Sotherly Hotels Inc. - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2019

SOTHERLY HOTELS INC.

(Exact name of registrant as specified in its charter)

Maryland

001-32379

20-1531029

(State or Other Jurisdiction of

Incorporation or Organization)

(Commission

File Number)

(I.R.S. Employer

Identification No.)

SOTHERLY HOTELS LP

(Exact name of registrant as specified in its charter)

Delaware

001-36091

20-1965427

(State or Other Jurisdiction of

Incorporation or Organization)

(Commission

File Number)

(I.R.S. Employer

Identification No.)

410 West Francis Street

Williamsburg, Virginia 23185

(757) 229-5648

(Address and Telephone Number of Principal Executive Offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Sotherly Hotels Inc. Yes ☒ No ☐ Sotherly Hotels LP Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files.)

Sotherly Hotels Inc. Yes ☒ No ☐ Sotherly Hotels LP Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Securities Exchange Act. (Check one):

Sotherly Hotels Inc.

Large Accelerated Filer	☐	Accelerated Filer	☒

Non-accelerated Filer	☐	Smaller Reporting Company	☒

Emerging Growth Company	☐

Sotherly Hotels LP

Large Accelerated Filer	☐	Accelerated Filer	☐

Non-accelerated Filer	☒	Smaller Reporting Company	☐

Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Sotherly Hotels Inc. Yes ☐ No ☒ Sotherly Hotels LP Yes ☐ No ☒

As of November 1, 2019, there were 14,272,378 shares of Sotherly Hotels Inc.’s common stock issued and outstanding.

Securities registered or to be registered pursuant to Section 12(b) of the Act.


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.01 par value	SOHO	The NASDAQ Stock Market LLC
8.0% Series B Cumulative Redeemable Perpetual Preferred Stock, $0.01 par value	SOHOB	The NASDAQ Stock Market LLC
7.875% Series C Cumulative Redeemable Perpetual Preferred Stock, $0.01 par value	SOHOO	The NASDAQ Stock Market LLC
8.25% Series D Cumulative Redeemable Perpetual Preferred Stock, $0.01 par value	SOHON	The NASDAQ Stock Market LLC

EXPLANATORY NOTE

We refer to Sotherly Hotels Inc. as the “Company,” Sotherly Hotels LP as the “Operating Partnership,” the Company’s common stock as “common stock,” the Company’s preferred stock as “preferred stock,” and the Operating Partnership’s preferred interest as the “preferred interest.” References to “we” and “our” mean the Company, its Operating Partnership and its subsidiaries and predecessors, collectively, unless the context otherwise requires or where otherwise indicated.

The Company conducts virtually all of its activities through the Operating Partnership and is its sole general partner. The partnership agreement provides that the Operating Partnership will assume and pay when due, or reimburse the Company for payment of, all costs and expenses relating to the ownership and operations of, or for the benefit of, the Operating Partnership. The partnership agreement further provides that all expenses of the Company are deemed to be incurred for the benefit of the Operating Partnership.

This report combines the Quarterly Reports on Form 10-Q for the period ended September 30, 2019 of the Company and the Operating Partnership. We believe combining the quarterly reports into this single report results in the following benefits:

•

combined reports better reflect how management and investors view the business as a single operating unit;

•

combined reports enhance investors' understanding of the Company and the Operating Partnership by enabling them to view the business as a whole and in the same manner as management;

•

combined reports are more efficient for the Company and the Operating Partnership and result in savings in time, effort and expense; and

•

combined reports are more efficient for investors by reducing duplicative disclosure and providing a single document for their review.

To help investors understand the significant differences between the Company and the Operating Partnership, this report presents the following separate sections for each of the Company and the Operating Partnership:

•

Consolidated Financial Statements;

•

the following Notes to Consolidated Financial Statements:

•

Note 7 – Preferred Stock and Units;

•

Note 8 – Common Stock and Units;

•

Note 13 – Loss Per Share and Per Unit; and

•

Note 14 – Subsequent Events;

•

Item 4 - Controls and Procedures; and

•

Item 6 - Certifications of CEO and CFO pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act.

SOTHERLY HOTELS INC.

SOTHERLY HOTELS LP

INDEX

		Page

PART I
Item 1.	Consolidated Financial Statements	5

	Sotherly Hotels Inc.
	Consolidated Balance Sheets as of September 30, 2019 (unaudited) and December 31, 2018	5
	Consolidated Statements of Operations (unaudited) for the Three and Nine Months Ended September 30, 2019 and 2018	6
	Consolidated Statements of Changes in Equity (unaudited) for the Three Months Ended March 31, June 30 and September 30, 2019 and 2018	7
	Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended September 30, 2019 and 2018	10

	Sotherly Hotels LP
	Consolidated Balance Sheets as of September 30, 2019 (unaudited) and December 31, 2018	11
	Consolidated Statements of Operations (unaudited) for the Three and Nine Months Ended September 30, 2019 and 2018	12
	Consolidated Statements of Changes in Partners’ Capital (unaudited) for the Three Months Ended March 31, June 30 and September 30, 2019 and 2018	13
	Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended September 30, 2019 and 2018	17
	Notes to Consolidated Financial Statements	18
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	49
Item 4	Controls and Procedures	50

PART II
Item 1.	Legal Proceedings	52
Item 1A.	Risk Factors	52
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	52
Item 3.	Defaults Upon Senior Securities	52
Item 4.	Mine Safety Disclosures	52
Item 5.	Other Information	52
Item 6.	Exhibits	53

PART I

Item 1.

Consolidated Financial Statements

SOTHERLY HOTELS INC.

CONSOLIDATED BALANCE SHEETS

	September 30, 2019			December 31, 2018
	(unaudited)
ASSETS
Investment in hotel properties, net	$	446,839,580		$	435,725,814
Cash and cash equivalents		30,059,697			33,792,773
Restricted cash		5,192,730			4,075,508
Accounts receivable, net		6,298,119			6,766,696
Accounts receivable - affiliate		86,663			262,572
Prepaid expenses, inventory and other assets		5,494,165			5,262,884
Favorable lease assets, net		—			2,465,421
Deferred income taxes		4,679,010			5,131,179
TOTAL ASSETS	$	498,649,964		$	493,482,847
LIABILITIES
Mortgage loans, net	$	360,549,890		$	364,828,845
Unsecured notes, net		—			23,894,658
Accounts payable and accrued liabilities		24,308,930			16,268,096
Advance deposits		2,397,095			2,815,283
Dividends and distributions payable		4,210,494			3,409,593
TOTAL LIABILITIES	$	391,466,409		$	411,216,475
Commitments and contingencies (See Note 6)		—			—
EQUITY
Sotherly Hotels Inc. stockholders’ equity
Preferred stock, $0.01 par value, 11,000,000 shares authorized;
8.0% Series B cumulative redeemable perpetual preferred stock, liquidation preference $25 per share, 1,610,000 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively.		16,100			16,100
7.875% Series C cumulative redeemable perpetual preferred stock, liquidation preference $25 per share, 1,554,610 and 1,352,141 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively.		15,546			13,521
8.25% Series D cumulative redeemable perpetual preferred stock, liquidation preference $25 per share, 1,200,000 shares issued and outstanding at September 30, 2019 and none at December 31, 2018.		12,000			—
Common stock, par value $0.01, 49,000,000 shares authorized, 14,222,378 shares and 14,209,378 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively.		142,223			142,093
Additional paid-in capital		180,415,231			147,085,112
Unearned ESOP shares		(4,175,564	)		(4,379,742	)
Distributions in excess of retained earnings		(68,687,461	)		(61,052,418	)
Total Sotherly Hotels Inc. stockholders’ equity		107,738,075			81,824,666
Noncontrolling interest		(554,520	)		441,706
TOTAL EQUITY		107,183,555			82,266,372
TOTAL LIABILITIES AND EQUITY	$	498,649,964		$	493,482,847

The accompanying notes are an integral part of these consolidated financial statements.

SOTHERLY HOTELS INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

	Three Months Ended			Three Months Ended			Nine Months Ended			Nine Months Ended
	September 30, 2019			September 30, 2018			September 30, 2019			September 30, 2018
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
REVENUE
Rooms department	$	29,253,447		$	28,626,265		$	98,561,643		$	92,242,385
Food and beverage department		8,997,948			8,417,293			29,584,705			27,849,844
Other operating departments		4,300,780			4,374,504			13,336,834			14,614,915
Total revenue		42,552,175			41,418,062			141,483,182			134,707,144
EXPENSES
Hotel operating expenses
Rooms department		8,064,771			7,873,836			24,264,623			22,750,381
Food and beverage department		7,036,887			6,680,563			21,795,051			20,748,688
Other operating departments		1,352,205			1,661,128			5,007,651			4,870,037
Indirect		17,194,148			16,027,496			52,757,527			48,901,037
Total hotel operating expenses		33,648,011			32,243,023			103,824,852			97,270,143
Depreciation and amortization		4,980,168			4,547,043			16,117,278			15,783,174
Loss (gain) on disposal of assets		4,918			(7,555	)		32,088			(3,816	)
Corporate general and administrative		1,768,912			1,516,408			5,008,290			4,566,258
Total operating expenses		40,402,009			38,298,919			124,982,508			117,615,759
NET OPERATING INCOME		2,150,166			3,119,143			16,500,674			17,091,385
Other income (expense)
Interest expense		(4,722,456	)		(5,306,641	)		(15,115,690	)		(14,571,142	)
Interest income		102,768			88,484			357,576			236,693
Loss on early extinguishment of debt		-			(753,133	)		(1,152,356	)		(753,133	)
Unrealized (loss) gain on hedging activities		(226,491	)		123,443			(1,554,924	)		141,970
Gain on exercise of development right		3,940,000			—			3,940,000			—
Gain on involuntary conversion of assets		130,569			—			291,902			898,565
Net income (loss) before income taxes		1,374,556			(2,728,704	)		3,267,182			3,044,338
Income tax benefit (provision)		694,190			746,924			(439,323	)		(882,045	)
Net income (loss)		2,068,746			(1,981,780	)		2,827,859			2,162,293
Less: Net loss attributable to noncontrolling interest		13,337			385,616			311,642			245,298
Net income (loss) attributable to the Company		2,082,083			(1,596,164	)		3,139,501			2,407,591
Distributions to preferred stockholders		(2,188,910	)		(1,469,719	)		(5,631,799	)		(4,359,407	)
Net loss available to common stockholders	$	(106,827	)	$	(3,065,883	)	$	(2,492,298	)	$	(1,951,816	)
Net loss per share available to common stockholders
Basic	$	(0.01	)	$	(0.23	)	$	(0.18	)	$	(0.14	)
Weighted average number of common shares outstanding
Basic		13,636,706			13,513,996			13,624,760			13,491,807

The accompanying notes are an integral part of these consolidated financial statements.

SOTHERLY HOTELS INC.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

									Additional			Unearned			Distributions
	Preferred Stock				Common Stock				Paid-			ESOP			in Excess of			Noncontrolling
	Shares		Par Value		Shares		Par Value		In Capital			Shares			Retained Earnings			Interest			Total

Balances at December 31, 2018		2,962,141	$	29,621		14,209,378	$	142,093	$	147,085,112		$	(4,379,742	)	$	(61,052,418	)	$	441,706		$	82,266,372
Net loss		—		—		—		—		—			—			(183,256	)		(206,949	)		(390,205	)
Issuance of restricted common stock awards		—		—		13,000		130		92,203			—			—			—			92,333
Amortization of ESOP shares		—		—		—		—		(1,141	)		67,234			—			—			66,093
Amortization of restricted stock award		—		—		—		—		8,025			—			—			—			8,025
Preferred stock dividends declared:
Series B Preferred Stock, $0.50/share		—		—		—		—		—			—			(805,000	)		—			(805,000	)
Series C Preferred Stock, $0.492188/share		—		—		—		—		—			—			(665,507	)		—			(665,507	)
Common stock, $0.125/share dividends and distributions declared		—		—		—		—		—			—			(1,699,906	)		(222,268	)		(1,922,174	)
Balances at March 31, 2019 (unaudited)		2,962,141	$	29,621		14,222,378	$	142,223	$	147,184,199		$	(4,312,508	)	$	(64,406,087	)	$	12,489		$	78,649,937
Net income		—		—		—		—		—			—			1,240,673			(91,356	)		1,149,317
Issuance of preferred stock		1,200,000		12,000		—		—		28,365,519			—			—			—			28,377,519
Amortization of ESOP shares		—		—		—		—		—			67,160			—			—			67,160
Amortization of restricted stock award		—		—		—		—		8,025			—			—			—			8,025
Preferred stock dividends declared:																						—
Series B Preferred Stock, $0.50/share		—		—		—		—		—			—			(805,000	)		—			(805,000	)
Series C Preferred Stock, $0.492188/share		—		—		—		—		—			—			(665,507	)		—			(665,507	)
Series D Preferred Stock, $0.41823/share		—		—		—		—		—			—			(501,876	)		—			(501,876	)
Common stock, $0.13/share dividends and distributions declared		—		—		—		—		—			—			(1,682,361	)		(231,158	)		(1,913,519	)
Balances at June 30, 2019 (unaudited)		4,162,141	$	41,621		14,222,378	$	142,223	$	175,557,743		$	(4,245,348	)	$	(66,820,158	)	$	(310,025	)	$	104,366,056
Net income		—		—		—		—		—			—			2,082,083			(13,337	)		2,068,746
Issuance of preferred stock		202,469		2,025		—		—		4,858,988			—			—			—			4,861,013
Amortization of ESOP shares		—		—		—		—		(9,525	)		69,784			—			—			60,259
Amortization of restricted stock award		—		—		—		—		8,025			—			—			—			8,025
Preferred stock dividends declared:
Series B Preferred Stock, $0.50/share		—		—		—		—		—			—			(805,000	)		—			(805,000	)
Series C Preferred Stock, $0.492188/share		—		—		—		—		—			—			(765,160	)		—			(765,160	)
Series D Preferred Stock, $0.515625/share		—		—		—		—		—			—			(618,750	)		—			(618,750	)
Common stock, $0.13/share dividends and distributions declared		—		—		—		—		—			—			(1,760,476	)		(231,158	)		(1,991,634	)
Balances at September 30, 2019 (unaudited)		4,364,610	$	43,646		14,222,378	$	142,223	$	180,415,231		$	(4,175,564	)	$	(68,687,461	)	$	(554,520	)	$	107,183,555

The accompanying notes are an integral part of these consolidated financial statements.

SOTHERLY HOTELS INC.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

									Additional		Unearned			Distributions
	Preferred Stock				Common Stock				Paid-		ESOP			in Excess of			Noncontrolling
	Shares		Par Value		Shares		Par Value		In Capital		Shares			Retained Earnings			Interest			Total
Balances at December 31, 2017		2,910,000	$	29,100		14,078,831	$	140,788	$	146,249,339	$	(4,633,112	)	$	(48,765,860	)	$	1,154,775		$	94,175,030
Net income		—		—		—		—		—		—			1,206,501			(30,013	)		1,176,488
Issuance of unrestricted common stock awards		—		—		2,250		23		13,454		—			—			—			13,477
Issuance of restricted common stock awards		—		—		40,000		400		89,450		—			—			—			89,850
Amortization of ESOP shares		—		—		—		—		—		60,170			—			—			60,170
Amortization of restricted stock award		—		—		—		—		8,025		—			—			—			8,025
Preferred stock dividends declared:
Series B Preferred Stock, $0.50/share		—		—		—		—		—		—			(805,000	)		—			(805,000	)
Series C Preferred Stock, $0.492188/share		—		—		—		—		—		—			(639,844	)		—			(639,844	)
Common stock, $0.115/share dividends and distributions declared		—		—		—		—		—		—			(1,553,864	)		(204,486	)		(1,758,350	)
Balances at March 31, 2018 (unaudited)		2,910,000	$	29,100		14,121,081	$	141,211	$	146,360,268	$	(4,572,942	)	$	(50,558,067	)	$	920,276		$	92,319,846
Net income		—		—		—		—		—		—			2,797,258			170,331			2,967,589
Amortization of ESOP shares		—		—		—		—		—		61,673			—			—			61,673
Amortization of restricted stock award		—		—		—		—		8,025		—			—			—			8,025
Preferred stock dividends declared:
Series B Preferred Stock, $0.50/share		—		—		—		—		—		—			(805,000	)		—			(805,000	)
Series C Preferred Stock, $0.492188/share		—		—		—		—		—		—			(639,844	)		—			(639,844	)
Common stock, $0.12/share dividends and distributions declared		—		—		—		—		—		—			(1,605,893	)		(213,377	)		(1,819,270	)
Balances at June 30, 2018 (unaudited)		2,910,000	$	29,100		14,121,081	$	141,211	$	146,368,293	$	(4,511,269	)	$	(50,811,546	)	$	877,230		$	92,093,019
Net loss		—		—		—		—		—		—			(1,596,164	)		(385,616	)		(1,981,780	)
Issuance of preferred stock		50,541		505		—		—		1,187,561		—			—			—			1,188,066
Issuance of common stock		—		—		88,297		882		576,780		—			—			—			577,662
Amortization of ESOP shares		—		—		—		—		—		64,294			—			—			64,294
Amortization of restricted stock award		—		—		—		—		8,025		—			—			—			8,025
Preferred stock dividends declared:
Series B Preferred Stock, $0.50/share		—		—		—		—		—		—			(805,000	)		—			(805,000	)

Series C Preferred Stock, $0.492188/share

—

(664,719

)

—

(664,719

)

Common stock, $0.125/share dividends and

distributions declared

—

(1,754,486

)

(222,268

)

(1,976,754

)

Balances at September 30, 2018 (unaudited)

2,960,541

29,605

14,209,378

142,093

148,140,659

(4,446,975

)

(55,631,915

)

269,346

88,502,813

The accompanying notes are an integral part of these consolidated financial statements.

SOTHERLY HOTELS INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	Nine Months Ended			Nine Months Ended
	September 30, 2019			September 30, 2018
	(unaudited)			(unaudited)
Cash flows from operating activities:
Net income	$	2,827,859		$	2,162,293
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		16,117,278			15,783,174
Amortization of deferred financing costs		650,638			598,142
Amortization of mortgage premium		(18,511	)		(18,511	)
Gain on exercise of development right		(3,940,000	)		—
Gain on involuntary conversion of assets		(291,902	)		(898,565	)
Unrealized loss (gain) on hedging activities		1,554,924			(141,970	)
Loss (gain) on disposal of assets		32,088			(3,816	)
Loss on early extinguishment of debt		1,152,356			753,133
ESOP and stock - based compensation		309,920			313,540
Changes in assets and liabilities:
Accounts receivable		468,577			(1,942,179	)
Prepaid expenses, inventory and other assets		(1,395,457	)		1,045,824
Deferred income taxes		452,169			750,739
Accounts payable and other accrued liabilities		4,211,459			3,006,385
Advance deposits		(418,188	)		566,621
Accounts receivable - affiliate		175,909			(8,959	)
Net cash provided by operating activities		21,889,119			21,965,851
Cash flows from investing activities:
Acquisitions of hotel properties		(6,346,378	)		(79,732,716	)
Improvements and additions to hotel properties		(10,846,325	)		(18,497,781	)
Proceeds from involuntary conversion		291,902			898,565
Proceeds from the disposal of assets		4,934			7,555
Net cash used in investing activities		(16,895,867	)		(97,324,377	)
Cash flows from financing activities:
Proceeds of mortgage debt		—			145,795,332
Proceeds of unsecured debt		—			25,000,000
Proceeds from issuance of common stock, net		—			577,661
Proceeds from issuance of preferred stock, net		33,238,532			1,188,066
Redemption of unsecured notes		(25,250,000	)		—
Payments on mortgage loans		(4,582,990	)		(75,346,629	)
Payments of deferred financing costs		(106,950	)		(3,669,192	)
Dividends on common stock and distributions paid		(5,994,302	)		(5,318,695	)
Preferred dividends paid		(4,913,396	)		(4,256,328	)
Net cash (used in) provided by financing activities		(7,609,106	)		83,970,215
Net (decrease) increase in cash, cash equivalents and restricted cash		(2,615,854	)		8,611,689
Cash, cash equivalents and restricted cash at the beginning of the period		37,868,281			33,429,042
Cash, cash equivalents and restricted cash at the end of the period	$	35,252,427		$	42,040,731
Supplemental disclosures:
Cash paid during the period for interest	$	13,995,139		$	12,859,556
Cash paid (received) during the period for income taxes	$	(46,695	)	$	278,720
Non-cash investing and financing activities:
Deficiency of fair value of interest rate swap to cost	$	-		$	294,176
Change in amount of improvements to hotel property in accounts payable and accrued liabilities	$	335,331		$	251,195
Exercise of development right	$	3,940,000		$	-

The accompanying notes are an integral part of these consolidated financial statements.

