0.1 million for both the three months ended March 31, 2022 and 2021. We have calculated the provision for income taxes during interim periods by applying an estimate of the annual effective tax rate for the full fiscal year to “ordinary” income or loss (pretax income or loss excluding unusual or infrequently occurring discrete items) for the interim period.
Notes to Consolidated Financial Statements (Unaudited)
Our TRSs are subject to U.S. federal and state income taxes. As such, deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of assets and liabilities at the enacted tax rates expected to be in effect when the temporary differences reverse. A valuation allowance for deferred tax assets is provided if we believe that it is more likely than not that we will not realize the tax benefit of deferred tax assets based on available evidence at the time the determination is made. A change in circumstances may cause us to change our judgment about whether a deferred tax asset will more likely than not be realized. We generally report any change in the valuation allowance through our income statement in the period in which such changes in circumstances occur. The majority of our deferred tax assets relate to net operating losses, accrued expenses and deferred key money liabilities. Due to significant negative evidence, including cumulative losses in the most recent three-year period, our assessment as of March 31, 2021 is that our net deferred tax assets are not more likely than not to be realized and we reported a valuation allowance against those balances. Provision for income taxes included deferred income tax expense of $0.4 million and less than $0.1 million for the three months ended March 31, 2022 and 2021, respectively.
Note 12. Mandatorily Redeemable Preferred Stock
As of both March 31, 2022 and December 31, 2021, we had authorized 50,000,000 shares of preferred stock, $0.001 par value per share.
Series A Preferred Stock
On April 13, 2020, we issued 1,300,000 shares of WLT Series A preferred stock, $0.001 par value per share, with a liquidation preference of $50.00 per share (the “Series A Preferred Stock”) to WPC.
Dividends
Dividends are comprised of cumulative preferential dividends that holders of the Series A Preferred Stock are entitled to receive at a rate of 5% per year, with the rate increasing to 7% on the second anniversary of the Merger and increasing to 8% on the third anniversary of the Merger. Dividends accrue annually. Any dividend payable on the Series A Preferred Stock will be computed on the basis of a 360-day year consisting of twelve 30-day months.
Redemption
Partial Redemption – On both April 13, 2023 and April 13, 2024, the holders of the Series A Preferred Stock may elect to have the Company redeem 25% of the shares of the Series A Preferred Stock outstanding as of the respective dates for cash at a redemption price per share equal to $50.00, plus all accrued and unpaid dividends thereon up to and including the date of redemption, without interest, to the extent the Company has funds legally available therefor.
Full Redemption – At the earlier of April 13, 2025 or a redemption event (as defined in the Articles Supplementary governing the Series A Preferred Stock), the holders of the Series A Preferred Stock may elect to have the Company redeem all of the outstanding shares of the Series A Preferred Stock for cash at a redemption price per share equal to $50.00, plus all accrued and unpaid dividends thereon up to and including the date of redemption, without interest, to the extent the Company has funds legally available therefor.
On January 25, 2022, the Company redeemed the 1,300,000 shares of Series A Preferred Stock at the liquidation preference of $50.00 per share for a total of $65.0 million. All accrued and unpaid dividends, which totaled $0.1 million, were paid at redemption. We recognized a loss of $9.7 million during the three months ended March 31, 2022 related to the write-off of the unamortized fair value discount at the date of redemption, which is included in Loss on extinguishment of debt in the consolidated statement of operations.
Notes to Consolidated Financial Statements (Unaudited)
Series B Preferred Stock and Warrants
On July 21, 2020, we entered into a securities purchase agreement (the “Purchase Agreement”) with ACP Watermark Investment LLC (the “Purchaser”) and, solely with respect to a guaranty, certain other parties thereto. Pursuant to the Purchase Agreement, the Company, in a private placement made in reliance on an exemption from the registration requirements of the Securities Act of 1933, as amended, agreed to issue and sell to the Purchaser 200,000 shares of 12% Series B Cumulative Redeemable Preferred Stock, liquidation preference $1,000.00 per share (the “Series B Preferred Stock”) and warrants (the “Warrants”) to purchase 16,778,446 units of limited partnership interest of the Operating Partnership (“OP Units”) (“Warrant Units”), for an aggregate purchase price of $200.0 million (the “July 2020 Capital Raise”), both of which were issued on July 24, 2020. The Warrant exercise price is $0.01 per Warrant Unit, and the Warrants expire on July 24, 2027. The Warrant Units are recorded as noncontrolling interest in the consolidated balance sheets totaling $10.7 million and $13.7 million as of March 31, 2022 and December 31, 2021, respectively. The Warrants require that, if the Operating Partnership pays any distribution to holders of OP Units, then the Operating Partnership shall concurrently distribute the same securities, cash, indebtedness, rights or other property to the holders of Warrants as if the Warrants had been exercised into Warrant Units on the date of such distribution. The Warrants include a call option that will allow the Company to purchase Warrants, Warrant Units and Common Stock issued on redemption of Warrant Units from the purchaser or its transferees at a specified call price until the Common Stock is approved for trading on any securities exchange registered as a national securities exchange under Section 6 of the Securities and Exchange Act of 1934, as amended (or the equivalent thereof in a jurisdiction outside the United States).
