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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549





FORM 10-Q







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

For the quarterly period ended September 30, 2010

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from to  to
.

Commission file number 001-32379





MHI HOSPITALITY CORPORATION

(Exact name of registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|MARYLAND                                                       |  | 20-1531029                          
|(State or Other Jurisdiction of
Incorporation or Organization) |  | (I.R.S. Employer Identification No.)

410 W. Francis Street,
Williamsburg, Virginia 23185

Telephone Number (757) 229-5648





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.    Yes  x    No   ̈

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted 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 and post such
files.)    Yes   ̈    No   ̈

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



|                        |  |   |  |                           |  |  
|----------------------- |  | - |  | ------------------------- |  | -
|Large Accelerated Filer |  |  ̈ |  | Accelerated Filer         |  |  ̈
|                        |  |   | 
|Non-accelerated Filer   |  |  ̈ |  | Smaller Reporting Company |  | x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).    Yes   ̈    No  x

As of November 10, 2010, there were 9,541,286 shares of the registrants common stock issued and outstanding.









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MHI HOSPITALITY CORPORATION

INDEX



|         |  |                                                                                       |  |      |    | 
|-------- |  | ------------------------------------------------------------------------------------- |  | ---- | -- | 
|         |  |                                                                                       |  | Page |   
|         |  | PART I                                                                                |  |      |    | 
|         |  |                                                                                      
|Item 1.  |  | Financial Statements                                                                  |  |      | 3  | 
|         |  |                                                                                      
|Item 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  |      | 19 | 
|         |  |                                                                                      
|Item 3.  |  | Quantitative and Qualitative Disclosures About Market Risk                            |  |      | 28 | 
|         |  |                                                                                      
|Item 4.  |  | Controls and Procedures                                                               |  |      | 29 | 
|         |  |                                                                                      
|         |  | PART II                                                                               |  |      |    | 
|         |  |                                                                                      
|Item 1.  |  | Legal Proceedings                                                                     |  |      | 30 | 
|         |  |                                                                                      
|Item 1A. |  | Risk Factors                                                                          |  |      | 30 | 
|         |  |                                                                                      
|Item 2.  |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  |      | 30 | 
|         |  |                                                                                      
|Item 3.  |  | Defaults Upon Senior Securities                                                       |  |      | 30 | 
|         |  |                                                                                      
|Item 4.  |  | Removed and Reserved                                                                  |  |      | 30 | 
|         |  |                                                                                      
|Item 5.  |  | Other Information                                                                     |  |      | 30 | 
|         |  |                                                                                      
|Item 6.  |  | Exhibits                                                                              |  |      | 30 | 



2



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PART I



|Item 1. | Financial Statements
|------- | --------------------

MHI HOSPITALITY CORPORATION

CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ----------- | - | ----------------- | - | ----------- | -
|                                                                                                                                                                                    |  | September 30, 2010 |             |   | December 31, 2009 |  
|                                                                                                                                                                                    |  | (unaudited)        |             |   |                   |  
|ASSETS                                                                                                                                                                              |  |                    |             |   |                   |   |             |  
|Investment in hotel properties, net                                                                                                                                                 |  | $                  | 184,666,214 |   |                   | $ | 188,587,507 |  
|Investment in joint venture                                                                                                                                                         |  |                    | 9,552,547   |   |                   |   | 9,685,844   |  
|Cash and cash equivalents                                                                                                                                                           |  |                    | 3,746,472   |   |                   |   | 3,490,487   |  
|Restricted cash                                                                                                                                                                     |  |                    | 2,155,506   |   |                   |   | 701,730     |  
|Accounts receivable                                                                                                                                                                 |  |                    | 2,829,419   |   |                   |   | 1,625,161   |  
|Accounts receivable-affiliate                                                                                                                                                       |  |                    | 5,783       |   |                   |   | 32,444      |  
|Prepaid expenses, inventory and other assets                                                                                                                                        |  |                    | 2,550,520   |   |                   |   | 2,046,082   |  
|Notes receivable, net                                                                                                                                                               |  |                    | 100,000     |   |                   |   | 100,000     |  
|Shell Island lease purchase, net                                                                                                                                                    |  |                    | 1,170,956   |   |                   |   | 1,441,176   |  
|Deferred income taxes                                                                                                                                                               |  |                    | 4,593,054   |   |                   |   | 4,920,973   |  
|Deferred financing costs, net                                                                                                                                                       |  |                    | 1,108,975   |   |                   |   | 1,328,351   |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|TOTAL ASSETS                                                                                                                                                                        |  | $                  | 212,479,446 |   |                   | $ | 213,959,755 |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|LIABILITIES                                                                                                                                                                         |  |                    |             |   |                   |   |             |  
|Line of credit                                                                                                                                                                      |  | $                  | 75,197,858  |   |                   | $ | 75,522,858  |  
|Mortgage loans                                                                                                                                                                      |  |                    | 72,430,567  |   |                   |   | 72,738,250  |  
|Loans payable                                                                                                                                                                       |  |                    | 4,543,970   |   |                   |   | 4,613,163   |  
|Accounts payable and other accrued liabilities                                                                                                                                      |  |                    | 7,493,592   |   |                   |   | 6,696,605   |  
|Advance deposits                                                                                                                                                                    |  |                    | 856,767     |   |                   |   | 547,653     |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|TOTAL LIABILITIES                                                                                                                                                                   |  |                    | 160,522,754 |   |                   |   | 160,118,529 |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|                                                                                                                                                                                    |  |                   
|Commitments and contingencies (see Note 6)                                                                                                                                          |  |                    |             |   |                   |   |             |  
|                                                                                                                                                                                    |  |                   
|EQUITY                                                                                                                                                                              |  |                    |             |   |                   |   |             |  
|MHI Hospitality Corporation stockholders equity                                                                                                                                    |  |                    |             |   |                   |   |             |  
|Preferred stock, par value $0.01, 1,000,000 shares authorized, 0 shares issued and outstanding                                                                                      |  |                    |            |   |                   |   |            |  
|Common stock, par value $0.01, 49,000,000 shares authorized, 9,541,286 shares and 9,096,943 shares issued and outstanding at
September 30, 2010 and December 31, 2009, respectively |  |                    | 95,413      |   |                   |   | 90,969      |  
|Additional paid in capital                                                                                                                                                          |  |                    | 55,654,475  |   |                   |   | 52,543,562  |  
|Distributions in excess of retained earnings                                                                                                                                        |  |                    | (15,982,863 | ) |                   |   | (14,454,238 | )
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|Total MHI Hospitality Corporation stockholders equity                                                                                                                              |  |                    | 39,767,025  |   |                   |   | 38,180,293  |  
|Noncontrolling interest                                                                                                                                                             |  |                    | 12,189,667  |   |                   |   | 15,660,933  |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|TOTAL EQUITY                                                                                                                                                                        |  |                    | 51,956,692  |   |                   |   | 53,841,226  |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|TOTAL LIABILITIES AND EQUITY                                                                                                                                                        |  | $                  | 212,479,446 |   |                   | $ | 213,959,755 |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  

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



3



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MHI HOSPITALITY
CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)



|                                                          |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|--------------------------------------------------------- |  | ------------------------------------ | ---------- | - | ------------------------------------ | - | ---------- | ----------------------------------- |  | - | ----------------------------------- | - |  | - | ---------- | -
|                                                          |  | Three months endedSeptember 30, 2010 |            |   | Three months endedSeptember 30, 2009 |   |            | Nine months endedSeptember 30, 2010 |  |   | Nine months endedSeptember 30, 2009 |  
|REVENUE                                                   |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Rooms department                                          |  | $                                    | 13,736,101 |   |                                      | $ | 12,781,958 |                                     |  | $ | 40,784,193                          |   |  | $ | 37,404,739 |  
|Food and beverage department                              |  |                                      | 4,657,257  |   |                                      |   | 4,124,670  |                                     |  |   | 14,395,240                          |   |  |   | 13,187,953 |  
|Other operating departments                               |  |                                      | 1,144,373  |   |                                      |   | 1,073,404  |                                     |  |   | 3,383,410                           |   |  |   | 3,419,049  |  
|                                                          |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Total revenue                                             |  |                                      | 19,537,731 |   |                                      |   | 17,980,032 |                                     |  |   | 58,562,843                          |   |  |   | 54,011,741 |  
|EXPENSES                                                  |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Hotel operating expenses                                  |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Rooms department                                          |  |                                      | 3,972,346  |   |                                      |   | 3,765,650  |                                     |  |   | 11,495,313                          |   |  |   | 10,498,088 |  
|Food and beverage department                              |  |                                      | 3,227,304  |   |                                      |   | 2,957,662  |                                     |  |   | 9,756,741                           |   |  |   | 8,990,305  |  
|Other operating departments                               |  |                                      | 196,410    |   |                                      |   | 206,865    |                                     |  |   | 540,248                             |   |  |   | 581,202    |  
|Indirect                                                  |  |                                      | 7,770,926  |   |                                      |   | 7,290,182  |                                     |  |   | 22,610,861                          |   |  |   | 21,677,157 |  
|                                                          |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Total hotel operating expenses                            |  |                                      | 15,166,986 |   |                                      |   | 14,220,359 |                                     |  |   | 44,403,163                          |   |  |   | 41,746,752 |  
|Depreciation and amortization                             |  |                                      | 2,123,761  |   |                                      |   | 2,152,350  |                                     |  |   | 6,381,378                           |   |  |   | 6,148,408  |  
|Corporate general and administrative                      |  |                                      | 725,909    |   |                                      |   | 744,171    |                                     |  |   | 2,687,719                           |   |  |   | 2,497,275  |  
|                                                          |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Total operating expenses                                  |  |                                      | 18,016,656 |   |                                      |   | 17,116,880 |                                     |  |   | 53,472,260                          |   |  |   | 50,392,435 |  
|                                                          |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|OPERATING INCOME                                          |  |                                      | 1,521,075  |   |                                      |   | 863,152    |                                     |  |   | 5,090,583                           |   |  |   | 3,619,306  |  
|Other income (expense)                                    |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Interest expense                                          |  |                                      | (2,608,276 | ) |                                      |   | (2,546,971 | )                                   |  |   | (7,385,350                          | ) |  |   | (7,131,677 | )
|Interest income                                           |  |                                      | 4,843      |   |                                      |   | 9,861      |                                     |  |   | 15,779                              |   |  |   | 37,689     |  
|Equity income (loss) in joint venture                     |  |                                      | (184,237   | ) |                                      |   | (157,942   | )                                   |  |   | 5,089                               |   |  |   | (169,966   | )
|Unrealized gain (loss) on hedging activities              |  |                                      | (16,566    | ) |                                      |   | 316,914    |                                     |  |   | 630,828                             |   |  |   | 854,171    |  
|Loss on disposal of assets                                |  |                                      | (84,128    | ) |                                      |   | (51,740    | )                                   |  |   | (84,128                             | ) |  |   | (42,870    | )
|                                                          |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Loss, before tax                                          |  |                                      | (1,367,289 | ) |                                      |   | (1,566,726 | )                                   |  |   | (1,727,199                          | ) |  |   | (2,833,347 | )
|Income tax benefit (provision)                            |  |                                      | (3,461     | ) |                                      |   | 502,019    |                                     |  |   | (365,861                            | ) |  |   | 1,026,874  |  
|                                                          |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Net loss                                                  |  |                                      | (1,370,750 | ) |                                      |   | (1,064,707 | )                                   |  |   | (2,093,060                          | ) |  |   | (1,806,473 | )
|Add: Net loss attributable to the noncontrolling interest |  |                                      | 366,400    |   |                                      |   | 371,894    |                                     |  |   | 564,435                             |   |  |   | 631,031    |  
|                                                          |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|NET LOSS ATTRIBUTABLE TO THE COMPANY                      |  | $                                    | (1,004,350 | ) |                                      | $ | (692,813   | )                                   |  | $ | (1,528,625                          | ) |  | $ | (1,175,442 | )
|                                                          |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Net loss per share                                        |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Basic                                                     |  | $                                    | (0.11      | ) |                                      | $ | (0.10      | )                                   |  | $ | (0.16                               | ) |  | $ | (0.17      | )
|Diluted                                                   |  | $                                    | (0.11      | ) |                                      | $ | (0.10      | )                                   |  | $ | (0.16                               | ) |  | $ | (0.17      | )
|Weighted average number of shares outstanding             |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Basic                                                     |  |                                      | 9,541,286  |   |                                      |   | 6,964,263  |                                     |  |   | 9,415,593                           |   |  |   | 6,962,170  |  
|Diluted                                                   |  |                                      | 9,557,286  |   |                                      |   | 6,990,263  |                                     |  |   | 9,431,593                           |   |  |   | 6,988,170  |  

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



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MHI HOSPITALITY
CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

(unaudited)



|                                                             |  |              |           |  |                           |   |        |                                           |  |   |                        |  |  |       |             |   |  |   |            |   |  |   |            |  
|------------------------------------------------------------ |  | ------------ | --------- |  | ------------------------- | - | ------ | ----------------------------------------- |  | - | ---------------------- |  |  | ----- | ----------- | - |  | - | ---------- | - |  | - | ---------- | -
|                                                             |  | Common Stock |           |  | AdditionalPaid-In Capital |   |        | Distributionsin Excess
ofRetainedEarnings |  |   | NoncontrollingInterest |  |  | Total |            
|                                                             |  | Shares       |           |  | Par Value                 |   |        |                                           |  |  
|Balances at December 31, 2009                                |  |              | 9,096,943 |  |                           | $ | 90,969 |                                           |  | $ | 52,543,562             |  |  | $     | (14,454,238 | ) |  | $ | 15,660,933 |   |  | $ | 53,841,226 |  
|Issuance of restricted common stock awards                   |  |              | 76,175    |  |                           |   | 762    |                                           |  |   | 139,864                |  |  |       |            |   |  |   |           |   |  |   | 140,626    |  
|Amortization of deferred stock grants                        |  |              |          |  |                           |   |       |                                           |  |   | 85,500                 |  |  |       |            |   |  |   |           |   |  |   | 85,500     |  
|Conversion of units in Operating Partnership to common stock |  |              | 368,168   |  |                           |   | 3,682  |                                           |  |   | 2,885,549              |  |  |       |            |   |  |   | (2,889,231 | ) |  |   |           |  
|Redemption of units in Operating Partnership                 |  |              |          |  |                           |   |       |                                           |  |   |                       |  |  |       |            |   |  |   | (17,600    | ) |  |   | (17,600    | )
|Net loss                                                     |  |              |          |  |                           |   |       |                                           |  |   |                       |  |  |       | (1,528,625  | ) |  |   | (564,435   | ) |  |   | (2,093,060 | )
|                                                             |  |              |           |  |                           |   |        |                                           |  |   |                        |  |  |       |             |   |  |   |            |   |  |   |            |  
|Balances at September 30, 2010                               |  |              | 9,541,286 |  |                           | $ | 95,413 |                                           |  | $ | 55,654,475             |  |  | $     | (15,982,863 | ) |  | $ | 12,189,667 |   |  | $ | 51,956,692 |  
|                                                             |  |              |           |  |                           |   |        |                                           |  |   |                        |  |  |       |             |   |  |   |            |   |  |   |            |  