SOTHERLY HOTELS LP

CONSOLIDATED BALANCE SHEETS

	September 30, 2019		December 31, 2018
	(unaudited)
ASSETS
Investment in hotel properties, net	$	446,839,580	$	435,725,814
Cash and cash equivalents		30,059,697		33,792,773
Restricted cash		5,192,730		4,075,508
Accounts receivable, net		6,298,119		6,766,696
Accounts receivable - affiliate		86,663		262,572
Loan receivable - affiliate		4,270,679		4,446,410
Prepaid expenses, inventory and other assets		5,494,165		5,262,884
Favorable lease assets, net		—		2,465,421
Deferred income taxes		4,679,010		5,131,179
TOTAL ASSETS	$	502,920,643	$	497,929,257
LIABILITIES
Mortgage loans, net	$	360,549,890	$	364,828,845
Unsecured notes, net		—		23,894,658
Accounts payable and other accrued liabilities		24,308,930		16,268,100
Advance deposits		2,397,095		2,815,283
Dividends and distributions payable		4,268,977		3,466,136
TOTAL LIABILITIES	$	391,524,892	$	411,273,022

Commitments and contingencies (see Note 6)		—		—

PARTNERS’ CAPITAL
Preferred units, 11,000,000 units authorized;
8.0% Series B cumulative redeemable perpetual preferred units, liquidation preference $25 per unit, 1,610,000 units issued and outstanding at September 30, 2019 and December 31, 2018, respectively.		37,766,531		37,766,531
7.875% Series C cumulative redeemable perpetual preferred units, liquidation preference $25 per unit, 1,554,610 and 1,352,141 units issued and outstanding at September 30, 2019 and December 31, 2018, respectively.		36,354,736		31,493,723
8.25% Series D cumulative redeemable perpetual preferred units, liquidation preference $25 per unit, 1,200,000 units issued and outstanding at September 30, 2019 and none at December 31, 2018.		28,377,519		—
General Partner: 160,006 units and 159,876 units issued and outstanding as of September 30, 2019 and December 31, 2018, respectively.		375,888		452,165
Limited Partners: 15,840,512 units and 15,827,642 units issued and outstanding as of September 30, 2019 and December 31, 2018, respectively.		8,521,077		16,943,816
TOTAL PARTNERS’ CAPITAL		111,395,751		86,656,235
TOTAL LIABILITIES AND PARTNERS’ CAPITAL	$	502,920,643	$	497,929,257

The accompanying notes are an integral part of these consolidated financial statements.

SOTHERLY HOTELS LP

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

	Three Months Ended			Three Months Ended			Nine Months Ended			Nine Months Ended
	September 30, 2019			September 30, 2018			September 30, 2019			September 30, 2018
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
REVENUE
Rooms department	$	29,253,447		$	28,626,265		$	98,561,643		$	92,242,385
Food and beverage department		8,997,948			8,417,293			29,584,705			27,849,844
Other operating departments		4,300,780			4,374,504			13,336,834			14,614,915
Total revenue		42,552,175			41,418,062			141,483,182			134,707,144
EXPENSES
Hotel operating expenses
Rooms department		8,064,771			7,873,836			24,264,623			22,750,381
Food and beverage department		7,036,887			6,680,563			21,795,051			20,748,688
Other operating departments		1,352,205			1,661,128			5,007,651			4,870,037
Indirect		17,194,148			16,027,496			52,757,527			48,901,037
Total hotel operating expenses		33,648,011			32,243,023			103,824,852			97,270,143
Depreciation and amortization		4,980,168			4,547,043			16,117,278			15,783,174
Loss (gain) on disposal of assets		4,918			(7,555	)		32,088			(3,816	)
Corporate general and administrative		1,768,912			1,516,408			5,008,290			4,566,258
Total operating expenses		40,402,009			38,298,919			124,982,508			117,615,759
NET OPERATING INCOME		2,150,166			3,119,143			16,500,674			17,091,385
Other income (expense)
Interest expense		(4,722,456	)		(5,306,641	)		(15,115,690	)		(14,571,142	)
Interest income		102,768			88,484			357,576			236,693
Loss on early extinguishment of debt		—			(753,133	)		(1,152,356	)		(753,133	)
Unrealized (loss) gain on hedging activities		(226,491	)		123,443			(1,554,924	)		141,970
Gain on exercise of development right		3,940,000			—			3,940,000			—
Gain on involuntary conversion of assets		130,569			—			291,902			898,565
Net income (loss) before income taxes		1,374,556			(2,728,704	)		3,267,182			3,044,338
Income tax benefit (provision)		694,190			746,924			(439,323	)		(882,045	)
Net income (loss)		2,068,746			(1,981,780	)		2,827,859			2,162,293
Distributions to preferred unit holder		(2,188,910	)		(1,469,719	)		(5,631,799	)		(4,359,407	)
Net loss available to general and limited partnership unit holders	$	(120,164	)	$	(3,451,499	)	$	(2,803,940	)	$	(2,197,114	)
Net loss attributable per general and limited partner unit
Basic	$	(0.01	)	$	(0.22	)	$	(0.18	)	$	(0.14	)
Weighted average number of general and limited partner units outstanding
Basic		16,000,518			15,915,706			15,998,556			15,902,565

The accompanying notes are an integral part of these consolidated financial statements.

SOTHERLY HOTELS LP

CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS’ CAPITAL

	Preferred Units											General Partner					Limited Partner
	Units		Series B Amounts			Series C Amounts			Series D Amounts			Units		Amounts			Units		Amounts			Total
Balances at December 31, 2018		2,962,141	$	37,766,531		$	31,493,723		$	—			159,876	$	452,165			15,827,642	$	16,943,816		$	86,656,235
Issuance of general and limited partnership units		—		—			—			—			130		923			12,870		91,410			92,333
Amortization of restricted units award		—		—			—			—			—		80			—		7,945			8,025
Unit based compensation		—		—			—			—			—		908			—		89,860			90,768
Preferred units distributions declared:
Series B Preferred Units, $0.50/unit		—		(805,000	)		—			—			—		—			—		—			(805,000	)
Series C Preferred Units, $0.492188/unit		—		—			(665,507	)		—			—		—			—		—			(665,507	)
Partnership units, $0.125/unit distributions declared		—		—			—			—			—		(17,806	)		—		(1,985,071	)		(2,002,877	)
Net loss		—		805,000			665,507			—			—		(18,607	)		—		(1,842,105	)		(390,205	)
Balances at March 31, 2019 (unaudited)		2,962,141	$	37,766,531		$	31,493,723		$	—			160,006	$	417,663			15,840,512	$	13,305,855		$	82,983,772
Issuance of preferred partnership units		1,200,000		—			—			28,377,519			—		—			—		—			28,377,519
Amortization of restricted units award		—		—			—			—			—		80			—		7,945			8,025
Unit based compensation		—		—			—			—			—		1,730			—		171,299			173,029
Preferred units distributions declared:
Series B Preferred Units, $0.50/unit		—		(805,000	)		—			—			—		—			—		—			(805,000	)
Series C Preferred Units, $0.492188/unit		—		—			(665,507	)		—			—		—			—		—			(665,507	)
Series D Preferred Units, $0.41823/unit		—		—			—			(501,875	)		—		—			—		—			(501,875	)
Partnership units, $0.13/unit distributions declared		—		—			—			—			—		(16,622	)		—		(2,063,444	)		(2,080,066	)
Net income		—		805,000			665,507			501,875			—		(8,231	)		—		(814,836	)		1,149,315
Balances at June 30, 2019 (unaudited)		4,162,141	$	37,766,531		$	31,493,723		$	28,377,519			160,006	$	394,620			15,840,512	$	10,606,819		$	108,639,212
Issuance of preferred partnership units		202,469		—			4,861,013			—			—		—			—		—			4,861,013
Amortization of restricted units award		—		—			—			—			—		80			—		7,945			8,025
Unit based compensation		—		—			—			—			—		877			—		86,842			87,719
Preferred units distributions declared:
Series B Preferred Units, $0.50/unit		—		(805,000	)		—			—			—		—			—		—			(805,000	)
Series C Preferred Units, $0.492188/unit		—		—			(765,160	)		—			—		—			—		—			(765,160	)
Series D Preferred Units, $0.515625/unit		—		—			—			(618,750	)		—		—			—		—			(618,750	)
Partnership units, $0.13/unit distributions declared		—		—			—			—			—		(18,487	)		—		(2,061,567	)		(2,080,054	)
Net income		—		805,000			765,160			618,750			—		(1,202	)		—		(118,962	)		2,068,746
Balances at September 30, 2019 (unaudited)		4,364,610	$	37,766,531		$	36,354,736		$	28,377,519			160,006	$	375,888			15,840,512	$	8,521,077		$	111,395,751

The accompanying notes are an integral part of these consolidated financial statements.

SOTHERLY HOTELS LP

CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS’ CAPITAL

	Preferred Units										General Partner					Limited Partner
	Units		Series B Amounts			Series C Amounts			Series D Amounts		Units		Amounts			Units		Amounts			Total
Balances at December 31, 2017		2,910,000	$	37,766,531		$	30,488,660		$	—		158,570	$	586,725			15,698,401	$	29,938,539		$	98,780,455
Issuance of general and limited partnership units		—		—			—			—		423		1,034			41,827		102,294			103,328
Amortization of restricted units award		—		—			—			—		—		—			—		8,025			8,025
Unit based compensation		—		—			—			—		—		—			—		87,267			87,267
Preferred units distributions declared:
Series B Preferred Units, $0.50/unit		—		(805,000	)		—			—		—		—			—		—			(805,000	)
Series C Preferred Units, $0.492188/unit		—		—			(639,844	)		—		—		—			—		—			(639,844	)
Partnership units, $0.115/unit distributions declared		—		—			—			—		—		(18,285	)		—		(1,810,125	)		(1,828,410	)
Net income		—		805,000			639,844			—		—		11,765			—		(280,121	)		1,176,488
Balances at March 31, 2018 (unaudited)		2,910,000	$	37,766,531		$	30,488,660		$	—		158,993	$	581,239			15,740,228	$	28,045,879		$	96,882,309
Amortization of restricted units award		—		—			—			—		—		—			—		8,025			8,025
Unit based compensation		—		—			—			—		—		—			—		93,254			93,254
Preferred units distributions declared:
Series B Preferred Units, $0.50/unit		—		(805,000	)		—			—		—		—			—		—			(805,000	)
Series C Preferred Units, $0.492188/unit		—		—			(639,844	)		—		—		—			—		—			(639,844	)
Partnership units, $0.12/unit distributions declared		—		-			—			—		—		(19,080	)		—		(1,888,827	)		(1,907,907	)
Net income		—		805,000			639,844			—		—		29,676			—		1,493,069			2,967,589
Balances at June 30, 2018 (unaudited)		2,910,000	$	37,766,531		$	30,488,660		$	—		158,993	$	591,835			15,740,228	$	27,751,400		$	96,598,426
Issuance of general and limited partnership units		—		—			—			—		883		5,776			87,414		571,881			577,657
Issuance of preferred units		50,541		—			1,188,066			—		—		—			—		—			1,188,066
Amortization of restricted units award		—		—			—			—		—		—			—		8,025			8,025
Unit based compensation		—		—			—			—		—		—			—		27,611			27,611
Preferred units distributions declared:
Series B Preferred Units, $0.50/unit		—		(805,000	)		—			—		—		—			—		—			(805,000	)
Series C Preferred Units, $0.492188/unit		—		—			(664,719	)		—		—		—			—		—			(664,719	)
Partnership units, $0.12/unit distributions declared		—		-			—			—		—		(19,955	)		—		(1,975,673	)		(1,995,628	)
Net loss		—		805,000			664,719			—		—		(63,413	)		—		(3,388,086	)		(1,981,780	)

Balances at September 30, 2018

(unaudited)

2,960,541

37,766,531

31,676,726

159,876

514,243

15,827,642

22,995,158

92,952,658

The accompanying notes are an integral part of these consolidated financial statements.

SOTHERLY HOTELS LP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	Nine Months Ended			Nine Months Ended
	September 30, 2019			September 30, 2018
	(unaudited)			(unaudited)
Cash flows from operating activities:
Net income	$	2,827,859		$	2,162,293
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		16,117,278			15,783,174
Amortization of deferred financing costs		650,638			598,142
Amortization of mortgage premium		(18,511	)		(18,511	)
Gain on exercise of development right		(3,940,000	)		—
Gain on involuntary conversion of assets		(291,902	)		(898,565	)
Unrealized loss (gain) on hedging activities		1,554,924			(141,970	)
Loss (gain) on disposal of assets		32,088			(3,816	)
Loss on early extinguishment of debt		1,152,356			753,133
ESOP and unit - based compensation		467,924			335,531
Changes in assets and liabilities:
Accounts receivable		468,577			(1,942,179	)
Prepaid expenses, inventory and other assets		(1,395,457	)		1,045,824
Deferred income taxes		452,169			750,739
Accounts payable and other accrued liabilities		4,211,459			3,006,385
Advance deposits		(418,188	)		566,621
Accounts receivable - affiliate		175,909			(8,959	)
Net cash provided by operating activities		22,047,123			21,987,842
Cash flows from investing activities:
Acquisitions of hotel properties		(6,346,378	)		(79,732,716	)
Improvements and additions to hotel properties		(10,846,325	)		(18,497,781	)
ESOP loan payments received		175,731			148,016
Proceeds from involuntary conversion		291,902			898,565
Proceeds from the disposal of assets		4,934			7,555
Net cash used in investing activities		(16,720,136	)		(97,176,361	)
Cash flows from financing activities:
Proceeds of mortgage debt		—			145,795,332
Proceeds of unsecured debt		—			25,000,000
Proceeds from issuance of general and limited partnership units, net		—			577,661
Proceeds from issuance of preferred partnership units, net		33,238,532			1,188,066
Redemption of unsecured notes		(25,250,000	)		—
Payments on mortgage loans		(4,582,990	)		(75,346,629	)
Payments of deferred financing costs		(106,950	)		(3,669,192	)
Distributions on general and limited partnership interests		(6,328,037	)		(5,488,702	)
Distributions on preferred partnership interests		(4,913,396	)		(4,256,328	)
Net cash(used in) provided by financing activities		(7,942,841	)		83,800,208
Net (decrease) increase in cash, cash equivalents and restricted cash		(2,615,854	)		8,611,689
Cash, cash equivalents and restricted cash at the beginning of the period		37,868,281			33,429,042
Cash, cash equivalents and restricted cash at the end of the period	$	35,252,427		$	42,040,731
Supplemental disclosures:
Cash paid during the period for interest	$	13,993,340		$	12,859,556
Cash paid during the period for income taxes	$	(46,695	)	$	278,720
Non-cash investing and financing activities:
Deficiency of fair value of interest rate swap to cost	$	-		$	294,176
Change in amount of improvements to hotel property in accounts payable and accrued liabilities	$	335,331		$	251,195
Exercise of development right	$	3,940,000		$	-

The accompanying notes are an integral part of these consolidated financial statements.

SOTHERLY HOTELS INC.

SOTHERLY HOTELS LP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Organization and Description of Business

Sotherly Hotels Inc. (the “Company”) is a self-managed and self-administered lodging real estate investment trust (“REIT”) that was incorporated in Maryland on August 20, 2004 to own full-service, primarily upscale and upper-upscale hotels located in primary and secondary markets in the mid-Atlantic and southern United States. Currently, the Company is focused on the acquisition, renovation, upbranding and repositioning of upscale to upper-upscale full-service hotels in the southern United States. The Company’s portfolio consists of investments in twelve hotel properties comprising 3,156 rooms, as well as interests in two condominium hotels and their associated rental programs. The Company owns hotels that operate under the Hilton Worldwide, Marriott International, Inc., and Hyatt Hotels Corporation brands, as well as independent hotels.

The Company commenced operations on December 21, 2004 when it completed its initial public offering and thereafter consummated the acquisition of six hotel properties (the “Initial Properties”). Substantially all of the Company’s assets are held by, and all of its operations are conducted through, Sotherly Hotels LP (the “Operating Partnership”), which at September 30, 2019, was approximately 88.9% owned by the Company. Pursuant to the terms of the Amended and Restated Agreement of Limited Partnership (the “Partnership Agreement”) of the Operating Partnership, the Company, as general partner, is not entitled to compensation for its services to the Operating Partnership. The Company, as general partner, conducts substantially all of its operations through the Operating Partnership and the Company’s administrative expenses are the obligations of the Operating Partnership. Additionally, the Company is entitled to reimbursement for any expenditure incurred by it on the Operating Partnership’s behalf.

For the Company to qualify as a REIT, it cannot operate hotels. Therefore, the Operating Partnership, through its subsidiaries, leases the hotels to direct and indirect subsidiaries of MHI Hospitality TRS Holding, Inc. (collectively, “MHI TRS”), which is a wholly-owned subsidiary of the Operating Partnership. MHI TRS then engages eligible independent hotel management companies, including MHI Hotels Services, LLC, which does business as Chesapeake Hospitality (“Chesapeake Hospitality”) and Highgate Hotels, L.P. (“Highgate Hotels”), to operate the hotels under management contracts. MHI TRS is treated as a taxable REIT subsidiary for federal income tax purposes.

All references in this report to “we”, “us” and “our” refer to the Company, its Operating Partnership and its subsidiaries and predecessors, collectively, unless the context otherwise requires or where otherwise indicated.

Significant transactions occurring during the current and prior fiscal year include the following:

On February 1, 2018, we received proceeds of $5.0 million on the Hotel Ballast mortgage loan after meeting certain requirements, per the mortgage documents.

On February 12, 2018, the Company and the Operating Partnership closed on a sale and issuance by the Operating Partnership of an aggregate $25.0 million of the 7.25% senior unsecured notes due 2021 (the “7.25% Notes”), unconditionally guaranteed by the Company, for net proceeds after all estimated expenses of approximately $23.3 million. The Operating Partnership used the net proceeds from this offering, together with existing cash on hand and $57.0 million of asset-level mortgage indebtedness, to finance the acquisition of the Hyatt Centric Arlington and for working capital.

On February 26, 2018, we entered into a First Amendment to Loan Agreement, Amended and Restated Promissory Note, and other related documents with International Bank of Commerce to amend the terms of the mortgage loan on The Whitehall hotel located in Houston, TX. Pursuant to the amended loan documents, payments of principal and interest on a 25-year amortization schedule have begun and the maturity date was extended until February 26, 2023.

On March 1, 2018, we acquired the 318-room Hyatt Centric Arlington located in Arlington, Virginia at an aggregate purchase price of approximately $79.7 million, including seller credits (the “Arlington Acquisition”). Concurrently with the closing, we entered into a franchise agreement with an affiliate of Hyatt Hotels Corporation for the hotel to continue operating as the Hyatt Centric Arlington, and a management agreement with Highgate Hotels for the management of the hotel. The management agreement: (i) has an initial term of three years commencing March 1, 2018; (ii) provides for a base management fee equal to 2.50% of gross revenues; and (iii) provides for an incentive management fee equal to 10% of the amount by which gross operating profit, as defined in the management agreement, for a given year exceeds the budgeted gross operating profit for such year; provided, however, that the incentive management fee payable in respect of any year shall not exceed 0.5% of the gross revenues of the hotel. The Hyatt Centric Arlington is subject to a long-term ground lease agreement that covers all of the land underlying the hotel. The ground lease requires us to make rental payments of $50,000 per year in base rent and percentage rent equal to 3.5% of gross rooms revenues in excess of

certain thresholds, as defined in the agreements. The initial term of the ground lease expires in 2025 and may be extended by us for five additional renewal periods of 10 years each.