Among other terms of the Series B Preferred Stock, the Series B Preferred Stock generally prohibits the Company from paying distributions on common stock or redeeming common stock unless the Company has first paid all accrued dividends (and dividends thereon) on the Series B Preferred Stock in cash for all past dividend periods and the current dividend period. There are certain exceptions for the payment of dividends on common stock required for the Company to maintain its REIT qualification, special circumstances redemptions of common stock and redemptions of common stock that are funded with proceeds from issuances of common stock under the Company's distribution reinvestment plan.
Dividends
The holders are entitled to receive cumulative dividends per share of Series B Preferred Stock at the rate of 12% per year. Dividends can be paid in cash or in the form of additional shares of Series B Preferred Stock with the value thereof equal to the liquidation preference of such shares, at the option of the Company. The dividends are cumulative, compound quarterly and accrue, whether or not earned or declared, from and after the date of issue.
Redemption
On July 24, 2025, the Company is obligated to redeem all shares of Series B Preferred Stock at a redemption price, payable in cash, equal to the then applicable liquidation preference plus all accrued and unpaid dividends. In the event of a change of control, as defined in the Articles Supplementary, the holders have the right, but not the obligation, to require the Company to redeem for cash, in whole or in part, the outstanding shares of Series B Preferred Stock owned by the holder at the applicable Optional Redemption Price in effect at the date of the Fundamental Change Notice, as defined in the Articles Supplementary. The Company, at its option, may redeem for cash, in whole or in part from time to time, any or all of the outstanding shares of Series B Preferred Stock upon giving the notice described in the Articles Supplementary governing the Series B Preferred Stock at a price determined in the Articles Supplementary.
Dividends accrued included in interest expense in the consolidated financial statements related to our Series A and Series B Preferred Stock as of March 31, 2022 and December 31, 2021 totaled $5.9 million and $6.5 million, respectively.
Notes to Consolidated Financial Statements (Unaudited)
The following table presents the carrying value of our Series A and Series B Preferred Stock as of March 31, 2022 and December 31, 2021:
| | | | | | | | | | | | | | | | | | | | | | | |
| Series A Preferred Stock at | Series B Preferred Stock at |
| March 31, 2022 | | December 31, 2021 | | March 31, 2022 | | December 31, 2021 |
Liquidation value | $ | — | | | $ | 65,000 | | | $ | 231,255 | | | $ | 231,255 | |
Fair value discount | — | | (14,310) | | (30,358) | | (30,358) |
| — | | 50,690 | | 200,897 | | 200,897 |
Accumulated amortization of fair value discount | — | | 4,364 | | 10,235 | | 8,740 |
Deferred financing costs | — | | — | | (10,177) | | (11,177) |
Accumulated amortization of deferred financing costs | — | | — | | 3,432 | | 3,217 |
| $ | — | | | $ | 55,054 | | | $ | 204,387 | | | $ | 201,677 | |
Note 13. Subsequent Event
Proposed Merger
On May 6, 2022, the Company, along with the Operating Partnership, entered into a definitive merger agreement with affiliates of private real estate funds managed by Brookfield, under which Brookfield will acquire all of the outstanding shares of common stock of the Company for $6.768 per Class A share and $6.699 per Class T share in an all-cash transaction, including the assumption of mortgage debt and Series B Preferred Stock and Warrants. Further details concerning the proposed merger are described in a Form 8-K that we filed with the SEC on May 9, 2022.
Refinancings
On April 29, 2022, we refinanced the $83.6 million Westin Pasadena non-recourse mortgage loan with a new mortgage loan of $86.4 million. The loan has a floating annual interest rate, subject to an interest rate cap, and a maturity date of May 2025, with two one-year extension options, subject to certain conditions.
On May 11, 2022, we refinanced the $65.0 million Marriott Raleigh City Center non-recourse mortgage loan with a new mortgage loan of $68.0 million. The loan has a floating annual interest rate, subject to an interest rate cap, and a maturity date of May 2025, with two one-year extension options, subject to certain conditions.
On May 11, 2022, we refinanced the $103.0 million Charlotte Marriott City Center non-recourse mortgage loan with a new senior mortgage loan of $86.0 million and a $22.0 million mezzanine loan. The loans have floating annual interest rates, subject to an interest rate cap, and maturity dates of June 2025, each with two one-year extension options, subject to certain conditions.