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



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MHI HOSPITALITY
CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)



|                                                                                          |  |                                     |            |   |                                     |   |            |  
|----------------------------------------------------------------------------------------- |  | ----------------------------------- | ---------- | - | ----------------------------------- | - | ---------- | -
|                                                                                          |  | Nine months endedSeptember 30, 2010 |            |   | Nine months endedSeptember 30, 2009 |  
|Cash flows from operating activities:                                                     |  |                                     |            |   |                                     |   |            |  
|Net loss                                                                                  |  | $                                   | (2,093,060 | ) |                                     | $ | (1,806,473 | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                                     |            |   |                                     |   |            |  
|Depreciation and amortization                                                             |  |                                     | 6,381,378  |   |                                     |   | 6,148,408  |  
|Equity (income) loss in joint venture                                                     |  |                                     | (5,089     | ) |                                     |   | 169,966    |  
|Unrealized gain on hedging activities                                                     |  |                                     | (630,828   | ) |                                     |   | (854,171   | )
|Loss on disposal of assets                                                                |  |                                     | 84,128     |   |                                     |   | 42,870     |  
|Amortization of deferred financing costs                                                  |  |                                     | 871,506    |   |                                     |   | 554,241    |  
|Charges related to equity-based compensation                                              |  |                                     | 226,126    |   |                                     |   | 106,010    |  
|Changes in assets and liabilities:                                                        |  |                                     |            |   |                                     |   |            |  
|Restricted cash                                                                           |  |                                     | (692,151   | ) |                                     |   | 234,179    |  
|Accounts receivable                                                                       |  |                                     | (1,204,259 | ) |                                     |   | (1,957,876 | )
|Prepaid expenses, inventory and other assets                                              |  |                                     | (567,234   | ) |                                     |   | (721,221   | )
|Deferred income taxes                                                                     |  |                                     | 327,919    |   |                                     |   | (1,127,889 | )
|Accounts payable and other accrued liabilities                                            |  |                                     | 1,306,279  |   |                                     |   | (1,607,668 | )
|Advance deposits                                                                          |  |                                     | 309,113    |   |                                     |   | 246,237    |  
|Due from affiliates                                                                       |  |                                     | 26,662     |   |                                     |   | (26,327    | )
|                                                                                          |  |                                     |            |   |                                     |   |            |  
|Net cash provided by (used in) operating activities                                       |  |                                     | 4,340,490  |   |                                     |   | (599,714   | )
|                                                                                          |  |                                     |            |   |                                     |   |            |  
|Cash flows from investing activities:                                                     |  |                                     |            |   |                                     |   |            |  
|Improvements and additions to hotel properties                                            |  |                                     | (2,211,195 | ) |                                     |   | (8,253,701 | )
|Distributions from joint venture                                                          |  |                                     | 138,386    |   |                                     |   | 266,803    |  
|Funding of restricted cash reserves                                                       |  |                                     | (1,359,144 | ) |                                     |   | (887,733   | )
|Proceeds of restricted cash reserves                                                      |  |                                     | 597,518    |   |                                     |   | 2,467,295  |  
|                                                                                          |  |                                     |            |   |                                     |   |            |  
|Net cash used in investing activities                                                     |  |                                     | (2,834,435 | ) |                                     |   | (6,407,336 | )
|                                                                                          |  |                                     |            |   |                                     |   |            |  
|Cash flows from financing activities:                                                     |  |                                     |            |   |                                     |   |            |  
|Dividends and distributions paid                                                          |  |                                     |           |   |                                     |   | (214,037   | )
|Proceeds of mortgage refinancing                                                          |  |                                     |           |   |                                     |   | 743,832    |  
|Proceeds of credit facility                                                               |  |                                     |           |   |                                     |   | 6,300,000  |  
|Payments on credit facility                                                               |  |                                     | (325,000   | ) |                                     |   | (750,000   | )
|Redemption of units in Operating Partnership                                              |  |                                     | (17,600    | ) |                                     |   |           |  
|Payment of deferred financing costs                                                       |  |                                     | (530,595   | ) |                                     |   | (771,278   | )
|Proceeds of loans                                                                         |  |                                     |           |   |                                     |   | 4,750,000  |  
|Payment of mortgages and loans                                                            |  |                                     | (376,875   | ) |                                     |   | (273,303   | )
|                                                                                          |  |                                     |            |   |                                     |   |            |  
|Net cash provided by (used in) financing activities                                       |  |                                     | (1,250,070 | ) |                                     |   | 9,785,214  |  
|                                                                                          |  |                                     |            |   |                                     |   |            |  
|Net increase in cash and cash equivalents                                                 |  |                                     | 255,985    |   |                                     |   | 2,778,164  |  
|Cash and cash equivalents at the beginning of the period                                  |  |                                     | 3,490,487  |   |                                     |   | 1,719,147  |  
|                                                                                          |  |                                     |            |   |                                     |   |            |  
|Cash and cash equivalents at the end of the period                                        |  | $                                   | 3,746,472  |   |                                     | $ | 4,497,311  |  
|                                                                                          |  |                                     |            |   |                                     |   |            |  
|Supplemental disclosures:                                                                 |  |                                     |            |   |                                     |   |            |  
|Cash paid during the period for interest                                                  |  | $                                   | 6,584,127  |   |                                     | $ | 6,842,607  |  
|                                                                                          |  |                                     |            |   |                                     |   |            |  
|Cash paid during the period for income taxes                                              |  | $                                   | 19,625     |   |                                     | $ | 107,087    |  
|                                                                                          |  |                                     |            |   |                                     |   |            |  

The accompanying notes are an integral part of these financial statements



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##### Table of Contents



MHI HOSPITALITY
CORPORATION

NOTES TO FINANCIAL STATEMENTS

(unaudited)

1. Organization and Description of Business

MHI Hospitality Corporation (the Company) is a self-managed and self-administered real estate investment trust
(REIT) that was incorporated in Maryland on August 20, 2004 to own and manage a portfolio of primarily full-service upper-upscale and upscale hotels located in primary and secondary markets in the mid-Atlantic and Southern United
States. The hotels operate under well-known national hotel brands such as Hilton, Crowne Plaza, Sheraton and Holiday Inn.

The
Company commenced operations on December 21, 2004 when it completed its initial public offering (IPO) 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, MHI Hospitality, L.P. (the Operating Partnership). The Company also owns a 25.0% non-controlling interest in the Crowne Plaza Hollywood Beach Resort
through a joint venture with CRP/MHI Holdings, LLC, an affiliate of both Carlyle Realty Partners V, L.P. and The Carlyle Group (Carlyle).

For the Company to qualify as a REIT, it cannot operate hotels. Therefore, the Operating Partnership, which, at September 30, 2010, was approximately 73.9% owned by the Company, leases its hotels to
a subsidiary of MHI Hospitality TRS Holding Inc., MHI Hospitality TRS, LLC, (collectively, MHI TRS), a wholly-owned subsidiary of the Operating Partnership. MHI TRS then engages a hotel management company, MHI Hotels Services, LLC
(MHI Hotels Services) to operate the hotels under a management contract. MHI TRS is treated as a taxable REIT subsidiary for federal income tax purposes.

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

On February 9, 2009, the indirect subsidiary of the Company, which is a member of the joint venture entity that owns the Crowne Plaza Hollywood Beach Resort, borrowed $4.75 million from the Carlyle
entity that is the other member of such joint venture (the Carlyle Affiliate Lender), for the purpose of improving the Companys liquidity. The interest rate and maturity date of the loan are tied to a note that is secured by a
mortgage on the property. In June 2008, the joint venture that owns the property purchased a junior participation in a portion of the mortgage loan from the lender. The amount of the loan from the Carlyle Affiliate Lender approximates the amount the
Company contributed to the joint venture to enable the joint venture to purchase its interest in the mortgage loan. The Company makes monthly payments of interest and is required to make principal payments equal to 50.0% of any distributions it
receives from the joint venture.

On February 19, 2009, the Company entered into a third amendment to its credit
agreement with BB&T, as administrative agent and lender, to address certain financial covenants including the Companys total leverage ratio. The amendment established new methodologies for valuing the Companys hotel properties under
renovation and modified certain other aspects of the original credit agreement. In addition to waiving potential covenant defaults in 2008, the amendment increased the Companys interest rate spread for its variable LIBOR-based interest rate by
1.125%, establishing a new spread range from 2.75% to 3.25% based on the Companys total leverage ratio and added a one hundred basis point spread for any prime rate loans made under the facility. It also eased the Companys total leverage
ratio test by increasing the Companys total maximum permitted leverage from 55.0% to 62.5% of the total value of the Companys assets; established new limitations on cash distributions that the Company may pay to stockholders to a level
necessary to maintain the Companys REIT qualification, until such time as the Company meets certain liquidity and other tests; required the Company to add the Companys hotel property in Laurel, Maryland to the credit agreements
borrowing base; and provided for fixed valuation of certain of the Companys hotel properties, for purposes of determining compliance with various financial covenants, through April 2010.

On May 18, 2009, the Company entered into a fourth amendment to its credit agreement modifying the minimum tangible net worth
covenant and waiving compliance with respect to such covenant for the quarter ended June 30, 2009. Subject to certain conditions, the fourth amendment permitted the Company to pay in any fiscal year a dividend in an amount minimally necessary
to maintain the Companys REIT status, provided that no dividend may generally be paid during the first three quarters of such fiscal year. Notwithstanding this limitation, the Company was permitted to pay the dividend declared on or about
April 20, 2009. If certain liquidity thresholds and other conditions are met, the Company will be able to declare and pay additional cash dividends in any fiscal year during the term of the credit agreement.

On December 1, 2009, the Company issued 2,132,680 shares of common stock at $1.60 per share pursuant to a rights offering. The
Company received gross proceeds of approximately $3.4 million, the proceeds of which, after payment of fees and expenses associated with the offering, were used for additional working capital.

On June 4, 2010, the Company entered into a fifth amendment to its credit agreement to address the sufficiency of the borrowing
base. The amendment revises the methodology used to value the Companys existing hotel properties in the borrowing base and modifies certain other aspects of the credit agreement, as amended, including fixing the interest rate spread for the
variable



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##### Table of Contents

MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)



LIBOR-based interest rate at 4.00% and a minimum LIBOR of 0.75%. The amendment converts the facility to non-revolving, eliminates the Companys ability to re-borrow principal paid in the
future and establishes minimum repayments equal to 50% of excess cash flow, as defined in the agreement, payable quarterly. Pursuant to the amendment, the Company is required to fund reserves for insurance and real estate taxes as well as a reserve
for the replacement of furniture, fixtures and equipment equal to 3.0% of gross room revenues. The amendment also modifies the fixed charge covenant, eliminates the leverage covenant, places limits on capital expenditures and requires prepayments
from a portion of the proceeds of future equity offerings of up to $21.7 million. In the event that the Company makes prepayments totaling $21.7 million, the excess cash flow prepayment requirement will terminate. The amendment allows the Company to
pay additional dividends in any fiscal quarter, subject to the existing cap of 90% of the prior years funds from operations (FFO) provided certain liquidity thresholds and other conditions are met. The amendment provides for a
contingent extension of the maturity date for one year to May 2012, provided that certain valuation and other criteria are met, including payment of an extension fee and an extension or refinancing of the Jacksonville mortgage.

2. Summary of Significant Accounting Policies

Basis of Presentation The consolidated financial statements of the Company presented herein include all of the accounts of MHI Hospitality Corporation, the Operating Partnership, MHI TRS and
subsidiaries as of and for the three months and nine months ended September 30, 2010 and 2009. All significant inter-company balances and transactions have been eliminated.

Investment in Hotel Properties Investments in hotel properties are recorded at acquisition cost 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 the Companys accounts and any resulting gain or loss is included in the statements of operations. Expenditures under a renovation project, 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 10 to 39 years for buildings and building improvements and 3 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.

The Company reviews its 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 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 exceed its carrying value. If the estimated undiscounted future cash flows are 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 is recorded and an impairment loss recognized.

Properties Under Development
Investments in hotel property that have been taken out of service for an extensive renovation in anticipation of re-opening under a new brand are included in properties under development. In March 2009, the property under development in Tampa,
Florida re-opened as the Crowne Plaza Tampa Westshore. As of September 30, 2010 and December 31, 2009, there were no properties under development.

For properties under development, interest and real estate taxes incurred during the renovation period are capitalized and depreciated over the lives of the renovated assets. Capitalized interest for each
of the three months and nine months ended September 30, 2010 totaled $0, while capitalized interest for the three months and nine months ended September 30, 2009 totaled $0 and $270,555, respectively.

Investment in Joint Venture  Investment in joint venture represents the Companys non-controlling indirect 25.0% equity
interest in (i) the entity that owns the Crowne Plaza Hollywood Beach Resort; (ii) the entity that leases the hotel and has engaged MHI Hotels Services to operate the hotel under a management contract; (iii) the entity that entered
into a lease agreement upon closing of the hotel acquisition with respect to the adjacent three-acre site on which is located a parking garage that is utilized by the hotel; and (iv) the entity that owned the junior participation in the
existing mortgage. Carlyle owns a 75.0% controlling indirect interest in all these entities. The Company accounts for its investment in the joint venture under the equity method of accounting and is entitled to receive its pro rata share of annual
cash flow. The Company also has the opportunity to earn an incentive participation in net sale proceeds based upon the achievement of certain overall investment returns, in addition to its pro rata share of net sale proceeds.

Cash and Cash Equivalents The Company considers all highly liquid investments with an original maturity of three months or
less to be cash equivalents.

Concentration of Credit Risk The Company holds cash accounts at several
institutions in excess of the FDIC protection limits of $250,000. The Companys 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 the Companys potential risk.