On March 1, 2018, we entered into a loan agreement, a first and second promissory note (“Note A” and “Note B”, respectively), and other loan documents, including a guarantee by the Operating Partnership, to secure an aggregate $57.0 million mortgage (the “Mortgage Loan”) on the Hyatt Centric Arlington with Fifth Third Bank. Pursuant to the Mortgage Loan documents, Note A had an original principal balance in the amount of $50.0 million; had a term of 3 years, with two 1-year extension options, each of which was subject to certain criteria; bore a floating interest rate of one-month LIBOR plus 3.00%, payable monthly; and required monthly principal payments of $78,650. Pursuant to the Mortgage Loan documents, Note B had an original principal balance in the amount of $7.0 million; had a term of 1-year, with two 1-year extension options, each of which was subject to certain criteria; bore a floating interest rate of three-month LIBOR plus 5.00%, payable monthly; and required monthly principal payments of $100,000 during the initial 1-year term, $150,000 during the first 1-year extended term, and $250,000 during the second 1-year extended term, with interest payments due monthly on the outstanding principal amount during all three terms. The full amount of the loan proceeds, together with proceeds of the 7.25% Notes offering and cash on hand, were used to finance the Arlington Acquisition.

On July 2, 2018, we purchased a portion of the parking lot, previously leased, adjacent to the DoubleTree by Hilton Raleigh Brownstone-University for an aggregate purchase price of $3.5 million.

On July 27, 2018, we entered into a loan agreement and other documents, including a promissory note, to secure a mortgage on the DoubleTree by Hilton Raleigh Brownstone-University with MetLife Commercial Mortgage Originator, LLC. The mortgage has an initial principal balance of $18.3 million, with an additional $5.2 million available upon the satisfaction of certain conditions. The mortgage has an initial term of 4 years with a 1-year extension and bears a floating rate of interest equal to the 1-month LIBOR rate plus 4.00%. The mortgage requires monthly interest-only payments and, following a 12-month lockout, can be prepaid with a penalty during its second year and without penalty thereafter. We entered into an interest-rate cap agreement to limit our exposure through August 1, 2022 to increases in LIBOR exceeding 3.25% on a notional amount of $23,500,000. We used a portion of the proceeds to repay the existing first mortgage on the DoubleTree by Hilton Raleigh Brownstone-University and to pay closing costs, and intend to use the balance of the proceeds for general corporate purposes.

On July 31, 2018, we entered into a second amendment to the loan and security agreement; an amended, restated and consolidated mortgage loan note; and other related documents with our existing lender, TD Bank, N.A., to amend the terms of our mortgage loan on the DoubleTree by Hilton Philadelphia Airport. Concurrent with the loan modification, we also entered into a 5-year swap agreement with The Toronto-Dominion Bank. Pursuant to the amended loan documents: (i) the principal balance of the loan was increased from approximately $30.0 million to $42.2 million; (ii) the loan’s maturity date was extended to July 31, 2023; (iii) the loan bears a floating interest rate equal to the 1-month LIBOR rate plus 2.27% (the “Loan Rate”); (iv) the loan amortizes on a 30-year schedule with payments of principal and interest beginning immediately; (v) the loan can be prepaid without penalty; and (vi) the loan will no longer be fully guaranteed by the Operating Partnership, but the Operating Partnership has guaranteed certain standard “bad boy” carveouts. Pursuant to the swap agreement: (i) the Loan Rate has been swapped for a fixed interest rate of 5.237%; notional amounts of the swap approximate the declining balance of the loan; and (iii) we are responsible for any potential termination fees associated with early termination of the swap agreement. We used a portion of the proceeds to repay in full the existing Note B to the mortgage loan on our Hyatt Centric Arlington and to pay closing costs associated with the amendment and will use the balance of the proceeds for general corporate purposes.

On August 31, 2018, we entered into a Sales Agency Agreement, with Sandler O’Neill & Partners, L.P. (“Sandler O’Neill”), under which the Company may sell from time to time through Sandler O’Neill, as sales agent, shares of the Company’s common stock, par value $0.01 per share, having an aggregate gross sales price of up to $5,000,000 and up to 400,000 shares of the Company’s 7.875% Series C Cumulative Redeemable Preferred Stock, $0.01 par value per share.

On September 18, 2018, we entered into a loan agreement and other documents, including a promissory note, to secure a mortgage on the Hyatt Centric Arlington with MetLife Real Estate Lending LLC. Pursuant to the loan documents, the Mortgage Loan has an initial principal balance of $50.0 million; has a term of 10 years; bears a fixed interest rate of 5.25%; amortizes on a 30-year schedule; and following a 5-year lockout, can be prepaid with penalty in years 6-10 and without penalty during the final 4 months of the term. The Company used the proceeds to repay the existing first mortgage on the Hyatt Centric Arlington, to pay closing costs, and for general corporate purposes.

On April 18, 2019, the Company closed a sale and issuance of 1,080,000 shares of its 8.25% Series D cumulative redeemable perpetual preferred stock (the “Series D Preferred Stock”), for gross proceeds of $27.0 million before underwriting discounts and commissions and expenses payable by the Company. On May 1, 2019, the Company closed a sale and issuance of an additional 120,000 shares of its Series D Preferred Stock, for gross proceeds of $3.0 million before underwriting discounts and commissions and expenses payable by the Company, in connection with the partial exercise of the underwriters’ option to purchase additional shares of the Series D Preferred Stock. Total net proceeds after all estimated expenses were approximately $28.4 million, which the Company contributed to its Operating Partnership for an equivalent number of Series D preferred units. We used the net proceeds to redeem in full the Operating Partnership’s 7.25% Notes and for working capital.

On April 24, 2019, the Hyde Resort & Residences condominium association, 4111 South Ocean Drive Condominium Association, Inc., unilaterally terminated both (i) the existing Lease Agreement for the 400-space parking garage and meeting rooms associated with the condominium hotel and (ii) the Association Management Agreement relating to the operation and management of the hotel condominium association. We continue to operate our rental program at the Hyde Resort & Residences.

On April 26, 2019, we entered into amended loan documents to modify the existing mortgage loan on the Hotel Alba (f/k/a Crowne Plaza Tampa Westshore) with the existing lender, Fifth Third Bank. Pursuant to the modification, the mortgage loan principal balance remained at approximately $18.2 million; the maturity date was extended to June 30, 2022, and may be extended for two additional periods of one year each, subject to certain conditions; the mortgage loan continues to bear a floating interest rate of 1-month LIBOR plus 3.75% subject to a floor rate of 3.75%, with a new provision to reduce the floating interest rate to 1-month LIBOR plus 3.00% upon the successful achievement of certain performance hurdles; the mortgage loan amortizes on a 25-year schedule; and the mortgage loan continues to be guaranteed by Sotherly Hotels LP.

On May 20, 2019, the Operating Partnership redeemed the entire $25.0 million aggregate principal amount of its 7.25% Notes, at a redemption price equal to 101% of the principal amount of the 7.25% Notes, plus any accrued and unpaid interest to, but not including, the redemption date.

On September 6, 2019, we entered into a master agreement with Newport Hospitality Group, Inc., a Virginia corporation, and Our Town Hospitality LLC, a Virginia limited liability company relating to the management of ten of our hotels. The master agreement is designed to address the scheduled termination on January 1, 2020 of certain individual hotel management agreements by and between us and Chesapeake Hospitality. On July 15, 2019 we notified Chesapeake Hospitality of our intent not to renew or extend the expiring hotel management agreements. The new master agreement establishes terms for new hotel management agreements governing the management of our hotels. Chesapeake Hospitality has committed to providing assistance in transitioning the hotels to a new manager.

On September 26, 2019, we closed on the purchase of a commercial condominium unit of the Hyde Beach House Resort & Residences, a newly constructed 342-unit condominium hotel located in Hollywood, Florida (“Hyde Beach House”), from 4000 South Ocean Property Owner, LLLP. In connection with the closing, we (i) acquired commercial unit 2 of the Hyde Beach House, along with rights to certain limited common elements appurtenant to the commercial unit, for an adjusted purchase price of approximately $5.4 million; (ii) purchased inventories and equipment for additional consideration in the amount of approximately $0.7 million; (iii) entered into a Second Addendum to the purchase agreement; (iv) entered into a 20-year parking and cabana management agreement for the parking garage and poolside cabanas associated with the Hyde Beach House; (v) entered into a 20-year management agreement relating to the operation and management of the Hyde Beach House condominium association; and (vi) received a pre-opening services fee of $1.0 million. We began operating a condominium unit rental program for residential units in the facility in November 2019. Also, in connection with the closing, our DoubleTree Resort by Hilton Hollywood Beach acquired a commercial condominium unit consisting of a 3,000 square foot ballroom and adjacent pre-function space, as well as 200 dedicated parking spaces within the parking garage adjacent to the hotel.

2. Summary of Significant Accounting Policies

Basis of Presentation – The consolidated financial statements of the Company presented herein include all of the accounts of Sotherly Hotels Inc., the Operating Partnership, MHI TRS and subsidiaries. All significant inter-company balances and transactions have been eliminated. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

The consolidated financial statements of the Operating Partnership presented herein include all of the accounts of Sotherly Hotels LP, MHI TRS and subsidiaries. All significant inter-company balances and transactions have been eliminated. Additionally, all administrative expenses of the Company and those expenditures made by the Company on behalf of the Operating Partnership are reflected as the administrative expenses, expenditures and obligations thereto of the Operating Partnership, pursuant to the terms of the Partnership Agreement.

Investment in Hotel Properties – Investments in hotel properties include investments in operating properties which are recorded at fair value on acquisition date and allocated to land, property and equipment and identifiable intangible assets. Replacements and improvements are capitalized, while repairs and maintenance are expensed as incurred. Upon the sale or retirement of a fixed asset, the cost and related accumulated depreciation are removed from our accounts and any resulting gain or loss is included in the statements of operations. Expenditures which constitute additions or improvements that extend the life of the property, are capitalized.

Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally 7 to 39 years for buildings and building improvements and 5 to 10 years for furniture, fixtures and equipment. Leasehold improvements are amortized over the shorter of the lease term or the useful lives of the related assets.

We review our investments in hotel properties for impairment whenever events or changes in circumstances indicate that the carrying value of the hotel properties may not be recoverable. Events or circumstances that may cause a review include, but are not limited to, adverse permanent changes in the demand for lodging at the properties due to declining national or local economic conditions and/or new hotel construction in markets where the hotels are located. When such conditions exist, management performs an analysis to determine if the estimated undiscounted future cash flows from operations and the proceeds from the ultimate disposition of a hotel property exceeds its carrying value. If the estimated undiscounted future cash flows are found to be less than the carrying amount of the asset, an adjustment to reduce the carrying amount to the related hotel property’s estimated fair market value would be recorded and an impairment loss recognized.

Cash and Cash Equivalents – We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents.

Concentration of Credit Risk – We hold cash accounts at several institutions in excess of the Federal Deposit Insurance Corporation (the “FDIC”) protection limits of $250,000. Our exposure to credit loss in the event of the failure of these institutions is represented by the difference between the FDIC protection limit and the total amounts on deposit. Management monitors, on a regular basis, the financial condition of the financial institutions along with the balances there on deposit to minimize our potential risk.

Restricted Cash – Restricted cash includes real estate tax escrows, insurance escrows and reserves for replacements of furniture, fixtures and equipment pursuant to certain requirements in our various mortgage agreements.

Accounts Receivable – Accounts receivable consists primarily of hotel guest and banqueting receivables. Ongoing evaluations of collectability are performed and an allowance for potential credit losses is provided against the portion of accounts receivable that is estimated to be uncollectible.

Inventories – Inventories, consisting primarily of food and beverages, are stated at the lower of cost or net realizable value, with cost determined on a method that approximates first-in, first-out basis.

Franchise License Fees – Fees expended to obtain or renew a franchise license are amortized over the life of the license or renewal. The unamortized franchise fees as of September 30, 2019 and December 31, 2018 were $428,223 and $471,996, respectively. Amortization expense for the three-month periods ended September 30, 2019 and 2018, totaled $14,869 and $14,868, respectively, and for the nine-month periods ended September 30, 2019 and 2018, totaled $43,773 and $45,204, respectively.

Right-of-Use Assets and Lease Obligations – In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-02, Leases, which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively.

A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases, to clarify how to apply certain aspects of the new lease standard. In July 2018, the FASB also issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, to give companies another option for transition and to provide lessors with a practical expedient to reduce the cost and complexity of implementing the new standard. The transition option allows companies to not apply the new lease standard in the comparative periods they present in their financial statements in the year of adoption.

We adopted this standard on January 1, 2019. We elected the practical expedients allowed under the guidance and retained the original lease classification and historical accounting for initial direct costs for leases existing prior to the adoption date. We also elected not to restate prior periods for the impact of the adoption of the new standard. The adoption of this standard has resulted in the recognition of right-of-use assets and related liabilities to account for our future obligations under the acquired operating ground lease,

equipment, office space, parking and land leases for which we are the lessee. See Notes 4 and 6 to the accompanying financial statements for additional disclosures on the adoption of this standard. As of September 30, 2019, we had right of use assets, net of approximately $6.6 million, and lease obligations of approximately $4.4 million. The right-of-use assets are included in investments in hotel properties, net or in prepaid expenses, inventory and other assets and the lease obligations are included in accounts payable and accrued liabilities on the consolidated balance sheets.

Deferred Financing and Offering Costs – Deferred financing costs are recorded at cost and consist of loan fees and other costs incurred in issuing debt and are reflected in mortgage loans, net and unsecured notes, net on the consolidated balance sheets. Deferred offering costs are recorded at cost and consist of offering fees and other costs incurred in advance of issuing equity and are reflected in prepaid expenses, inventory and other assets on the consolidated balance sheets. Amortization of deferred financing costs is computed using a method that approximates the effective interest method over the term of the related debt and is included in interest expense in the consolidated statements of operations.

Deferred offering costs are netted against our equity offerings when the offering is complete, whereby the costs are offset against the equity funds raised in the future and included in additional paid-in capital on the consolidated balance sheets, or if the offering expires and the offering costs exceed the funds raised in the offering then the excess will be included in corporate general and administrative expenses in the consolidated statements of operations.

Derivative Instruments – Our derivative instruments are reflected as assets or liabilities on the consolidated balance sheets and measured at fair value. Derivative instruments used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as an interest rate risk, are considered fair value hedges. Derivative instruments used to hedge exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. For a derivative instrument designated as a cash flow hedge, the change in fair value each period is reported in accumulated other comprehensive income in stockholders’ equity and partners’ capital to the extent the hedge is effective. For a derivative instrument designated as a fair value hedge, the change in fair value each period is reported in earnings along with the change in fair value of the hedged item attributable to the risk being hedged. For a derivative instrument that does not qualify for hedge accounting or is not designated as a hedge, the change in fair value each period is reported in earnings.

We use derivative instruments to add stability to interest expense and to manage our exposure to interest-rate movements. To accomplish this objective, we currently use interest rate caps and an interest rate swap which act as cash flow hedges and are not designated as hedges. We value our interest-rate caps and interest rate swap at fair value, which we define as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). We also have used derivative instruments in the Company’s stock to obtain more favorable terms on our financing. We do not enter into contracts to purchase or sell derivative instruments for speculative trading purposes.

Fair Value Measurements –

We classify the inputs used to measure fair value into the following hierarchy:

Level 1

Unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2

Unadjusted quoted prices in active markets for similar assets or liabilities, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.

Level 3

Unobservable inputs for the asset or liability.

We endeavor to utilize the best available information in measuring fair value. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following table represents our assets and liabilities measured at fair value and the basis for that measurement (our interest rate caps and interest rate swap are the only assets or liabilities measured at fair value on a recurring basis, there is one asset added during the three month period ending September 30, 2019 in the amount of $3,940,000 which is non-recurring, and there were no non-recurring liabilities for fair value measurements as of September 30, 2019 and December 31, 2018, respectively):

	Level 1			Level 2			Level 3
December 31, 2018
Interest Rate Caps ⁽¹⁾	$	—		$	94,697		$	—
Interest Rate Swap ⁽²⁾	$	—		$	(984,677	)	$	—
Mortgage loans ⁽³⁾	$	—		$	(357,279,949	)	$	—
Unsecured notes ⁽⁴⁾	$	(25,390,000	)	$	—		$	—
September 30, 2019
Interest Rate Cap ⁽¹⁾	$	—		$	4,421		$	—
Interest Rate Swap ⁽²⁾	$	—		$	(2,443,591	)	$	—
Development of ballroom and parking spaces	$	—		$	3,940,000		$	—
Mortgage loans ⁽³⁾	$	—		$	(365,393,515	)	$	—

(1)	Interest rate cap, which cap the 1-month LIBOR rate between 2.5% and 3.25%.

(2)	Interest rate swap, which takes the Loan Rate and swaps it for a fixed interest rate of 5.237%; notional amounts of the swap approximate the declining balance of the loan.

(3)	Mortgage loans are reflected at outstanding principal balance, net of deferred financing costs on our Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018.

(4)	Unsecured notes are recorded at outstanding principal balance, net of deferred financing costs on our Consolidated Balance Sheets as of December 31, 2018.

Noncontrolling Interest in Operating Partnership – Certain hotel properties were acquired, in part, by the Operating Partnership through the issuance of limited partnership units of the Operating Partnership. The noncontrolling interest in the Operating Partnership is: (i) increased or decreased by the limited partners’ pro-rata share of the Operating Partnership’s net income or net loss, respectively; (ii) decreased by distributions; (iii) decreased by redemption of partnership units for the Company’s common stock; and (iv) adjusted to equal the net equity of the Operating Partnership multiplied by the limited partners’ ownership percentage immediately after each issuance of units of the Operating Partnership and/or the Company’s common stock through an adjustment to additional paid-in capital. Net income or net loss is allocated to the noncontrolling interest in the Operating Partnership based on the weighted average percentage ownership throughout the period.

Revenue Recognition – Revenue consists of amounts derived from hotel operations, including the sales of rooms, food and beverage, and other ancillary services. Room revenue is recognized over a customer's hotel stay. Revenue from food and beverage and other ancillary services is generated when a customer chooses to purchase goods or services separately from a hotel room and revenue is recognized on these distinct goods and services at the point in time or over the time period that goods or services are provided to the customer. Certain ancillary services are provided by third parties and the Company assesses whether it is the principal or agent in these arrangements. If the Company is the agent, revenue is recognized based upon the commission earned from the third party. If the Company is the principal, the Company recognizes revenue based upon the gross sales price. Some contracts for rooms or food and beverage services require an upfront deposit which is recorded as advanced deposits (or contract liabilities) and recognized once the performance obligations are satisfied and shown on our consolidated balance sheets.

Certain of the Company's hotels have retail spaces, restaurants or other spaces which the Company leases to third parties. Lease revenue is recognized on a straight-line basis over the life of the lease and included in other operating revenues in the Company's consolidated statements of operations.

The Company collects sales, use, occupancy and similar taxes at its hotels which are presented on a net basis on the consolidated statements of operations. Accounts receivable primarily represents receivables from hotel guests who occupy hotel rooms and utilize hotel services. The Company maintains an allowance for doubtful accounts sufficient to cover estimated potential credit losses.

Lease Revenue – Several of our properties generate revenue from leasing commercial space adjacent to the hotel, the restaurant space within the hotel, apartment units and space on the roofs of our hotels for antennas and satellite dishes. We account for the lease income as revenue from other operating departments within the consolidated statements of operations pursuant to the terms of each

lease. Lease revenue was approximately $0.4 million and $0.3 million, for the three months ended September 30, 2019 and 2018, respectively, and approximately $1.2 million and $1.2 million for the nine months ended September 30, 2019 and 2018, respectively.

A schedule of minimum future lease payments receivable for the remaining three and twelve-month periods is as follows:

For the remaining three months ending December 31, 2019	$	486,304
December 31, 2020		1,452,866
December 31, 2021		1,395,363
December 31, 2022		1,221,343
December 31, 2023		612,940
December 31, 2024 and thereafter		3,158,088
Total	$	8,326,904

Variable Interest Entities – The Operating Partnership is a variable interest entity. The Company’s only significant asset is its investment in the Operating Partnership, and consequently, substantially all of the Company’s assets and liabilities represent those assets and liabilities of the Operating Partnership and its subsidiaries. All of the Company’s debt is an obligation of the Operating Partnership and its subsidiaries.

Income Taxes – The Company has elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. As a REIT, the Company generally will not be subject to federal income tax. MHI TRS, our wholly owned taxable REIT subsidiary which leases our hotels from subsidiaries of the Operating Partnership, is subject to federal and state income taxes.

