SHO

Business Context and Reporting Period

Sunstone Hotel Investors, Inc. (Sunstone) is a Maryland corporation operating as a Real Estate Investment Trust (REIT). As of September 30, 2008, the Company owned 44 hotels (14,889 rooms) across the United States, managed by third parties including Interstate SHP, Marriott, Hyatt, and others. The Company leases its properties to a taxable REIT subsidiary (TRS) which contracts with these managers. This filing covers the quarterly period ended September 30, 2008.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue: Total revenues decreased 2.0% in the third quarter compared to the same period in 2007, driven by a 2.1% decline in room revenue. However, for the nine-month period, total revenues increased 3.8% year-over-year, aided by acquisitions made in 2007.
• Operating Performance: For the three months ended September 30, 2008, the Total Hotel Portfolio RevPAR decreased 2.1% to $124.30, with occupancy down 260 basis points to 78.5% and Average Daily Rate (ADR) up 1.1% to $158.34. For the nine-month period, RevPAR increased 1.2% to $122.41.
• Discontinued Operations: Net income includes significant gains from discontinued operations in the nine-month period ($52.2 million) due to the sale of the Hyatt Regency Century Plaza in May 2008 for net proceeds of $358.8 million. There was no income from discontinued operations in the third quarter of 2008.
• Stock Repurchases: The Company repurchased 11.1 million shares of common stock during the nine months ended September 30, 2008, at a total cost of approximately $184.4 million, including a tender offer in June 2008.

Outlook, Risks, and Management Commentary

• Economic Outlook: Management anticipates year-over-year declines in operations for the remainder of 2008 and into 2009 due to economic deterioration and a prolonged U.S. recession. Lodging demand is expected to weaken further until credit markets stabilize.
• Liquidity: As of September 30, 2008, the Company held $189.1 million in cash and cash equivalents. The $200 million unsecured credit facility had no outstanding borrowings, with $196.1 million available after letters of credit. Management intends to maintain higher-than-historical cash levels for working capital.
• Capital Expenditures: The Company invested $80.6 million in capital improvements during the first nine months of 2008. Remaining contractual construction commitments totaled $18.4 million.
• Accounting Changes: The Company noted the upcoming adoption of FSP APB 14-1 regarding convertible debt, which is expected to increase annual interest expense by $2.0 million to $4.0 million starting in 2008 through 2013, though it will not affect cash interest payments.
• Risks: Key risks include the impact of the recession on lodging demand, volatility in credit markets affecting refinancing, and the Company's ability to comply with debt covenants if operations decline.

Investor Verification Checklist

• Debt Covenants: Verify compliance with financial covenants under the $200 million credit facility, as a decline in operations could reduce or eliminate available funds.
• Discontinued Operations Impact: Assess the sustainability of earnings by excluding the $42.1 million gain from the sale of the Hyatt Regency Century Plaza included in the nine-month results.
• Occupancy Trends: Monitor the 260 basis point decline in occupancy in Q3 2008 to gauge the severity of the economic downturn on the portfolio.
• Stock Repurchase Authorization: Confirm the remaining $67.1 million authorization under the 2008 Repurchase Program and its potential impact on share count and liquidity.
• Future Interest Expense: Review the projected increase in non-cash interest expense due to the new accounting standard for convertible debt (FSP APB 14-1).