11. Commitments and Contingencies

Management Agreements

Management agreements with the Company’s third-party hotel managers require the Company to pay between 1.75% 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 management fees, net of key money incentives received from third-party hotel managers, along with incentive management fees incurred by the Company during the three months ended March 31, 2017 and 2016 were included in other property-level expenses on the Company’s consolidated statements of operations and comprehensive income as follows (in thousands):


	Three Months Ended		Three Months Ended
	March 31, 2017		March 31, 2016
	(unaudited)		(unaudited)
Basic management fees	$	7,895	$	7,667
Incentive management fees		2,553		1,704
Total basic and incentive management fees	$	10,448	$	9,371

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 fees incurred by the Company during the three months ended March 31, 2017 and 2016 were included in franchise costs on the Company’s consolidated statements of operations and comprehensive income as follows (in thousands):


	Three Months Ended		Three Months Ended
	March 31, 2017		March 31, 2016
	(unaudited)		(unaudited)
Franchise assessments (1)	$	5,927	$	5,813
Franchise royalties		2,128		2,283
Total franchise costs	$	8,055	$	8,096

(1)

Includes advertising, reservation and frequent guest club assessments.

Renovation and Construction Commitments

At March 31, 2017, the Company had various contracts outstanding with third parties in connection with the renovation and repositioning of certain of its hotel properties. The remaining commitments under these contracts at March 31, 2017 totaled $46.1 million.

Capital Leases

The Hyatt Centric 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 capital lease asset was included in investment in hotel properties, net on the Company’s consolidated balance sheets as follows (in thousands):


	March 31,		December 31,
	2017		2016
	(unaudited)
Gross capital lease asset - buildings and improvements	$	58,799	$	58,799
Accumulated depreciation		(7,105)		(6,738)
Net capital lease asset - buildings and improvements	$	51,694	$	52,061

Future minimum lease payments under the Company’s capital lease together with the present value of the net minimum lease payments as of March 31, 2017 are as follows (in thousands):


2017	$	1,403
2018		1,403
2019		1,403
2020		1,403
2021		1,403
Thereafter		106,257
Total minimum lease payments (1)		113,272
Less: Amount representing interest (2)		(97,697)
Present value of net minimum lease payments (3)	$	15,575

(1)

Minimum lease payments do not include percentage rent which may be paid under the Hyatt Centric Chicago Magnificent Mile building lease on the basis of 4.0% of the hotel’s gross room revenues over a certain threshold. No percentage rent was due during either the three months ended March 31, 2017 or 2016.

(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 March 31, 2017 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 months ended March 31, 2017 and 2016 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
	March 31, 2017		March 31, 2016
	(unaudited)		(unaudited)
Minimum rent, including straight-line adjustments	$	2,340	$	2,396
Percentage rent (1)		1,585		2,060
Total	$	3,925	$	4,456

(1)

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

Rent expense incurred pursuant to a lease on the corporate facility totaled $0.1 million for both the three months ended March 31, 2017 and 2016, and is included in corporate overhead expense.

Concentration of Risk

The concentration of the Company’s hotels in California, 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 March 31, 2017, 16 of the Company’s 27 hotels were concentrated in California, Illinois, Massachusetts and the greater Washington DC area as follows:


							Greater
							Washington DC
	California		Illinois		Massachusetts		Area
	(unaudited)		(unaudited)		(unaudited)		(unaudited)
Number of hotels	7		3		3		3
Percentage of total rooms	29	%	9	%	15	%	14	%
Percentage of total consolidated revenue during the past 12 months	34	%	7	%	15	%	14	%

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 March 31, 2017, the Company had $0.5 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 March 31, 2017.

The Company is subject to various claims, lawsuits and legal proceedings, including routine litigation arising in the ordinary course of business, regarding the operation of its hotels and Company matters. While it is not possible to ascertain the ultimate outcome of such matters, the Company believes that the aggregate amount of such liabilities, if any, in excess of amounts covered by insurance will not have a material adverse impact on its financial condition or results of operations. The outcome of claims, lawsuits and legal proceedings brought against the Company, however, is subject to significant uncertainties.