We account for income taxes using the asset and liability method under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. As of September 30, 2019 and December 31, 2018, deferred tax assets totaled approximately $4.7 million and $5.1 million, respectively, of which approximately $4.1 million and $4.4 million relate to net operating losses of our TRS Lessee. A valuation allowance is required for deferred tax assets if, based on all available evidence, it is “more-likely-than-not” that all or a portion of the deferred tax asset will or will not be realized due to the inability to generate sufficient taxable income in certain financial statement periods. The “more-likely-than-not” analysis means the likelihood of realization is greater than 50%, that we will or will not be able to fully utilize the deferred tax assets against future taxable income. The net amount of deferred tax assets that are recorded on the financial statements must reflect the tax benefits that are expected to be realized using these criteria. We perform this analysis by evaluating future hotel revenues and expenses accounting for certain non-recurring costs and expenses during the current and prior two fiscal years as well as anticipated changes in the lease rental payments from the TRS Lessee to subsidiaries of the Operating Partnership. We have determined that it is more-likely-than-not that we will be able to fully utilize our deferred tax assets for future tax consequences, therefore no valuation allowance is required.

As of September 30, 2019 and December 31, 2018, we had no uncertain tax positions. Our policy is to recognize interest and penalties related to uncertain tax positions in income tax expense. As of September 30, 2019, the tax years that remain subject to examination by the major tax jurisdictions to which the Company is subject generally include 2015 through 2017. In addition, as of September 30, 2019, the tax years that remain subject to examination, because of NOL carryforwards, by the major tax jurisdictions to which MHI TRS is subject include the years 2009 and 2014 through 2018.

The Operating Partnership is generally not subject to federal and state income taxes as the unit holders of the Partnership are subject to tax on their respective shares of the Partnership’s taxable income.

Stock-based Compensation – The Company’s 2013 Long-Term Incentive Plan (the “2013 Plan”), which the Company’s stockholders approved in April 2013, permit the grant of stock options, restricted stock, unrestricted stock and performance share compensation awards to its employees and directors for up to 350,000 and 750,000 shares of common stock, respectively. The Company believes that such awards better align the interests of its employees with those of its stockholders.

Under the 2013 Plan, the Company has made stock awards totaling 176,350 shares, including 143,350 non-restricted shares and 33,000 restricted shares issued to certain executives and employees and to its independent directors. All awards have vested except for 20,000 shares issued to one employee, which will vest over 4 years, and 13,000 shares issued to the Company’s independent directors in February 2019, which will vest by December 31, 2019.

Under the 2013 Plan, the Company may issue a variety of performance-based stock awards, including nonqualified stock options. The value of the awards is charged to compensation expense on a straight-line basis over the vesting or service period based on the value of the award as determined by the Company’s stock price on the date of grant or issuance. As of September 30, 2019, no

performance-based stock awards have been granted. Total compensation cost recognized under the 2013 Plan for the three months ended September 30, 2019 and 2018 was each $8,025 and for the nine months ended September 30, 2019 and 2018 was $116,408 and $127,402, respectively.

Additionally, the Company sponsors and maintains an Employee Stock Ownership Plan (“ESOP”) and related trust for the benefit of its eligible employees. We reflect unearned ESOP shares as a reduction of stockholders’ equity. Dividends on unearned ESOP shares, when paid, are considered compensation expense. The Company recognizes compensation expense equal to the fair value of the Company’s ESOP shares during the periods in which they are committed to be released. For the three months ended September 30, 2019 and 2018, the ESOP compensation cost was $60,259 and $64,294, respectively and for the nine months ended September 30 2019 and 2018, the ESOP compensation cost was $193,513 and $186,137, respectively. To the extent that the fair value of the Company’s ESOP shares differs from the cost of such shares, the differential is recognized as additional paid in capital. Because the ESOP is internally leveraged through a loan from the Company to the ESOP, the loan receivable by the Company from the ESOP is not reported as an asset nor is the debt of the ESOP shown as a liability in the consolidated financial statements.

Advertising – Advertising costs were $132,227 and $88,154 for the three months ended September 30, 2019 and 2018, respectively and were $319,947 and $334,271 for the nine months ended September 30, 2019 and 2018, respectively. Advertising costs are expensed as incurred.

Involuntary Conversion of Assets – We record gains or losses on involuntary conversions of assets due to recovered insurance proceeds to the extent the undepreciated cost of a nonmonetary asset differs from the amount of monetary proceeds received. During the three-month periods ending September 30, 2019 and 2018, we recognized approximately $0.1 million and $0, respectively and during the nine-month periods ending September 30, 2019 and 2018, we recognized approximately $0.3 million and $0.9 million, respectively, in gain on involuntary conversion of assets, which is reflected in the consolidated statements of operations.

Comprehensive Income – Comprehensive income as defined, includes all changes in equity during a period from non-owner sources. We do not have any items of comprehensive income other than net income.

Segment Information – We have determined that our business is conducted in one reportable segment: hotel ownership.

Use of Estimates – The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

New Accounting Pronouncements – In July 2018, FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, The FASB decided to provide another transition method and practical expedients in addition to the existing transition method (a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements) by allowing entities to initially apply the new leases standard at the adoption date (such as January 1, 2019, for calendar year-end public business entities) and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. We adopted the practical expedients allowed under the guidance and retained the original lease classification and historical accounting for initial direct costs for leases existing prior to the adoption date on January 1, 2019. We also elected not to restate prior periods for the impact of the adoption of the new standard and instead recognized a cumulative-effect adjustment to beginning retained earnings as of the adoption date. These standards resulted in the recognition of right-to-use assets and related liabilities to account for our future obligations under the ground lease arrangements for which we are the lessee. The right of use assets and corresponding liabilities were recorded in the amount of approximately $6.3 million and $3.8 million, respectively as of January 1, 2019.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The FASB issued this ASU to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet by lessees for those leases classified as operating leases under current GAAP and disclosing key information about leasing arrangements. The amendments in this ASU were effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early application of this ASU was permitted for all entities. We created an inventory of our leases and have recorded current ground lease, office lease, other right-of-use assets and lease liabilities. The standard required a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. This standard has been updated as noted above in ASU No. 2018-11. We adopted this ASU as of January 1, 2019. The adoption of this ASU did not have a material impact on our consolidated balance sheets, statements of operations or cash flows.

3. Acquisition of Hotel Properties

Hyatt Centric Arlington. On March 1, 2018, we acquired the Hyatt Centric Arlington hotel, for a total fair value of consideration transferred including inventory and other assets of approximately $79.7 million (after amendment of the initial purchase price of $81.0 million). We considered this acquisition to be an asset acquisition as opposed to a business combination, applying the screen test, as discussed in the Accounting Standards Update 2017-01 – Business Combinations – Clarifying the Definition of a Business (Topic 805).

The results of operations of the hotel are included in our consolidated financial statements from the date of acquisition. The total revenue and net income related to the Hyatt Centric Arlington acquisition for the period March 1, 2018 to September 30, 2018 were approximately $13.4 million and $1.6 million, respectively. The total revenue and net income related to the Hyatt Centric Arlington acquisition for the period January 1, 2019 to September 30, 2019 were approximately $16.3 million and $0.1 million, respectively.

Hyde Beach House Resort & Residences. On September 26, 2019, we acquired a commercial condominium unit of the Hyde Beach House condominium hotel, for a total fair value of consideration transferred including inventory and other assets of approximately $6.3 million.

The results of operations of the hotel commercial condominium unit are included in our consolidated financial statements from the date of the acquisition. The total revenue and net loss related to the acquisition for the period September 26, 2019 to September 30, 2019 are approximately $1.0 million and $0.3, respectively. There is no pro forma financial information, since this is a new operation without prior historical information.

The allocation of the respective purchase price is based on fair value as follows:

	Hyatt Centric Arlington			Hyde Beach House
Land and land improvements	$	190,916		$	500
Buildings and improvements		70,369,046			5,564,219
Furniture, fixtures and equipment		6,229,888			347,621
Favorable lease and other intangible assets		3,054,812			—
Investment in hotel properties		79,844,662			5,912,340
Accrued liabilities and other costs		(111,946	)		—
Prepaid expenses, inventory and other assets		—			434,038
Net cash	$	79,732,716		$	6,346,378

4. Investment in Hotel Properties, Net

Investment in hotel properties, net as of September 30, 2019 and December 31, 2018 consisted of the following:

	September 30, 2019			December 31, 2018
	(unaudited)
Land and land improvements	$	66,055,121		$	64,409,730
Buildings and improvements		437,705,155			424,657,327
Right of use assets		6,576,971			—
Furniture, fixtures and equipment		56,809,756			57,830,987
		567,147,003			546,898,044
Less: accumulated depreciation and impairment		(120,307,423	)		(111,172,230	)
Investment in Hotel Properties, Net	$	446,839,580		$	435,725,814

On January 1, 2019, we adopted ASU 842, Leases and applied it prospectively. At adoption, we also elected the practical expedients which permitted us to not reassess our prior conclusions about lease identification, classification, and initial direct costs. Consequently, on January 1, 2019, we recognized right-of-use assets and related liabilities related to our acquired operating ground lease, equipment, parking, office space and land leases, all of which are operating leases. Since most of our leases do not provide an implicit rate, we used incremental borrowing rates, which averaged to 8.0%. All of these leases have terms ranging from less than one year to 50 years and we included the exercise of options to extend when it is reasonably certain we will exercise such option. See Note 6 for additional information about the acquired operating ground lease, parking, office space and land leases. The right-of-use assets and liabilities are amortized to rent expense and depreciation and amortization expense over the term of the underlying lease

agreements. As of September 30, 2019, our right-of-use assets, net of approximately $6.6 million, are included in the investment in hotel properties, net or prepaid expenses, inventory and other assets and our related lease liabilities of approximately $4.4 million are presented in accounts payable and accrued expenses in our consolidated balance sheets. The adoption of this standard had minimal impact on our statements of operations.

5. Debt

Mortgage Loans, Net. As of September 30, 2019 and December 31, 2018, we had approximately $360.5 million and approximately $364.8 million of outstanding mortgage debt, respectively. The following table sets forth our mortgage debt obligations on our hotels.

	Balance Outstanding as of
	September 30,			December 31,			Prepayment	Maturity	Amortization	Interest
Property	2019			2018			Penalties	Date	Provisions	Rate
	(unaudited)
The DeSoto ⁽¹⁾	$	33,256,944		$	33,824,350		Yes	7/1/2026	25 years	4.25%
DoubleTree by Hilton Jacksonville Riverfront ⁽²⁾		34,366,547			34,773,546		Yes	7/11/2024	30 years	4.88%
DoubleTree by Hilton Laurel ⁽³⁾		8,614,350			8,845,299		Yes	8/5/2021	25 years	5.25%
DoubleTree by Hilton Philadelphia Airport⁽⁴⁾		41,580,419			42,026,986		None	7/31/2023	30 years	LIBOR plus 2.27 %
DoubleTree by Hilton Raleigh- Brownstone University ⁽⁵⁾		18,300,000			18,300,000		Yes	7/27/2022	(5)	LIBOR plus 4.00 %
DoubleTree Resort by Hilton Hollywood Beach ⁽⁶⁾		56,396,039			57,064,824		n/a	10/1/2025	30 years	4.913%
Georgian Terrace ⁽⁷⁾		43,627,014			44,202,968		n/a	6/1/2025	30 years	4.42%
Hotel Alba Tampa, Tapestry Collection by Hilton ⁽⁸⁾		18,107,352			18,307,000		None	6/30/2022	(8)	LIBOR plus 3.75 %
Hotel Ballast Wilmington, Tapestry Collection by Hilton⁽⁹⁾		33,683,726			34,236,104		Yes	1/1/2027	25 years	4.25%
Hyatt Centric Arlington ⁽¹⁰⁾	$	49,355,146			49,885,045		Yes	9/18/2028	30 years	5.25%
Sheraton Louisville Riverside⁽¹¹⁾		11,215,621			11,414,300		Yes	12/1/2026	25 years	4.27%
The Whitehall ⁽¹²⁾		14,527,731			14,733,458		Yes	2/26/2023	25 years	LIBOR plus 3.50 %
Total Mortgage Principal Balance	$	363,030,889		$	367,613,880
Deferred financing costs, net		(2,628,780	)		(2,951,327	)
Unamortized premium on loan		147,781			166,292
Total Mortgage Loans, Net	$	360,549,890		$	364,828,845

(1)	The note amortizes on a 25-year schedule after an initial 1-year interest-only period (which expired in August 2017), and is subject to a pre-payment penalty except for any pre-payments made within 120 days of the maturity date.
(2)	The note is subject to a pre-payment penalty until March 2024. Prepayment can be made without penalty thereafter.
(3)	The note is subject to a pre-payment penalty until April 2021. Prepayment can be made without penalty thereafter.
(4)	The note bears a floating interest rate of 1-month LIBOR plus 2.27%, but we entered into a swap agreement to fix the rate at 5.237%. Under the swap agreement, notional amounts approximate the declining balance of the loan and we are responsible for any potential termination fees associated with early termination of the swap agreement.
(5)	The note provides initial proceeds of $18.3 million, with an additional $5.2 million available upon the satisfaction of certain conditions; has an initial term of 4 years with a 1-year extension; bears a floating interest rate of 1-month LIBOR plus 4.00%; requires interest only monthly payments; and following a 12-month lockout, can be prepaid with penalty in year 2 and without penalty thereafter. We entered into an interest-rate cap agreement to limit our exposure through August 1, 2022 to increases in LIBOR exceeding 3.25% on a notional amount of $23,500,000.
(6)	With limited exception, the note may not be prepaid until June 2025.
(7)	With limited exception, the note may not be prepaid until February 2025.
(8)	The note bears a floating interest rate of 1-month LIBOR plus 3.75% subject to a floor rate of 3.75%; with monthly principal payments of $26,812; the note provides that the mortgage can be extended for two additional periods of one year each, subject to certain conditions.
(9)	The note amortizes on a 25-year schedule after an initial 1-year interest-only period, and is subject to a pre-payment penalty except for any pre-payments made within 120 days of the maturity date.
(10)	Following a 5-year lockout, the note can be prepaid with penalty in years 6-10 and without penalty during the final 4 months of the term.
(11)	The note bears a fixed interest rate of 4.27% for the first 5 years of the loan, with an option for the lender to reset the interest rate after 5 years.
(12)	The note bears a floating interest rate of 1-month LIBOR plus 3.5%, subject to a floor rate of 4.0%, and is subject to prepayment penalties on a declining scale with a 3.0% penalty on or before the first anniversary date, a 2.0% penalty during the second anniversary year and a 1.0% penalty after the third anniversary date.

As of September 30, 2019, we were in compliance with all debt covenants, current on all loan payments and not otherwise in default under any of our mortgage loans, as amended or modified, with the exception of the mortgage on the Hotel Alba, for which we failed to meet the quarterly Debt Service Coverage Ratio (“DSCR”) requirement. The loan agreement contains a balancing provision that allows us to pay down the principal balance of the loan or provide cash collateral. Should we be unable to obtain a waiver, we believe cash collateral of approximately $2.9 million will be required until the quarterly DSCR requirement is met.

Total future mortgage debt maturities for the remaining three and twelve month periods, without respect to any extension of loan maturity, were as follows:

For the remaining three months ending December 31, 2019	$	1,611,840
December 31, 2020		6,611,161
December 31, 2021		14,815,761
December 31, 2022		42,273,913
December 31, 2023		59,921,466
December 31, 2024 and thereafter		237,796,748
Total future maturities	$	363,030,889

7.25% Unsecured Notes. On February 12, 2018, the Operating Partnership issued its 7.25% Notes in the aggregate amount of $25.0 million, unconditionally guaranteed by the Company. The indenture requires quarterly payments of interest and was to mature on February 15, 2021. The 7.25% Notes were redeemed on May 20, 2019 at 101% of face value.

6. Commitments and Contingencies

Ground, Building, Parking and Land Leases – We lease 2,086 square feet of commercial space next to The DeSoto for use as an office, retail or conference space, or for any related or ancillary purposes for the hotel and/or atrium space. In December 2007, we signed an amendment to the lease to include rights to the outdoor esplanade adjacent to the leased commercial space. The areas are leased under a six-year operating lease, which expired October 31, 2006 and has been renewed for the third of three optional five-year renewal periods expiring October 31, 2011, October 31, 2016 and October 31, 2021, respectively. Rent expense for this operating lease for each of the three and nine months ended September 30, 2019 and 2018 totaled $18,246 and $54,738, respectively.

We lease, as landlord, the entire fourteenth floor of The DeSoto hotel property to The Chatham Club, Inc. under a ninety-nine year lease expiring July 31, 2086. This lease was assumed upon the purchase of the building under the terms and conditions agreed to by the previous owner of the property. No rental income is recognized under the terms of this lease as the original lump sum rent payment of $990 was received by the previous owner and not prorated over the life of the lease.

We lease land adjacent to the Hotel Alba for use as parking under a five-year renewable agreement with the Florida Department of Transportation that commenced in July 2009. In May 2014, we extended the agreement for an additional five years. The agreement expires in July 2024. The agreement requires annual payments of $2,432, plus tax, and may be renewed for an additional five years. Rent expense for the three and nine months ended September 30, 2019, totaled $412 and $1,713, respectively, and for the three and nine months ended September 30, 2018, totaled $651 and $1,952, respectively.

We lease 5,216 square feet of commercial office space in Williamsburg, Virginia under an agreement, as amended, that commenced September 1, 2009 and was extended until such date as we take possession of new premises under a contingent lease with the same landlord, which is expected to occur in December 2019. Rent expense for the three-month periods ended September 30, 2019 and 2018 totaled $26,984 and $23,775, respectively and for the nine-month periods ended September 30, 2019 and 2018, totaled $80,952 and $68,874.

We have agreed to lease approximately 8,500 square feet of commercial office space in Williamsburg, Virginia under an agreement with a ten-year term commencing upon occupancy of the premises, which is expected to occur in December 2019. The initial annual rent under the agreement is $218,875, with the rent for each successive annual period increasing by 3.0% over the prior annual period’s rent. The annual rent will be offset by a tenant improvement allowance of $200,000, to be applied against one-half of each monthly rent payment until such time as the tenant improvement allowance is exhausted.

We lease the land underlying all of the Hyatt Centric Arlington hotel pursuant to a ground lease. The ground lease requires us to make rental payments of $50,000 per year in base rent and percentage rent equal to 3.5% of gross room revenue in excess of certain thresholds, as defined in the ground lease agreement. The initial term of the ground lease expires in 2025 and may be extended for five additional renewal periods of 10 years each. Rent expense for the three months ended September 30, 2019 and 2018, was $141,587 and $136,813, respectively and for the nine months ended September 30, 2019 and 2018 was $474,945 and $392,042, respectively.

We entered into a 20-year parking and cabana management agreement for the parking garage and poolside cabanas associated with the Hyde Beach House. The parking and cabana embedded lease requires us to make rental payments of $270,100 per year in base rent. The initial term of the parking garage and cabana lease expires in 2034 and may be extended for four additional renewal periods of 5 years each. There was no rent expense for the 4 days of September 2019.

We also lease certain parking space, storage facilities, furniture and equipment under financing arrangements expiring between July 2019 and June 2025.

A schedule of minimum future lease payments for the following three and twelve-month periods is as follows:

For the remaining three months ending December 31, 2019	$	112,769
December 31, 2020		423,331
December 31, 2021		412,099
December 31, 2022		400,100
December 31, 2023		363,529
December 31, 2024 and thereafter		2,898,146
Total	$	4,609,974

Employment Agreements - The Company has entered into various employment contracts with employees that could result in obligations to the Company in the event of a change in control or termination without cause.

Management Agreements – As of September 30, 2019, the Hyatt Centric Arlington hotel operated under a management agreement with Highgate Hotels L.P. The management agreement has an initial term of three years expiring March 1, 2021.

As of September 30, 2019, the eleven remaining wholly-owned hotels and the rental program and condominium association of the Hyde Resort & Residences operated under management agreements with Chesapeake Hospitality (see Note 9). The management agreements expire between January 1, 2020 and December 31, 2020, and may be extended for up to two additional periods of five years each subject to the approval of both parties. Each of the individual hotel management agreements may be terminated earlier than the stated term upon the sale of the hotel covered by the respective management agreement, in which case we may incur early termination fees.

