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. Following the sale of Hyatt Regency Newport Beach, the fees paid to third-party managers each month as a basic management fee will be between 1.75% and 3.0% of total revenue. 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 and six months ended June 30, 2018 and 2017 were included in other property-level expenses on the Company’s consolidated statements of operations as follows (unaudited and in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017

Basic management fees	$	8,812	$	8,942	$	16,346	$	16,837
Incentive management fees		2,128		1,800		4,848		4,353
Total basic and incentive management fees	$	10,940	$	10,742	$	21,194	$	21,190

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 and six months ended June 30, 2018 and 2017 were included in franchise costs on the Company’s consolidated statements of operations as follows (unaudited and in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017

Franchise assessments (1)	$	7,224	$	7,175	$	13,132	$	13,102
Franchise royalties		2,737		2,706		4,682		4,834
Total franchise costs	$	9,961	$	9,881	$	17,814	$	17,936

(1)

Includes advertising, reservation and frequent guest program assessments.

Renovation and Construction Commitments

At June 30, 2018, 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 June 30, 2018 totaled $70.9 million.

Capital Leases

The Hyatt Centric Chicago Magnificent Mile is subject to a building lease which expires in December 2097. The Company evaluated the terms of the lease agreement and determined the lease to be a capital lease.

The Company determined that the ground lease at the Courtyard by Marriott Los Angeles is a capital lease due to the lease containing a future bargain purchase right option, which the Company will likely exercise as the economic disincentive for continuing to lease the property will be significant.

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


	June 30,		December 31,
	2018		2017
	(unaudited)
Gross capital lease asset - buildings and improvements	$	58,799	$	58,799
Gross capital lease asset - land		6,605		6,605
Gross capital lease assets		65,404		65,404
Accumulated depreciation		(8,942)		(8,208)
Net capital lease assets	$	56,462	$	57,196

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, 2018 and 2017 was included in property tax, ground lease and insurance on the Company’s consolidated statements of operations as follows (unaudited and in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017

Minimum rent, including straight-line adjustments	$	2,131	$	2,340	$	4,261	$	4,680
Percentage rent (1)		1,896		1,755		3,640		3,340
Total	$	4,027	$	4,095	$	7,901	$	8,020

(1)

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

Rent expense incurred pursuant to leases on the corporate facility which expire in August 2018, along with straight-line adjustments for a new office space lease for which the Company has taken possession, totaled $0.4 million and $0.5 million for the three and six months ended June 30, 2018, respectively. For the three and six months ended June 30, 2017, the Company incurred rent expense of $0.1 million and $0.2 million, respectively, pursuant to leases on the corporate facility. The Company includes its corporate rent expense in corporate overhead expense on its consolidated statements of operations.

Concentration of Risk

The concentration of the Company’s hotels in California, Hawaii, Illinois, Massachusetts, the greater Washington DC area and Florida exposes the Company’s business to economic and severe weather conditions, competition and real and personal property tax rates unique to these locales. As of June 30, 2018, 17 of the Company’s 24 hotels were geographically concentrated as follows:


				Trailing 12-Month
		Percentage of		Total
	Number of Hotels	Total Rooms		Consolidated Revenue

California	6	28	%	32	%
Hawaii	1	5	%	9	%
Illinois	3	10	%	7	%
Massachusetts	2	12	%	13	%
Greater Washington DC area	3	15	%	14	%
Florida	2	8	%	9	%

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, 2018, the Company had $0.5 million of outstanding irrevocable letters of credit to guarantee 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, 2018.

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.