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MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)





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 the Companys various mortgage agreements and line of credit.
During the renovation of the property in Hampton, Virginia, TowneBank required the Company to maintain an operating reserve which was returned to the Company in February 2009, upon completion of the renovations.

Inventories  Inventories which consist primarily of food and beverage are stated at the lower of cost or market, 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 un-amortized franchise fees as of September 30, 2010 and December 31, 2009 were $275,290 and $311,852, respectively. Amortization expense for
the three months and nine months ended September 30, 2010 totaled $12,187 and $36,562, respectively, and totaled $13,727 and $39,560, respectively, for the three months and nine months ended September 30, 2009.

Deferred Financing Costs  Deferred financing costs are recorded at cost and consist of loan fees and other costs incurred in
issuing debt. 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.

Derivative Instruments  The Companys derivative instruments are reflected as assets or liabilities on the
balance sheet 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 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.

The Companys objective in using derivatives is to add stability to interest
expense and to manage its exposure to interest-rate movements. To accomplish this objective, the Company primarily uses an interest-rate swap as part of its interest-rate risk management strategy. The interest-rate swap is required under its credit
agreement and acts as a cash flow hedge involving the receipts of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreement without exchange of the underlying $30.0 million
principal amount. During the three months and nine months ended September 30, 2010 and 2009, such derivatives were used to hedge the variable cash flows associated with the credit facility. The Company does not enter into derivative instruments
for speculative trading purposes.

At September 30, 2010 and December 31, 2009, the interest-rate swap agreement had
an estimated fair value of $(142,308) and $(651,600), respectively, and is included in accounts payable and other accrued liabilities.

The Company values its interest-rate swap at fair value, which it defines 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). The Company classifies 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.                                                           

The Company endeavors 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 Companys interest-rate swap liability is valued by discounting expected future cash flows based on quoted prices for forward interest-rate contracts. As such, these derivative instruments are
classified within level 2.

Noncontrolling Interest in Operating Partnership Certain hotel properties have been
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



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MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)



(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 Revenues from operations of the hotels are recognized when
the services are provided. Revenues consist of room sales, food and beverage sales and other hotel department revenues, such as telephone, rooftop leases and gift shop sales and rentals.

Occupancy and Other Taxes Revenues are reported net of occupancy and other taxes collected from customers and remitted to
governmental authorities.

Income Taxes The Company has elected to be taxed as a REIT under Sections 856 through
860 of the Internal Revenue Code. As a REIT, the Company generally will not be subject to federal income tax on that portion of its net income that does not relate to MHI Hospitality TRS, LLC, the Companys wholly-owned taxable REIT subsidiary.
MHI Hospitality TRS, LLC, which leases the Companys hotels from subsidiaries of the Operating Partnership, is subject to federal and state income taxes.

The Company accounts 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. In addition, the Company recognizes obligations for interest and penalties related to uncertain tax positions, if any, as income tax
expense.

Stock-based Compensation  The Companys 2004 Long Term Incentive Plan (the Plan)
permits the grant of stock options, restricted (non-vested) stock and performance stock compensation awards to its employees for up to 350,000 shares of common stock. The Company believes that such awards better align the interests of its employees
with those of its stockholders.

Under the Plan, the Company has made restricted stock and deferred stock awards totaling
186,438 shares including 60,000 shares granted under a deferred stock award to its Chief Operating Officer, 94,438 restricted shares issued to certain executives and employees, and 32,000 restricted shares issued to its directors. The 60,000 shares
granted under the deferred stock award to the Companys Chief Operating Officer vest over five years. Of the 60,000 shares granted to the Companys Chief Operating Officer, only 30,000 shares have vested; another 14,000 shares were issued
January 14, 2008, but do not vest until January 1, 2011. Of the 94,438 restricted shares issued to certain of the Companys executives and employees, all have vested except (i) 15,000 shares issued to the Chief Executive Officer
upon renewal of his employment contract which will vest on January 1, 2011 and (ii) 21,000 shares issued to the Vice President and General Counsel upon execution of his employment contract which will vest in equal amounts of 7,000 shares
on each anniversary of the effective date of his employment agreement over a three-year period. Regarding the restricted shares awarded to the Companys directors, the shares vest at the end of the year of service for which the shares are
awarded.

The value of the awards is charged to compensation expense on a straight-line basis over the vesting or service
period based on the Companys stock price on the date of grant or issuance. Under the Plan, the Company may issue a variety of performance-based stock awards, including nonqualified stock options. As of September 30, 2010, no
performance-based stock awards have been granted. Consequently, stock-based compensation as determined under the fair-value method would be the same under the intrinsic-value method. Compensation cost recognized under the Plan for the three months
and nine months ended September 30, 2010 totaled $46,418 and $132,337, respectively, and totaled $30,600 and $91,800, respectively, for the three and nine months ended September 30, 2009.

Comprehensive Income (Loss)  Comprehensive income (loss), as defined, includes all changes in equity (net assets) during a
period from non-owner sources. The Company does not have any items of comprehensive income (loss) other than net income (loss).

Segment Information The Company has determined that its 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 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.

Reclassifications  Certain reclassifications have been made to the prior period balances to conform to the current period
presentation.

Recent Accounting Pronouncements  In December 2007, the Financial Accounting Standards Board
(FASB) issued authoritative guidance related to ASC Topic 805, Business Combinations. This authoritative guidance establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree. The statement also provides guidance for recognizing and



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MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)



measuring the goodwill acquired in the business combination, recognizing assets acquired and liabilities assumed arising from contingencies, and determining what information to disclose to enable
users of the financial statement to evaluate the nature and financial effects of the business combination. The authoritative guidance is effective for acquisitions consummated in fiscal years beginning after December 15, 2008. On
January 1, 2009, the Company adopted the authoritative guidance related to ASC Topic 805, which may have an impact in future periods on its consolidated financial statements, but the nature and magnitude of the specific effects will depend upon
the nature, terms and size of any future acquisitions the Company consummates.

In December 2007, the FASB issued
authoritative guidance related to ASC Topic 810, Consolidation. This authoritative guidance changes the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component
of equity. The Company adopted the authoritative guidance related to ASC Topic 810 on January 1, 2009. Under the authoritative guidance, such noncontrolling interests are reported on the consolidated balance sheets within equity, separate from
the Companys equity. On the consolidated statements of operations, revenues, expenses and net income or loss from less-than-wholly-owned subsidiaries are reported at the consolidated amounts, including both the amounts attributable to the
Company and noncontrolling interests. Consolidated statements of changes in equity include beginning balances, activity for the period and ending balances for stockholders equity, noncontrolling interests and total equity.

In March 2008, the FASB issued authoritative guidance related to ASC Topic 815, Derivatives and Hedging. This authoritative
guidance requires expanded disclosures regarding the location and amounts of derivative instruments in an entitys financial statements, how derivative instruments and related hedged items are accounted for under guidance previously issued in
June 1998 and how derivative instruments and related hedged items affect an entitys financial position, operating results and cash flows. The Company adopted the authoritative guidance related to ASC Topic 815 on January 1, 2009, which
had no material impact on its consolidated financial statements.

In April 2008, the FASB issued authoritative guidance
related to ASC Topics 275, Risks and Uncertainties and ASC Topic 350, Intangibles  Goodwill and Otherto improve the consistency between the useful life of a recognized intangible asset (under guidance previously issued in June
2001) and the period of expected cash flows used to measure the fair value of the intangible asset (under guidance issued in December 2007). This authoritative guidance amends the factors to be considered when developing renewal or extension
assumptions that are used to estimate an intangible assets life under guidance issued in June 2001. The Company adopted the authoritative guidance related to ASC Topics 275 and 350 on January 1, 2009, which had no material impact on its
consolidated financial statements.

In November 2008, the FASB ratified authoritative guidance related to ASC Topic 323,
Investments  Equity Method and Joint Ventures. This authoritative guidance clarifies the accounting for certain transactions and impairment considerations involving equity method investments. The authoritative guidance is effective on a
prospective basis for fiscal years beginning after December 15, 2008. The Company adopted the authoritative guidance related to ASC Topic 323 on January 1, 2009, which had no material impact on its consolidated financial statements.

In May 2009, the FASB issued authoritative guidance related to ASC Topic 855, Subsequent Events. This authoritative
guidance establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The Company adopted the authoritative guidance
related to ASC Topic 855 effective June 15, 2009, which had no material impact on its consolidated financial statements.

In June 2009, the FASB issued Accounting Standards Update (ASU) 2009-01 related to ASC Topic 105, Generally Accepted
Accounting Principles. The update instituted a major change in the way accounting standards are organized. The accounting standards codification became the single official source of authoritative, nongovernmental U.S. generally accepted
accounting principles (GAAP). As of September 30, 2009, only one level of authoritative GAAP exists, other than guidance issued by the Securities and Exchange Commission. All other literature is non-authoritative. The Company
adopted the codification in the third quarter of 2009. The adoption of the codification had no impact on the Companys consolidated financial position, results of operations or cash flows.

3. Acquisition of Hotel Properties

There were no new acquisitions during the nine months ended September 30, 2010.



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MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)





4. Investment in Hotel
Properties

Investment in hotel properties as of September 30, 2010 and December 31, 2009 consisted of the
following (in thousands):



|                                  |  |                    |         |   |                   |   |         |  
|--------------------------------- |  | ------------------ | ------- | - | ----------------- | - | ------- | -
|                                  |  | September 30, 2010 |         |   | December 31, 2009 |  
|                                  |  | (unaudited)        |         |   |                   |  
|Land and land improvements        |  | $                  | 19,225  |   |                   | $ | 19,142  |  
|Buildings and improvements        |  |                    | 175,734 |   |                   |   | 173,387 |  
|Furniture, fixtures and equipment |  |                    | 31,082  |   |                   |   | 31,566  |  
|                                  |  |                    |         |   |                   |   |         |  
|                                  |  |                    | 226,041 |   |                   |   | 224,095 |  
|Less: accumulated depreciation    |  |                    | (41,375 | ) |                   |   | (35,507 | )
|                                  |  |                    |         |   |                   |   |         |  
|                                  |  | $                  | 184,666 |   |                   | $ | 188,588 |  
|                                  |  |                    |         |   |                   |   |         |  

5. Debt

Credit Facility.As of September 30, 2010, the Company had a secured credit facility with a syndicated bank group comprised of BB&T, Key Bank National Association and Manufacturers and
Traders Trust Company. The credit facility was established during the second quarter of 2006 and replaced a $23.0 million secured, revolving credit facility with BB&T.

On August 1, 2007, the Company entered into an amendment to its credit agreement modifying certain provisions of the agreement as well as reducing the rate of interest on the credit facility by
0.375% and extending the maturity date by one year. On April 15, 2008, the Company entered into a second amendment to its credit agreement modifying certain provisions of the agreement including increases in the lenders revolver
commitments by $20.0 million, thereby enabling the Company to borrow up to $80.0 million. On February 19, 2009, the Company entered into a third amendment to its credit agreement modifying certain provisions of the agreement as well as
increasing the rate of interest on the credit facility by 1.125%. On June 4, 2010, the Company entered into a fifth amendment to its credit agreement modifying certain provisions of the agreement including an increase in the rate of interest to
LIBOR plus additional interest of 4.00%; a LIBOR floor of 0.75%; a conversion to a non-revolving facility; a provision for mandatory quarterly pre-payments based on excess cash flow, as defined in the amendment, as well as a mandatory prepayment if
the Company raises equity within certain parameters; and provides an option to extend the maturity for one year if certain conditions are met. The Company had borrowings under the credit facility of approximately $75.2 million and $75.5 million at
September 30, 2010 and December 31, 2009, respectively.

The credit facility matures in May 2011 and bore interest
at a floating rate of LIBOR plus additional interest ranging from 1.625% to 2.125% prior to February 19, 2009 and additional interest ranging from 2.75% to 3.25% from February 19, 2009 through June 4, 2010 after which the facility
bore interest at a floating rate of LIBOR plus additional interest of 4.00%, subject to a LIBOR floor of 0.75%. On September 30, 2010, LIBOR was 0.256%. Prior to June 4, 2010, the Company was required to pay a fee of 0.25% on the unused
portion of the credit facility. Under the terms of the agreement, the Company is required to maintain an interest rate swap in order to hedge against interest rate risk.

The credit facility is secured by the Holiday Inn Brownstone in Raleigh North Carolina, the Hilton Philadelphia Airport, the Sheraton Louisville Riverside, the Holiday Inn Laurel and the Crowne Plaza
Tampa Westshore, as well as a lien on all business assets of those properties including, but not limited to, equipment, accounts receivable, inventory, furniture, fixtures and proceeds thereof. At September 30, 2010, the five properties had a
net carrying value of approximately $103.9 million. Under the terms of the BB&T line of credit, the Company must satisfy certain financial and non-financial covenants. The Company was in compliance with all required covenants as of
September 30, 2010.