Franchise Agreements – As of September 30, 2019, nine of our hotels operated under franchise licenses from national hotel companies. Under the franchise agreements, we are required to pay a franchise fee generally between 3.0% and 5.0% of room revenues, plus additional fees for marketing, central reservation systems, and other franchisor programs and services that amount to between 2.5% and 6.0% of room revenues from the hotels. The franchise agreements expire between November 2021 and March 2038. Each of our franchise agreements provides for early termination fees in the event the agreement is terminated before the stated term.

Restricted Cash Reserves – Each month, we are required to escrow with the lenders on the Hotel Ballast, The DeSoto, the DoubleTree by Hilton Raleigh Brownstone-University, the DoubleTree by Hilton Jacksonville Riverside, the DoubleTree Resort by Hilton Hollywood Beach, and the Georgian Terrace an amount equal to one-twelfth (1/12) of the annual real estate taxes due for the properties. We are also required by several of our lenders to establish individual property improvement funds to cover the cost of replacing capital assets at our properties. Each month, those contributions equal 4.0% of gross revenues for the Hotel Ballast, The DeSoto, the DoubleTree by Hilton Raleigh Brownstone–University, the DoubleTree by Hilton Jacksonville Riverside, the DoubleTree Resort by Hilton Hollywood Beach, The Whitehall and the Georgian Terrace and equal 4.0% of room revenues for the DoubleTree by Hilton Philadelphia Airport and the Hyatt Centric Arlington.

ESOP Loan Commitment – The Company’s board of directors approved the ESOP on November 29, 2016, which was adopted by the Company in December 2016 and effective January 1, 2016. The ESOP is a non-contributory defined contribution plan covering all employees of the Company. The ESOP is a leveraged ESOP, meaning the contributed funds are loaned to the ESOP from the Company. The Company entered into a loan agreement with the ESOP on December 29, 2016, pursuant to which the ESOP may borrow up to $5.0 million to purchase shares of the Company’s common stock on the open market. Under the loan agreement, the

aggregate principal amount outstanding at any time may not exceed $5.0 million and the ESOP may borrow additional funds up to that limit in the future, until December 29, 2036.

Litigation –We are involved in routine litigation arising out of the ordinary course of business, all of which we expect to be covered by insurance and we believe it is not reasonably possible such matters will have a material adverse impact on our financial condition or results of operations or cash flows.

7. Preferred Stock and Units

Preferred Stock - The Company is authorized to issue up to 11,000,000 shares of preferred stock. The following table sets forth our Cumulative Redeemable Perpetual Preferred Stock by series:

	Per				Number of Shares				Quarterly
	Annum			Liquidation	Issued and Outstanding as of				Distributions
Preferred Stock - Series	Rate			Preference	September 30, 2019		December 31, 2018		Per Share
Series B Preferred Stock		8.000	%	$25.00		1,610,000		1,610,000	$	0.500000
Series C Preferred Stock		7.875	%	$25.00		1,554,610		1,352,141	$	0.492188
Series D Preferred Stock		8.250	%	$25.00		1,200,000		-	$	0.515625	⁽¹⁾

(1)	The initial quarterly distribution for the Series D Preferred Stock paid on July 15, 2019 was pro-rated per the terms of the security in the amount of $0.41823 per share.

The Company pays cumulative cash distributions on the preferred stock at rates in the above table per annum of the $25.00 liquidation preference per share. Holders of the Company’s preferred stock are entitled to receive distributions when authorized by the Company’s board of directors out of assets legally available for the payment of distributions. The preferred stock is not redeemable by the holders, has no maturity date and is not convertible into any other security of the Company or its affiliates.

On August 31, 2018, we entered into a Sales Agency Agreement, with Sandler O’Neill, under which the Company may sell from time to time through Sandler O’Neill, as sales agent, up to 400,000 shares of the Company’s 7.875% Series C Cumulative Redeemable Preferred Stock, $0.01 par value per share. Through the period ended December 31, 2018, the Company sold 52,141 shares of Series C Preferred Stock, for net proceeds of approximately $1.0 million. For the three and nine months ended September 30, 2019, the Company issued and sold 202,469 shares of Series C Preferred Stock, for net proceeds after all estimated expenses of approximately $4.9 million, pursuant to the Sales Agency Agreement. The Company contributed the net proceeds from the offering to its Operating Partnership for an equivalent number of Series C Preferred Units.

In April and May 2019, the Company issued 1,200,000 shares of Series D Preferred Stock, for net proceeds after all estimated expenses of approximately $28.4 million. The Company contributed the net proceeds from the offering to its Operating Partnership for an equivalent number of Series D Preferred Units.

Preferred Units - The Company is the holder of the Operating Partnership’s preferred partnership units and is entitled to receive distributions when authorized by the general partner of the Operating Partnership out of assets legally available for the payment of distributions. The following table sets forth our Cumulative Redeemable Perpetual Preferred Units by series:

	Per				Number of Units				Quarterly
	Annum			Liquidation	Issued and Outstanding as of				Distributions
Preferred Units - Series	Rate			Preference	September 30, 2019		December 31, 2018		Per Unit
Series B Preferred Units		8.000	%	$25.00		1,610,000		1,610,000	$	0.500000
Series C Preferred Units		7.875	%	$25.00		1,554,610		1,352,141	$	0.492188
Series D Preferred Units		8.250	%	$25.00		1,200,000		-	$	0.515625	⁽¹⁾

(1)	The initial quarterly distribution for the Series D Preferred Units paid on July 15, 2019 was pro-rated per the terms of the security in the amount of $0.41823 per unit.

The Company pays cumulative cash distributions on the preferred units at rates in the above table per annum of the $25.00 liquidation preference per unit. Holders of the Operating Partnership’s preferred units are entitled to receive distributions when authorized by the Operating Partnership’s general partner out of assets legally available for the payment of distributions. The preferred units are not redeemable by the holders, has no maturity date and is not convertible into any other security of the Operating Partnership or its affiliates.

Through the period ended December 2018, the Operating Partnership issued a total of 52,141 units of 7.875% Series C Preferred Units, for net proceeds after all estimated expenses of approximately $1.0 million. The Operating Partnership used the net proceeds for working capital.

In April and May 2019, the Operating Partnership issued 1,200,000 units of 8.25% Series D Preferred Units, for net proceeds after all estimated expenses of approximately $28.4 million. The Operating Partnership used the net proceeds to redeem in full the Operating Partnership’s 7.25% Senior Unsecured Notes due 2021 and for working capital.

For the three and nine months ending September 2019, the Operating Partnership issued 202,469 units of 7.875% Series C Preferred Units, for net proceeds after all estimated expenses of approximately $4.9 million. The Operating Partnership used the net proceeds to acquire a commercial condominium unit of the Hyde Beach House condominium hotel and for working capital.

8. Common Stock and Units

Common Stock – As of September 30, 2019, the Company was authorized to issue up to 49,000,000 shares of common stock, $0.01 par value per share. Each outstanding share of common stock entitles the holder to one vote on all matters submitted to a vote of stockholders. Holders of the Company’s common stock are entitled to receive distributions when authorized by the Company’s board of directors out of assets legally available for the payment of distributions.

On December 2, 2016, the Company’s board of directors authorized a stock repurchase program under which the Company may purchase up to $10.0 million of its outstanding common stock, par value $0.01 per share, at prevailing prices on the open market or in privately negotiated transactions, at the discretion of management. The Company has and expects to continue to use available working capital to fund purchases under the stock repurchase program and intends to complete the repurchase program prior to December 31, 2019, unless extended by the board of directors. Through December 31, 2018 the Company repurchased 882,820 shares of common stock for approximately $5.9 million and the repurchased shares have been returned to the status of authorized but unissued shares of common stock. The Company did not repurchase any shares under the stock repurchase program during the nine months ended September 30, 2019.

During 2017, the ESOP purchased 682,500 shares of the Company’s common stock for approximately $4.9 million. There have been no more purchases of shares of common stock made by the ESOP in 2018 or 2019.

The following is a schedule of issuances, since January 1, 2018, of the Company’s common stock and related units of the Operating Partnership:

On January 1, 2018, the Company was issued 25,000 units in the Operating Partnership and awarded 25,000 shares of restricted stock to one of its employees.

On February 5, 2018, the Company was issued 17,250 units in the Operating Partnership and awarded 15,000 shares of restricted stock and 2,250 shares of unrestricted stock to its independent directors.

On August 31, 2018, we entered into a Sales Agency Agreement, with Sandler O’Neill, under which the Company may sell from time to time through Sandler O’Neill, as sales agent, shares of the Company’s common stock, par value $0.01 per share, having an aggregate gross sales price of up to $5,000,000. Through December 31, 2018, the Company sold 88,297 shares of common stock, for net proceeds of approximately $0.6 million and none have been sold during the nine months ended September 30, 2019.

On February 11, 2019, the Company was issued 12,750 units in the Operating Partnership and awarded shares of restricted stock to its independent directors.

On February 22, 2019, the Company was issued 250 units in the Operating Partnership and awarded shares of restricted stock to an independent director.

As of September 30, 2019 and December 31, 2018, the Company had 14,222,378 and 14, 209,378 shares of common stock outstanding, respectively.

Operating Partnership Units – Holders of Operating Partnership units, other than the Company as general partner, have certain redemption rights, which enable them to cause the Operating Partnership to redeem their units in exchange for shares of the Company’s common stock on a one-for-one basis or, at the option of the Company, cash per unit equal to the average of the market price of the Company’s common stock for the 10 trading days immediately preceding the notice date of such redemption. The number of shares issuable upon exercise of the redemption rights will be adjusted upon the occurrence of stock splits, mergers, consolidations or similar pro-rata share transactions, which otherwise would have the effect of diluting the ownership interests of the limited partners or the stockholders of the Company.

Since January 1, 2018, there have been no issuances or redemptions, of units in the Operating Partnership other than the issuances of units in the Operating Partnership to the Company described above.

As of September 30, 2019 and December 31, 2018, the total number of Operating Partnership units outstanding was 16,000,518 and 15,987,518, respectively.

As of September 30, 2019 and December 31, 2018, the total number of outstanding Operating Partnership units not owned by the Company was 1,778,140 and 1,778,140, respectively, with a fair market value of approximately $11.9 million and $10.0 million, respectively, based on the price per share of the common stock on such respective dates.

9. Related Party Transactions

Chesapeake Hospitality. Chesapeake Hospitality is owned and controlled by individuals including Andrew M. Sims, our chairman and chief executive officer, and Kim E. Sims and Christopher L. Sims, each a former director of Sotherly and immediate family member of our chairman and chief executive officer. As of September 30, 2019, Andrew M. Sims, Kim E. Sims and Christopher L. Sims, beneficially owned, directly or indirectly, approximately 19.3375%, 20.0%, and 20.0%, respectively, of the total outstanding ownership interests of Chesapeake Hospitality. Kim E. Sims and Christopher L. Sims are currently officers and employees of Chesapeake Hospitality. The following is a summary of the transactions between Chesapeake Hospitality and us:

Accounts Receivable – At September 30, 2019 and December 31, 2018, we were due $96,599 and $91,987, respectively, from Chesapeake Hospitality.

Management Agreements – As of September 30, 2019, all of our wholly-owned hotels (with the exception of the Hyatt Centric Arlington hotel) and the Hyde Resort & Residences operated under various management agreements with Chesapeake Hospitality. On December 15, 2014, we entered into a master agreement and a series of individual hotel management agreements that became effective on January 1, 2015. The master agreement has a five-year term but may be extended for such additional periods as long as an individual management agreement remains in effect. The base management fee for the Whitehall and the Georgian Terrace remained at 2.00% through 2015, increased to 2.25% in 2016 and increased to 2.50% thereafter. The base management fees for the remaining properties in the current portfolio was 2.65% through 2017 and decreased to 2.50% thereafter. For new individual hotel management agreements, Chesapeake Hospitality will receive a base management fee of 2.00% of gross revenues for the first full year from the commencement date through the anniversary date, 2.25% of gross revenues the second full year, and 2.50% of gross revenues for every year thereafter.

Each management agreement sets an incentive management fee equal to 10.0% of the amount by which gross operating profit, as defined in the management agreement, for a given year exceeds the budgeted gross operating profit for such year; provided, however, that the incentive management fee payable in respect of any such year shall not exceed 0.25% of the gross revenues of the hotel included in such calculation.

Base management and administrative fees earned by Chesapeake Hospitality for our properties was approximately $1.1 million and $1.0 million for the three months ended September 30, 2019 and 2018, respectively and approximately $3.6 million and $3.2 million for the nine months ended September 30, 2019 and 2018, respectively. In addition, estimated incentive management fees each of approximately $0.1 million were accrued for the nine months ended September 30, 2019 and 2018, respectively. On July 15, 2019 we notified Chesapeake Hospitality of our intent not to renew or extend the management agreements for ten of our wholly-owned hotels when they expire on January 1, 2020.

Employee Medical Benefits – We purchase employee medical benefits through Maryland Hospitality, Inc. (d/b/a MHI Health), an affiliate of Chesapeake Hospitality for those employees that are employed by Chesapeake Hospitality that work exclusively for our hotel properties. Gross premiums for employee medical benefits paid by the Company (before offset of employee co-payments) were each approximately $1.4 million for the three months ended September 30, 2019 and 2018, respectively and were approximately $4.2 million and $4.3 million for the nine months ended September 30, 2019 and 2018, respectively.

Workers’ Compensation Insurance – Pursuant to our management agreements with Chesapeake Hospitality, we pay the premiums for workers’ compensation insurance under a self-insured policy owned by Chesapeake Hospitality or its affiliates, and which covers those employees of Chesapeake Hospitality that work exclusively for the properties managed by Chesapeake Hospitality. For the three months ended September 30, 2019 and 2018, we paid approximately $0.2 million and $0.3 million, respectively, and for the nine months ended September 30, 2019 and 2018, we paid approximately $0.8 million and $0.8 million, respectively, in premiums for the portion of the plan covering those employees that work exclusively for our properties under our management agreements with Chesapeake Hospitality.

Loan Receivable – Affiliate. As of September 30, 2019 and December 31, 2018, approximately $4.3 million and $4.4 million, respectively, was due to the Operating Partnership for advances to the Company under a loan agreement dated December 29, 2016. The Company used the proceeds to make advances to the ESOP to purchase shares of the Company’s common stock.

Others. We employ Ashley S. Kirkland, the daughter of our Chief Executive Officer as a legal analyst and Robert E. Kirkland IV, her husband, as our compliance officer. We also employ Andrew M. Sims Jr., the son of our Chief Executive Officer, as a manager. Total compensation, including salary and benefits, for the three months ended September 30, 2019 and 2018 totaled $103,585 and $95,568, respectively and for the nine months ended September 30, 2019 and 2018 totaled $309,875 and $290,144, respectively, for all three individuals.

During the three-month period ending September 30, 2019 and 2018, the Company reimbursed $26,157 and $27,491, respectively, and during the nine-month period ending September 30, 2019 and 2018, the Company reimbursed $113,415 and $87,847, respectively to a partnership controlled by the Chief Executive Officer for business-related air travel pursuant to the Company’s travel reimbursement policy.

10. Retirement Plans

401(k) Plan - We maintain a 401(k) plan for qualified employees which is subject to “safe harbor” provisions and which requires that we match 100.0% of the first 3.0% of employee contributions and 50.0% of the next 2.0% of employee contributions. All employer matching funds vest immediately in accordance with the “safe harbor” provision. Contributions to the plan totaled $12,892 and $12,568 for the three months ended September 30, 2019 and 2018, respectively and $63,453 and $61,607 for the nine months ended September 30, 2019 and 2018, respectively.

Employee Stock Ownership Plan - The Company adopted an Employee Stock Ownership Plan in December 2016, effective January 1, 2016. The ESOP is a non-contributory defined contribution plan covering all employees of the Company. The Company sponsors and maintains the ESOP and related trust for the benefit of its eligible employees. The ESOP is a leveraged ESOP, meaning funds are loaned to the ESOP from the Company. The Company entered into a loan agreement with the ESOP on December 29, 2016, pursuant to which the ESOP may borrow up to $5.0 million to purchase shares of the Company’s common stock on the open market, which serve as collateral for the loan. Between January 3, 2017 and February 28, 2017, the Company’s ESOP purchased 682,500 shares of the Company’s common stock of an aggregate cost of $4.9 million.

Shares purchased by the ESOP are held in a suspense account for allocation among participants as contributions are made to the ESOP by the Company. The share allocations will be accounted for at fair value at the date of allocation. As of September 30, 2019, the ESOP had purchased 682,500 shares of the Company’s common stock in the open market for approximately $4.9 million, which the ESOP borrowed from the Company pursuant to the loan agreement. A total of 94,894 and 59,893 shares with a fair value of $634,843 and $416,088 remained allocated or committed to be released from the suspense account as of September 30, 2019 and 2018, respectively. We recognized as compensation cost $170,700 and $173,856 during the nine months ended September 30, 2019 and 2018, respectively. The remaining 584,594 unallocated shares have an approximate fair value of $3.9 million, as of September 30, 2019. At September 30, 2019, the ESOP held a total of 66,308 allocated shares, 28,586 committed-to-be-released shares and 584,594 suspense shares. Dividends on allocated and unallocated shares are used to pay down the ESOP loan from the Operating Partnership. The share allocations are accounted for at fair value on the date of allocation as follows:

	September 30, 2019				December 31, 2018
	Number of Shares		Fair Value		Number of Shares		Fair Value
Allocated shares		66,308	$	443,601		33,832	$	189,798
Committed to be released shares		28,586		191,242		35,474		199,007
Total Allocated and Committed-to-be-Released		94,894	$	634,843		69,306	$	388,805

Unallocated shares		584,594		3,910,932		613,194		3,440,020

Total ESOP Shares		679,488	$	4,545,775		682,500	$	3,828,825

11. Indirect Hotel Operating Expenses

Indirect hotel operating expenses consists of the following expenses incurred by the hotels:

	Three Months Ended		Three Months Ended		Nine Months Ended		Nine Months Ended
	September 30, 2019		September 30, 2018		September 30, 2019		September 30, 2018
	(unaudited)		(unaudited)		(unaudited)		(unaudited)
Sales and marketing		4,164,001	$	4,015,942	$	12,848,029	$	12,046,880
General and administrative		3,698,817		3,540,054		11,511,241		10,880,130
Repairs and maintenance		2,013,706		1,887,113		5,997,166		5,655,711
Utilities		1,750,826		1,749,562		4,761,352		4,735,195
Property taxes		1,751,234		950,148		5,212,700		4,113,025
Management fees, including incentive		1,053,456		1,066,120		3,792,643		3,570,974
Franchise fees		1,095,564		1,059,522		3,597,319		3,244,833
Insurance		823,420		746,175		2,497,230		2,114,351
Information and telecommunications		612,988		515,225		1,855,903		1,317,290
Other		230,136		497,635		683,944		1,222,648
Total indirect hotel operating expenses	$	17,194,148	$	16,027,496	$	52,757,527	$	48,901,037

12. Income Taxes

The components of the income tax (benefit) provision for the three and nine months ended September 30, 2019 and 2018 are as follows:

	Three Months Ended			Three Months Ended			Nine Months Ended			Nine Months Ended
	September 30, 2019			September 30, 2018			September 30, 2019			September 30, 2018
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
Current:
Federal	$	(33,254	)	$	—		$	(125,587	)	$	—
State		41,839			24,266			112,741			131,306
		8,585			24,266			(12,846	)		131,306
Deferred:
Federal		(569,928	)		(612,703	)		356,590			591,917
State		(132,847	)		(158,487	)		95,579			158,822
		(702,775	)		(771,190	)		452,169			750,739
	$	(694,190	)	$	(746,924	)	$	439,323		$	882,045

A reconciliation of the statutory federal income tax provision to the Company’s income tax provision is as follows:

	Three Months Ended			Three Months Ended			Nine Months Ended			Nine Months Ended
	September 30, 2019			September 30, 2018			September 30, 2019			September 30, 2018
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
Statutory federal income tax provision	$	290,535		$	(573,028	)	$	687,986		$	639,311
Effect of non-taxable REIT loss		(893,717	)		(39,675	)		(456,983	)		(47,394	)
State income tax provision		(91,008	)		(134,221	)		208,320			290,128
	$	(694,190	)	$	(746,924	)	$	439,323		$	882,045

As of September 30, 2019 and December 31, 2018, we had a net deferred tax asset of approximately $4.7 million and $5.1 million, respectively, of which, approximately $4.1 million and $4.4 million, respectively, are due to accumulated net operating losses of our TRS Lessee. These loss carryforwards will begin to expire in 2028 if not utilized by such time. As of September 30, 2019 and December 31, 2018, the remainder of the deferred tax asset is attributable to year-to-year timing differences of approximately $0.6 million and $0.7 million, respectively, for accrued, but not deductible, employee performance awards, vacation and sick pay, bad debt allowance and depreciation.

