Overview

We are a self-advised REIT incorporated in Maryland in August 2004 to pursue opportunities in the full-service, upper-upscale, upscale and mid-scale segments of the hotel industry. We commenced operations in December 2004 when we completed our initial public offering ("IPO") and thereafter consummated the acquisition of six hotel properties ("initial properties").

Our hotel portfolio currently consists of nine full-service, upper-upscale and mid-scale hotels with 2,113 rooms, which operate under well-known brands such as Hilton, Crowne Plaza, Sheraton and Holiday Inn. We also own a 25% indirect non-controlling interest in the Crowne Plaza Hollywood Beach Resort through a joint venture with The Carlyle Group and we have a leasehold interest in a resort condominium facility in Wrightsville Beach, North Carolina.

As of September 30, 2008, we owned the following hotel properties:

                                                      Number
Property                                             of Rooms        Location        Date of Acquisition
Operating properties
Hilton Philadelphia Airport                               331   Philadelphia, PA     December 21, 2004
Holiday Inn Laurel West                                   207   Laurel, MD           December 21, 2004
Holiday Inn Brownstone                                    187   Raleigh, NC          December 21, 2004
Hilton Wilmington Riverside                               272   Wilmington, NC       December 21, 2004
Hilton Savannah DeSoto                                    246   Savannah, GA         December 21, 2004
Crowne Plaza Jacksonville                                 292   Jacksonville, FL     July 22, 2005
Sheraton Louisville Riverside                             181   Jeffersonville, IN   September 20, 2006
Hampton Marina Hotel (1)                                  172   Hampton, VA          April 24, 2008
Properties under development
Crowne Plaza Tampa Westshore (2)                          225   Tampa, FL            October 29, 2007

Total                                                   2,113

(1) On October 7, 2008, the Company completed the hotel's conversion to the Crowne Plaza Hampton Marina.

(2) The property formerly operated as the Tampa Clarion Hotel in Tampa, Florida is undergoing extensive renovations and is expected to re-open as the Crowne Plaza Tampa Westshore in the first quarter of 2009.

We conduct substantially all our business through our operating partnership, MHI Hospitality, L.P. We are the sole general partner of our operating partnership, and we own an approximate 65.0% interest in our operating partnership, with the remaining interest being held by the contributors of our initial properties as limited partners.

To qualify as a REIT, we cannot operate hotels. Therefore, our operating partnership leases our hotel properties to MHI Hospitality TRS, LLC, our TRS Lessee, which then engages a hotel management company to operate the hotels under a management contract. Our TRS Lessee has engaged MHI Hotels Services, LLC to manage our hotels. Our TRS Lessee, and its parent, MHI Hospitality TRS Holding, Inc., are consolidated into our financial statements for accounting purposes. The earnings of MHI Hospitality TRS Holding, Inc. are subject to taxation similar to other C corporations.

Recent Portfolio Changes

On April 26, 2007, we entered into a program agreement and related operating agreements with CRP/MHI Holdings, LLC, an affiliate of Carlyle Realty Partners V, L.P. and The Carlyle Group ("Carlyle"). The agreements provide for the formation of entities to be jointly owned by us and Carlyle, which will source, underwrite, acquire, develop and operate hotel assets and/or hotel portfolios. Under the agreement, we will offer the joint venture the first right to acquire potential investment opportunities identified by us with total capitalization requirements in excess of $30.0 million. Carlyle has agreed to commit up to $100.0 million of equity capital to the joint venture over a three-year period. Carlyle will fund up to 90% of the equity of an acquisition, and we will provide between 10% and 25%.

We will receive an asset management fee of 1.5% of the gross revenues of the hotels owned by the venture. In addition, we will have a first right of offer with respect to any investment disposed by the joint venture. It is expected that hotels acquired by the joint venture will be managed by MHI Hotels Services.

On August 8, 2007, the joint venture completed the acquisition of the Crowne Plaza Hollywood Beach Resort, a newly renovated 311-room hotel in Hollywood, Florida for $74.0 million, with Carlyle retaining a 75% equity position. A portion of the purchase was financed with a two-year $57.6 million non-recourse loan from Société Générale with two one-year extensions and

which bore a rate of LIBOR plus 1.94%. On June 13, 2008, the joint venture purchased a $22.0 million junior participation in the mortgage loan and amended the promissory notes so that the first $35.6 million bears a rate of LIBOR plus 0.98%. The hotel is managed by MHI Hotels Services. We will also receive an asset management fee of 1.5% of gross revenues of the hotel in addition to our share of the operating profits and proceeds of sale pursuant to the joint venture agreement.

