NOTE 6 - DEBT

Mortgages and Notes Payable

We had total mortgages payable at June 30, 2011, and December 31, 2010 of $667,858 and $596,949, respectively. These balances consisted of mortgages with fixed and variable interest rates, which ranged from 2.19% to 8.25% as of June 30, 2011. Aggregate interest expense incurred under the mortgage loans payable totaled $9,745 and $9,375 for the three months ended June 30, 2011 and 2010, respectively, and $18,805 and $18,836 for the six months ended June 30, 2011 and 2010, respectively.

Our mortgage indebtedness contains various financial and non-financial covenants customarily found in secured, non-recourse financing arrangements. Our mortgage loans payable typically require that specified debt service coverage ratios be maintained with respect to the financed properties before we can exercise certain rights under the loan agreements relating to such properties. If the specified criteria are not satisfied, the lender may be able to escrow cash flow generated by the property securing the applicable mortgage loan. We have determined that certain debt service coverage ratio covenants contained in the loan agreements securing fifteen of our hotel properties were not met as of June 30, 2011. Pursuant to the loan agreements, the lender has elected to escrow the operating cash flow for a number of these properties. However, these covenants do not constitute an event of default for these loans. As of June 30, 2011 we were in compliance with all event of default covenants under the applicable loan agreements, with the exception of our non-recourse mortgage loan payable on the Comfort Inn, North Dartmouth, MA. As noted in “Note 2 – Investment in Hotel Properties,” the Comfort Inn, North Dartmouth, MA, ceased operations on March 31, 2011. We are currently in discussions to transfer title to the property to the lender. As of June 30, 2011, the remaining principal and accrued interest due on the mortgage loan payable related to this asset were $2,968 and $114, respectively.

As of June 30, 2011, the maturities for the outstanding mortgage loans ranged from July 2011 to September 2023, including $17,861 due in 2011.

Subordinated Notes Payable

We have two junior subordinated notes payable in the aggregate amount of $51,548 to the Hersha Statutory Trusts pursuant to indenture agreements which will mature on July 30, 2035, but may be redeemed at our option, in whole or in part, prior to maturity in accordance with the provisions of the indenture agreement. Effective July 30, 2010, the $25,774 notes issued to Hersha Statutory Trust I and Hersha Statutory Trust II, bear interest at a variable rate of LIBOR plus 3% per annum. This rate resets two business days prior to each quarterly payment. Prior to this, the $25,774 note issued to Hersha Statutory Trust I incurred interest at a fixed rate of 7.34% per annum through July 30, 2010, and the $25,774 note issued to Hersha Statutory Trust II incurred interest at a fixed rate of 7.173% per annum through July 30, 2010. The weighted average interest rate on our two junior subordinated notes payable during the three months ended June 30, 2011 and 2010 was 3.30% and 7.26%, respectively. The weighted average interest rate on our two junior subordinated notes payable for the six months ended June 30, 2011 and 2010 was 3.31% and 7.28%, respectively. Interest expense in the amount of $428 and $940 was recorded for the three months ended June 30, 2011 and 2010, respectively and $853 and $1,875 was recorded for the six months ended June 30, 2011 and 2010, respectively.

Other Notes Payable

HHLP has entered into a management agreement with an unaffiliated hotel manager that has extended a $349 interest-free loan to HHLP for working capital contributions that are due at either the termination or expiration of the management agreement. A discount was recorded on the note payable which reduced the principal balances recorded in the mortgages and notes payable. The discount is being amortized over the remaining life of the loan and is recorded as interest expense. The balance of the note payable, net of unamortized discount, was $231 as of June 30, 2011 and $223 as of December 31, 2010.

Revolving Line of Credit

We maintain a Revolving Credit Loan and Security Agreement with T.D. Bank, NA and various other lenders. The credit agreement provides for a revolving line of credit in the principal amount of up to $250,000, including a sub-limit of $25,000 for irrevocable stand-by letters of credit and a $10,000 sub-limit for the swing line loans. Borrowings under the line of credit provided by T.D. Bank, NA may be used for working capital and general corporate purposes and for the purchase of additional hotels. The line of credit expires on November 5, 2013, and, provided no event of default has occurred and remains uncured, we may request that T.D. Bank, NA and the other lenders renew the line of credit for an additional one-year period.