We record a valuation allowance to reduce deferred tax assets to an amount that we believe is more likely than not to be realized. Because of expected future taxable income of our TRS Lessee, we have not recorded a valuation allowance to reduce our net deferred tax asset as of September 30, 2019 and December 31, 2018, respectively. We regularly evaluate the likelihood that our TRS Lessee will be able to realize its deferred tax assets and the continuing need for a valuation allowance. At September 30, 2019 and December 31, 2018, we determined, based on all available positive and negative evidence, that it is more-likely-than-not that future taxable income will be available during the carryforward periods to absorb all of the consolidated federal and state net operating loss carryforward of our TRS Lessee. A number of factors played a critical role in this determination, including:

•

a demonstrated track record of past profitability and utilization of past NOL carryforwards,

•

reasonable forecasts of future taxable income, and

•

changes in the lease rental payments from the TRS Lessee to subsidiaries of the Operating Partnership.

13. Loss Per Share and Per Unit

Loss per Share. The limited partners’ outstanding limited partnership units in the Operating Partnership (which may be redeemed for common stock upon notice from the limited partner and following our election to redeem the units for stock rather than cash) have been excluded from the diluted earnings per share calculation as there would be no effect on the amounts since the limited partners’ share of loss would also be added back to net loss. The shares of the Series B Preferred Stock and Series C Preferred Stock and Series D Preferred Stock are not convertible into or exchangeable for any other property or securities of the Company, except upon the occurrence of a change of control and have been excluded from the diluted earnings per share calculation as there would be no impact on the current controlling stockholders. The non-committed, unearned ESOP shares are treated as reducing the number of issued and outstanding common shares and similarly reducing the weighted average number of common shares outstanding. The allocated and committed to be released shares have been included in the weighted average diluted earnings per share calculation, and the amount of compensation for allocated shares is reflected in net loss. There are no ESOP units, therefore there is no dilution on the calculation of earnings per unit. The computation of basic and diluted net loss per share is presented below.

	Three Months Ended			Three Months Ended			Nine Months Ended			Nine Months Ended
	September 30, 2019			September 30, 2018			September 30, 2019			September 30, 2018
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
Numerator
Net loss available to common stockholders for basic and diluted computation	$	(106,827	)	$	(3,065,883	)	$	(2,492,298	)	$	(1,951,816	)
Denominator
Weighted average number of common shares outstanding		14,222,378			14,154,414			14,220,416			14,141,273
Weighted average number of Unearned ESOP Shares		(585,672	)		(640,418	)		(595,656	)		(649,466	)
Total weighted average number of common shares outstanding for basic computation		13,636,706			13,513,996			13,624,760			13,491,807
Basic net loss per share	$	(0.01	)	$	(0.23	)	$	(0.18	)	$	(0.14	)

Income Per Unit – The computation of basic and diluted net loss per unit is presented below.

	Three Months Ended			Three Months Ended			Nine Months Ended			Nine Months Ended
	September 30, 2019			September 30, 2018			September 30, 2019			September 30, 2018
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
Numerator
Net loss available to general and limited partnership unitholders for basic computation	$	(120,164	)	$	(3,451,499	)	$	(2,803,940	)	$	(2,197,114	)
Denominator
Weighted average number of general and limited partnership units outstanding		16,000,518			15,915,706			15,998,556			15,902,565
Basic and diluted net loss per general and limited partnership unit	$	(0.01	)	$	(0.22	)	$	(0.18	)	$	(0.14	)

14. Subsequent Events

On October 11, 2019, we paid a quarterly dividend (distribution) of $0.13 per common share (and unit) to those stockholders (and unitholders of the Operating Partnership) of record on September 13, 2019.

On October 15, 2019, we paid a quarterly distribution of $0.50 per share (and unit) of Series B Preferred Stock (and Series B Preferred Units) to holders of the Series B Preferred Stock (and Series B Preferred Units) of record as of October 1, 2019.

On October 15, 2019, we paid a quarterly distribution of $0.4921875 per share (and unit) of Series C Preferred Stock (and Series C Preferred Units) to holders of the Series C Preferred Stock (and Series C Preferred Units) of record as of October 1, 2019.

On October 15, 2019, we paid a quarterly distribution of $0.515625 per share (and unit) of Series D Preferred Stock (and Series D Preferred Units) to holders of the Series D Preferred Stock (and Series D Preferred Units) of record as of October 1, 2019.

On October 28, 2019, we authorized payment of a quarterly dividend (distribution) of $0.13 per common share (and unit) to the stockholders (and unitholders of the Operating Partnership) of record as of December 13, 2019. The dividend (distribution) is to be paid on January 10, 2020.

On October 28, 2019, we authorized payment of a quarterly distribution of $0.50 per share (and unit) of Series B Preferred Stock (and Series B Preferred Units) to holders of the Series B Preferred Stock (and Series B Preferred Units) of record as of December 31, 2019, to be paid on January 15, 2020.

On October 28, 2019, we authorized payment of a quarterly distribution of $0.4921875 per share (and unit) of Series C Preferred Stock (and Series C Preferred Units) to holders of the Series C Preferred Stock (and Series C Preferred Units) of record as of December 31, 2019, to be paid on January 15, 2020.

On October 28, 2019, we authorized payment of a quarterly distribution of $0.515625 per share (and unit) of Series D Preferred Stock (and Series D Preferred Units) to holders of the Series D Preferred Stock (and Series D Preferred Units) of record as of December 31, 2019, to be paid on January 15, 2020.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Sotherly Hotels Inc. is a self-managed and self-administered lodging REIT incorporated in Maryland in August 2004 to pursue opportunities in the full-service, primarily upscale and upper-upscale segments of the hotel industry located in primary and secondary markets in the mid-Atlantic and southern United States. Substantially all of the assets of Sotherly Hotels Inc. are held by, and all of its operations are conducted through, Sotherly Hotels LP. We commenced operations in December 2004 when we completed our initial public offering and thereafter consummated the acquisition of the Initial Properties.

Our hotel portfolio currently consists of twelve full-service, primarily upscale and upper-upscale hotels, comprising 3,156 rooms, as well as interests in two condominium hotels and their associated rental programs. The Company owns hotels that operate under well-known brands such as DoubleTree by Hilton, Tapestry Collection by Hilton, Sheraton and Hyatt Centric, as well as independent hotels. We sometimes refer to our independent and soft-branded properties as our collection of boutique hotels. As of September 30, 2019, our portfolio consisted of the following hotel properties:

	Number
Property	of Rooms			Location	Date of Acquisition	Chain/Class Designation
Wholly-owned Hotels
The DeSoto		246		Savannah, GA	December 21, 2004	Upper Upscale⁽¹⁾
DoubleTree by Hilton Jacksonville Riverfront		293		Jacksonville, FL	July 22, 2005	Upscale
DoubleTree by Hilton Laurel		208		Laurel, MD	December 21, 2004	Upscale
DoubleTree by Hilton Philadelphia Airport		331		Philadelphia, PA	December 21, 2004	Upscale
DoubleTree by Hilton Raleigh Brownstone-University		190		Raleigh, NC	December 21, 2004	Upscale
DoubleTree Resort by Hilton Hollywood Beach		311		Hollywood, FL	August 9, 2007	Upscale
Georgian Terrace		326		Atlanta, GA	March 27, 2014	Upper Upscale⁽¹⁾
Hotel Alba Tampa, Tapestry Collection by Hilton		222		Tampa, FL	October 29, 2007	Upscale
Hotel Ballast Wilmington, Tapestry Collection by Hilton		272		Wilmington, NC	December 21, 2004	Upscale
Hyatt Centric Arlington		318		Arlington, VA	March 1, 2018	Upper Upscale
Sheraton Louisville Riverside		180		Jeffersonville, IN	September 20, 2006	Upper Upscale
The Whitehall		259		Houston, TX	November 13, 2013	Upper Upscale⁽¹⁾
Hotel Rooms Subtotal		3,156

Condominium Hotel
Hyde Resort & Residences		198	⁽²⁾	Hollywood, FL	January 30, 2017	Luxury⁽¹⁾
Hyde Beach House Resort & Residences		-	⁽³⁾	Hollywood, FL	September 26, 2019	Luxury⁽¹⁾
Total Hotel & Participating Condominium Hotel Rooms		3,354

(1)

Operated as an independent hotel.

(2)

Reflects only those condominium units that were participating in the rental program as of September 30, 2019. At any given time, some portion of the units participating in our rental program may be occupied by the unit owner(s) and unavailable for rental to hotel guests. We sometimes refer to each participating condominium unit as a “room.”

(3)

We launched the rental program for the Hyde Beach House in November 2019.

We conduct substantially all our business through our Operating Partnership. We are the sole general partner of our Operating Partnership, and we own an approximate 88.9% interest in our Operating Partnership, as of the date of this filing, with the remaining interest being held by limited partners who were the contributors of our Initial Properties and related assets.

To qualify as a REIT, neither the Company nor the Operating Partnership can operate our hotels. Therefore, our wholly-owned hotel properties are leased to our TRS Lessees, which are indirect wholly owned subsidiaries of the Operating Partnership. Our TRS Lessees then engage eligible independent hotel management companies to operate the hotels under a management agreement. Our TRS Lessees have engaged Chesapeake Hospitality and Highgate Hotels to manage our hotels. Our TRS Lessees, and their parent, MHI Hospitality TRS Holding, Inc., are consolidated into each of our financial statements for accounting purposes. The earnings of MHI Hospitality TRS Holding, Inc. are subject to taxation similar to other C corporations.

Our hotel management agreements with Chesapeake Hospitality for all of our hotels that it manages, other than the DoubleTree Resort by Hilton Hollywood Beach and the Hyde Resort & Residences, terminate according to their terms on January 1, 2020 (the “Expiring Agreements”). On July 15, 2019 we notified Chesapeake Hospitality of our intent not to renew or extend the Expiring Agreements. On September 6, 2019, we entered into a master agreement with Newport Hospitality Group, Inc., a Virginia corporation, and Our Town Hospitality LLC, a Virginia limited liability company relating to the management of ten of our hotels. The master agreement is designed to address the scheduled termination on January 1, 2020 of the Expiring Agreements. The master agreement establishes terms relating to new hotel management agreements governing the management of our hotels. Chesapeake Hospitality has committed to providing assistance in transitioning the hotels to a new manager.

Key Operating Metrics

In the hotel industry, room revenue is considered the most important category of revenue and drives other revenue categories such as food, beverage, catering, parking, and telephone. There are three key performance indicators used in the hotel industry to measure room revenues:

•

Occupancy, or the number of rooms sold, usually expressed as a percentage of total rooms available;

•

Average daily rate, or ADR, which is total room revenue divided by the number of rooms sold; and

•

Revenue per available room, or RevPAR, which is total room revenue divided by the total number of available rooms.

RevPAR changes that are primarily driven by changes in occupancy have different implications for overall revenues and profitability than changes that are driven primarily by changes in ADR. For example, an increase in occupancy at a hotel would lead to additional variable operating costs (such as housekeeping services, laundry, utilities, room supplies, franchise fees, management fees, credit card commissions and reservations expense), but could also result in increased non-room revenue from the hotel’s restaurant, banquet or parking facilities. Changes in RevPAR that are primarily driven by changes in ADR typically have a greater impact on operating margins and profitability as they do not generate all of the additional variable operating costs associated with higher occupancy.

When calculating composite portfolio metrics, we include available rooms at the Hyde Resort & Residences that participate in our rental program and are not reserved for owner-occupancy.

We also use FFO, Adjusted FFO and Hotel EBITDA as measures of our operating performance. See “Non-GAAP Financial Measures.”

Results of Operations

The following tables illustrate the key operating metrics for the three and nine months ended September 30, 2019 and 2018, respectively, for the Company’s wholly-owned properties (“actual” portfolio metrics), as well as eleven wholly-owned properties in the portfolio that were under the Company’s control during the nine months ended September 30, 2019 and the corresponding period in 2018 (“same-store” portfolio metrics). Accordingly, the actual data does not include the participating condominium hotel rooms at the Hyde Resort & Residences or the Hyde Beach House, and the same-store data does not reflect the performance of the Hyatt Centric Arlington which was acquired on March 1, 2018, or our interest in the Hyde Resort & Residences and the Hyde Beach House. The composite portfolio metrics represent all of the Company’s wholly-owned properties and the participating condominium hotel rooms at the Hyde Resort & Residences during the nine months ended September 30, 2019 and the corresponding periods in 2018. As of September 30, 2019, there were no participating condominium hotel rooms at the Hyde Beach House.

	Three Months Ended			Three Months Ended			Nine Months Ended			Nine Months Ended
	September 30, 2019			September 30, 2018			September 30, 2019			September 30, 2018
Actual Portfolio Metrics
Occupancy %		70.6	%		69.3	%		72.7	%		71.6	%
ADR	$	142.75		$	142.26		$	157.36		$	152.75
RevPAR	$	100.75		$	98.59		$	114.40		$	109.44
Same-Store Portfolio Metrics
Occupancy %		69.1	%		67.4	%		71.7	%		70.2	%
ADR	$	139.98		$	140.71		$	153.33		$	149.16
RevPAR	$	96.77		$	94.89		$	109.92		$	104.77
Composite Portfolio Metrics
Occupancy %		68.8	%		68.0	%		71.7	%		70.1	%
ADR	$	145.51		$	146.54		$	162.69		$	159.10
RevPAR	$	100.06		$	99.72		$	116.57		$	111.60

Comparison of the Three Months Ended September 30, 2019 to the Three Months Ended September 30, 2018

Revenue. Total revenue for the three months ended September 30, 2019 increased approximately $1.2 million, or 2.7%, to approximately $42.6 million compared to total revenue of approximately $41.4 million for the three months ended September 30, 2018. The increase in revenue for the three months ended September 30, 2019 resulted mainly from revenues of the newly acquired Hyde Beach House of approximately $0.8 million and a net increase of approximately $0.4 million across most of the portfolio, including an aggregate increase at our fully renovated and rebranded property in Wilmington, North Carolina of approximately $0.6 million. A significant increase in our Houston, Texas property from favorable local market changes of approximately $1.0 million, offset by a noticeable seasonal trend for the quarter which included the effects of Hurricane Dorian impacting our properties in Savannah, Georgia, Atlanta, Georgia, Jacksonville, Florida and two properties in Hollywood, Florida, with a decrease of approximately $1.7 million, as well as a net increase of approximately $0.5 million at the remaining properties.

Room revenue increased approximately $0.6 million, or 2.2%, to approximately $29.2 million for the three months ended September 30, 2019 compared to room revenue of approximately $28.6 million for the three months ended September 30, 2018. The increase in room revenue for the three months ended September 30, 2019 resulted mainly from an aggregate increase at our fully renovated and rebranded properties in Wilmington, North Carolina and Savannah, Georgia of approximately $0.3 million, as well as a net increase of approximately $0.3 million at the remaining properties.

Food and beverage revenues increased approximately $0.6 million, or 6.9%, to approximately $9.0 million for the three months ended September 30, 2019 compared to food and beverage revenues of approximately $8.4 million for the three months ended September 30, 2018. The increase in food and beverage revenues for the three months ended September 30, 2019 resulted mainly from an increase at our properties in Wilmington, North Carolina, Houston, Texas and Hollywood, Florida of approximately $0.9 million as well as a net decrease of approximately $0.3 million at the remaining properties.

Revenue from other operating departments decreased approximately $0.1 million, or 1.7%, to approximately $4.3 million for the three months ended September 30, 2019 compared to revenue from other operating departments of approximately $4.4 million for the three months ended September 30, 2018. The decrease in revenue from other operating departments for the three months ended September 30, 2019 resulted mainly from an aggregate decrease of approximately $0.1 million at our three Hollywood, Florida properties.

Hotel Operating Expenses. Hotel operating expenses, which consist of room expenses, food and beverage expenses, other direct expenses, indirect expenses and management fees, were approximately $33.6 million for the three months ended September 30, 2019, an increase of approximately $1.4 million, or 4.4%, compared to total hotel operating expenses of approximately $32.2 million for the three months ended September 30, 2018. The increase in hotel operating expenses for the three months ended September 30, 2019 resulted mainly from an aggregate increase at our fully renovated properties in Wilmington, North Carolina and Savannah, Georgia of approximately $1.3 million, as well as a net increase of approximately $0.1 million at the remaining properties.

Rooms expense for the three months ended September 30, 2019 increased approximately $0.2 million, or 2.4%, to approximately $8.1 million compared to rooms expense for the three months ended September 30, 2018 of approximately $7.9 million. The net increase in rooms expense for the three months ended September 30, 2019 resulted mainly from an aggregate increase at our fully renovated properties in Wilmington, North Carolina and Savannah, Georgia of approximately $0.2 million.

Food and beverage expenses for the three months ended September 30, 2019 increased approximately $0.3 million, or 5.3%, to approximately $7.0 million compared to food and beverage expenses of approximately $6.7 million for the three months ended September 30, 2018. The net increase in food and beverage expenses for the three months ended September 30, 2019 resulted mainly from an aggregate increase of approximately $0.4 million at our Wilmington, North Carolina, Houston, Texas and Tampa, Florida properties, which was offset by an aggregate decrease of approximately $0.1 million at the remaining properties.

Expenses from other operating departments decreased approximately $0.3 million, or 18.6%, to approximately $1.4 million for the three months ended September 30, 2019 compared to expenses from other operating departments of approximately $1.7 million for the three months ended September 30, 2018. The decrease in expenses from other operating departments for the three months ended September 30, 2019 resulted mainly from an decrease at our property the Hyde Resort & Residences in Hollywood, Florida of approximately $0.2 million, and by an aggregate decrease of approximately $0.1 million at the remaining properties.

Indirect expenses at our wholly-owned properties for the three months ended September 30, 2019 increased approximately $1.2 million, or 7.3%, to approximately $17.2 million compared to indirect expenses of approximately $16.0 million for the three months ended September 30, 2018. The increase in indirect expenses for the three months ended September 30, 2019 resulted mainly from an increase in real estate and personal property taxes at our Savannah, Georgia property of approximately $0.8 million. There was also an aggregate increase in indirect expenses of approximately $0.4 million from the remaining properties.

Depreciation and Amortization. Depreciation and amortization expense for the three months ended September 30, 2019 increased approximately $0.5 million, or 9.5%, to approximately $5.0 million compared to depreciation and amortization of approximately $4.5 million for the three months ended September 30, 2018. The increase in depreciation was mainly related to our property in Arlington, Virginia with an increase of approximately $0.4 million. There was also an aggregate increase in depreciation and amortization of approximately $0.1 million from our remaining properties.

Corporate General and Administrative. Corporate general and administrative expenses for the three months ended September 30, 2019 increased approximately $0.3 million, or 16.7%, to approximately $1.8 million compared to corporate general and administrative expenses of approximately $1.5 million for the three months ended September 30, 2018. The increase in corporate general and administrative expenses was mainly due to increased legal and professional fees by approximately $0.2 million, an increase in salaries of approximately $0.2 million offset in part by a reduction in audit and accounting fees of approximately $0.1 million.

Interest Expense. Interest expense for the three months ended September 30, 2019 decreased approximately $0.6 million, or 11.0%, to approximately $4.7 million, as compared to interest expense of approximately $5.3 million for the three months ended September 30, 2018. The decrease in interest expense for the three months ended September 30, 2019, was substantially related to the reduction of the 7.25% unsecured notes, which accounted for a decrease of approximately $0.5 million compared to the three-month period ending September 30, 2018.

Interest Income. Interest income for the three months ended September 30, 2019 increased slightly by $14,284, or 16.1%, to $102,768 compared to interest income of $88,484 for the three months ended September 30, 2018. The increase is due to higher interest rates on our interest-bearing cash and cash equivalents held during the three-month period ending September 30, 2019 compared to the three-month period ending September 30, 2018.

Unrealized Gain (Loss) on Hedging Activities. As of September 30, 2019, the fair market value of our interest rate caps is $4,421 and the fair market value of our interest rate swap liability is approximately $2.4 million. The unrealized loss on hedging activities during the three months ended September 30, 2019, was approximately $0.2 million and during the three months ended September 30, 2018, the unrealized gain on hedging activities was approximately $0.1 million.

