11. Commitments and Contingencies

Management Agreements

Management agreements with the Company’s third-party hotel managers require the Company to pay between 1.5% and 3.5% of total revenue of the managed hotels to the third-party managers each month as a basic management fee. In addition to basic management fees, provided that certain operating thresholds are met, the Company may also be required to pay incentive management fees to certain of its third-party managers. Total basic and incentive management fees incurred by the Company during the three and six months ended June 30, 2015 and 2014 were included in property general and administrative expense on the Company’s consolidated statements of operations and comprehensive income as follows (in thousands):



	Three Months Ended		Three Months Ended		Six Months Ended		Six Months Ended
	June 30, 2015		June 30, 2014		June 30, 2015		June 30, 2014
	(unaudited)		(unaudited)		(unaudited)		(unaudited)
Basic management fees	$	9,309	$	8,268	$	17,131	$	14,981
Incentive management fees		1,946		926		3,235		1,958
Total basic and incentive management fees	$	11,255	$	9,194	$	20,366	$	16,939

License and Franchise Agreements

The Company has entered into license and franchise agreements related to certain of its hotel properties. The license and franchise agreements require the Company to, among other things, pay monthly fees that are calculated based on specified percentages of certain revenues. The license and franchise agreements generally contain specific standards for, and restrictions and limitations on, the operation and maintenance of the hotels which are established by the franchisors to maintain uniformity in the system created by each such franchisor. Such standards generally regulate the appearance of the hotel, quality and type of goods and services offered, signage and protection of trademarks. Compliance with such standards may from time to time require the Company to make significant expenditures for capital improvements.

Total license and franchise costs incurred by the Company during the three and six months ended June 30, 2015 and 2014 were included in the Company’s consolidated statements of operations and comprehensive income as follows (in thousands):



	Three Months Ended		Three Months Ended		Six Months Ended		Six Months Ended
	June 30, 2015		June 30, 2014		June 30, 2015		June 30, 2014
	(unaudited)		(unaudited)		(unaudited)		(unaudited)
Franchise assessments (1)	$	7,581	$	7,128	$	13,668	$	12,720
Franchise royalties		3,237		3,133		5,750		5,618
Total franchise costs	$	10,818	$	10,261	$	19,418	$	18,338

(1)

Includes advertising, reservation and priority club assessments.

Renovation and Construction Commitments

At June 30, 2015, the Company had various contracts outstanding with third parties in connection with the renovation of certain of its hotel properties aimed at maintaining the appearance and quality of its hotels. The remaining commitments under these contracts at June 30, 2015 totaled $75.7 million.

Capital Leases

The Hyatt Chicago Magnificent Mile is subject to a building lease which expires in December 2097. Upon acquisition of the hotel in June 2012, the Company evaluated the terms of the lease agreement and determined the lease to be a capital lease pursuant to the Leases Topic of the FASB ASC.

The Company leases certain printers and copiers which leases have been determined to be capital leases pursuant to the Leases Topic of the FASB ASC. All of the leases expired in December 2014.

Assets under capital lease were included in investment in hotel properties, net on the Company’s consolidated balance sheets as follows (in thousands):



	June 30,		December 31,
	2015		2014
	(unaudited)
Buildings and improvements	$	58,799	$	58,799
Furniture, fixtures and equipment		—		104
Capital lease assets, gross		58,799		58,903
Accumulated depreciation		(4,533)		(3,841)
Capital lease assets, net	$	54,266	$	55,062

Future minimum lease payments under capital leases together with the present value of the net minimum lease payments as of June 30, 2015 are as follows (in thousands):



2015	$	1,403
2016		1,403
2017		1,403
2018		1,403
2019		1,403
Thereafter		108,713
Total minimum lease payments (1)		115,728
Less: Amount representing interest (2)		(100,152)
Present value of net minimum lease payments (3)	$	15,576

(1)

Minimum lease payments do not include percentage rent which may be paid under the Hyatt Chicago Magnificent Mile building lease on the basis of 4.0% of the hotel’s gross room revenues over a certain threshold. For the three and six months ended June 30, 2015, $19,000 in percentage was due under the Hyatt Chicago Magnificent Mile’s building lease. No percentage rent was due for either the three or six months ended June 30, 2014.

(2)

Interest includes the amount necessary to reduce net minimum lease payments to present value calculated at the Company’s incremental borrowing rate at lease inception.

(3)

The present value of net minimum lease payments are presented on the Company’s consolidated balance sheet as of June 30, 2015 as a current obligation of $1,000, which is included in accounts payable and accrued expenses, and as a long term obligation of $15.6 million, which is included in capital lease obligations, less current portion.

Ground, Building and Air Leases

Total rent expense incurred pursuant to ground, building and air lease agreements for the three and six months ended June 30, 2015 and 2014 was included in property tax, ground lease and insurance on the Company’s consolidated statements of operations and comprehensive income as follows (in thousands):



	Three Months Ended		Three Months Ended		Six Months Ended		Six Months Ended
	June 30, 2015		June 30, 2014		June 30, 2015		June 30, 2014
	(unaudited)		(unaudited)		(unaudited)		(unaudited)
Minimum rent, including straightline adjustments	$	3,723	$	3,782		7,420		7,610
Percentage rent (1)		911		729		1,729		1,357
Total	$	4,634	$	4,511	$	9,149	$	8,967

(1)

Several of the Company’s hotels pay percentage rent, which is calculated on operating revenues above certain thresholds.

Prior to the Company’s June 2014 acquisition of the land underlying the Fairmont Newport Beach, the land was leased to the Company by a third party. Ground lease expense for the land underlying the Fairmont Newport Beach totaled $0.1 million and $0.3 million for the three and six months ended June 30, 2014, respectively.

Rent expense incurred pursuant to leases on the corporate facility, which is included in corporate overhead expense, totaled $0.1 million for both the three months ended June 30, 2015 and 2014, and $0.2 million for both the six months ended June 30, 2015 and 2014.

Concentration of Risk

The concentration of the Company’s hotels in California, New York, Illinois, Massachusetts and the greater Washington DC area exposes the Company’s business to economic conditions, competition and real and personal property tax rates unique to these locales. As of June 30, 2015, 21 of the Company’s 30 hotels were concentrated in California, New York, Illinois, Massachusetts and the greater Washington DC area as follows:



									Greater
									Washington DC
	California		New York		Illinois		Massachusetts		Area
	(unaudited)		(unaudited)		(unaudited)		(unaudited)		(unaudited)
Number of hotels	9		3		3		3		3
Percentage of total rooms	31	%	9	%	8	%	14	%	13	%
Percentage of total consolidated revenue for the six months ended June 30, 2015	35	%	11	%	7	%	12	%	12	%

Other

The Company has provided customary unsecured environmental indemnities to certain lenders. The Company has performed due diligence on the potential environmental risks, including obtaining an independent environmental review from outside environmental consultants. These indemnities obligate the Company to reimburse the indemnified parties for damages related to certain environmental matters. There is no term or damage limitation on these indemnities; however, if an environmental matter arises, the Company could have recourse against other previous owners or a claim against its environmental insurance policies.

At June 30, 2015, the Company had $0.6 million of outstanding irrevocable letters of credit to guaranty the Company’s financial obligations related to workers’ compensation insurance programs from prior policy years. The beneficiaries of these letters of credit may draw upon these letters of credit in the event of a contractual default by the Company relating to each respective obligation. No draws have been made through June 30, 2015.