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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, 2009

OR



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

For the transition period from  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 October 29, 2009, there were 6,964,263 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                            |  | 29  
|Item 4T  |  | Controls and Procedures                                                               |  | 29  
|         |  |                                                                                      
|         |  | PART II                                                                               |  |     
|Item 1.  |  | Legal Proceedings                                                                     |  | 31  
|Item 1A. |  | Risk Factors                                                                          |  | 31  
|Item 2.  |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 31  
|Item 3.  |  | Defaults Upon Senior Securities                                                       |  | 31  
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                   |  | 31  
|Item 5.  |  | Other Information                                                                     |  | 31  
|Item 6.  |  | Exhibits                                                                              |  | 31  



2



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##### Table of Contents

PART I



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

MHI HOSPITALITY CORPORATION

CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ----------- | - | ----------------- | - | ----------- | -
|                                                                                                                                                                                    |  | September 30, 2009 |             |   | December 31, 2008 |  
|                                                                                                                                                                                    |  | (unaudited)        |             |   |                   |  
|ASSETS                                                                                                                                                                              |  |                    |             |   |                   |   |             |  
|Investment in hotel properties, net                                                                                                                                                 |  | $                  | 189,827,578 |   |                   | $ | 154,295,611 |  
|Properties under development                                                                                                                                                        |  |                    |            |   |                   |   | 33,101,773  |  
|Investment in joint venture                                                                                                                                                         |  |                    | 9,816,963   |   |                   |   | 10,253,732  |  
|Cash and cash equivalents                                                                                                                                                           |  |                    | 4,497,311   |   |                   |   | 1,719,147   |  
|Restricted cash                                                                                                                                                                     |  |                    | 759,704     |   |                   |   | 2,573,444   |  
|Accounts receivable                                                                                                                                                                 |  |                    | 3,310,079   |   |                   |   | 1,352,203   |  
|Accounts receivable-affiliate                                                                                                                                                       |  |                    | 80,122      |   |                   |   | 53,795      |  
|Prepaid expenses, inventory and other assets                                                                                                                                        |  |                    | 6,393,281   |   |                   |   | 4,603,118   |  
|Notes receivable, net                                                                                                                                                               |  |                    | 100,000     |   |                   |   | 100,000     |  
|Shell Island lease purchase, net                                                                                                                                                    |  |                    | 1,544,117   |   |                   |   | 1,852,941   |  
|Deferred financing costs, net                                                                                                                                                       |  |                    | 1,529,706   |   |                   |   | 1,312,670   |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|TOTAL ASSETS                                                                                                                                                                        |  | $                  | 217,858,861 |   |                   | $ | 211,218,434 |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|                                                                                                                                                                                    |  |                   
|LIABILITIES                                                                                                                                                                         |  |                    |             |   |                   |   |             |  
|Line of credit                                                                                                                                                                      |  | $                  | 78,737,858  |   |                   | $ | 73,187,858  |  
|Mortgage loans                                                                                                                                                                      |  |                    | 72,837,675  |   |                   |   | 72,256,168  |  
|Loans payable                                                                                                                                                                       |  |                    | 4,639,022   |   |                   |   |            |  
|Accounts payable and other accrued liabilities                                                                                                                                      |  |                    | 8,990,136   |   |                   |   | 11,451,976  |  
|Advance deposits                                                                                                                                                                    |  |                    | 792,474     |   |                   |   | 546,236     |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|TOTAL LIABILITIES                                                                                                                                                                   |  |                    | 165,997,165 |   |                   |   | 157,442,238 |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|                                                                                                                                                                                    |  |                   
|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, 6,964,263 shares and 6,939,613 shares issued and outstanding at
September 30, 2009 and December 31, 2008, respectively |  |                    | 69,643      |   |                   |   | 69,396      |  
|Additional paid in capital                                                                                                                                                          |  |                    | 48,692,539  |   |                   |   | 48,586,775  |  
|Distributions in excess of retained earnings                                                                                                                                        |  |                    | (13,655,850 | ) |                   |   | (12,341,122 | )
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|Total MHI Hospitality Corporation stockholders equity                                                                                                                              |  |                    | 35,106,332  |   |                   |   | 36,315,049  |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|Noncontrolling interest                                                                                                                                                             |  |                    | 16,755,364  |   |                   |   | 17,461,147  |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|TOTAL EQUITY                                                                                                                                                                        |  |                    | 51,861,696  |   |                   |   | 53,776,196  |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  
|TOTAL LIABILITIES AND EQUITY                                                                                                                                                        |  | $                  | 217,858,861 |   |                   | $ | 211,218,434 |  
|                                                                                                                                                                                    |  |                    |             |   |                   |   |             |  