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MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)





Mortgage Debt.As of September 30, 2010, the Company had approximately $72.4 million of outstanding mortgage debt. The following table sets forth the Companys mortgage debt obligations on its hotels.



|                                     |                    |                           |            |                   |                     |   |            |              |  |  |                        |  |  |               |         |     |  |  |               |     |  |  |                  |     
|------------------------------------ | ------------------ | ------------------------- | ---------- | ----------------- | ------------------- | - | ---------- | ------------ |  |  | ---------------------- |  |  | ------------- | ------- | --- |  |  | ------------- | --- |  |  | ---------------- | ----
|Property                             |                    | Balance Outstanding as of |            |                   | PrepaymentPenalties |   |            | MaturityDate |  |  | AmortizationProvisions |  |  | Interest Rate |        
|                                     | September 30, 2010 |                           |            | December 31, 2009 |                     |   |            |              | 
|Crowne Plaza Hampton Marina          |                    | $                         | 9,000,000  |                   |                     | $ | 9,000,000  |              |  |  | N                      |  |  |               | 06/2011 | (1) |  |  | Interest Only |     |  |  | LIBOR plus 
2.75 | %(2)
|Crowne Plaza Jacksonville Riverfront |                    |                           | 18,000,000 |                   |                     |   | 18,000,000 |              |  |  | (3)                    |  |  |               | 07/2011 |     |  |  | Interest Only |     |  |  | 8.00             | %   
|Hilton Savannah DeSoto               |                    |                           | 23,000,000 |                   |                     |   | 23,000,000 |              |  |  | (4)                    |  |  |               | 08/2017 |     |  |  | 25 years      | (5) |  |  | 6.06             | %   
|Hilton Wilmington Riverside          |                    |                           | 22,430,567 |                   |                     |   | 22,738,250 |              |  |  | (4)                    |  |  |               | 03/2017 |     |  |  | 25 years      | (6) |  |  | 6.21             | %   
|                                     |                    |                           |            |                   |                     |   |            |              |  |  |                        |  |  |               |         |     |  |  |               |     |  |  |                  |     
|Total                                |                    | $                         | 72,430,567 |                   |                     | $ | 72,738,250 |              |  |  |                        |  |  |               |         |     |  |  |               |     |  |  |                  |     
|                                     |                    |                           |            |                   |                     |   |            |              |  |  |                        |  |  |               |         |     |  |  |               |     |  |  |                  |     



|(1) | The note may be extended for one 12-month period, subject to certain terms and conditions.
|--- | ------------------------------------------------------------------------------------------

|(2) | The note bears a minimum interest rate of 4.75%.
|--- | ------------------------------------------------

|(3) | The note could not be prepaid prior to July 2009. A prepayment may be made currently without penalty.
|--- | -----------------------------------------------------------------------------------------------------

|(4) | The notes may not be prepaid during the first six years of the term. Prepayment can be made with penalty thereafter until 90 days before maturity.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | The note provides for payments of interest only until July 2010 after which payments of principal and interest under a 25-year amortization schedule are due until the
note matures in July 2017.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | The note provides for payments of interest only until March 2009 after which payments of principal and interest under a 25-year amortization schedule are due until the
note matures in March 2017.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Total mortgage debt maturities as of September 30, 2010 without respect to any
loan extensions for the following twelve-month periods were as follows:



|                        |  |   |            | 
|----------------------- |  | - | ---------- | 
|September 30, 2011      |  | $ | 27,838,876 | 
|September 30, 2012      |  |   | 891,835    | 
|September 30, 2013      |  |   | 948,138    | 
|September 30, 2014      |  |   | 1,007,994  | 
|September 30, 2015      |  |   | 1,071,633  | 
|Thereafter              |  |   | 40,672,091 | 
|                        |  |   |            | 
|Total future maturities |  | $ | 72,430,567 | 
|                        |  |   |            | 

Other Loans.On February 9, 2009, the indirect subsidiary of the Company which is
a member of the joint venture entity that owns the Crowne Plaza Hollywood Beach Resort, borrowed $4.75 million from the Carlyle Affiliate Lender for the purpose of improving the Companys liquidity. In June 2008, the joint venture that owns the
property purchased a junior participation in a portion of the mortgage loan from the lender. The amount of the loan from the Carlyle Affiliate Lender approximated the amount the Company contributed to the joint venture to enable the joint venture to
purchase its interest in the mortgage loan. The interest rate and maturity date of the loan are tied to a note that is secured by a mortgage on the property. The loan, which currently bears a rate of LIBOR plus additional interest of 3.00%, requires
monthly payments of interest and principal equal to 50.0% of any distributions it receives from the joint venture. The maturity date of the mortgage to which the loan is tied matures in August 2014. The outstanding balance on the loan at
September 30, 2010 and December 31, 2009 was $4,543,970 and $4,613,163, respectively.

6. Commitments and Contingencies

Ground, Building and Submerged Land Leases  The Company leases 2,086 square feet of commercial space next to
the Savannah hotel property for use as an office, retail or conference space, or for any related or ancillary purposes for the hotel and/or



13



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##### Table of Contents

MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)



atrium space. In December 2007, the Company signed an amendment to the lease to include rights to the outdoor esplanade adjacent to the leased commercial space. These areas are leased under a
six-year operating lease, which expired October 31, 2006 and has been renewed for the first of three optional five-year periods expiring October 31, 2011, October 31, 2016 and October 31, 2021, respectively. Rent expense for the
three months and nine months ended September 30, 2010 totaled $14,251 and $44,530, respectively, and totaled $16,513 and $52,159, for the three months and nine months ended September 30, 2009, respectively, for this operating lease.

The Company leases, as landlord, the entire fourteenth floor of the Savannah 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.

The Company leases a parking lot adjacent to the Holiday Inn Brownstone in Raleigh, North Carolina. The land is leased under a second
amendment, dated April 28, 1998, to a ground lease originally dated May 25, 1966. The original lease is a 50-year operating lease, which expires August 31, 2016. There is a renewal option for up to three additional ten-year periods
expiring August 31, 2026, August 31, 2036, and August 31, 2046, respectively. The Company holds an exclusive and irrevocable option to purchase the leased land at fair market value at the end of the original lease term, subject
to the payment of an annual fee of $9,000, and other conditions. Rent expense for each of the three months and nine months ended September 30, 2010 totaled $23,871 and $71,612, respectively, and $23,871 and $71,612 for the three months and nine
months ended September 30, 2009, respectively.

In conjunction with the sublease arrangement for the property at Shell
Island, the Company incurs an annual lease expense for a leasehold interest other than the purchased leasehold interest. Lease expense totaled $48,750 and $146,250 for the three months and nine months ended September 30, 2010, respectively, and
totaled $64,250 and $161,750 for the three months and nine months ended September 30, 2009, respectively.

The Company
leases a parking lot in close proximity to the Sheraton Louisville Riverside. The land is leased under an agreement dated August 17, 2007 with the City of Jeffersonville, which in turn leases the property from the State of Indiana. The lease
term for the parking lot coincides with that of the lease with the State of Indiana, which expires December 31, 2011. The Company has the right to renew or extend the lease with the City of Jeffersonville pursuant to the conditions of the
original lease provided that the City of Jeffersonville is able to renew or extend the underlying lease with the State of Indiana. Rent expense totaled $8,400 and $25,200 for the three months and nine months ended September 30, 2010,
respectively, and totaled $8,400 and $25,200 for the three months and nine months ended September 30, 2009, respectively.

The Company leases a parking lot adjacent to the Crowne Plaza Tampa Westshore under a five-year agreement with the Florida Department of
Transportation that commenced in July 2009 and expires in July 2014. The agreement requires annual payments of $2,432 and may be renewed for an additional five years. Rent expense totaled $608 and $1,824 for the three months and nine months ended
September 30, 2010, respectively and totaled $405 for the three months and nine months ended September 30, 2009.

The Company leases certain submerged land in the Saint Johns River in front of the Crowne Plaza Jacksonville Hotel from the Board of
Trustees of the Internal Improvement Trust Fund of the State of Florida. The submerged land is leased under a five-year operating lease, which expires September 18, 2012 requiring annual payments of $4,961. Rent expense totaled $1,240 and
$3,720 for the three months and nine months ended September 30, 2010, respectively, and totaled $1,240 and $3,720 for the three months and nine months ended September 30, 2009, respectively.

The Company leases 3,542 square feet of commercial office space in Williamsburg, Virginia under an agreement that commenced
September 1, 2009 and expires August 31, 2015. Prior to September 1, 2009, the Company leased 1,842 feet of commercial office space under a separate lease that expired August 31, 2009. Rent expense totaled $13,750 and $41,250 for
the three months and nine months ended September 30, 2010, respectively, and totaled $11,935 and $33,992 for the three months and nine months ended September 30, 2009, respectively.

The Company leases 1,632 square feet of commercial office space in Rockville, Maryland under an agreement that commenced
December 14, 2009 and expires February 28, 2017. The agreement requires monthly payments at an annual rate of $22,848 for the first year of the lease term and monthly payments at an annual rate of $45,696 for the second year of the lease
term, increasing 2.75% per year for the remainder of the lease term. Rent expense for the three months and nine months ended September 30, 2010 was $11,013 and $33,039, respectively.



14



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##### Table of Contents

MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)





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



|                                    |  |   |           | 
|----------------------------------- |  | - | --------- | 
|September 30, 2011                  |  | $ | 637,789   | 
|September 30, 2012                  |  |   | 479,896   | 
|September 30, 2013                  |  |   | 458,709   | 
|September 30, 2014                  |  |   | 235,874   | 
|September 30, 2015                  |  |   | 205,431   | 
|Thereafter                          |  |   | 161,082   | 
|                                    |  |   |           | 
|Total future minimum lease payments |  | $ | 2,178,781 | 
|                                    |  |   |           | 

Management Agreements  Each of the operating hotels that the Company owned at
September 30, 2010, except for the Crowne Plaza Tampa Westshore, are operated by MHI Hotels Services under a master management agreement that expires between December 2014 and April 2018. The Company entered into a separate management agreement
with MHI Hotels Services for the management of the Crowne Plaza Tampa Westshore that expires in March 2019 (see Note 8).

Franchise Agreements  As of September 30, 2010, the Companys hotels operate under franchise licenses from
national hotel companies. Under the franchise agreements, the Company is required to pay a franchise fee generally between 2.5% and 5.0% of room revenues, plus additional fees that amount to between 2.5% and 6.0% of room revenues from the hotels.
The franchise agreements currently expire between December 2011 and April 2023.

Restricted Cash
Reserves  Each month, the Company is required to escrow with its lender on the Wilmington Riverside Hilton and the Savannah DeSoto Hilton an amount equal to1/12of the annual real estate taxes due for the properties. The Company is also required to establish a property improvement
fund for each of these two hotels to cover the cost of replacing capital assets at the properties. Each month, contributions to the property improvement fund equal 4.0% of gross revenues for the Savannah DeSoto Hilton and the Wilmington Riverside
Hilton.

Pursuant to the terms of the mortgage on the Crowne Plaza Jacksonville, the Company is required to make monthly
contributions equal to 4.0% of room revenues into a property improvement fund.

Pursuant to the terms of the mortgage on the
Crowne Plaza Hampton Marina, beginning in January 2010, the Company is required to make monthly contributions equal to 4.0% of gross revenues to a property improvement fund.

Pursuant to the terms of the fifth amendment to the credit agreement, the Company is required to escrow with its lender an amount sufficient to pay the real estate taxes as well as property and liability
insurance for the encumbered properties when due. In addition, the Company is required to make monthly contributions equal to 3.0% of room revenues into a property improvement fund.

Litigation  The Company is not involved in any material litigation, nor, to its knowledge, is any material litigation
threatened against the Company. The Company is involved in routine legal proceedings arising out of the ordinary course of business, all of which the Company expects to be covered by insurance. The Company does not expect any pending legal
proceedings to have a material impact on its financial condition or results of operations.

7. Capital Stock

Common Shares The Company is 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 June 7, 2010, the Company issued 21,000
shares of restricted stock to its Vice President and General Counsel in accordance with the terms of his employment contract.

On March 22, 2010, one holder of units in the Operating Partnership redeemed 368,168 units for an equivalent number of shares of the
Companys common stock.

During February 2010, the Company issued 18,175 shares of non-restricted stock to certain
executives and 12,000 shares of restricted stock to its independent directors.

In addition, on February 1, 2010, the
Company issued 15,000 shares of non-restricted stock to its Chief Executive Officer in accordance with the terms of his renewed employment contract.

On January 1, 2010, the Company issued 10,000 non-restricted shares to its Chief Operating Officer in accordance with the terms of his employment contract, as amended.



15



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##### Table of Contents

MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)





On
December 1, 2009, the Company issued 2,132,680 shares of common stock at $1.60 per share pursuant to a rights offering. The Company received gross proceeds of approximately $3.4 million, the proceeds of which, after payment of fees and expenses
associated with the offering, were used for additional working capital.

On February 9, 2009, the Company issued 8,650
shares of non-restricted stock to certain executives and 6,000 shares of restricted stock to its independent directors.

On
January 1, 2009, the Company issued 10,000 non-restricted shares to its Chief Operating Officer in accordance with the terms of his employment contract, as amended.

As of September 30, 2010 and December 31, 2009, the Company had 9,541,286 and 9,096,943 shares of common stock outstanding, respectively.

Warrants The Company has granted no warrants representing the right to purchase common stock.

Preferred Shares  The Company is authorized to issue 1,000,000 shares of preferred stock, $.01 par value per share. As of
September 30, 2010, there were no shares of preferred stock outstanding.

Operating Partnership Units 
Holders of Operating Partnership units 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 market price of the Companys common stock at the time of 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.

As of September 30, 2010, the total number of Operating Partnership units outstanding was 3,361,439, with a fair market value of
approximately $8.7 million based on the price per share of the common stock on that date.

8. Related Party Transactions

As of September 30, 2010, the members of MHI Hotels Services (a company that is majority-owned and controlled by the Companys
chief executive officer, its chief financial officer and two members of its Board of Directors) owned approximately 7.2% of the Companys outstanding common stock and 2,218,670 Operating Partnership units. The following is a summary of the
transactions between the Company and MHI Hotels Services:

Accounts Receivable At September 30, 2010 and
December 31, 2009, the Company was due $5,783 and $32,444, respectively, from MHI Hotels Services.

Shell Island
Sublease  The Company has a sublease arrangement with MHI Hotels Services on its leasehold interests in the property at Shell Island. Leasehold revenue for each of the three months and nine months ended September 30, 2010 and 2009 was
$160,000 and $480,000, respectively.

Sublease of Office Space The Company subleased office space in Greenbelt,
Maryland from MHI Hotels Services until December 2009. Rent expense totaled $12,320 and $32,420 for the three months and nine months ended September 30, 2009, respectively.

Strategic Alliance Agreement On December 21, 2004, the Company entered into a ten-year strategic alliance agreement
with MHI Hotels Services that provides in part for the referral of acquisition opportunities to the Company and the management of its hotels by MHI Hotels Services.

Management Agreements Each of the hotels that the Company owned at September 30, 2010, except for the Crowne Plaza Tampa Westshore, are operated by MHI Hotels Services under a master
management agreement that expires between December 2014 and April 2018. The Company entered into a separate management agreement with MHI Hotels Services for the management of the Crowne Plaza Tampa Westshore that expires in March 2019. Under both
management agreements, MHI Hotels Services receives a base management fee, and if the hotels meet and exceed certain thresholds, an additional incentive management fee. The base management fee for any hotel is 2.0% of gross revenues for the first
full fiscal year and partial fiscal year from the commencement date through December 31 of that year, 2.5% of gross revenues the second full fiscal year, and 3.0% of gross revenues for every year thereafter. Pursuant to the sale of the Holiday
Inn Downtown in Williamsburg, Virginia, one of the hotels initially contributed to the Company upon its formation, MHI Hotels Services agreed that the property in Jeffersonville, Indiana shall substitute for the Williamsburg property under the
master management agreement. The incentive management fee, if any, is due annually in arrears within 90 days of the end of the fiscal year and will be equal to 10.0% of the amount by which the gross operating profit of the hotels, on an aggregate
basis, for a given year exceeds the gross operating profit for the same hotels, on an aggregate basis, for the prior year. The incentive management fee may not exceed 0.25% of gross revenues of all of the hotels included in the incentive fee
calculation.