On October 29, 2007, we purchased a 250-room hotel in Tampa, Florida, formerly known as the Tampa Clarion Hotel for the aggregate purchase price of $13.5 million. We are in the process of making extensive renovations to the hotel, including a reconfiguration of guest rooms and suites. Such renovations are consistent with our repositioning strategy, and upon re-opening, the hotel will be re-branded as a Crowne Plaza with 225 rooms and suites. Renovation costs are estimated at $23.0 million. The cost to acquire and renovate the hotel has been and will continue to be funded by additional borrowings on the credit facility.

On April 24, 2008, we completed the purchase of the 172-room Hampton Marina Hotel in Hampton, Virginia for approximately $7.8 million, including transfer costs. To facilitate the purchase, we assumed $5.75 million of existing indebtedness, which bore a rate of 6.50% and was set to mature on July 1, 2016. The remainder of the purchase price as well as closing costs was funded with borrowings on our credit facility. On June 30, 2008, we refinanced the indebtedness drawing approximately $5.5 million on a three-year $9.0 million mortgage loan from TowneBank with one 12-month extension. The loan requires monthly payments of interest and bears a rate of LIBOR plus 2.75% during the renovation period and LIBOR plus 2.50% thereafter. The remainder of the proceeds, totaling approximately $3.5 million, has funded and will continue to fund a product improvement plan (or "PIP") for the hotel in connection with its Crowne Plaza licensing. On October 7, 2008, the Company completed the hotel's conversion to the Crowne Plaza Hampton Marina.

On May 1, 2008, we re-opened the Sheraton Louisville Riverside after completing a $16.1 million renovation.

Key Operating Metrics

In the hotel industry, most categories of operating costs, with the exception of franchise, management, credit card fees and the costs of the food and beverage served, do not vary directly with revenues. This aspect of our operating costs creates operating leverage, whereby changes in sales volume disproportionately impact operating results. Room revenue is the most important category of revenue and drives other revenue categories such as food, beverage 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.

Results of Operations

The following table illustrates the actual key operating metrics for the three
months and nine months ended September 30, 2008 and 2007 for the properties we
owned during each respective reporting period as well as comparable metrics for
properties that we owned and have operated throughout the respective periods.



                                        Three months ended           Three months ended           Nine months ended            Nine months ended
                                        September 30, 2008           September 30, 2007           September 30, 2008           September 30, 2007
Actual Portfolio Metrics
Occupancy %                                            59.6 %                       69.3 %                       64.1 %                       71.9 %
ADR                                    $             116.43         $             119.24         $             120.13         $             119.04
RevPAR                                 $              69.33         $              82.62         $              77.06         $              85.61
Comparable Portfolio Metrics (1)
Occupancy %                                            65.4 %                       69.3 %                       68.0 %                       71.9 %
ADR                                    $             116.10         $             119.24         $             120.25         $             119.04
RevPAR                                 $              75.96         $              82.62         $              81.77         $              85.61

(1) The hotels included in the comparable portfolio metrics are those that were owned and operated both during 2007 and the nine months ended September 30, 2008. They do not include results for the Sheraton Louisville Riverside which re-opened May 1, 2008, the property in Hampton, Virginia which was acquired on April 24, 2008, the Crowne Plaza Hollywood Beach Resort in which we have a 25.0% indirect non-controlling interest or the property in Tampa, Florida which is undergoing renovations and is expected to re-open in the first quarter of 2009 as the Crowne Plaza Tampa Westshore.

Comparison of the Three Months Ended September 30, 2008 to the Three Months Ended September 30, 2007

Revenue. Total revenue for the three months ended September 30, 2008 was approximately $17.2 million, an increase of approximately $0.5 million or 2.7% from total revenue of approximately $16.7 million for the three months ended September 30, 2007. The entire increase was attributable to operations at the Sheraton Louisville Riverside, which re-opened May 1, 2008 and the

property in Hampton, Virginia, which was acquired April 24, 2008. We expect these properties to contribute significantly to growth in room revenue over the next year as the Sheraton Louisville Riverside and the re-branded and renovated Crowne Plaza Hampton Marina become established in their markets. While we expect to see overall increases in revenue due to contributions from newly-opened and newly-renovated properties, we expect revenues from the remainder of our hotel portfolio to be negatively impacted by the weaker economy, higher travel costs and decreased consumer spending.