Loss on Early Debt Extinguishment. During the three months ended September 30, 2018 we refinanced mortgage loans, we had on the DoubleTree by Hilton Raleigh Brownstone University, the DoubleTree by Hilton Philadelphia Airport and the Hyatt Centric Arlington with an approximate aggregate loss on early debt extinguishment of $0.8 million. There were no debt extinguishments for the three months ended September 30, 2019.

Gain on Exercise of Development Right. On September 26, 2019, we received title to a commercial condominium unit of the Hyde Beach House, consisting of a 3,000 square foot ballroom and adjacent pre-function space. The unit will be available for use as an additional ballroom and function space for our adjacent hotel, the DoubleTree Resort by Hilton Hollywood Beach. Conveyance of the ballroom condominium unit was required pursuant to an existing obligation on the part of the owner of the property as a condition to the development of the Hyde Beach House. Accompanying the title to the ballroom condominium unit are dedicated rights to 200 parking spaces within the six-story parking structure adjacent to the ballroom. The estimated fair value of the condominium unit and parking right is approximately $3.9 million.

Gain on Involuntary Conversion of Assets. Gain on involuntary conversion of assets for the three months ended September 30, 2019 increased approximately $0.1 million to approximately $0.1 million compared to no gain on involuntary conversion of assets for the three months ended September 30, 2018. During September 2019, we had mechanical failure and flooding damage from failure of the sewer system resulting in damage to the boiler at The DeSoto property with a one-time involuntary conversion in the amount of approximately $0.1 million.

Income Taxes. We had an income tax benefit of approximately $0.7 million for the three months ended September 30, 2019 compared to an income tax benefit of approximately $0.7 million for the three months ended September 30, 2018. The income tax benefit is primarily derived from the operations of our TRS Lessees. Our TRS Lessees realized operating losses for each of the three months ended September 30, 2019 and 2018.

Net Income. We realized net income for the three months ended September 30, 2019 of approximately $2.1 million compared to a net loss of approximately $2.0 million for the three months ended September 30, 2018, because of the operating results discussed above.

Comparison of the Nine Months Ended September 30, 2019 to the Nine Months Ended September 30, 2018

Revenue. Total revenue for the nine months ended September 30, 2019 increased approximately $6.8 million, or 5.0%, to approximately $141.5 million compared to total revenue of approximately $134.7 million for the nine months ended September 30, 2018. The increase in revenue for the nine months ended September 30, 2019 resulted mainly from an aggregate increase at our fully renovated and rebranded properties in Wilmington, North Carolina and Savannah, Georgia of approximately $3.0 million. There was also a significant increase in revenue in the nine-month period at our property in Atlanta, Georgia, of approximately $1.5 million, and a significant increase in revenue in the nine-month period at our property in Arlington, Virginia of approximately $2.9 million, which had two additional months of revenue this year versus the comparable period last year. These increases were offset by a net decrease of approximately $0.6 million at our remaining properties.

Room revenue increased approximately $6.4 million, or 6.9%, to approximately $98.6 million for the nine months ended September 30, 2019 compared to room revenue of approximately $92.2 million for the nine months ended September 30, 2018. The increase in room revenue for the nine months ended September 30, 2019 resulted mainly from an aggregate increase at our fully renovated and rebranded properties in Wilmington, North Carolina and Savannah, Georgia of approximately $1.7 million. Additionally, there was a significant aggregate increase in room revenue in the nine-month period at our properties in Atlanta, Georgia and Arlington, Virginia of approximately $4.1 million, as well as a net increase of approximately $0.6 million at our remaining properties.

Food and beverage revenues increased approximately $1.8 million, or 6.2%, to approximately $29.6 million for the nine months ended September 30, 2019 compared to food and beverage revenues of approximately $27.8 million for the nine months ended September 30, 2018. The increase in food and beverage revenues for the nine months ended September 30, 2019 resulted mainly from an aggregate increase at our fully renovated and rebranded properties in Wilmington, North Carolina and Savannah, Georgia of approximately $1.1 million. Additionally, there was a significant increase in food and beverage revenue in the nine-month period at our properties in Houston, Texas and Arlington, Virginia of approximately $1.2 million. These increases were offset by a net decrease of approximately $0.5 million at our remaining properties.

Revenue from other operating departments decreased approximately $1.3 million, or 8.7%, to approximately $13.3 million for the nine months ended September 30, 2019 compared to revenue from other operating departments of approximately $14.6 million for the nine months ended September 30, 2018. The decrease in revenue from other operating departments for the nine months ended September 30, 2019 resulted mainly from a decrease of approximately $1.0 million at our Hollywood, Florida property, due to higher

revenues received in the nine months ended September 30, 2018 that were driven by a one-time event that did not occur this year. Our remaining properties reported a net decrease of approximately $0.3 million.

Hotel Operating Expenses. Hotel operating expenses, which consist of room expenses, food and beverage expenses, other direct expenses, indirect expenses and management fees, were approximately $103.8 million for the nine months ended September 30, 2019, an increase of approximately $6.5 million, or 6.7%, compared to total hotel operating expenses of approximately $97.3 million for the nine months ended September 30, 2018. The increase in hotel operating expenses for the nine months ended September 30, 2019 resulted mainly from the acquisition of our Hyatt Centric Arlington property, on March 1, 2018, which increased hotel operating expenses by approximately $2.8 million. Additionally, there was an aggregate increase at our fully renovated properties in Wilmington, North Carolina, Hollywood, Florida and Savannah, Georgia of approximately $2.8 million, as well as an increase from our newly acquired Hyde Beach House adding approximately $0.7 million and a net increase of approximately $0.2 million at the remaining properties.

Rooms expense for the nine months ended September 30, 2019 increased approximately $1.5 million, or 6.7%, to approximately $24.3 million compared to rooms expense for the nine months ended September 30, 2018 of approximately $22.8 million. The net increase in rooms expense for the nine months ended September 30, 2019 resulted mainly from an aggregate increase at our fully renovated properties in Wilmington, North Carolina, Hollywood, Florida and Savannah, Georgia of approximately $0.4 million. Additionally, there was a significant aggregate increase in room expense in the nine-month period at our properties in Atlanta, Georgia, Houston, Texas and Arlington, Virginia of approximately $1.0 million and a net increase of approximately $0.1 million at our remaining properties.

Food and beverage expenses for the nine months ended September 30, 2019 increased approximately $1.1 million, or 5.0%, to approximately $21.8 million compared to food and beverage expenses of approximately $20.7 million for the nine months ended September 30, 2018. The net increase in food and beverage expenses for the nine months ended September 30, 2019 resulted mainly from an aggregate increase at our fully renovated properties in Wilmington, North Carolina, Hollywood, Florida and Savannah, Georgia of approximately $0.5 million. Additionally, there was a significant increase in food and beverage expense in the nine-month period at our properties in Houston, Texas and Arlington, Virginia of approximately $0.7 million. These increases were offset by a net decrease of approximately $0.1 million at our remaining properties.

Expenses from other operating departments increased approximately $0.1 million, or 2.8%, to approximately $5.0 million for the nine months ended September 30, 2019 compared to expenses from other operating departments of approximately $4.9 million for the nine months ended September 30, 2018. The increase in expense from other operating departments for the nine months ended September 30, 2019 resulted mainly from an aggregate increase at our fully renovated properties in Wilmington, North Carolina, Savannah, Georgia and Hollywood, Florida of approximately $0.2 million and by a net decrease of approximately $0.1 million at our remaining properties.

Indirect expenses at our wholly-owned properties for the nine months ended September 30, 2019 increased approximately $3.9 million, or 7.9%, to approximately $52.8 million compared to indirect expenses of approximately $48.9 million for the nine months ended September 30, 2018. The increase in indirect expenses for the nine months ended September 30, 2019 resulted mainly from the acquisition of our Hyatt Centric Arlington property, on March 1, 2018, which increased indirect costs for the nine months ended September 30, 2019 by approximately $1.5 million. Additionally, there was an aggregate increase at our fully renovated properties in Wilmington, North Carolina, Savannah, Georgia and Hollywood, Florida of approximately $1.8 million. There was also an aggregate increase in indirect expenses of approximately $0.6 million at our remaining properties.

Depreciation and Amortization. Depreciation and amortization expense for the nine months ended September 30, 2019 increased approximately $0.3 million, or 2.1%, to approximately $16.1 million compared to depreciation and amortization of approximately $15.8 million for the nine months ended September 30, 2018. The increase in depreciation resulted mainly from the acquisition of our Hyatt Centric Arlington property, on March 1, 2018, which increased depreciation and amortization for the nine months ended September 30, 2019 by approximately $0.5 million. There were aggregate decreases to our properties in Wilmington, North Carolina, Savannah, Georgia, Hollywood, Florida and Tampa, Florida due to their renovations and disposals with a net decrease of approximately $0.5 million. There was also an aggregate increase in depreciation and amortization of approximately $0.3 million at our remaining properties.

Corporate General and Administrative. Corporate general and administrative expenses for the nine months ended September 30, 2019 increased approximately $0.4 million, or 9.7%, to approximately $5.0 million compared to corporate general and administrative expenses of approximately $4.6 million for the nine months ended September 30, 2018. The increase in corporate general and administrative expenses was mainly due to increased salaries, travel, legal and professional fees of approximately $0.5 million and a decrease in audit and accounting fees of approximately $0.1 million.

Interest Expense. Interest expense for the nine months ended September 30, 2019 increased approximately $0.5 million, or 3.7%, to approximately $15.1 million compared to interest expense of approximately $14.6 million for the nine months ended September 30, 2018. The increase in interest expense for the nine months ended September 30, 2019, was substantially related to the refinanced mortgages on our properties in Raleigh, North Carolina, Philadelphia, Pennsylvania, Tampa, Florida and Arlington, Virginia and deferred financing costs associated with those mortgages, which accounted for an increase of approximately $1.1 million compared to the nine-month period ending September 30, 2018. In addition, there was an approximate $0.6 million decrease in interest expense from the payoff of the 7.25% unsecured notes.

Interest Income. Interest income for the nine months ended September 30, 2019 increased approximately $0.1 million or 51.1%, to approximately $0.3 million, compared to interest income of approximately $0.2 million, for the nine months ended September 30, 2018. The increase is due to higher interest rates on the interest-bearing cash and cash equivalents held during the nine-month period ending September 30, 2019 compared to the nine-month period ending September 30, 2018.

Unrealized Gain (Loss) on Hedging Activities. As of September 30, 2019, the fair market value of our interest rate caps is $4,421 and the fair market value of our interest rate SWAP liability is approximately $2.4 million. The unrealized loss on hedging activities during the nine months ended September 30, 2019, was approximately $1.6 million and during the nine months ended September 30, 2018, the unrealized gain on hedging activities was approximately $0.1 million.

Gain on Involuntary Conversion of Assets. Gain on involuntary conversion of assets for the nine months ended September 30, 2019 decreased approximately $0.6 million to approximately $0.3 million compared to gain on involuntary conversion of assets of approximately $0.9 million for the nine months ended September 30, 2018. During March 2019, we received an involuntary conversion reimbursement for flooding damage to our Wilmington property of approximately $0.2 million. During September 2019, we had mechanical failure and flooding damage from failure of the sewer system resulting in damage to the boiler at The DeSoto property with a one-time involuntary conversion in the amount of approximately $0.1 million.

Loss on Early Debt Extinguishment. The 7.25% Notes were redeemed on May 20, 2019 at 101% of face value. A redemption premium of $0.25 million and the unamortized deferred financing costs related to the 7.25% Notes comprise loss on early debt extinguishment in the current period of approximate $1.2 million. During the nine months ended September 30, 2018, we refinanced the mortgage loans we had on the DoubleTree by Hilton Raleigh Brownstone University, the DoubleTree by Hilton Philadelphia Airport and the Hyatt Centric Arlington with an approximate aggregate loss on early debt extinguishment of approximately $0.8 million.

Income Taxes. We had an income tax provision of approximately $0.4 million for the nine months ended September 30, 2019 compared to an income tax provision of approximately $0.9 million for the nine months ended September 30, 2018. The income tax benefit is primarily derived from the operations of our TRS Lessees. Our TRS Lessees realized operating income for each of the nine months ended September 30, 2019 and 2018.

Net Income. We realized a net income for the nine months ended September 30, 2019 of approximately $2.8 million compared to a net income of approximately $2.2 million for the nine months ended September 30, 2018, because of the operating results discussed above.

Non-GAAP Financial Measures

We consider FFO, Adjusted FFO and Hotel EBITDA, all of which are non-GAAP financial measures, to be key supplemental measures of our performance and could be considered along with, not alternatives to, net income (loss) as a measure of our performance. These measures do not represent cash generated from operating activities determined by GAAP or amounts available for our discretionary use and should not be considered alternative measures of net income, cash flows from operations or any other operating performance measure prescribed by GAAP.

FFO and Adjusted FFO. Industry analysts and investors use FFO as a supplemental operating performance measure of an equity REIT. FFO is calculated in accordance with the definition adopted by the Board of Governors of the National Association of Real Estate Investment Trusts (“NAREIT”). FFO, as defined by NAREIT, represents net income or loss determined in accordance

with GAAP, excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated operating real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after adjustment for any noncontrolling interest from unconsolidated partnerships and joint ventures. Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by itself.

We consider FFO to be a useful measure of adjusted net income (loss) for reviewing comparative operating and financial performance because we believe FFO is most directly comparable to net income (loss), which remains the primary measure of performance, because by excluding gains or losses related to sales of previously depreciated operating real estate assets and excluding real estate asset depreciation and amortization, FFO assists in comparing the operating performance of a company’s real estate between periods or as compared to different companies. Although FFO is intended to be a REIT industry standard, other companies may not calculate FFO in the same manner as we do, and investors should not assume that FFO as reported by us is comparable to FFO as reported by other REITs.

We further adjust FFO for certain additional items that are not in NAREIT’s definition of FFO, including changes in deferred income taxes, any unrealized gain (loss) on hedging instruments or warrant derivative, loan impairment losses, losses on early extinguishment of debt, aborted offering costs, loan modification fees, franchise termination costs, costs associated with the departure of executive officers, litigation settlement, over-assessed real estate taxes on appeal, operating asset depreciation and amortization, change in control gains or losses and acquisition transaction costs. We exclude these items as we believe it allows for meaningful comparisons between periods and among other REITs and is more indicative than FFO of the on-going performance of our business and assets. Our calculation of Adjusted FFO may be different from similar measures calculated by other REITs.

The following is a reconciliation of net income (loss) to FFO and Adjusted FFO for the three and nine months ended September 30, 2019 and 2018:

	Three Months Ended			Three Months Ended			Nine Months Ended			Nine Months Ended
	September 30, 2019			September 30, 2018			September 30, 2019			September 30, 2018
Net loss available to common stockholders	$	(106,827	)	$	(3,065,883	)	$	(2,492,298	)	$	(1,951,816	)
Add: Net loss attributable to noncontrolling interest		(13,337	)		(385,616	)		(311,642	)		(245,298	)
Depreciation and amortization - real estate		4,965,299			4,450,181			16,073,505			15,545,088
Gain on involuntary conversion of assets		(130,569	)		—			(291,902	)		(898,565	)
(Gain) loss on disposal of assets		4,918			(7,555	)		32,088			(3,816	)
FFO available to common stockholders and unitholders	$	4,719,484		$	991,127		$	13,009,751		$	12,445,593
(Increase) decrease in deferred income taxes		(702,775	)		(771,190	)		452,169			750,739
Amortization		14,869			96,862			43,773			238,086
Loss on early extinguishment of debt		—			753,133			1,152,356			753,133
Unrealized (gain) loss on hedging activities		226,491			(123,443	)		1,554,924			(141,970	)
Adjusted FFO available to common stockholders and unitholders	$	4,258,069		$	946,489		$	16,212,973		$	14,045,581

Weighted average number of shares outstanding, basic		13,636,706			13,513,996			13,624,760			13,491,807

Weighted average number of non-controlling units		1,778,140			1,778,140			1,778,140			1,778,140

Weighted average number of shares and units outstanding, basic		15,414,846			15,292,136			15,402,900			15,269,947

FFO per common share and unit	$	0.31		$	0.06		$	0.84		$	0.82

Adjusted FFO per common share and unit	$	0.28		$	0.06		$	1.05		$	0.92

Hotel EBITDA. We define Hotel EBITDA as net income or loss excluding: (1) interest expense, (2) interest income, (3) income tax provision or benefit, (4) equity in the income or loss of equity investees, (5) unrealized gains and losses on derivative instruments not included in other comprehensive income, (6) gains and losses on disposal of assets, (7) realized gains and losses on investments, (8) impairment of long-lived assets or investments, (9) loss on early debt extinguishment, (10) gains or losses on change in control, (11) gain on exercise of development right, (12) corporate general and administrative expense, (13) depreciation and amortization, (14) gains and losses on involuntary conversions of assets, (15) distributions to preferred stockholders and (16) other operating revenue not related to our wholly-owned portfolio. We believe this provides a more complete understanding of the operating results over which our wholly-owned hotels and its operators have direct control. We believe Hotel EBITDA provides investors with supplemental information on the on-going operational performance of our hotels and the effectiveness of third-party management companies operating our business on a property-level basis.

Our calculation of Hotel EBITDA may be different from similar measures calculated by other REITs.

The following is a reconciliation of net income (loss) to Hotel EBITDA for the three and nine months ended September 30, 2019 and 2018:

	Three Months Ended			Three Months Ended			Nine Months Ended			Nine Months Ended
	September 30, 2019			September 30, 2018			September 30, 2019			September 30, 2018
Net loss available to common stockholders	$	(106,827	)	$	(3,065,883	)	$	(2,492,298	)	$	(1,951,816	)
Add: Net loss attributable to noncontrolling interest		(13,337	)		(385,616	)		(311,642	)		(245,298	)
Interest expense		4,722,456			5,306,641			15,115,690			14,571,142
Interest income		(102,768	)		(88,484	)		(357,576	)		(236,693	)
Income tax provision (benefit)		(694,190	)		(746,924	)		439,323			882,045
Depreciation and amortization		4,980,168			4,547,043			16,117,278			15,783,174
Distributions to preferred stockholders		2,188,910			1,469,719			5,631,799			4,359,407
EBITDA		10,974,412			7,036,496			34,142,574			33,161,961
(Gain) loss on disposal of assets		4,918			(7,555	)		32,088			(3,816	)
Loss on early extinguishment of debt		—			753,133			1,152,356			753,133
Gain on exercise of development right		(3,940,000	)		—			(3,940,000	)		—
Gain on involuntary conversion of assets		(130,569	)		—			(291,902	)		(898,565	)
Subtotal		6,908,761			7,782,074			31,095,116			33,012,713
Corporate general and administrative		1,768,912			1,516,408			5,008,290			4,566,258
Unrealized (gain) loss on hedging activities		226,491			(123,443	)		1,554,924			(141,970	)
Hotel EBITDA	$	8,904,164		$	9,175,039		$	37,658,330		$	37,437,001

Sources and Uses of Cash

Operating Activities. Our principal source of cash to meet our operating requirements, including distributions to unitholders of the Operating Partnership and stockholders of our preferred and common stock, as well as debt service (excluding debt maturities), is through the operations of our hotels. Cash flow provided by operating activities for the nine months ended September 30, 2019 was approximately $21.9 million. We had a net decrease in cash provided by operating activities for the nine months ended September 30, 2019 of approximately $0.1 million, compared to the nine months ended September 30, 2018. We expect that cash on hand and the net cash provided by operations will be adequate to fund our continuing operations, monthly and quarterly scheduled payments of principal and interest (excluding any balloon payments due upon maturity of a debt) and the payment of dividends (distributions) to the Company’s stockholders (and unitholders of the Operating Partnership) in accordance with federal income tax laws which require us to make annual distributions, as “qualifying distributions,” to the Company’s stockholders of at least 90% of its REIT taxable income (determined without regard to the dividends-paid deduction and by excluding its net capital gains, and reduced by certain non-cash items).

Investing Activities. During the nine months ended September 30, 2019, we acquired a commercial condominium unit of the Hyde Beach House for fair value transfer of approximately $6.3 million, including inventory and equipment, used approximately $10.8 million on capital expenditures, of which, approximately $5.8 million related to the routine replacement of furniture, fixtures and equipment, approximately $5.0 million related mainly to renovation of our hotels in Arlington, Virginia, Hollywood and Tampa, Florida. The Operating Partnership received a payment on its loan to the Company in the amount of approximately $0.2 million. We also received approximately $0.3 million in proceeds from insurance for damage to our hotels.

