Operating Results 

During the fourth quarter of 1998, the Company experienced a greater than anticipated impact from renovation due to weather and other factors.  In addition, the western United States and specific markets in which the Company owns properties experienced an increase in supply and reduced demand.  Markets which were affected included Colorado and Utah due to poor weather and ski conditions, where the Company owns 12 seasonally-affected hotels; the Pacific Northwest which suffered from soft demand; the Phoenix, Ariz. market which suffered from softer than anticipated demand in the Scottsdale market which created greater competition for the Company's Sheraton resort in Chandler, Ariz.; and the Anaheim, Calif. market which experienced a 5.0% decline in demand due to reduced convention volume, poor attendance at Disneyland and major road reconstruction of the I-5 freeway. 
 
Although results in certain markets and at certain properties were less than anticipated, Sunstone continued to experience strong revenue growth from its hotels in Rochester, Minn., which represent approximately 20.1% of the Company's lease revenue for the fourth quarter of 1998.  These hotels achieved REVPAR growth of approximately 12.4% during the fourth quarter of 1998. 

Additionally, strong revenue performance was achieved by those non-renovation hotels flagged under the Marriott, Residence Inn by Marriott and Courtyard by Marriott brands, posting a 12.2% average REVPAR gain for the quarter.  Hotels owned by Sunstone under Marriott franchises represent 34.9% of the Company's fourth quarter 1998 lease revenues.  Sunstone's non-renovation Holiday Inn brands, which represent 20.0% of the Company's lease revenues for the fourth quarter 1998 posted REVPAR gains of 7.7%. 
 
Solid revenue performance by certain of the Company's hotels in the fourth quarter of 1998 combined the effects of more stable and consistent market conditions with repositioning efforts as indicated in the following table: 
 

The Courtyard by Marriott-LAX posted a major turn-around in occupancy following the July 1998 conversion from an independent hotel to a Marriott brand.  The Rochester Marriott was also another significant success of branding independent hotels posting a significant increase in rate.  These two hotels achieved REVPAR increases in the fourth quarter of 92.1% and 34.5%, respectively. 

Franchise Branding and Upgrades 

Marriott Conversions. 

During 1998, the Company continued to execute its branding and repositioning strategy.  In March 1998, Sunstone branded the previously independent 194-room Kahler Plaza hotel as the full-service Marriott Rochester.  The hotel underwent a $1.7 million renovation, which included upgraded guestroom soft goods, furniture and guest baths, and extensive renovation of the lobby and restaurant.  The Marriott Rochester was the first of five hotels from the Kahler portfolio to be branded as a full-service Marriott.  In April 1998, the 333-room Provo Park Hotel in Utah was also flagged as a luxury, full-service Marriott, after undergoing a $4.6 million renovation upgrading the lobby, guest rooms and baths, restaurant, meeting rooms and the hotel's exterior. 
 
In May 1998, the Company branded the previously independent University Park hotel located in Salt Lake City, Utah as a full-service Marriott hotel. The hotel underwent a $4.1 million renovation, including lobby and restaurant renovation as well as guestroom soft goods, furniture and guest bath upgrades. In July 1998, Sunstone rebranded the former Ogden Park hotel in Ogden, Utah as a full-service Marriott after completing $5.8 million in renovations. 
Alter added, "We hope to realize considerable value and upside from the strength of these strong national franchises.  We believe the added advantages of brand recognition and national reservation systems will have a significant increase in revenue for these hotels." 
 
During 1998, Sunstone also rebranded the former Ramada Hotel -- San Diego (Old Town), Calif. to a Holiday Inn and Suites, the independent Fountain Suites -- Sacramento, Calif. to a Hawthorn Suites and upgraded the Holiday Inn -- La Mirada, Calif. to a Holiday Inn Select. 

1998 Acquisitions 

Sunstone reported that it acquired ten hotels in 1998 in strong markets in which it believes there are significant barriers to new competition for a total purchase price of $133.9 million as follows: 
 

Sale of Non-Core Hotel Assets 

During 1998, Sunstone executed its plan to reposition its portfolio of hotels towards the luxury and upscale markets by disposing non-core hotel assets.  Alter added, "We continue to consider certain non-core hotel assets for disposition, primarily limited service hotels, in order to redeploy capital to acquire full-service hotels which can better benefit from 
rebranding and repositioning and are in markets with greater barriers to entry." 