For the three months ended September 30, 2007, the six properties which we owned throughout 2007 and the nine months ended September 30, 2008 experienced an 8.1 % decrease in room revenue through a combination of a 2.6% decrease in ADR and a 5.6% decrease in occupancy. The most significant contribution to the decrease in room revenue was the renovation in progress at our Savannah, Georgia hotel, which impacted occupancy during the quarter. We expect improvements in room revenue at this property beginning in the fourth quarter of 2008 and continuing into 2009. We expect that renovation in Savannah will be fully complete in the first quarter of 2009. We also experienced declines in revenue at our Philadelphia and Jacksonville properties. Those travel markets have been harder hit by the weakening economy than other markets in which we operate.

Food and beverage revenues decreased approximately $0.1 million to approximately $4.0 million for the three months ended September 30, 2008 compared to food and beverage revenues of approximately $4.1 million for the three months ended September 30, 2007. Contributions to food and beverage revenues from the Sheraton Louisville Riverside and the property in Hampton, Virginia were offset by decreases at the Hilton Savannah DeSoto, which is undergoing renovation, as well as the Hilton Wilmington Riverside. The Hilton Wilmington Riverside closed its restaurant in 2007 and entered into a lease with a franchisee of Ruth's Chris restaurants. Revenues from the lease are reflected in other operating revenues.

Revenue from other operating departments for the three months ended September 30, 2008 increased approximately $0.2 million or 16.9% to approximately $1.1 million compared to other operating revenue of approximately $0.9 million for the three months ended September 30, 2007. Lease revenue from new restaurant tenants at the Hilton Wilmington Riverside and the Sheraton Louisville Riverside as well as the asset management fee we received from the joint venture that owns the Crowne Plaza Hollywood Beach Resort constituted most of the increase.

Hotel Operating Expenses. Hotel operating expenses, which consist of room expenses, food and beverage expenses, other direct expenses, and management fees, were approximately $13.9 million, an increase of approximately $1.3 million or 10.5% for the three months ended September 30, 2008 compared to approximately $12.6 million for the three months ended September 30, 2007. If not for the re-opening of the Sheraton Louisville Riverside and the acquisition of the property in Hampton, Virginia, hotel operating expenses would have decreased approximately $0.5 million. While we expect the overall level of hotel operating expenses to increase as the newly-opened Sheraton Louisville Riverside and the re-branded Crowne Plaza Hampton Marina become established in their markets, we expect that such increases will be tempered by cost-cutting initiatives at our other properties in response to weaker consumer demand due to higher travel costs and the weaker economy.

Rooms expense for the three months ended September 30, 2008 increased to approximately $3.5 million, an increase of approximately $0.4 million or 14.2% for the three months ended September 30, 2008 compared to approximately $3.0 million for the three months ended September 30, 2007. Rooms expense from the Sheraton Louisville Riverside and the property in Hampton, Virginia accounted for the entire increase.

Food and beverage expenses for the three months ended September 30, 2008 increased approximately $0.1 million to approximately $3.2 million compared to food and beverage expenses of approximately $3.1 million for the three months ended September 30, 2007. Lower food and beverage margins were severely impacted at the Hilton Savannah DeSoto by the decline in banqueting sales during renovation of the public spaces, as well as the write-off of food inventories due to spoilage following two citywide electric outages in Savannah, Georgia this summer.

Indirect expenses at our properties for the three months ended September 30, 2008 increased approximately $0.8 million or 12.0% to approximately $7.0 million compared to indirect expenses of approximately $6.2 million for the three months ended September 30, 2007. Indirect expenses related to the Sheraton Louisville Riverside and the property in Hampton, Virginia account for the increase in indirect expenses and were tempered by cost-cutting initiatives at our remaining properties.

Depreciation and Amortization. Depreciation and amortization expense for the three months ended September 30, 2008 increased approximately $0.6 million or 46.4% to approximately $1.8 million compared to depreciation and amortization expense of approximately $1.2 million for the three months ended September 30, 2007. The increase in depreciation and amortization was attributable to the renovations placed in service at the Hilton Wilmington Riverside and the Sheraton Louisville Riverside, as well as the acquisition of the property in Hampton, Virginia.

Corporate General and Administrative. Corporate general and administrative expenses for the three months ended September 30, 2008 remained constant at approximately $0.6 million compared to corporate general and administrative expense for the three months ended September 30, 2007.

Interest Expense. Interest expense for the three months ended September 30, 2008 increased approximately $0.9 million or 84.6% to approximately $1.9 million compared to interest expense for the three months ended September 30, 2007, primarily due to higher levels of borrowings on the credit facility and higher levels of mortgage debt. The increased interest expense relates to borrowing used to fund the purchase of the property in Hampton, Virginia as well as renovations at the Hilton Wilmington Riverside, the Sheraton Louisville Riverside, the Hilton Savannah DeSoto and the property in Hampton, Virginia.