The line of credit is collateralized by a first lien-security interest in all existing and future unencumbered assets of HHLP, a collateral assignment of all hotel management contracts of the management companies in the event of default, and title-insured, first-lien mortgages on the following hotel properties:

- Hampton Inn, Danville, PA	- Residence Inn, Langhorne, PA
- Hampton Inn, Philadelphia, PA	- Residence Inn, Norwood, MA
- Hampton Inn, Carlisle, PA	- Sheraton Hotel, JFK Airport, New York, NY
- Hampton Inn, Selinsgrove, PA	- Hampton Inn, Washington, DC
- Holiday Inn, Norwich, CT	- Hyatt Place, King of Prussia, PA
- Towneplace Suites, Harrisburg, PA	- Courtyard by Marriot, Westside, Los Angeles, CA
- Comfort Inn, Harrisburg, PA

At our option, the interest rate on loans provided under the line of credit will be either (i) the variable prime rate, as defined in the credit agreement, plus an applicable margin ranging between 150 and 175 basis points per annum or (ii) LIBOR plus an applicable margin ranging between 350 and 375 basis points per year, subject to a floor of 4.25%.

The credit agreement providing for the line of credit includes certain financial covenants and requires that we maintain: (1) a minimum tangible net worth of $500,000, which is subject to increases under certain circumstances; (2) maximum accounts and other receivables from affiliates of $125,000; (3) annual distributions not to exceed 95% of adjusted funds from operations; (4) maximum variable rate indebtedness to total debt of 30%; and (5) certain financial ratios, including the following:

●	a fixed charge coverage ratio of not less than 1.25 to 1.00 which will increase to 1.35 to 1.00 as of September 30, 2011, and 1.45 to 1.00 as of September 30, 2012; and

●	a total funded liabilities to gross asset value ratio of not more than 0.65 to 1.00

The Company is in compliance with each of the covenants listed above as of June 30, 2011.

The outstanding principal balance under the line of credit was $28,000 at June 30, 2011 and $46,000 at December 31, 2010. The Company recorded interest expense of $682 and $440 related to the line of credit borrowings for the three months ended June 30, 2011 and 2010, respectively, and $1,187 and $1,182 for the six months ended June 30, 2011 and 2010, respectively. The weighted average interest rate on our line of credit during the three months ended June 30, 2011 and 2010 was 4.42% and 4.39%, respectively, and for the six months ended June 30, 2011 and 2010 was 4.35% and 4.35%, respectively.

As of June 30, 2011, we had $8,562 in irrevocable letters of credit issued and our remaining borrowing capacity under the facility was $213,438.

Fair Value of Debt

The Company estimates the fair value of its fixed rate debt and the credit spreads over variable market rates on its variable rate debt by discounting the future cash flows of each instrument at estimated market rates or credit spreads consistent with the maturity of the debt obligation with similar credit policies. Credit spreads take into consideration general market conditions and maturity. As of June 30, 2011, the carrying value and estimated fair value of the Company's debt was $747,637 and $750,637, respectively. As of December 31, 2010, the carrying value and estimated fair value of the Company's debt was $694,720 and $658,487, respectively.

Capitalized Interest

We utilize mortgage debt and our revolving line of credit to finance on-going capital improvement projects at our properties. Interest incurred on mortgages and the revolving line of credit that relates to our capital improvement projects is capitalized through the date when the assets are placed in service. For the three months and six months ended June 30, 2011, we capitalized interest of $181 and $351, respectively. No interest was capitalized for the three and six months ended June 30, 2010.

Deferred Financing Costs

Costs associated with entering into mortgages and notes payable and our revolving line of credit are deferred and amortized over the life of the debt instruments. Amortization of deferred financing costs is recorded in interest expense. As of June 30, 2011, deferred financing costs were $9,289, net of accumulated amortization of $7,441. Amortization of deferred costs for the three months ended June 30, 2011 and 2010 was $853 and $537, respectively, and for the six months ended June 30, 2011 and 2010 was $1,630 and $1,076, respectively.

New Debt

On May 31, 2011, we entered into a $42,000 mortgage loan secured by our Holiday Inn Express Times Square, New York, NY, property. Previously, this property was included as collateral on our line of credit. The new mortgage loan bears interest at a variable interest rate of three month U.S. dollar LIBOR plus 4.0% and matures on June 1, 2016. As a result of this new debt, we incurred $222 in deferred costs. On the same date, we entered into an interest rate swap that effectively fixes the interest at 5.24%. See “Note 8 – Fair Value Measurements and Derivative Instruments” for more information.