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, 2009 |            |   | Three months endedSeptember 30, 2008 |   |            | Nine months endedSeptember 30, 2009 |  |   | Nine months endedSeptember 30, 2008 |  
|REVENUE                                                            |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Rooms department                                                   |  | $                                    | 12,781,958 |   |                                      | $ | 12,055,723 |                                     |  | $ | 37,404,739                          |   |  | $ | 36,680,246 |  
|Food and beverage department                                       |  |                                      | 4,124,670  |   |                                      |   | 4,040,957  |                                     |  |   | 13,187,953                          |   |  |   | 13,319,651 |  
|Other operating departments                                        |  |                                      | 1,073,404  |   |                                      |   | 1,085,229  |                                     |  |   | 3,419,049                           |   |  |   | 3,154,402  |  
|                                                                   |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Total revenue                                                      |  |                                      | 17,980,032 |   |                                      |   | 17,181,909 |                                     |  |   | 54,011,741                          |   |  |   | 53,154,299 |  
|EXPENSES                                                           |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Hotel operating expenses                                           |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Rooms department                                                   |  |                                      | 3,765,650  |   |                                      |   | 3,473,123  |                                     |  |   | 10,498,088                          |   |  |   | 10,219,413 |  
|Food and beverage department                                       |  |                                      | 2,957,662  |   |                                      |   | 3,220,355  |                                     |  |   | 8,990,305                           |   |  |   | 9,962,929  |  
|Other operating departments                                        |  |                                      | 206,865    |   |                                      |   | 226,483    |                                     |  |   | 581,202                             |   |  |   | 650,502    |  
|Indirect                                                           |  |                                      | 7,290,182  |   |                                      |   | 7,001,655  |                                     |  |   | 21,677,157                          |   |  |   | 20,895,882 |  
|                                                                   |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Total hotel operating expenses                                     |  |                                      | 14,220,359 |   |                                      |   | 13,921,616 |                                     |  |   | 41,746,752                          |   |  |   | 41,728,726 |  
|Depreciation and amortization                                      |  |                                      | 2,152,350  |   |                                      |   | 1,797,075  |                                     |  |   | 6,148,408                           |   |  |   | 4,777,680  |  
|Corporate general and administrative                               |  |                                      | 744,171    |   |                                      |   | 646,566    |                                     |  |   | 2,497,275                           |   |  |   | 2,318,828  |  
|                                                                   |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Total operating expenses                                           |  |                                      | 17,116,880 |   |                                      |   | 16,365,257 |                                     |  |   | 50,392,435                          |   |  |   | 48,825,234 |  
|                                                                   |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|OPERATING INCOME                                                   |  |                                      | 863,152    |   |                                      |   | 816,652    |                                     |  |   | 3,619,306                           |   |  |   | 4,329,065  |  
|Other income (expense)                                             |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Interest expense                                                   |  |                                      | (2,546,971 | ) |                                      |   | (1,933,052 | )                                   |  |   | (7,131,677                          | ) |  |   | (4,810,231 | )
|Interest income                                                    |  |                                      | 9,861      |   |                                      |   | 22,318     |                                     |  |   | 37,689                              |   |  |   | 57,141     |  
|Equity income (loss) in joint venture                              |  |                                      | (157,942   | ) |                                      |   | (333,188   | )                                   |  |   | (169,966                            | ) |  |   | 261,622    |  
|Loan impairment charge                                             |  |                                      |           |   |                                      |   | (100,000   | )                                   |  |   |                                    |   |  |   | (300,000   | )
|Unrealized gain on hedging activities                              |  |                                      | 316,914    |   |                                      |   | 116,016    |                                     |  |   | 854,171                             |   |  |   | 86,743     |  
|Gain (loss) on disposal of assets                                  |  |                                      | (51,740    | ) |                                      |   | 2,010      |                                     |  |   | (42,870                             | ) |  |   | (114,962   | )
|                                                                   |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Net loss, before tax                                               |  |                                      | (1,566,726 | ) |                                      |   | (1,409,244 | )                                   |  |   | (2,833,347                          | ) |  |   | (490,622   | )
|Income tax benefit                                                 |  |                                      | 502,019    |   |                                      |   | 603,135    |                                     |  |   | 1,026,874                           |   |  |   | 1,010,194  |  
|                                                                   |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Net income (loss)                                                  |  |                                      | (1,064,707 | ) |                                      |   | (806,109   | )                                   |  |   | (1,806,473                          | ) |  |   | 519,602    |  
|Add: Net (income) loss attributable to the noncontrolling interest |  |                                      | 371,894    |   |                                      |   | 282,336    |                                     |  |   | 631,031                             |   |  |   | (181,933   | )
|                                                                   |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|NET INCOME (LOSS) ATTRIBUTABLE TO THE COMPANY                      |  | $                                    | (692,813   | ) |                                      | $ | (523,773   | )                                   |  | $ | (1,175,442                          | ) |  | $ | 337,639    |  
|                                                                   |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|                                                                   |  |                                      |            |  
|Net income (loss) per share                                        |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Basic                                                              |  | $                                    | (0.10      | ) |                                      | $ | (0.08      | )                                   |  | $ | (0.17                               | ) |  | $ | 0.05       |  
|Diluted                                                            |  | $                                    | (0.10      | ) |                                      | $ | (0.08      | )                                   |  | $ | (0.17                               | ) |  | $ | 0.05       |  
|Weighted average number of shares outstanding                      |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Basic                                                              |  |                                      | 6,964,263  |   |                                      |   | 6,936,613  |                                     |  |   | 6,962,170                           |   |  |   | 6,936,435  |  
|Diluted                                                            |  |                                      | 6,990,263  |   |                                      |   | 6,975,613  |                                     |  |   | 6,988,170                           |   |  |   | 6,973,100  |  