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##### Table of Contents

MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)





Management fees
earned by MHI Hotels Services totaled $502,397 and $1,494,556 for the three months and nine months ended September 30, 2010, respectively, and $454,490 and $1,375,604 for the three months and nine months ended September 30, 2009,
respectively. In addition, estimated incentive management fees of $36,263 and $42,358 were accrued for the three months and nine months ended September 30, 2010, respectively. No estimated incentive management fees were accrued for the three
months and nine months ended September 30, 2009.

Employee Medical Benefits The Company purchases employee
medical benefits through Maryland Hospitality, Inc. (d/b/a MHI Health), an affiliate of MHI Hotels Services. Premiums for employee medical benefits paid by the Company were $617,763 and $1,593,923 for the three months and nine months ended
September 30, 2010, respectively, and $449,595 and $1,368,809 for the three months and nine months ended September 30, 2009, respectively.

Construction Management Services  The Company has engaged MHI Hotels Services to manage certain aspects of the renovations at the Crowne Plaza Tampa Westshore and the Holiday Inn Brownstone.
The Company paid construction management fees of $66,667 and $141,733 for the three months and nine months ended September 30, 2010, respectively, and $0 for each of the three months and nine months ended September 30, 2009.

Redemption of Units in Operating Partnership  On August 30, 2010, the Operating Partnership redeemed 8,000 units held
by the Edgar Sims, Jr. Irrevocable Trust, a trust for which three members of the Board of Directors serve as co-trustees, for $17,600 pursuant to the terms of the limited partnership agreement.

9. Retirement Plan

The
Company maintains a 401(k) plan for qualified employees which is subject to safe harbor provisions and which requires that the Company match 100% of the first 3% of employee contributions and 50% of the next 2% of employee contributions.
All Company matching funds vest immediately in accordance with the safe harbor provision. Company contributions to the plan totaled $16,434 and $37,396 for the three months and nine months ended September 30, 2010, respectively, and
$10,870 and $33,179 for the three months and nine months ended September 30, 2009, respectively.

10. Unconsolidated Joint Venture

The Company owns a 25.0% indirect interest in (i) the entity that owns the Crowne Plaza Hollywood Beach Resort;
(ii) the entity that leases the hotel and has engaged MHI Hotels Services to operate the hotel under a management contract; (iii) the entity that entered into a lease agreement upon closing of the hotel acquisition with respect to the
adjacent three-acre site on which is located a parking garage that is utilized by the hotel; and (iv) the entity that owned the junior participation in the existing mortgage. Carlyle owns a 75.0% indirect controlling interest in all these
entities. The joint venture purchased the property on August 8, 2007 and began operations on September 18, 2007. Summarized financial information for this investment, which is accounted for under the equity method, is as follows:



|                                               |  |                    |            |  |                   |   |            | 
|---------------------------------------------- |  | ------------------ | ---------- |  | ----------------- | - | ---------- | 
|                                               |  | September 30, 2010 |            |  | December 31, 2009 |  
|                                               |  | (unaudited)        |            |  |                   |  
|ASSETS                                         |  |                    |            |  |                   |   |            | 
|Investment in hotel properties, net            |  | $                  | 70,463,113 |  |                   | $ | 71,963,948 | 
|Cash and cash equivalents                      |  |                    | 2,504,527  |  |                   |   | 537,698    | 
|Restricted cash                                |  |                    | 167        |  |                   |   | 3,330,275  | 
|Accounts receivable                            |  |                    | 160,719    |  |                   |   | 326,359    | 
|Prepaid expenses, inventory and other assets   |  |                    | 2,249,079  |  |                   |   | 1,232,513  | 
|                                               |  |                    |            |  |                   |   |            | 
|TOTAL ASSETS                                   |  | $                  | 75,377,605 |  |                   | $ | 77,390,793 | 
|                                               |  |                    |            |  |                   |   |            | 
|LIABILITIES                                    |  |                    |            |  |                   |   |            | 
|Mortgage loans, net                            |  | $                  | 34,100,000 |  |                   | $ | 35,600,000 | 
|Accounts payable and other accrued liabilities |  |                    | 2,741,159  |  |                   |   | 2,629,521  | 
|Advance deposits                               |  |                    | 326,444    |  |                   |   | 418,082    | 
|                                               |  |                    |            |  |                   |   |            | 
|TOTAL LIABILITIES                              |  |                    | 37,167,603 |  |                   |   | 38,647,603 | 
|TOTAL MEMBERS EQUITY                          |  |                    | 38,210,002 |  |                   |   | 38,743,190 | 
|                                               |  |                    |            |  |                   |   |            | 
|TOTAL LIABILITIES AND MEMBERS EQUITY          |  | $                  | 75,377,605 |  |                   | $ | 77,390,793 | 
|                                               |  |                    |            |  |                   |   |            | 



17



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MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)





|                                      |  |                                      |           |   |                                      |   |           |                                     |  |   |                                     |   |  |   |           |  
|------------------------------------- |  | ------------------------------------ | --------- | - | ------------------------------------ | - | --------- | ----------------------------------- |  | - | ----------------------------------- | - |  | - | --------- | -
|                                      |  | Three months endedSeptember 30, 2010 |           |   | Three months endedSeptember 30, 2009 |   |           | Nine months endedSeptember 30, 2010 |  |   | Nine months endedSeptember 30, 2009 |  
|                                      |  | (unaudited)                          |           |   | (unaudited)                          |   |           | (unaudited)                         |  |   | (unaudited)                         |  
|Revenue                               |  |                                      |           |   |                                      |   |           |                                     |  |   |                                     |   |  |   |           |  
|Rooms department                      |  | $                                    | 1,932,975 |   |                                      | $ | 1,928,707 |                                     |  | $ | 8,300,101                           |   |  | $ | 7,182,096 |  
|Food and beverage department          |  |                                      | 419,511   |   |                                      |   | 340,402   |                                     |  |   | 1,567,029                           |   |  |   | 1,317,775 |  
|Other operating departments           |  |                                      | 250,914   |   |                                      |   | 237,384   |                                     |  |   | 827,554                             |   |  |   | 749,339   |  
|                                      |  |                                      |           |   |                                      |   |           |                                     |  |   |                                     |   |  |   |           |  
|Total revenue                         |  |                                      | 2,603,400 |   |                                      |   | 2,506,493 |                                     |  |   | 10,694,684                          |   |  |   | 9,249,210 |  
|Expenses                              |  |                                      |           |   |                                      |   |           |                                     |  |   |                                     |   |  |   |           |  
|Hotel operating expenses              |  |                                      |           |   |                                      |   |           |                                     |  |   |                                     |   |  |   |           |  
|Rooms department                      |  |                                      | 515,659   |   |                                      |   | 566,372   |                                     |  |   | 1,772,553                           |   |  |   | 1,713,801 |  
|Food and beverage department          |  |                                      | 348,170   |   |                                      |   | 325,713   |                                     |  |   | 1,220,033                           |   |  |   | 1,144,836 |  
|Other operating departments           |  |                                      | 148,313   |   |                                      |   | 156,440   |                                     |  |   | 495,053                             |   |  |   | 378,900   |  
|Indirect                              |  |                                      | 1,469,658 |   |                                      |   | 1,357,991 |                                     |  |   | 4,746,496                           |   |  |   | 4,392,639 |  
|                                      |  |                                      |           |   |                                      |   |           |                                     |  |   |                                     |   |  |   |           |  
|Total hotel operating expenses        |  |                                      | 2,481,800 |   |                                      |   | 2,406,516 |                                     |  |   | 8,234,135                           |   |  |   | 7,631,176 |  
|Depreciation and amortization         |  |                                      | 548,167   |   |                                      |   | 545,475   |                                     |  |   | 1,642,546                           |   |  |   | 1,635,161 |  
|General and administrative            |  |                                      | 34,166    |   |                                      |   | 14,091    |                                     |  |   | 170,532                             |   |  |   | 128,919   |  
|                                      |  |                                      |           |   |                                      |   |           |                                     |  |   |                                     |   |  |   |           |  
|Total operating expenses              |  |                                      | 3,064,133 |   |                                      |   | 2,966,082 |                                     |  |   | 10,047,213                          |   |  |   | 9,395,256 |  
|                                      |  |                                      |           |   |                                      |   |           |                                     |  |   |                                     |   |  |   |           |  
|Operating income (loss)               |  |                                      | (460,733  | ) |                                      |   | (459,589  | )                                   |  |   | 647,471                             |   |  |   | (146,046  | )
|Interest expense                      |  |                                      | (326,972  | ) |                                      |   | (173,048  | )                                   |  |   | (681,675                            | ) |  |   | (539,631  | )
|Interest income                       |  |                                      | 1,078     |   |                                      |   | 867       |                                     |  |   | 4,883                               |   |  |   | 5,733     |  
|Unrealized gain on hedging activities |  |                                      | 49,678    |   |                                      |   |          |                                     |  |   | 49,678                              |   |  |   |          |  
|                                      |  |                                      |           |   |                                      |   |           |                                     |  |   |                                     |   |  |   |           |  
|Net income (loss)                     |  | $                                    | (736,949  | ) |                                      | $ | (631,770  | )                                   |  | $ | 20,357                              |   |  | $ | (679,944  | )
|                                      |  |                                      |           |   |                                      |   |           |                                     |  |   |                                     |   |  |   |           |  

11. Income Taxes

The components of the income tax provision (benefit) for the three months and nine months ended September 30, 2010 and 2009 are as follows (in thousands):



|          |  |                                      |    |   |                                      |   |      |                                     |  |   |                                     |  |  |   |        |  
|--------- |  | ------------------------------------ | -- | - | ------------------------------------ | - | ---- | ----------------------------------- |  | - | ----------------------------------- |  |  | - | ------ | -
|          |  | Three months endedSeptember 30, 2010 |    |   | Three months endedSeptember 30, 2009 |   |      | Nine months endedSeptember 30, 2010 |  |   | Nine months endedSeptember 30, 2009 | 
|          |  | (unaudited)                          |    |   | (unaudited)                          |   |      | (unaudited)                         |  |   | (unaudited)                         | 
|Current:  |  |                                      |    |   |                                      |   |      |                                     |  |   |                                     |  |  |   |        |  
|Federal   |  | $                                    |   |   |                                      | $ |     |                                     |  | $ |                                    |  |  | $ |       |  
|State     |  |                                      | (2 | ) |                                      |   | 13   |                                     |  |   | 38                                  |  |  |   | 101    |  
|          |  |                                      |    |   |                                      |   |      |                                     |  |   |                                     |  |  |   |        |  
|          |  |                                      | (2 | ) |                                      |   | 13   |                                     |  |   | 38                                  |  |  |   | 101    |  
|          |  |                                      |    |   |                                      |   |      |                                     |  |   |                                     |  |  |   |        |  
|Deferred: |  |                                      |    |   |                                      |   |      |                                     |  |   |                                     |  |  |   |        |  
|Federal   |  |                                      | 6  |   |                                      |   | (434 | )                                   |  |   | 296                                 |  |  |   | (875   | )
|State     |  |                                      | (1 | ) |                                      |   | (81  | )                                   |  |   | 32                                  |  |  |   | (253   | )
|          |  |                                      |    |   |                                      |   |      |                                     |  |   |                                     |  |  |   |        |  
|          |  |                                      | 5  |   |                                      |   | (515 | )                                   |  |   | 328                                 |  |  |   | (1,128 | )
|          |  |                                      |    |   |                                      |   |      |                                     |  |   |                                     |  |  |   |        |  
|          |  | $                                    | 3  |   |                                      | $ | (502 | )                                   |  | $ | 366                                 |  |  | $ | (1,027 | )
|          |  |                                      |    |   |                                      |   |      |                                     |  |   |                                     |  |  |   |        |  

A reconciliation of the statutory federal income tax (benefit) expense to the Companys income tax
provision is as follows (in thousands):



|                                     |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  
|------------------------------------ |  | ------------------------------------ | ---- | - | ------------------------------------ | - | ---- | ----------------------------------- |  | - | ----------------------------------- | - |  | - | ------ | -
|                                     |  | Three months endedSeptember 30, 2010 |      |   | Three months endedSeptember 30, 2009 |   |      | Nine months endedSeptember 30, 2010 |  |   | Nine months endedSeptember 30, 2009 |  
|                                     |  | (unaudited)                          |      |   | (unaudited)                          |   |      | (unaudited)                         |  |   | (unaudited)                         |  
|Statutory federal income tax expense |  | $                                    | (465 | ) |                                      | $ | (533 | )                                   |  |   | (587                                | ) |  | $ | (963   | )
|Effect of non-taxable REIT income    |  |                                      | 471  |   |                                      |   | 99   |                                     |  |   | 883                                 |   |  |   | 88     |  
|State income tax expense             |  |                                      | (3   | ) |                                      |   | (68  | )                                   |  |   | 70                                  |   |  |   | (152   | )
|                                     |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  
|                                     |  | $                                    | 3    |   |                                      | $ | (502 | )                                   |  | $ | 366                                 |   |  | $ | (1,027 | )
|                                     |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  

As of September 30, 2010 and December 31, 2009, the Company had a net deferred tax asset of
approximately $4.6 million and $4.9 million, respectively, of which, approximately $4.1 million and $4.4 million, respectively, are due to accumulated net operating



18



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MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)



losses. These loss carryforwards will begin to expire in 2024 if not utilized by then. As of September 30, 2010 and December 31, 2009, approximately $0.4 million of the net deferred tax
asset is attributable to the Companys share of start-up expenses related to the Crowne Plaza Hollywood Beach Resort, start-up expenses related to the opening of the Sheraton Louisville Riverside and the Crowne Plaza Tampa Westshore that were
not deductible in the year incurred, but are being amortized over 15 years. The remainder of the net deferred tax asset is attributable to year-to-year timing differences including accrued, but not deductible, employee performance awards, vacation
and sick pay, bad debt allowance and depreciation. The Company believes that it is more likely than not that the deferred tax asset will be realized and that no valuation allowance is required.