Impairment of Note Receivable. Impairment of note receivable represents a $0.1 million valuation allowance against the $0.4 million promissory note we received upon the sale of the Holiday Inn Downtown Williamsburg in August 2006. In August 2008, the property was sold at auction for less than the total mortgage indebtedness on the property. We are pursuing the collection of the note, which was guaranteed by individuals affiliated with the debtor. A charge for impairment is being taken in anticipation that a negotiated settlement for less than the full value of the note is more likely to occur than collection of the full face value of the note.

Equity in Joint Venture. Equity in joint venture for the three months ended September 30, 2008 represents our 25.0% share of the net loss from operations of the Crowne Plaza Hollywood Beach Resort. For the three months ended September 30, 2008, the hotel reported occupancy of 54.9%, ADR of $113.71 and RevPAR of $62.40.

Income Taxes. The income tax benefit for the three months ended September 30, 2008 increased approximately $0.3 million or 105.3% to approximately $0.6 million. The income tax benefit is primarily derived from the operations of our TRS lessee. The net operating loss of our TRS lessee for the three months ended September 30, 2008 was greater than the net operating loss for the three months ended September 30, 2007.

Net Income (Loss). The net operating results for the Company for the three months ended September 30, 2008 decreased to a loss of approximately $0.5 million from net income of approximately $0.4 million for the three months ended September 30, 2007 as a result of the operating results discussed above.

Comparison of the Nine Months Ended September 30, 2008 to the Nine Months Ended September 30, 2007

Revenue. Total revenue for the nine months ended September 30, 2008 was approximately $53.2 million, an increase of approximately $0.1 million or 0.3% from the nine months ended September 30, 2007. If not for revenue from the Sheraton Louisville Riverside, which re-opened May 1, 2008, and the property in Hampton, Virginia, which was acquired April 24, 2008, total revenue would have decreased approximately $3.1 million.

The six properties which we owned throughout 2007 and the nine months ended September 30, 2008 experienced a 4.2% decrease in room revenue despite a 1.0% increase in ADR, which was offset by a 5.4% decrease in occupancy. Most of the decrease in room revenue is attributable to renovations in progress at our Wilmington, North Carolina and Savannah, Georgia properties, which impacted occupancy during the quarter. We have seen improvements in room revenue following the completion of renovations at the Hilton Wilmington Riverside and expect similar improvements in room revenue at the Hilton Savannah DeSoto beginning in the fourth quarter of 2008 continuing into 2009. We expect that the renovation of the Hilton Savannah DeSoto will be fully completed in the first quarter of 2009. While we expect to see overall increases in revenue due to contributions from newly-opened and newly-renovated properties, we expect revenues from the remainder of our hotel portfolio to be negatively impacted by the weaker economy, higher travel costs and decreased consumer spending.

The largest decrease in revenue was from food and beverage revenues, which, for the nine months ended September 30, 2008 declined to approximately $13.3 million, a decrease of approximately $1.0 million or 6.9% compared to food and beverage revenues of approximately $14.3 million for the nine months ended September 30, 2007. While earlier in the year, room sales from group business has remained strong at properties not undergoing renovation, there had been less demand for banqueting services resulting in a decrease in food and beverage revenue. As the economy weakened into the third quarter of 2008, demand for banqueting services continued to decline. Additionally, we realized lower food and beverage revenue at the Hilton Wilmington Riverside, which closed one of its restaurants in 2007 in order to renovate it for use by a franchisee of Ruth's Chris restaurants beginning in June 2008. Revenues from the new lease are reflected in other operating revenues.

Revenue from other operating departments for the nine months ended September 30, 2008 increased approximately $0.4 million or 13.1% to approximately $3.2 million compared to other operating revenue of approximately $2.8 million for the nine months ended September 30, 2007. Lease revenue from new restaurant tenants at the Hilton Wilmington Riverside and the Sheraton Louisville Riverside as well as the asset management fee we received from the joint venture that owns the Crowne Plaza Hollywood Beach Resort constituted a significant portion of the increase.

Hotel Operating Expenses. Hotel operating expenses, which consist of room expenses, food and beverage expenses, other direct expenses, and management fees, were approximately $41.7 million, an increase of approximately $2.4 million or 6.1% for the nine months ended September 30, 2008 compared to approximately $39.3 million for the nine months ended September 30, 2007. If not for the re-opening of the Sheraton Louisville Riverside and the acquisition of the property in Hampton, Virginia, hotel operating expenses would have decreased approximately $1.2 million.