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 ofRetained Earnings |   |            | NoncontrollingInterest |   |             | Total | 
|                                           |  | Shares       |  | Par Value                 |        |                                            |   |           
|Balances at December 31, 2008              |  | 6,939,613    |  | $                         | 69,396 |                                            | $ | 48,586,775 |                        | $ | (12,341,122 | )     |  | $ | 17,461,147 |   |  | $ | 53,776,196 |  
|Issuance of restricted common stock awards |  | 24,650       |  |                           | 247    |                                            |   | 20,264     |                        |   |            |       |  |   |           |   |  |   | 20,511     |  
|Amortization of deferred stock grants      |  |             |  |                           |       |                                            |   | 85,500     |                        |   |            |       |  |   |           |   |  |   | 85,500     |  
|Net loss                                   |  |             |  |                           |       |                                            |   |           |                        |   | (1,175,442  | )     |  |   | (631,031   | ) |  |   | (1,806,473 | )
|Dividends and distributions declared       |  |             |  |                           |       |                                            |   |           |                        |   | (139,286    | )     |  |   | (74,752    | ) |  |   | (214,038   | )
|                                           |  |              |  |                           |        |                                            |   |            |                        |   |             |       |  |   |            |   |  |   |            |  
|Balances at September 30, 2009             |  | 6,964,263    |  | $                         | 69,643 |                                            | $ | 48,692,539 |                        | $ | (13,655,850 | )     |  | $ | 16,755,364 |   |  | $ | 51,861,696 |  
|                                           |  |              |  |                           |        |                                            |   |            |                        |   |             |       |  |   |            |   |  |   |            |  