12. Earnings 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 partners and following the Companys 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 income would also be added back to net income. The computation of basic and diluted earnings per share is presented below.



|                                                          |  |                                      |            |   |                                      |   |           |                                     |  |   |                                     |   |  |   |            |  
|--------------------------------------------------------- |  | ------------------------------------ | ---------- | - | ------------------------------------ | - | --------- | ----------------------------------- |  | - | ----------------------------------- | - |  | - | ---------- | -
|                                                          |  | Three months endedSeptember 30, 2010 |            |   | Three months endedSeptember 30, 2009 |   |           | Nine months endedSeptember 30, 2010 |  |   | Nine months endedSeptember 30, 2009 |  
|                                                          |  | (unaudited)                          |            |   | (unaudited)                          |   |           | (unaudited)                         |  |   | (unaudited)                         |  
|Net loss attributable to the Company                      |  | $                                    | (1,009,350 | ) |                                      | $ | (692,813  | )                                   |  | $ | (1,528,625                          | ) |  | $ | (1,175,442 | )
|Basic:                                                    |  |                                      |            |   |                                      |   |           |                                     |  |   |                                     |   |  |   |            |  
|Weighted average number of common shares outstanding      |  |                                      | 9,541,286  |   |                                      |   | 6,964,263 |                                     |  |   | 9,415,593                           |   |  |   | 6,962,170  |  
|Net loss per sharebasic                                  |  | $                                    | (0.11      | ) |                                      | $ | (0.10     | )                                   |  | $ | (0.16                               | ) |  | $ | (0.17      | )
|Diluted:                                                  |  |                                      |            |   |                                      |   |           |                                     |  |   |                                     |   |  |   |            |  
|Dilutive awards                                           |  |                                      | 16,000     |   |                                      |   | 26,000    |                                     |  |   | 16,000                              |   |  |   | 26,000     |  
|Diluted weighted average number common shares outstanding |  |                                      | 9,557,286  |   |                                      |   | 6,990,263 |                                     |  |   | 9,431,593                           |   |  |   | 6,998,170  |  
|Net loss per sharediluted                                |  | $                                    | (0.11      | ) |                                      | $ | (0.10     | )                                   |  | $ | (0.16                               | ) |  | $ | (0.17      | )

Diluted net loss
per share takes into consideration the pro forma dilution of certain unvested stock awards.



|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

Overview

We are a self-managed and self-administered REIT incorporated in Maryland in August 2004 to pursue opportunities in the full-service upper-upscale and upscale segments of the hotel industry located in
primary and secondary markets in the Mid-Atlantic and Southern United States. We commenced operations in December 2004 when we completed our initial public offering (the IPO) and thereafter consummated the acquisition of the initial
properties.

Our hotel portfolio currently consists of ten full-service, upper-upscale, upscale and mid-scale hotels with
2,421 rooms, which operate under well-known brands such as Hilton, Crowne Plaza, Sheraton and Holiday Inn. Nine of these hotels, totaling 2,110 rooms, are 100% owned by subsidiaries of our Operating Partnership. We also own a 25.0% indirect
non-controlling interest in the Crowne Plaza Hollywood Beach Resort through a joint venture with Carlyle and we have leasehold interests in a resort condominium facility in Wrightsville Beach, North Carolina. As of September 30, 2010, we owned
the following hotel properties:



|                                    |  |                |       |  |          |  |                    |                     |  |  |                    | 
|----------------------------------- |  | -------------- | ----- |  | -------- |  | ------------------ | ------------------- |  |  | ------------------ | 
|Property                            |  | Numberof Rooms |       |  | Location |  |                    | Date of Acquisition | 
|Wholly-owned                        |  |                |       |  |          |  |                    |                     |  |  |                    | 
|Crowne Plaza Hampton Marina         |  |                | 173   |  |          |  | Hampton, VA        |                     |  |  | April 24, 2008     | 
|Crowne Plaza Jacksonville           |  |                | 292   |  |          |  | Jacksonville, FL   |                     |  |  | July 22, 2005      | 
|Crowne Plaza Tampa Westshore        |  |                | 222   |  |          |  | Tampa, FL          |                     |  |  | October 29, 2007   | 
|Holiday Inn Brownstone              |  |                | 187   |  |          |  | Raleigh, NC        |                     |  |  | December 21, 2004  | 
|Holiday Inn Laurel West             |  |                | 207   |  |          |  | Laurel, MD         |                     |  |  | December 21, 2004  | 
|Hilton Philadelphia Airport         |  |                | 331   |  |          |  | Philadelphia, PA   |                     |  |  | December 21, 2004  | 
|Hilton Savannah DeSoto              |  |                | 246   |  |          |  | Savannah, GA       |                     |  |  | December 21, 2004  | 
|Hilton Wilmington Riverside         |  |                | 272   |  |          |  | Wilmington, NC     |                     |  |  | December 21, 2004  | 
|Sheraton Louisville Riverside       |  |                | 180   |  |          |  | Jeffersonville, IN |                     |  |  | September 20, 2006 | 
|                                    |  |                |       |  |          |  |                    |                     |  |  |                    | 
|                                    |  |                | 2,110 |  |          |  |                    |                     |  |  |                    | 
|                                    |  |                |      
|Joint Venture Property              |  |                |       |  |          |  |                    |                     |  |  |                    | 
|Crowne Plaza Hollywood Beach Resort |  |                | 311   |  |          |  | Hollywood, FL      |                     |  |  | August 9, 2007     | 
|                                    |  |                |       |  |          |  |                    |                     |  |  |                    | 
|Total                               |  |                | 2,421 |  |          |  |                    |                     |  |  |                    | 
|                                    |  |                |       |  |          |  |                    |                     |  |  |                    | 



19



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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 73.9% 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 wholly-owned 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 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 March 6, 2009, we re-opened the Crowne Plaza Tampa Westshore after completing a $23.5 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, 2010 and 2009 for the properties we wholly-owned during each respective
reporting period (actual properties). The same table also illustrates the key operating metrics for the nine wholly-owned properties and eight wholly-owned properties that were in our portfolio and open and operating during the entire
three months and the entire nine months ended September 30, 2009, respectively (same-store properties). Accordingly, the same store data does not reflect the performance of the Crowne Plaza Tampa Westshore, which opened in March
2009, for the nine months ended September 30, 2009.



|                             |  |                                      |        |   |                                      |   |        |                                     |  |   |                                     |   |  |   |        |  
|---------------------------- |  | ------------------------------------ | ------ | - | ------------------------------------ | - | ------ | ----------------------------------- |  | - | ----------------------------------- | - |  | - | ------ | -
|                             |  | Three months endedSeptember 30, 2010 |        |   | Three months endedSeptember 30, 2009 |   |        | Nine months endedSeptember 30, 2010 |  |   | Nine months endedSeptember 30, 2009 |  
|Actual Portfolio Metrics     |  |                                      |        |   |                                      |   |        |                                     |  |   |                                     |   |  |   |        |  
|Occupancy %                  |  |                                      | 69.2   | % |                                      |   | 63.5   | %                                   |  |   | 68.1                                | % |  |   | 61.7   | %
|ADR                          |  | $                                    | 102.19 |   |                                      | $ | 103.63 |                                     |  | $ | 104.03                              |   |  | $ | 107.90 |  
|RevPAR                       |  | $                                    | 70.62  |   |                                      | $ | 65.85  |                                     |  | $ | 70.80                               |   |  | $ | 66.58  |  
|Same-Store Portfolio Metrics |  |                                      |        |   |                                      |   |        |                                     |  |   |                                     |   |  |   |        |  
|Occupancy %                  |  |                                      | 69.2   | % |                                      |   | 63.5   | %                                   |  |   | 68.7                                | % |  |   | 63.8   | %
|ADR                          |  | $                                    | 102.19 |   |                                      | $ | 103.63 |                                     |  | $ | 105.73                              |   |  | $ | 109.46 |  
|RevPAR                       |  | $                                    | 70.62  |   |                                      | $ | 65.85  |                                     |  | $ | 72.67                               |   |  | $ | 69.87  |  

Comparison
of the Three Months Ended September 30, 2010 to the Three Months Ended September 30, 2009

Revenue. Total
revenue for the three months ended September 30, 2010 increased approximately $1.5 million or 8.7% to approximately $19.5 million compared to total revenue of approximately $18.0 million for the three months ended September 30, 2009.
Increases in revenue at our Tampa, Florida, Jeffersonville, Indiana and Savannah, Georgia properties offset declines in revenue at our Jacksonville, Florida, Laurel, Maryland and Raleigh, North Carolina properties.

Room revenue increased approximately $0.9 million or 7.5% to approximately $13.7 million for the three months ended September 30,
2010 compared to room revenue of approximately $12.8 million for the three months ended September 30, 2009. The increase in room revenue for the three months ended September 30, 2010 resulted from a 1.4% decrease in ADR and a 9.0% increase
in occupancy as compared to the same period in 2009. Increases in room revenue at our properties in Tampa, Florida, Jeffersonville, Indiana, and Savannah, Georgia offset decreases in room revenue at our property in Jacksonville, Florida, which has
been adversely affected by the weakened economy.

Food and beverage revenues increased approximately $0.6 million or 12.9% to
approximately $4.7 million for the three months ended September 30, 2010 compared to food and beverage revenues of approximately $4.1 million for the three months ended September 30, 2009. Increases in banqueting revenue at our properties
in Tampa, Florida and Wilmington, North Carolina offset decreases in food and beverage revenue at our properties in Laurel, Maryland and Raleigh, North Carolina.



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Revenue from other
operating departments for the three months ended September 30, 2010 remained constant at approximately $1.1 million compared to revenue from other operating departments for the three months ended September 30, 2009.

Hotel Operating Expenses. Hotel operating expenses, which consist of room expenses, food and beverage expenses, other direct
expenses and management fees, were approximately $15.2 million, an increase of approximately $1.0 million or 6.7% for the three months ended September 30, 2010 compared to total hotel operating expenses of approximately $14.2 million for the
three months ended September 30, 2009. The increase in hotel operating expense was mostly attributable to an increase in operating revenue.

Rooms expense for the three months ended September 30, 2010 increased approximately $0.2 million or 5.5% to approximately $4.0 million compared to rooms expense of approximately $3.8 million for the
three months ended September 30, 2009. The increase was largely attributable to an increase in occupancy of 9.0% over the three months ended September 30, 2009.

Food and beverage expenses for the three months ended September 30, 2010 increased approximately $0.2 million to approximately $3.2 million or 9.1% compared to food and beverage expenses of
approximately $3.0 million for the three months ended September 30, 2009. Most of the increase in food and beverage expense was directly related to the increase in food and beverage revenues. An improvement in food and beverage margins from
28.3% to 30.7% offset the cost of higher volume.

Indirect expenses at our wholly-owned properties for the three months ended
September 30, 2010 increased approximately $0.5 million or 6.6% to approximately $7.8 million compared to indirect expenses of approximately $7.3 million for the three months ended September 30, 2009. Management fees and franchise fees
increased significantly due to the increase in revenue. Energy costs increased as well due to the increase in occupancy and higher costs due to the expiration of favorable fixed rate contracts. Sales and marketing costs, repairs and maintenance,
insurance, real and personal property taxes as well as general and administrative costs at the property level are also included in indirect expenses.

Depreciation and Amortization. Depreciation and amortization expense for the three months ended September 30, 2010 remained constant at approximately $2.1 million compared to depreciation and
amortization expense for the three months ended September 30, 2009.

Corporate General and Administrative.
Corporate general and administrative expenses for the three months ended September 30, 2010 remained constant at approximately $0.7 million compared to corporate general and administrative expense for the three months ended September 30,
2009.

Interest Expense. Interest expense for the three months ended September 30, 2010 increased approximately
$0.1 million or 2.4% to approximately $2.6 million compared to interest expense of approximately $2.5 million for the three months ended September 30, 2009. The increase was the combined result of a higher effective interest rate due mostly to
the recent amendment to the credit agreement offset by the lower average balance of debt outstanding.

Equity Loss in Joint
Venture. Equity loss in joint venture for the three months ended September 30, 2010 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, 2010,
our 25.0% share of the net loss from operations of the hotel remained constant at approximately $0.2 million, as compared to the same for the three months ended September 30, 2009. For the three months ended September 30, 2010, the hotel
reported occupancy of 71.8%, ADR of $94.13 and RevPAR of $67.56. This compares with results reported by the hotel for the three months ended September 30, 2009 of occupancy of 72.8%, ADR of $92.61 and RevPAR of $67.41.

Income Taxes. The income tax benefit for the three months ended September 30, 2010 decreased to approximately $0.0 million
compared to an income tax benefit for the three months ended September 30, 2009 of approximately $0.5 million. The income tax provision 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, 2010 was substantially less than the net operating loss for the three months ended September 30, 2009.

Net Loss. The net loss attributable to the Company for the three months ended September 30, 2010 increased approximately $0.3 million or 45.0% to approximately $1.0 million as compared to a
net loss attributable to the Company of approximately $0.7 million for the three months ended September 30, 2009 as a result of the operating results discussed above.

Comparison of the Nine months Ended September 30, 2010 to the Nine months Ended September 30, 2009

Revenue. Total revenue for the nine months ended September 30, 2010 increased approximately $4.6 million or 8.4% to approximately $58.6 million compared to total revenue of approximately $54.0
million for the nine months ended September 30, 2009. Incremental revenue of approximately $2.8 million from our property in Tampa, Florida, which was not open for a portion of the nine months ended September 30, 2009, accounted for most
of the increase in revenue. Increases in revenue at our Jeffersonville, Indiana and Savannah, Georgia properties accounted for much of the additional increase in revenue, but were offset by declines in revenue at our Jacksonville, Florida and
Laurel, Maryland properties.



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Room revenue increased
approximately $3.4 million or 9.0% to approximately $40.8 million for the nine months ended September 30, 2010 compared to room revenue of approximately $37.4 million for the nine months ended September 30, 2009. Incremental room revenue
of approximately $1.9 million from our property in Tampa, Florida, which was not open for a portion of the nine months ended September 30, 2009, accounted for most of the increase in revenue. For the nine months ended September 30, 2010,
our same-store wholly-owned properties experienced a 4.0% increase in room revenue through a combination of a 3.4% decrease in ADR and a 7.7% increase in occupancy as compared to the same period in 2009. Increases in room revenue at our properties
in Jeffersonville, Indiana and Savannah, Georgia accounted for much of the additional increase in revenue, but were offset by decreases in room revenue at our property in Jacksonville, Florida, which has been adversely affected by the weakened
economy.