During the third quarter, the Company sold six hotels for which the locations and sizes were inconsistent with the Company's strategy of renovating and rebranding luxury, upscale and mid-price hotels in large metropolitan areas, downtown and airport hotel markets.  Four of the hotels, comprising 651 rooms, were sold to Cavanaughs Hospitality Corporation (NYSE: CVH) and included the Boise Park Suite Hotel in Boise, Idaho; the Pocatello Park Quality Inn in Pocatello, Idaho; the Best Western Canyon Springs Park Hotel in Twin Falls, Idaho and the Best Western Colonial Inn in Helena, Mont.  Two additional hotels sold included the 187-room Lakeview Resort & Conference Center in Morgantown, W.Va. and the 284-room Green Oaks Park Hotel in Fort Worth, Texas.  These six hotels were acquired by Sunstone as part of the Kahler Realty Corporation in October 1997.  As of Jan. 1999, the Company entered into an agreement to sell the 131-room Hampton Inn in Arcadia, Calif.  The sale is expected to close in the first quarter of 1999. 

Renovations and Development 

During 1998, Sunstone continued to implement its strategy of renovating, rebranding and repositioning its acquired hotels.  In 1998, the Company expended $68.2 million redeveloping and renovating 20 of the 57 hotels owned during the year as compared to completing $48.8 million in renovations to 19 of its 51 hotels owned in 1997.  Sunstone is currently redeveloping or renovating another eight hotels for an additional estimated aggregate cost of $32 million, all of which are expected to be completed by the second quarter of 1999. 

Award Winning Properties from Sunstone's Renovation and Repositioning Strategy 
 
Sunstone was named Developer of the Year by Marriott Hotels, Resorts and Suites at Marriott's 1998 National Franchise Conference, held in November at the Renaissance Stanford Court in San Francisco.  CEO Robert Alter accepted the award on behalf of the Company, which opened five full-service Marriott hotels in 1998.  Alter acknowledged, "We are delighted to receive such an esteemed award from one of the highest quality franchisors in our industry. Sunstone's commitment to developing high quality assets has been well received by Marriott International." 
 
Sunstone owns 18 Marriott-branded hotels including seven Marriott full-service hotels, six Residence Inns, four Courtyards and one Fairfield Inn.  In 1999, Sunstone will add a Residence Inn, a Courtyard and two Marriott full-service hotels to its portfolio.  The two full-service Marriott hotels are located in Santa Monica, Calif. and Park City, Utah. 
 
Additionally, in September 1998, at the annual Bass Hotels Worldwide Conference in New Orleans, La., Sunstone Hotels demonstrated its leadership in quality and service excellence in the Holiday Inn brand segment by winning seven awards for hotels acquired and renovated in 1997. The hotels and their respective awards are as follows: 

•     Holiday Inn Express, Poulsbo, Wash.           Quality Excellence Award
•     Holiday Inn Select, Renton, Wash.                Modernization Award
•     Holiday Inn Harbor View, San Diego, Calif.   Modernization Award
•     Holiday Inn & Suites, Mesa, Ariz.                  Modernization Award
•     Holiday Inn & Suites, San Diego, Calif.         Newcomer of the Year
•     Holiday Inn & Suites, Price, Utah                  Newcomer of the Year
•     Holiday Inn, Provo, Utah                               Torchbearer Award

Sunstone Hotel Investors, Inc. is a leading self-administered real estate investment trust whose portfolio consists of luxury, upscale and mid-price hotels located primarily in the Pacific and Mountain regions of the western United States.  The Company's growth strategy is to maximize shareholder value by (i) acquiring underperforming and undercapitalized hotels that management believes are in attractive locations with significant barriers to entry and 
(ii) improving such hotels' financial performance by renovating, redeveloping, rebranding and repositioning the hotels and through the implementation of focused sales and marketing programs.  Sunstone Hotel Investors, Inc. is the only hotel REIT that currently focuses its acquisition strategy primarily in the western United States.  Through Sunstone Hotel Investors, L.P., the Company owns 57 hotels comprising 10,215 rooms.  In particular, a primary  component of the Company's strategy is to enter markets which it believes have growth potential and in which it believes there are barriers to entry such as a scarcity of desirable land, perceived difficulties obtaining local government approvals, etc.  It is possible that the underlying assumptions regarding the Company's strategy may prove incorrect, as, for example, when adverse weather conditions make ski resort locales less desirable, or local 
governments become more open to growth.  Moreover, the growth in the Company's REVPAR and similar measures of financial performance are in part reflective of a strong national economy, particularly in the West where the Company's interests are concentrated.  An economic slowdown could have a material adverse effect on the Company's future performance.  For a fuller description of the risk factors facing the Company, please refer to its most recently filed Forms 10-K and 10-Q filed with the SEC.