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, 2009 |            |   | Nine months endedSeptember 30, 2008 |  
|Cash flows from operating activities:                                                     |  |                                     |            |   |                                     |   |             |  
|Net income (loss) attributable to the Company                                             |  | $                                   | (1,175,442 | ) |                                     | $ | 337,639     |  
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                                     |            |   |                                     |   |             |  
|Depreciation and amortization                                                             |  |                                     | 6,148,408  |   |                                     |   | 4,777,680   |  
|Equity in joint venture                                                                   |  |                                     | 169,966    |   |                                     |   | (261,622    | )
|Loss on disposal of assets                                                                |  |                                     | 42,870     |   |                                     |   | 114,962     |  
|Loan impairment charge                                                                    |  |                                     |           |   |                                     |   | 300,000     |  
|Unrealized gain on hedging activities                                                     |  |                                     | (854,171   | ) |                                     |   | (86,743     | )
|Amortization of deferred financing costs                                                  |  |                                     | 554,241    |   |                                     |   | 256,002     |  
|Charges related to equity-based compensation                                              |  |                                     | 106,010    |   |                                     |   | 237,196     |  
|Noncontrolling interest in operating partnership                                          |  |                                     | (631,031   | ) |                                     |   | 181,933     |  
|Changes in assets and liabilities:                                                        |  |                                     |            |   |                                     |   |             |  
|Restricted cash                                                                           |  |                                     | 234,179    |   |                                     |   | (216,844    | )
|Accounts receivable                                                                       |  |                                     | (1,957,876 | ) |                                     |   | 47,573      |  
|Inventory, prepaid expenses and other assets                                              |  |                                     | (1,849,110 | ) |                                     |   | (2,399,976  | )
|Accounts payable and other accrued liabilities                                            |  |                                     | (1,607,668 | ) |                                     |   | (1,009,373  | )
|Advance deposits                                                                          |  |                                     | 246,237    |   |                                     |   | 279,138     |  
|Due from affiliates                                                                       |  |                                     | (26,327    | ) |                                     |   | (20,680     | )
|                                                                                          |  |                                     |            |   |                                     |   |             |  
|Net cash provided by (used in) operating activities                                       |  |                                     | (599,714   | ) |                                     |   | 2,536,885   |  
|                                                                                          |  |                                     |            |   |                                     |   |             |  
|                                                                                          |  |                                    
|Cash flows from investing activities:                                                     |  |                                     |            |   |                                     |   |             |  
|Acquisition of hotel properties                                                           |  |                                     |           |   |                                     |   | (2,063,794  | )
|Improvements and additions to hotel properties                                            |  |                                     | (8,253,701 | ) |                                     |   | (29,793,040 | )
|Contributions to joint venture                                                            |  |                                     |           |   |                                     |   | (4,743,207  | )
|Distributions from joint venture                                                          |  |                                     | 266,803    |   |                                     |   | 27,362      |  
|Funding of restricted cash reserves                                                       |  |                                     | (887,733   | ) |                                     |   | (1,262,108  | )
|Proceeds of restricted cash reserves                                                      |  |                                     | 2,467,295  |   |                                     |   | 765,402     |  
|                                                                                          |  |                                     |            |   |                                     |   |             |  
|Net cash used in investing activities                                                     |  |                                     | (6,407,336 | ) |                                     |   | (37,069,385 | )
|                                                                                          |  |                                     |            |   |                                     |   |             |  
|                                                                                          |  |                                    
|Cash flows from financing activities:                                                     |  |                                     |            |   |                                     |   |             |  
|Dividends and distributions paid                                                          |  |                                     | (214,037   | ) |                                     |   | (5,438,138  | )
|Proceeds of mortgage refinancing                                                          |  |                                     | 743,832    |   |                                     |   | 10,707,127  |  
|Net proceeds of credit facility                                                           |  |                                     | 5,550,000  |   |                                     |   | 32,800,000  |  
|Payment of deferred financing costs                                                       |  |                                     | (771,278   | ) |                                     |   | (508,019    | )
|Proceeds of loans                                                                         |  |                                     | 4,750,000  |   |                                     |   |            |  
|Payment of mortgages and loans                                                            |  |                                     | (273,303   | ) |                                     |   | (490,000    | )
|                                                                                          |  |                                     |            |   |                                     |   |             |  
|Net cash provided by financing activities                                                 |  |                                     | 9,785,214  |   |                                     |   | 37,070,970  |  
|                                                                                          |  |                                     |            |   |                                     |   |             |  
|Net increase in cash and cash equivalents                                                 |  |                                     | 2,778,164  |   |                                     |   | 2,538,470   |  
|Cash and cash equivalents at the beginning of the period                                  |  |                                     | 1,719,147  |   |                                     |   | 3,988,700   |  
|                                                                                          |  |                                     |            |   |                                     |   |             |  
|Cash and cash equivalents at the end of the period                                        |  | $                                   | 4,497,311  |   |                                     | $ | 6,527,170   |  
|                                                                                          |  |                                     |            |   |                                     |   |             |  
|                                                                                          |  |                                    
|Supplemental disclosures:                                                                 |  |                                     |            |   |                                     |   |             |  
|Cash paid during the period for interest                                                  |  | $                                   | 6,842,607  |   |                                     | $ | 5,487,558   |  
|                                                                                          |  |                                     |            |   |                                     |   |             |  
|Cash paid during the period for income taxes                                              |  | $                                   | 107,087    |   |                                     | $ | 158,240     |  
|                                                                                          |  |                                     |            |   |                                     |   |             |  
|                                                                                          |  |                                    
|Non-cash investing and financing activities:                                              |  |                                     |            |   |                                     |   |             |  
|Assumption of existing indebtedness on purchase of hotel properties                       |  | $                                   |           |   |                                     | $ | 5,750,000   |  
|                                                                                          |  |                                     |            |   |                                     |   |             |  
|Refinance of mortgage notes                                                               |  | $                                   |           |   |                                     | $ | 5,260,000   |  
|                                                                                          |  |                                     |            |   |                                     |   |             |  