Food and beverage revenues increased approximately $1.2 million or 9.2% to approximately $14.4 million for the nine
months ended September 30, 2010 compared to food and beverage revenues of approximately $13.2 million for the nine months ended September 30, 2009. Incremental food and beverage revenue of approximately $0.9 million from our property in
Tampa, Florida, which was not open for a portion of the nine months ended September 30, 2009, accounted for most of the increase in food and beverage revenue. Increases in banqueting revenue at our properties in Wilmington, North Carolina and
Savannah, Georgia offset decreases in food and beverage revenue at our properties in Jacksonville, Florida and Laurel, Maryland.

Revenue from other operating departments for the nine months ended September 30, 2010 remained constant at approximately $3.4 million compared to revenue from other operating departments for the nine
months ended September 30, 2009.

Hotel Operating Expenses. Hotel operating expenses, which consist of room
expenses, food and beverage expenses, other direct expenses, and management fees, were approximately $44.4 million, an increase of approximately $2.7 million or 6.4% for the nine months ended September 30, 2010 compared to total hotel operating
expenses of approximately $41.7 million for the nine months ended September 30, 2009.

Rooms expense for the nine months
ended September 30, 2010 increased approximately $1.0 million or 9.5% to approximately $11.5 million compared to rooms expense of approximately $10.5 million for the nine months ended September 30, 2009. Incremental rooms expense of
approximately $0.4 million from our property in Tampa, Florida, which was not open for a portion of the nine months ended September 30, 2009, accounted for a portion of the increase in rooms expense. The remainder of the increase was largely
attributable to a 7.7% increase in occupancy at our same-store wholly-owned properties for the nine months ended September 30, 2010.

Food and beverage expenses for the nine months ended September 30, 2010 increased approximately $0.8 million to approximately $9.8 million or 8.5% compared to food and beverage expenses of
approximately $9.0 million for the nine months ended September 30, 2009. Most of the increase in food and beverage expense was directly related to the increase in food and beverage revenues as there was almost no change in food and beverage
margins.

Indirect expenses at our wholly-owned properties for the nine months ended September 30, 2010 increased
approximately $0.9 million or 4.3% to approximately $22.6 million compared to indirect expenses of approximately $21.7 million for the nine months ended September 30, 2009. Management fees and franchise fees increased significantly due to the
increase in revenue. Sales and marketing costs, utilities, repairs and maintenance, insurance, real and personal property taxes as well as general and administrative costs at the property level are included in indirect expenses.

Depreciation and Amortization. Depreciation and amortization expense for the nine months ended September 30, 2010 increased
approximately $0.3 million or 3.8% to approximately $6.4 million compared to depreciation and amortization expense of approximately $6.1 million for the nine months ended September 30, 2009. The increase in depreciation and amortization was
primarily attributable to the renovations placed in service in March 2009 with the opening of the Crowne Plaza Tampa Westshore.

Corporate General and Administrative. Corporate general and administrative expenses for the nine months ended September 30,
2010 increased approximately $0.2 million or 7.6% to approximately $2.7 million compared to corporate general and administrative expense of approximately $2.5 million for the nine months ended September 30, 2009, due mostly to higher personnel
costs.

Interest Expense. Interest expense for the nine months ended September 30, 2010 increased approximately
$0.3 million or 3.6% to approximately $7.4 million compared to interest expense of approximately $7.1 million (net of capitalized interest of approximately $0.3 million) for the nine months ended September 30, 2009. Increased interest expense
related to the portion of the borrowings used to fund the acquisition and renovation of the Crowne Plaza Tampa Westshore, which ceased being capitalized upon the opening of the property in March 2009, was offset by decreases arising from a lower
effective interest rate on the credit facility.

Equity in Joint Venture. Equity in joint venture for the nine months
ended September 30, 2010 represents our 25.0% share of the net loss from operations of the Crowne Plaza Hollywood Beach Resort. For the nine months ended September 30, 2010, we recognized equity income of approximately $0.0 million
representing our 25.0% share of the net income from operations of the hotel



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##### Table of Contents

as compared to an equity loss of less than $0.2 million for the nine months ended September 30, 2009. For the nine months ended September 30, 2010, the hotel reported occupancy of
79.7%, ADR of $122.59 and RevPAR of $97.76. This compares with results reported by the hotel for the nine months ended September 30, 2009 of occupancy of 69.6%, ADR of $121.53 and RevPAR of $84.59.

Income Taxes. We recorded an income tax provision for the nine months ended September 30, 2010 of approximately $0.4 million
compared to an income tax benefit for the nine months ended September 30, 2009 of approximately $1.0 million. The income tax provision or benefit is primarily derived from the operations of our TRS Lessee. Our TRS Lessee recognized operating
income for the nine months ended September 30, 2010 as compared to a net operating loss for the nine months ended September 30, 2009.

Net Loss. The net loss attributable to the Company for the nine months ended September 30, 2010 increased approximately $0.3 million or 30.0% to approximately $1.5 million compared to the net
loss attributable to the Company of approximately $1.2 million for the nine months ended September 30, 2009 as a result of the operating results discussed above.

Funds From Operations

Funds from Operations (FFO) is used by
industry analysts and investors as a supplemental operating performance measure of an equity REIT. FFO is calculated in accordance with the definition that was 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. Thus, NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost
depreciation, among other items, from GAAP net income.

Management believes that the use of FFO, combined with the required
GAAP presentations, has improved the understanding of the operating results of REITs among the investing public and made comparisons of REIT operating results more meaningful. Management considers FFO to be a useful measure of adjusted net income
for reviewing comparative operating and financial performance. Management believes 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.

The following table reconciles net income to FFO for the three months and nine months ended September 30, 2010 and 2009
(unaudited):



|                                            |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|------------------------------------------- |  | ------------------------------------ | ---------- | - | ------------------------------------ | - | ---------- | ----------------------------------- |  | - | ----------------------------------- | - |  | - | ---------- | -
|                                            |  | Three months endedSeptember 30, 2010 |            |   | Three months endedSeptember 30, 2009 |   |            | Nine months endedSeptember 30, 2010 |  |   | Nine months endedSeptember 30, 2009 |  
|Net loss attributable to the Company        |  | $                                    | (1,004,350 | ) |                                      | $ | (692,813   | )                                   |  | $ | (1,528,625                          | ) |  | $ | (1,175,442 | )
|Noncontrolling interest                     |  |                                      | (366,400   | ) |                                      |   | (371,894   | )                                   |  |   | (564,435                            | ) |  |   | (631,031   | )
|Add depreciation and amortization           |  |                                      | 2,123,761  |   |                                      |   | 2,152,350  |                                     |  |   | 6,381,378                           |   |  |   | 6,148,408  |  
|Add equity in depreciation of joint venture |  |                                      | 136,695    |   |                                      |   | 135,935    |                                     |  |   | 409,660                             |   |  |   | 407,814    |  
|Add loss on disposal of assets              |  |                                      | 84,128     |   |                                      |   | 51,740     |                                     |  |   | 84,128                              |   |  |   | 42,870     |  
|                                            |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|FFO                                         |  | $                                    | 973,834    |   |                                      | $ | 1,275,318  |                                     |  | $ | 4,782,106                           |   |  | $ | 4,792,619  |  
|                                            |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Weighted average shares outstanding         |  |                                      | 9,541,286  |   |                                      |   | 6,964,263  |                                     |  |   | 9,415,593                           |   |  |   | 6,962,170  |  
|Weighted average units outstanding          |  |                                      | 3,366,656  |   |                                      |   | 3,737,607  |                                     |  |   | 3,476,389                           |   |  |   | 3,737,607  |  
|                                            |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Weighted average shares and units           |  |                                      | 12,907,942 |   |                                      |   | 10,701,870 |                                     |  |   | 12,891,982                          |   |  |   | 10,699,777 |  
|                                            |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|FFO per share and unit                      |  | $                                    | 0.08       |   |                                      | $ | 0.12       |                                     |  |   | 0.37                                |   |  | $ | 0.45       |  
|                                            |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  

Sources and Uses of Cash

Operating Activities.Our principal source of cash to meet our operating requirements, including distributions to unitholders and
stockholders as well as repayments of indebtedness, is the operations of our hotels. Cash flow provided by operating activities for the nine months ended September 30, 2010 was approximately $4.3 million. We expect that the net cash provided by
operations will be adequate to fund our continuing operations, monthly and quarterly payments of principal and interest and the payment of dividends in accordance with federal income tax laws which require us to make annual distributions to our
stockholders of at least 90% of our REIT taxable income, excluding net capital gains.



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Investing
Activities. Approximately $2.2 million was spent during the nine months ended September 30, 2010 on capital improvements and the replacement of furniture, fixtures and equipment.

Financing Activities. During the nine months ended September 30, 2010, we paid approximately $0.3 million to reduce the
balance on our credit facility due to a decline in the value of the collateral pool securing the facility. We also paid approximately $0.5 million in deferred financing costs in relation to the fifth amendment to the credit agreement.

Capital Expenditures

Since mid-2004, we have completed product improvement plans (PIPs) in connection with the licensing or re-licensing at eight of our nine wholly-owned properties. With the exception of a
product improvement plan in connection with the re-licensing of the Holiday Inn Brownstone, whose franchise license expires in December 2011, we anticipate that capital expenditures for the replacement and refurbishment of furniture, fixtures and
equipment over the next 12 to 24 months will be lower than historical norms for our properties and the industry. Historically, we have aimed to maintain overall capital expenditures at 4.0% of gross revenue. However, in light of the current slowdown
of the economy and in the interest of preserving capital, we aim to restrict capital expenditures to the replacement of broken or damaged furniture and equipment and the acquisition of items mandated by our licensors that are necessary to maintain
our brand affiliations. We anticipate that capital expenditures for the replacement and refurbishment of furniture, fixtures and equipment that are not related to a product improvement plan should total 1.5% to 2.0% of gross revenues during the next
12 to 24 months.

During the next 12 months, we expect capital expenditures, other than costs that we incur to make capital
improvements required by our franchisors, will be funded by our replacement reserve accounts. With respect to all nine of our hotels, the reserve accounts are escrowed accounts with funds deposited monthly and reserved for capital improvements or
expenditures. We deposit an amount equal to 4.0% of gross revenue for the Hilton Savannah DeSoto, the Hilton Wilmington Riverside and the Crowne Plaza Hampton Marina and 4.0% of room revenues for the Crowne Plaza Jacksonville Riverfront. Commencing
in June 2010, we began depositing an amount equal to 3.0% of room revenues for our remaining wholly-owned properties. We intend to maintain overall capital expenditures at 4.0% of gross revenue.

Liquidity and Capital Resources

As of September 30, 2010, we had cash and cash equivalents of approximately $5.9 million, of which approximately $2.2 million was in restricted reserve accounts and real estate tax and insurance
escrows. As of September 30, 2010, our credit facility had an outstanding balance of approximately $75.2 million. We expect that our cash on hand combined with our cash flow from our hotels should be adequate to fund continuing operations,
recurring capital expenditures for the refurbishment and replacement of furniture, fixtures and equipment, monthly and quarterly payments of principal and interest, as well as mandatory prepayments on the credit facility based on excess cash flow,
as defined in the agreement, as amended.

In June 2010, we executed an amendment to our credit agreement that did not require
any immediate reduction in the outstanding indebtedness. Among other modifications to the existing amended credit agreement, the amendment provides us the option to extend the maturity date for one year to May 2012, provided we meet certain
loan-to-value requirements and satisfy certain additional conditions. Our ability to maintain existing levels of debt on our credit facility beyond May 2011 is dependent on our ability to comply with the loan-to-value requirements of the extension
provision of our credit agreement as well as various other financial covenants. The loan-to-value requirements of the extension provision of our credit agreement contemplate valuations of our encumbered properties at a multiple of their net
operating income, as defined by our credit agreement. The maximum amount that we can borrow under the credit facility during the extension period is 70.0% of the value of the encumbered properties. Other financial covenants relate to minimum levels
of cash flow that ensure our ability to pay the interest due under the credit facility, minimum levels of expenditures to maintain the quality of the encumbered assets, existence of a hedge against rising interest rates on a substantial portion of
the facility, as well as the funding of escrows for real estate taxes, insurance and refurbishment or replacement of furniture, fixtures and equipment. In addition, our credit agreement imposes limitations on our ability to incur additional debt.

We do not believe our encumbered properties will realize sufficient operating performance to allow the properties in our
collateral pool to meet the loan-to-value requirements of the extension provision. We estimate that in order to exercise the extension option we will be required to reduce the outstanding balance on the facility by making a payment ranging between
$17.5 million and $22.5 million during the second quarter 2011. In the event we do not satisfy all of the conditions of the loan extension, we will be required to repay or refinance the outstanding balance of the loan. We will need to raise
additional capital and for this purpose are pursuing potential sources of additional capital. Sources of additional capital to fund any required reductions in the amount outstanding on the credit facility may include a combination of some or all of
the following:



| |  |  | The issuance of shares of preferred stock;
| | - |  | ------------------------------------------



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| |  |  | The issuance of additional shares of our common stock;
| | - |  | ------------------------------------------------------



| |  |  | The issuance of additional units in the Operating Partnership;
| | - |  | --------------------------------------------------------------



| |  |  | The incurrence by the subsidiaries of the Operating Partnership of mortgage indebtedness in connection with the refinancing of hotel properties;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The selective disposition of core or non-core assets; and
| | - |  | ---------------------------------------------------------



| |  |  | The sale or contribution of some of our wholly-owned properties, development projects or development land to strategic joint ventures to be formed with
unrelated investors, which would have the net effect of generating additional capital through such sale or contribution.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We are uncertain whether, when and under what terms such sources of capital will be available to us.

Should the current economic recovery falter or weakness in the lodging industry return and reduce our operating cash flows and financial performance or weaken our financial condition below the levels
necessary to comply with the loan-to-value requirements or the financial covenants in our credit agreement, we may be required to make additional payments beyond those described above on all or a portion of the outstanding debt. Any such payment
will require us to obtain additional capital, which may not be available to us on favorable terms, if at all.

We recently
exercised our right to extend the mortgage on the Crowne Plaza Jacksonville Riverfront for an additional twelve months. We intend to refinance the existing mortgage indebtedness when the mortgage matures in July 2011. Depending on market conditions,
we may be required to reduce the mortgage balance by an amount ranging between $0 and $4.8 million.