Financing Activities. During the nine months ended September 30, 2019, we received approximately $28.4 million for the issuance of Series D Preferred Shares and Units and approximately $4.9 million for the issuance of Series C Preferred Shares and Units, we redeemed the 7.25% Notes for $25.3 million, we paid dividend and distribution payments of approximately $10.9 million for the Company and approximately $11.2 million for the Operating Partnership, made payments on financing costs of approximately $0.1 million and made payments on mortgages of approximately $4.6 million.

Capital Expenditures

We anticipate that our need for recurring capital expenditures for the replacement and refurbishment of furniture, fixtures and equipment over the next 12 to 24 months will be at historical norms for our properties and the industry. Historically, we have aimed to maintain overall capital expenditures, except for those required by our franchisors as a condition to a franchise license or license renewal, at 4.0% of gross revenue.

We expect capital expenditures for the recurring replacement or refurbishment of furniture, fixtures and equipment at our properties will be funded by our replacement reserve accounts, other than costs that we incur to make capital improvements required by our franchisors. Reserve accounts are escrowed accounts with funds deposited monthly and reserved for capital improvements or expenditures with respect to all of our hotels. We currently deposit an amount equal to 4.0% of gross revenue for The DeSoto, the Hotel Ballast, the DoubleTree by Hilton Raleigh Brownstone-University, The Whitehall, the DoubleTree by Hilton Jacksonville Riverfront, the DoubleTree Resort by Hilton Hollywood Beach and the Georgian Terrace, as well as 4.0% of room revenues for the DoubleTree by Hilton Philadelphia Airport and Hyatt Centric Arlington on a monthly basis.

Liquidity and Capital Resources

As of September 30, 2019, we had total cash of approximately $35.3 million, of which approximately $30.1 million was in cash and cash equivalents and approximately $5.2 million was restricted for real estate taxes, insurance, capital improvement and certain other expenses, or otherwise restricted. We expect that our cash on hand combined with our cash flow from the operations of our hotels should be adequate to fund continuing operations, recurring capital expenditures for the refurbishment and replacement of furniture, fixtures and equipment, and monthly and quarterly scheduled payments of principal and interest (excluding any balloon payments due upon maturity of the indentures or mortgage debt).

We intend to continue to invest in hotel properties as suitable opportunities arise. The success of our acquisition strategy depends, in part, on our ability to access additional capital through other sources. There can be no assurance that we will continue to make investments in properties that meet our investment criteria. Additionally, we may choose to dispose of certain hotels as a means to provide liquidity.

We expect to meet our liquidity requirements for hotel property acquisitions, property redevelopment, investments in new joint ventures, the retirement of maturing mortgage debt, and other debt maturities, through net proceeds from additional issuances of common shares, additional issuances of preferred shares, issuances of units of limited partnership interest in our Operating Partnership, secured and unsecured borrowings, the selective disposition of non-core assets, and cash on hand. From time to time and subject to market conditions, we may also seek to refinance mortgage debt prior to maturity where appropriate. We remain committed to a flexible capital structure and strive to maintain prudent debt leverage.

Other than monthly mortgage loan principal payments, we do not have any upcoming mortgage debt obligations maturing in 2019 or 2020. We have approximately $8.2 million in mortgage loan principal obligations maturing in 2021, which relates to the mortgage on the DoubleTree by Hilton Laurel, accounting for reductions for future monthly principal payments.

Financial Covenants

Mortgage Loans

Our mortgage loan agreements contain various financial covenants. Failure to comply with these financial covenants could result from, among other things, changes in the local competitive environment, general economic conditions and disruption caused by renovation activity or major weather disturbances.

If we violate the financial covenants contained in these agreements, we may attempt to negotiate waivers of the violations or amend the terms of the applicable mortgage loan agreement with the lender; however, we can make no assurance that we would be successful in any such negotiation or that, if successful in obtaining waivers or amendments, such waivers or amendments would be on attractive terms. Some mortgage loan agreements provide alternate cure provisions which may allow us to otherwise comply with the financial covenants by obtaining an appraisal of the hotel, prepaying a portion of the outstanding indebtedness or by providing cash collateral until such time as the financial covenants are met by the collateralized property without consideration of the cash collateral. Alternate cure provisions which include prepaying a portion of the outstanding indebtedness or providing cash collateral may have a material impact on our liquidity.

If we are unable to negotiate a waiver or amendment or satisfy alternate cure provisions, if any, or unable to meet any alternate cure requirements and a default were to occur, we would possibly have to refinance the debt through additional debt financing, private or public offerings of debt securities, or additional equity financing.

Under the terms of our non-recourse secured mortgage loan agreements, failure to comply with the financial covenants in the loan agreement triggers cash flows from the property to be directed to the lender, which may limit our overall liquidity as that cash flow would not be available to us.

Dividend Policy

We intend to continue to declare quarterly distributions to our stockholders. The amount of future common stock (and Operating Partnership unit) distributions will be based upon quarterly operating results, general economic conditions, requirements for capital improvements, the availability of debt and equity capital, the Internal Revenue Code’s annual distribution requirements and other factors, which the Company’s board of directors deems relevant. The amount, timing and frequency of distributions will be authorized by the Company’s board of directors and declared by us based upon a variety of factors deemed relevant by our directors, and no assurance can be given that our distribution policy will not change in the future.

In January 2019, we authorized a quarterly dividend (distribution) of $0.125 per common share (and unit).

In April 2019, we increased the quarterly dividend (distribution) to $0.13 per common share (and unit).

In July 2019, we authorized a quarterly dividend (distribution) of $0.13 per common share (and unit).

In October 2019, we authorized a quarterly dividend (distribution) of $0.13 per common share (and unit).

Off-Balance Sheet Arrangements

None.

Inflation

We generate revenues primarily from lease payments from our TRS Lessees and net income from the operations of our TRS Lessees. Therefore, we rely primarily on the performance of the individual properties and the ability of the management company to increase revenues and to keep pace with inflation. Operators of hotels, in general, possess the ability to adjust room rates daily to keep pace with inflation. However, competitive pressures at some or all of our hotels may limit the ability of the management company to raise room rates.

Our expenses, including hotel operating expenses, administrative expenses, real estate taxes and property and casualty insurance are subject to inflation. These expenses are expected to grow with the general rate of inflation, except for energy, liability insurance, property and casualty insurance, property tax rates, employee benefits, and some wages, which are expected to increase at rates higher than inflation.

Geographic Concentration and Seasonality

Our hotels are located in Florida, Georgia, Indiana, Maryland, North Carolina, Pennsylvania, Texas and Virginia. As a result, we are particularly susceptible to adverse market conditions in these geographic areas, including industry downturns, relocation of businesses and any oversupply of hotel rooms or a reduction in lodging demand. Adverse economic developments in the markets in which we have a concentration of hotels, or in any of the other markets in which we operate, or any increase in hotel supply or decrease in lodging demand resulting from the local, regional or national business climate, could materially and adversely affect us.

The operations of our hotel properties have historically been seasonal. The months of April and May are traditionally strong, as is October. The periods from mid-November through mid-February are traditionally slow with the exception of hotels located in certain markets, namely Florida and Texas, which typically experience significant room demand during this period.

Critical Accounting Policies

The critical accounting policies are described below. We consider these policies critical because they involve difficult management judgments and assumptions, are subject to material change from external factors or are pervasive and are significant to fully understand and evaluate our reported financial results.

Investment in Hotel Properties. Hotel properties are stated at cost, net of any impairment charges, and are depreciated using the straight-line method over an estimated useful life of 7-39 years for buildings and improvements and 3-10 years for furniture and equipment. In accordance with generally accepted accounting principles, the controlling interests in hotels comprising our accounting predecessor, MHI Hotels Services Group, and noncontrolling interests held by the controlling holders of our accounting predecessor in hotels, which were acquired from third parties, contributed to us in connection with the Company’s initial public offering, are recorded at historical cost basis. Noncontrolling interests in those entities that comprise our accounting predecessor and the interests in hotels, other than those held by the controlling members of our accounting predecessor, acquired from third parties are recorded at fair value at the time of acquisition.

We review our hotel properties for impairment whenever events or changes in circumstances indicate the carrying value of the hotel properties may not be recoverable. Events or circumstances that may cause us to perform our review include, but are not limited to, adverse permanent changes in the demand for lodging at our properties due to declining national or local economic conditions and/or new hotel construction in markets where our hotels are located. When such conditions exist, management performs a recoverability analysis to determine if the estimated undiscounted future cash flows from operating activities and the estimated proceeds from the ultimate disposition of a hotel property exceed its carrying value. If the estimated undiscounted future cash flows are found to be less than the carrying amount of the hotel property, an adjustment to reduce the carrying value to the related hotel property’s estimated fair market value would be recorded and an impairment loss is recognized.

There were no charges for impairment of hotel properties recorded for the nine months ended September 30, 2019.

In performing the recoverability analysis, we project future operating cash flows based upon significant assumptions regarding growth rates, occupancy, room rates, economic trends, property-specific operating costs and future capital expenditures required to maintain the hotel in its current operating condition. We also project cash flows from the eventual disposition of the hotel based upon various factors including property-specific capitalization rates, ratio of selling price to gross hotel revenues and the selling price per room.

Revenue Recognition. Hotel revenues, including room, food, beverage and other hotel revenues, are recognized as the related services are delivered. We generally consider accounts receivable to be fully collectible; accordingly, no allowance for doubtful accounts is required. If we determine that amounts are uncollectible, which would generally be the result of a customer’s bankruptcy or other economic downturn, such amounts will be charged against operations when that determination is made. Revenues are reported net of occupancy and other taxes collected from customers and remitted to governmental authorities. Receivables for amounts earned under various contracts are subject to audit.

Income Taxes. We record a valuation allowance to reduce deferred tax assets to an amount that we believe is more likely than not to be realized. Because of expected future taxable income of our TRS Lessee, we have not recorded a valuation allowance to reduce our net deferred tax asset as of September 30, 2019 and December 31, 2018, respectively. We regularly evaluate the likelihood that our TRS Lessee will be able to realize its deferred tax assets and the continuing need for a valuation allowance. At each of September 30, 2019 and December 31, 2018, we determined, based on all available positive and negative evidence, that it is more-likely-than-not that future taxable income will be available during the carryforward periods to absorb all of the consolidated federal and state net operating loss carryforward. A number of factors played a critical role in this determination, including:

•

a demonstrated track record of past profitability and utilization of past NOL carryforwards,

•

reasonable forecasts of future taxable income, and

•

anticipated changes in the lease rental payments from the TRS Lessee to subsidiaries of the Operating Partnership.

Should unanticipated adverse financial trends occur, or other negative evidence develop, a valuation allowance may be necessary in the future against some or all of our deferred tax assets.

Recent Accounting Pronouncements

For a summary of recently adopted and newly issued accounting pronouncements, please refer to the New Accounting Pronouncements section of Note 2, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements.

Forward Looking Statements

Information included and incorporated by reference in this Form 10-Q may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and as such may involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements, which are based on certain assumptions and describe our current strategies, expectations, and future plans are generally identified by our use of words, such as “intend,” “plan,” “may,” “should,” “will,” “project,” “estimate,” “anticipate,” “believe,” “expect,” “continue,” “potential,” “opportunity,” and similar expressions, whether in the negative or affirmative, but the absence of these words does not necessarily mean that a statement is not forward-looking. All statements regarding our expected financial position, business and financing plans are forward-looking statements. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to:

•

national and local economic and business conditions that affect occupancy rates and revenues at our hotels and the demand for hotel products and services;

•

risks associated with the hotel industry, including competition and new supply of hotel rooms, increases in wages, energy costs and other operating costs;

•

risks associated with adverse weather conditions, including hurricanes;

•

the availability and terms of financing and capital and the general volatility of the securities markets;

•

the Company’s intent to repurchase shares from time to time;

•

risks associated with the level of our indebtedness and our ability to meet covenants in our debt agreements and, if necessary, to refinance or seek an extension of the maturity of such indebtedness or modify such debt agreements;

•

management and performance of our hotels;

•

risks associated with maintaining our system of internal controls;

•

risks associated with the conflicts of interest of the Company’s officers and directors;

•

risks associated with redevelopment and repositioning projects, including delays and cost overruns;

•

supply and demand for hotel rooms in our current and proposed market areas;

•

risks associated with our ability to maintain our franchise agreements with our third party franchisors;

•

our ability to acquire additional properties and the risk that potential acquisitions may not perform in accordance with expectations;

•

our ability to successfully expand into new markets;

•

legislative/regulatory changes, including changes to laws governing taxation of REITs;

•

the Company’s ability to maintain its qualification as a REIT; and

•

our ability to maintain adequate insurance coverage.

Additional factors that could cause actual results to vary from our forward-looking statements are set forth under the section titled “Risk Factors” in our Annual Report on Form 10-K and subsequent reports filed with the Securities and Exchange Commission.

These risks and uncertainties should be considered in evaluating any forward-looking statement contained in this report or incorporated by reference herein. All forward-looking statements speak only as of the date of this report or, in the case of any document incorporated by reference, the date of that document. All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are qualified by the cautionary statements in this section. We undertake no obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances or changes in expectations after the date of this report, except as required by law. In addition, our past results are not necessarily indicative of our future results.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

The effects of potential changes in interest rates are discussed below. Our market risk discussion includes “forward-looking statements” and represents an estimate of possible changes in fair value or future earnings that could occur assuming hypothetical future movements in interest rates. These disclosures are not precise indicators of expected future losses, but only indicators of reasonably possible losses. As a result, actual future results may differ materially from those presented. The analysis below presents the sensitivity of the market value of our financial instruments to selected changes in market interest rates.

To meet in part our long-term liquidity requirements, we will borrow funds at a combination of fixed and variable rates. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. From time to time we may enter into interest rate hedge contracts such as collars and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. We do not intend to hold or issue derivative contracts for trading or speculative purposes.

As of September 30, 2019, we had approximately $312.1 million of fixed-rate debt, including the mortgage on our Philadelphia, Pennsylvania hotel, which is fixed by an interest rate swap to 5.237% and approximately $50.9 million of variable-rate debt. The weighted-average interest rate on the fixed-rate debt was 4.78%. A change in market interest rates on the fixed portion of our debt would impact the fair value of the debt but have no impact on interest incurred or cash flows. Our variable-rate debt is exposed to changes in interest rates, specifically the changes in 1-month LIBOR. Assuming that the aggregate amount outstanding on the mortgages on the Hotel Alba, DoubleTree by Hilton Raleigh Brownstone-University and The Whitehall remains at approximately $50.9 million, the balance at September 30, 2019, the impact on our annual interest incurred and cash flows of a one percent increase in 1-month LIBOR would be approximately $0.5 million.

As of December 31, 2018, we had approximately $341.3 million of fixed-rate debt, including the mortgage on our Philadelphia, Pennsylvania hotel, which is fixed by an interest rate swap to 5.237% and approximately $51.3 million of variable-rate debt. The weighted-average interest rate on the fixed-rate debt was 4.96%. A change in market interest rates on the fixed portion of our debt would impact the fair value of the debt but have no impact on interest incurred or cash flows. Our variable-rate debt is exposed to changes in interest rates, specifically the changes in 1-month LIBOR. Assuming that the aggregate amount outstanding on the mortgages on the Hotel Alba, DoubleTree by Hilton Raleigh Brownstone and the mortgage on The Whitehall remained at approximately $51.3 million, the balance at December 31, 2018, the impact on our annual interest incurred and cash flows of a one percent increase in 1-month LIBOR would be approximately $0.5 million.

Item 4.Controls and Procedures

Sotherly Hotels Inc.

Disclosure Controls and Procedures

The Company’s management, under the supervision and participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as required by paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act), as of September 30, 2019. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2019, its disclosure controls and procedures were effective and designed to ensure that (i) information required to be disclosed in its reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and instructions, and (ii) information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

The Company’s management, including its Chief Executive Officer and Chief Financial Officer, does not expect that the Company’s disclosure controls and procedures or its internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of the controls can provide absolute assurance that all control issues and instances of fraud, if any, within Sotherly Hotels Inc. have been detected.

Changes in Internal Control over Financial Reporting

There was no change in Sotherly Hotels Inc.’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act during Sotherly Hotels Inc.’s last fiscal quarter that materially affected, or is reasonably likely to materially affect, Sotherly Hotels Inc.’s internal control over financial reporting.

Sotherly Hotels LP

Disclosure Controls and Procedures

The Operating Partnership’s management, under the supervision and participation of the Chief Executive Officer and Chief Financial Officer of Sotherly Hotels Inc., as general partner, has evaluated the effectiveness of the disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as required by paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act), as of September 30, 2019. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2019, the disclosure controls and procedures were effective and designed to ensure that (i) information required to be disclosed in the reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and instructions, and (ii) information is accumulated and communicated

to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

The Operating Partnership’s management, including the Chief Executive Officer and Chief Financial Officer of Sotherly Hotels Inc., as general partner, does not expect that the disclosure controls and procedures or the internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of the controls can provide absolute assurance that all control issues and instances of fraud, if any, within Sotherly Hotels LP have been detected.

Changes in Internal Control over Financial Reporting

There was no change in Sotherly Hotels LP’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act during Sotherly Hotels LP’s last fiscal quarter that materially affected, or is reasonably likely to materially affect, Sotherly Hotels LP’s internal control over financial reporting.

PART II

Item 1.

Legal Proceedings

We are not involved in any legal proceedings other than routine legal proceedings occurring in the ordinary course of business. We believe that these routine legal proceedings, in the aggregate, are not material to our financial condition and results of operations.

Item 1A.

Risk Factors

There have been no material changes in our risk factors from those disclosed in our annual report on Form 10-K for the year ended December 31, 2018 and our quarterly reports on Form 10-Q for the quarterly periods ended March 31, 2019 and June 30, 2019.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

From time to time, the Operating Partnership issues limited partnership units to the Company, as required by the Partnership Agreement, to mirror the capital structure of the Company to reflect additional issuances by the Company and to preserve equitable ownership ratios.

Item 3.

Defaults upon Senior Securities

Not applicable.

Item 4.

Mine Safety Disclosures

Not applicable.

Item 5.

Other Information

Not applicable.

Item 6.

Exhibits

The following exhibits are filed as part of this Form 10-Q:

Exhibit
Number		Description of Exhibit

10.17		Master Agreement by and among Sotherly Hotels Inc., Sotherly Hotels LP, MHI Hospitality TRS, LLC, Newport Hospitality Group, Inc. and Our Town Hospitality LLC (incorporated by reference to the document previously filed as Exhibit 10.17 to our Current Report on Form 8-K filed with the Securities and Exchange Commission on September 9, 2019).

10.20		Second Addendum to Commercial Unit Purchase Agreement between SOHO ICW Resort Owner LLC and 4000 South Ocean Property Owner, LLLP, dated as of September 26, 2019 (incorporated by reference to the document previously filed as Exhibit 10.20 to our Current Report on Form 8-K filed with the Securities and Exchange Commission on September 30, 2019).

31.1		Certification of Chief Executive Officer pursuant to Exchange Act Rules 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Company.

31.2		Certification of Chief Financial Officer pursuant to Exchange Act Rules 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Company.

31.3		Certification of Chief Executive Officer pursuant to Exchange Act Rules 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Operating Partnership.

31.4		Certification of Chief Financial Officer pursuant to Exchange Act Rules 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Operating Partnership.

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Company.

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Company.

32.3		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Operating Partnership.

32.4		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Operating Partnership.

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB		XBRL Taxonomy Extension Label Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	SOTHERLY HOTELS INC.

Date: November 12, 2019	By:	/s/ Andrew M. Sims
		Andrew M. Sims
		Chief Executive Officer

	By:	/s/ Anthony E. Domalski
		Anthony E. Domalski
		Chief Financial Officer

SIGNATURES

	SOTHERLY HOTELS LP

	By:	SOTHERLY HOTELS INC.
		Its General Partner

Date: November 12, 2019	By:	/s/ Andrew M. Sims
		Andrew M. Sims
		Chief Executive Officer

	By:	/s/ Anthony E. Domalski
		Anthony E. Domalski
		Chief Financial Officer