Rooms expense for the nine months ended September 30, 2008 increased to approximately $10.2 million, an increase of approximately $0.9 million or 9.2% for the nine months ended September 30, 2008 compared to approximately $9.3 million for the nine months ended September 30, 2007. Rooms expense from the Sheraton Louisville Riverside and the property in Hampton, Virginia, as well as additional charges for three months of outside laundry services at our Philadelphia property necessitated by the breakdown of laundry equipment in mid-January 2008, contributed to the increase in rooms expense.

Food and beverage expenses for the nine months ended September 30, 2008 decreased approximately $0.1 million or 1.5% to approximately $10.0 million compared to food and beverage expenses of approximately $10.1 million for the nine months ended September 30, 2007. A significant decrease in sales of food and beverage through lower orders of banqueting services at our hotels was partially offset by higher food costs in the first quarter as well as the write-off of food inventories due to spoilage following two citywide electric outages at the Hilton Savannah DeSoto this summer.

Indirect expenses at our properties for the nine months ended September 30, 2008 increased approximately $1.7 million or 8.8% to approximately $20.9 million compared to indirect expenses of approximately $19.2 million for the nine months ended September 30, 2007. Indirect expenses related to the Sheraton Louisville Riverside and the property in Hampton, Virginia, including approximately $0.3 million of start-up costs at the Sheraton Louisville Riverside, account for the increase in indirect expenses.

Depreciation and Amortization. Depreciation and amortization expense for the nine months ended September 30, 2008 increased approximately $1.1 million or 29.9% to approximately $4.8 million compared to depreciation and amortization expense of approximately $3.7 million for the nine months ended September 30, 2007. The increase in depreciation and amortization was attributable to the renovations placed in service at the Hilton Wilmington Riverside and the Sheraton Louisville Riverside as well as the acquisition of the property in Hampton, Virginia.

Corporate General and Administrative. Corporate general and administrative expenses for the nine months ended September 30, 2008 decreased approximately $0.1 million or 1.9% to approximately $2.3 million compared to corporate general and administrative expense of approximately $2.4 million for the nine months ended September 30, 2007. One-time costs incurred in the prior period associated with structuring the program and operating agreements that allow us to jointly acquire, develop and operate hotels assets and hotel portfolios with Carlyle contributed to the decrease.

Interest Expense. Interest expense for the nine months ended September 30, 2008 increased approximately $1.7 million or 54.3% to approximately $4.8 million compared to interest expense of approximately $3.1 million for the nine months ended September 30, 2007, primarily due to increased borrowings on the credit facility used to fund the renovations at the Hilton Wilmington Riverside. Additionally, we are realizing interest expense on the borrowings associated with the Sheraton Louisville Riverside subsequent to its re-opening and completion of its renovations as well as borrowings associated with the purchase of the property in Hampton, Virginia. Lastly, we incurred an interest penalty of approximately $0.1 million associated with pre-payment of the indebtedness on that hotel when it was refinanced with a new $9.0 million mortgage from TowneBank.

Impairment of Note Receivable. Impairment of note receivable represents a $0.3 million valuation allowance against the $0.4 million promissory note we received upon sale of the Holiday Inn Downtown Williamsburg in August 2006. In August 2008, the property was sold at auction for less than the total mortgage indebtedness on the property. We are pursuing the collection of the note, which was guaranteed by individuals affiliated with the debtor. A charge for impairment is being taken in anticipation that a negotiated settlement for less than the full value of the note is more likely to occur than collection of the full face value of the note.

Equity in Joint Venture. Equity in joint venture for the nine months ended September 30, 2008 represents our 25.0% share of the net income of the Crowne Plaza Hollywood Beach Resort. During the nine months ended September 30, 2008, the joint venture was able to restructure the mortgage on the property by purchasing a $22.0 million junior participation at a price of $19.0 million resulting in a $3.0 million gain on extinguishment of debt to the joint venture. For the nine months ended September 30, 2008, the hotel reported occupancy of 59.0%, ADR of $154.22 and RevPAR of $90.95.

Income Taxes. The effect of income taxes swung from an income tax provision of approximately $0.1 million for the nine months ended September 30, 2007 to an income tax benefit of approximately $1.0 million for the nine months ended September 30, 2008. The income tax benefit or provision is primarily derived from the operations of our TRS lessee. Our TRS lessee experienced a taxable loss for the nine months ended September 30, 2008 in contrast to generating taxable . . .