We believe that as the
economy begins to recover, there will be numerous opportunities to acquire properties at attractive prices. However, with the constraints of the covenants in our credit agreement, we have limited, if any, ability to incur additional debt in order to
take advantage of such opportunities. Given the potential for attractive acquisitions emerging from the recent economic downturn, we intend to pursue additional equity financing in the future to enable us to take advantage of such opportunities.
However, should additional equity financing not be available on acceptable terms, we may not be able to take advantage of such opportunities.

Beyond the funding of any required principal reduction on our existing indebtedness or acquisitions in the near-term, our medium and long-term capital needs will generally include the retirement of
maturing mortgage debt, amounts outstanding under our secured credit facility and obligations under our tax indemnity agreements, if any. We remain committed to maintaining a flexible capital structure. Accordingly, in addition to the sources
described above with respect to our short-term liquidity, we expect to meet our long-term liquidity needs through a combination of those sources as well as the following:



| |  |  | The issuance by the Operating Partnership of the Company and/or their subsidiary entities of secured and unsecured debt securities to the extent
permitted by our credit agreement; or
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The incurrence by the subsidiaries of the Operating Partnership of mortgage indebtedness in connection with the acquisition of hotel properties.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------

Dividend Policy

In December 2008, in the interest of capital preservation and based on the expectation that the U.S. economy, and in particular the lodging industry, would continue to face declining operating trends
through 2009, we amended our dividend policy and reduced the level of our cash dividend payments. Our ability to make distributions is constrained by the terms of the fourth and fifth amendments to our credit agreement. While our credit agreement
permits the minimum distributions that allow us to maintain our status as a REIT provided that no default or event of default exists at the time of, or after giving effect to, the distribution and we do not incur indebtedness to make the
distribution, it provides additional conditions that must be met before payments in excess of the minimum distributions can be made. We may make such additional dividend distributions so long as no event of default exists at the time, or after
giving effect to, such additional distributions if we maintain a minimum liquidity position of $10.0 million and satisfy a debt yield ratio of EBITDA to total liabilities of at least 10% before and after giving effect to such distribution, provided
the aggregate amount of such distributions in a given year cannot exceed 90% of FFO for the prior fiscal year. The amount of future 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, the terms of our credit agreement or any future or similar credit agreement, and other factors, which our board of
directors deems relevant. The amount, timing and frequency of distributions will be authorized by our board of directors and declared by us based upon a variety of factors deemed relevant by our board of directors, and no assurance can be given that
our distribution policy will not change in the future.

Off-Balance Sheet Arrangements

Through a joint venture with a Carlyle subsidiary, we own a 25.0% indirect, non-controlling interest in an entity (the JV
Owner) that acquired the 311-room Crowne Plaza Hollywood Beach Resort in Hollywood, Florida. We have the right to receive a pro rata share of operating surpluses and we have an obligation to fund our pro rata share of operating shortfalls. We
also have the



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opportunity to earn an incentive participation in the net proceeds realized from the sale of the hotel based upon the achievement of certain overall investment returns, in addition to our pro
rata share of net sale proceeds. The Crowne Plaza Hollywood Beach Resort is leased to another entity (the Joint Venture Lessee) in which we also own a 25.0% indirect, non-controlling interest.

Adjacent to the Crowne Plaza Hollywood Beach Resort is a three-acre hotel development site which is leased by a joint venture entity.
That entity, in which we also have a 25.0% indirect ownership interest, has an option to purchase the site, which is improved with a parking garage currently being used by the hotel. The purchase option expires in August 2011 and allows the site to
be purchased at fair market value as determined by independent appraisal, but no less than $5.0 million or more than $10.0 million.

The acquisition of the property was funded in part by a mortgage loan in the amount of $57.6 million. The mortgage, which had an original two-year term maturing on August 1, 2009, was restructured on
June 13, 2008 so that the first $35.6 million bore interest at a rate of LIBOR plus additional interest of 0.98%. The remaining $22.0 million bore a rate of LIBOR plus additional interest of 3.50%. Upon that restructure, a fourth entity, in
which we own a 25.0% indirect non-controlling interest, purchased the $22.0 million junior participation for $19.0 million. The loan previously had been extended for one year and was modified in August 2010 to extend the maturity date to August
2014, require monthly payments of interest at a rate of LIBOR plus additional interest of 1.94% and require annual principal payments of $0.5 million. In conjunction with the loan modification, the joint venture made an additional $1.5 million
payment of principal and executed an interest-rate swap with a notional amount and maturity tied to the projected outstanding balance and maturity date of the loan. The Crowne Plaza Hollywood Beach Resort secures the mortgage. We have provided
limited guarantees to the lender with respect to this mortgage.

Carlyle owns a 75.0% controlling interest in the JV Owner,
the Joint Venture Lessee, the entity with the purchase option and the entity that held the junior participation. Carlyle may elect to dispose of the Crowne Plaza Hollywood Beach Resort without our consent. We account for our non-controlling 25.0%
interest in all of these entities under the equity method of accounting.

Inflation

We generate revenues primarily from lease payments from our TRS Lessee and net income from the operations of our TRS Lessee. Therefore, we
rely primarily on the performance of the individual properties and the ability of our 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 our 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.

Seasonality

The operations of our hotel properties have historically been seasonal. The months of March and April are traditionally strong, as is October. The periods from mid-November through mid-February are
traditionally slow with the exception of the Crowne Plaza Jacksonville Hotel, the Crowne Plaza Tampa Westshore and our joint venture property, the Crowne Plaza Hollywood Beach Resort. The remaining months are generally good, but can be impacted by
bad weather and can vary significantly.

Geographic Concentration

Our hotels are located in Florida, Georgia, Indiana, Maryland, North Carolina, Pennsylvania and Virginia.

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 10-39 years for buildings 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 acquired from third parties 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 time of acquisition.



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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 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 an analysis to
determine if the estimated undiscounted future cash flows from operating activities and the proceeds from the ultimate disposition of a hotel property exceed its carrying value. If the estimated undiscounted future cash flows are less than the
carrying amount of the asset, an adjustment to reduce the carrying value to the related hotel propertys estimated fair market value is recorded and an impairment loss is recognized.

There were no charges for impairment recorded for the three months and nine months ended September 30, 2010 or 2009.

We estimate the fair market values of our properties through cash flow analysis taking into account each propertys expected cash
flow generated from operations, holding period and expected proceeds from ultimate disposition. These cash flow analyses are based upon significant management judgments and assumptions including revenues and operating costs, growth rates and
economic conditions at the time of ultimate disposition. In projecting the expected cash flows from operations of the asset, we base our estimates on future projected net operating income before depreciation and eliminating non-recurring operating
expenses, which is a non-GAAP operational measure, and deduct expected capital expenditure requirements. We then apply growth assumptions based on estimated changes in room rates and expenses and the demand for lodging at our properties, as impacted
by local and national economic conditions and estimated or known future new hotel supply. The estimated proceeds from disposition are determined as a matter of managements business judgment based on a combination of anticipated cash flow in
the year of disposition, terminal capitalization rate, ratio of selling price to gross hotel revenues and selling price per room.

If actual conditions differ from those in our assumptions, the actual results of each assets operations and fair market value could be significantly different from the estimated results and value
used in our analysis.

Revenue Recognition.Hotel revenue, including room, food, beverage and other hotel revenue, is
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.

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, 2010. Should our estimate of future taxable income be less than expected, we would record an adjustment to the net deferred tax asset in
the period such determination was made.

Recent Accounting Pronouncements

For a summary of recently adopted and newly issued accounting pronouncements, please refer to the Recent Accounting Pronouncementssection of Note 2, Summary of Significant Accounting Policies, in the Notes to 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 and Section 21E of the Securities Exchange Act of 1934, 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 future plans, strategies and expectations, 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. 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, including the current economic downturn, that will affect occupancy rates at our hotels and the
demand for hotel products and services;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | risks associated with the hotel industry, including competition, increases in wages, energy costs and other operating costs;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | the availability and terms of financing and capital and the general volatility of the securities markets, specifically, the impact of the current
credit crisis which has severely constrained the availability of debt financing and, if necessary, to refinance or seek an extension of the maturity of such indebtedness;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | risks associated with the level of our indebtedness and our ability to meet covenants in our debt agreements;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | management and performance of our hotels;
| | - |  | -----------------------------------------



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| |  |  | risks associated with the conflicts of interest of our 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;
| | - |  | ---------------------------------------------------------------------------



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



| |  |  | legislative/regulatory changes, including changes to laws governing taxation of REITs.
| | - |  | --------------------------------------------------------------------------------------

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.



|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. In August 2006, we purchased an interest-rate swap with a notional amount of $30.0 million in order
to comply with the terms of our credit agreement which requires us to hedge a portion of the maximum borrowing amount. In June 2010, we replaced the interest-rate swap with another interest-rate swap with a notional amount of $30.0 million which
expires in May 2011. As of September 30, 2010, a derivative with a fair value of approximately $0.1 million was included in accounts payable and other accrued liabilities. From time to time we may enter into other 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, 2010, we had approximately $63.4 million of fixed-rate debt and approximately $88.7 million of variable-rate
debt. The weighted-average interest rate on the fixed-rate debt was 6.66%. 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 change in 30-day LIBOR, but would be limited to the effect on our mortgage on the Crowne Plaza Hampton Marina as well as the loan from the Carlyle Affiliate Lender and the
gap between the balance on the credit facility and the $30.0 million notional amount of the interest-rate swap purchased on June 10, 2010. Assuming that the amount outstanding on our mortgage on the Crowne Plaza Hampton Marina, the loan from
the Carlyle Affiliate Lender and the amount outstanding under our credit facility remain at approximately $88.7 million, the balance at September 30, 2010, the impact on our annual interest incurred and cash flows of a one percent change in
30-day LIBOR would be approximately $587,000.

As of December 31, 2009, we had approximately $63.7 million of fixed-rate
debt and approximately $89.1 million of variable-rate debt. The weighted average interest rate on the fixed-rate debt was 6.66%. 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 change in 30-day LIBOR, but would be limited to the effect on the gap between the balance on the revolving credit facility
and the $30.0 million notional amount of the interest-rate swap executed August 8, 2006, as well as the balance of the mortgage on the Crowne Plaza Hampton Marina  to the extent that 30-day LIBOR exceeds 2.00%  as well as the loan
from the Carlyle entity that is the other member of the joint venture entity that owns the Crowne Plaza Hollywood Beach Resort. Assuming that the amount outstanding under our credit facility remains at approximately $75.5 million, the balance at
December 31, 2009, the impact on our annual interest incurred and cash flows of a one percent change in interest rate would be approximately $501,000.



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|Item 4. | Controls and Procedures
|------- | -----------------------

The Chief Executive Officer and Chief Financial Officer of MHI Hospitality Corporation have evaluated the effectiveness of the 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, and have
concluded that as of the end of the period covered by this report, MHI Hospitality Corporations disclosure controls and procedures were effective.

As of September 30, 2010, there was no change in MHI Hospitality Corporation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 MHI Hospitality Corporations last fiscal quarter that materially affected, or is reasonably likely to materially affect, MHI Hospitality Corporations internal control over
financial reporting.



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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 (i) our annual report on Form 10-K for the year ended December 31, 2009 and (ii) our quarterly report on Form 10-Q for the second quarter 2010.



|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds
|------- | -----------------------------------------------------------

Not applicable.



|Item 3. | Defaults Upon Senior Securities
|------- | -------------------------------

Not applicable.



|Item 4. | [Removed and Reserved]
|------- | ----------------------



|Item 5. | Other Information
|------- | -----------------

Not
applicable.



|Item 6. | Exhibits
|------- | --------

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



|              |  |                                                                                                                                                                                        
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description of Exhibit                                                                                                                                                                 
|              | 
|3.1           |  | Articles of Amendment and Restatement of MHI Hospitality Corporation.(1)                                                                                                               
|              | 
|3.2           |  | Amended and Restated Bylaws of MHI Hospitality Corporation.(2)                                                                                                                         
|              | 
|31.1          |  | Certification of President and Chief Executive Officer pursuant to Exchange Act Rules Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|              | 
|31.2          |  | Certification of Chief Financial Officer pursuant to Exchange Act Rules Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.              
|              | 
|32.1          |  | Certification of President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                       
|              | 
|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.                                     



|(1) | Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Registrants Pre-Effective Amendment No. 1 to its Registration
Statement on Form S-11 filed with the Securities and Exchange Commission on October 20, 2004. (333-118873).
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Registrants Pre-Effective Amendment No. 5 to its Registration
Statement on Form S-11 filed with the Securities and Exchange Commission on December 13, 2004. (333-118873).
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURE

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.



| |  |                         |  |                             |  |     |  |                                                             
| |  | ----------------------- |  | --------------------------- |  | --- |  | ------------------------------------------------------------
| |  |                         |  | MHI HOSPITALITY CORPORATION
| |  |                         |  |                            
| |  | Date: November 10, 2010 |  |                             |  | By: |  | /s/    ANDREW M.
SIMS                                       
| |  |                         |  |                             |  |     |  | Andrew M. Sims                                              
| |  |                         |  |                             |  |     |  | President, Chief Executive Officer and Chairman of the Board
| |  |                         |  |                            
| |  |                         |  |                             |  | By: |  | /s/    WILLIAM J.
ZAISER                                    
| |  |                         |  |                             |  |     |  | William J. Zaiser                                           
| |  |                         |  |                             |  |     |  | Chief Financial Officer                                     



31



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##### Table of Contents



EXHIBIT INDEX



|              |  |                                                                                                                                                                                        
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description of Exhibit                                                                                                                                                                 
|              | 
|3.1           |  | Articles of Amendment and Restatement of MHI Hospitality Corporation.(1)                                                                                                               
|              | 
|3.2           |  | Amended and Restated Bylaws of MHI Hospitality Corporation.(2)                                                                                                                         
|              | 
|31.1          |  | Certification of President and Chief Executive Officer pursuant to Exchange Act Rules Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|              | 
|31.2          |  | Certification of Chief Financial Officer pursuant to Exchange Act Rules Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.              
|              | 
|32.1          |  | Certification of President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                       
|              | 
|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.                                     



|(1) | Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Registrants Pre-Effective Amendment No. 1 to its Registration
Statement on Form S-11 filed with the Securities and Exchange Commission on October 20, 2004. (333-118873).
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Registrants Pre-Effective Amendment No. 5 to its Registration
Statement on Form S-11 filed with the Securities and Exchange Commission on December 13, 2004. (333-118873).
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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