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-advised real estate investment trust (REIT) that was incorporated in Maryland on August 20, 2004 to own full-service
upper-upscale, upscale and mid-scale hotels located in primary and secondary markets in the mid-Atlantic, Midwest and Southeastern regions of the 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 (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 or the Partnership). For the Company to qualify as a REIT, it cannot operate hotels. Therefore, the Operating Partnership, which is approximately 65.0% 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 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 April 15,
2008, the Company entered into a second amendment to its credit agreement with Branch Banking and Trust Company (BB&T), as administrative agent and lender, dated May 8, 2006, modifying certain provisions of the agreement
including increases in the lenders revolver commitments by $20.0 million in the aggregate thereby enabling the Company to borrow up to $80.0 million under the credit agreement.

On April 24, 2008, the Company purchased the 172-room Hampton Marina Hotel in Hampton, Virginia for approximately $7.8 million,
including transfer costs. To facilitate the purchase, a subsidiary of the Company assumed $5.75 million of existing indebtedness. The Company made significant renovations to re-brand the hotel as is consistent with the Companys repositioning
strategy. In October 2008, the Company completed the hotels conversion to the Crowne Plaza Hampton Marina.

On
June 13, 2008, through its joint venture with CRP/MHI Holdings, LLC, an affiliate of Carlyle Realty Partners V, LP and The Carlyle Group (Carlyle), the Company closed on a restructuring of the mortgage on the Crowne Plaza Hollywood
Beach Resort whereby the joint venture, in which Carlyle maintains a 75.0% equity interest, purchased a $22.0 million junior participation in the existing mortgage for $19.0 million. The mortgage note was restructured so that the first $35.6 million
of indebtedness bears a rate of LIBOR plus 0.98%. The Company funded its portion of the purchase of the junior participation with funds drawn on its credit facility.

On June 30, 2008, the Company closed a $9.0 million refinancing of the existing indebtedness on the property in Hampton, Virginia. At closing, the Company accessed approximately $5.5 million of the
proceeds and paid approximately $0.5 million in order to retire the existing indebtedness and pay closing costs. The remainder of the proceeds, approximately $3.5 million, funded a product improvement plan for the hotel in connection with the Crowne
Plaza licensing. The new mortgage matures June 30, 2011 and bears a rate of the greater of LIBOR plus 2.75% or 4.75%, payable monthly during the term. The loan can be extended for one 12-month period.

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 establishes new
methodologies for valuing the Companys existing hotel properties under renovation and modifies certain other aspects of the original credit agreement. In addition to waiving potential covenant defaults in 2008, the amendment increases 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 adds a new one hundred basis point spread for any prime
rate loans made under the facility. It also eases 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; establishes new
limitations on cash distributions that the Company may pay to stockholders to



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MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)



a level necessary to maintain the Companys REIT qualification, until such time as the Company meets certain liquidity and other tests; requires the Company to add the Companys hotel
property in Laurel, Maryland to the credit agreements borrowing base; and provides 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 March 31, 2009. The fourth amendment permits 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 be paid during the first three quarters of such fiscal year. The Company anticipates the amount of such a dividend will remain at 90% of taxable income. 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 may be able to declare and pay additional cash dividends in any fiscal year during the
term of the credit agreement.

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 as of and for the three months and nine months ended September 30, 2009 and 2008.

Principles
of Consolidation The consolidated financial statements of the Company include the accounts of the Company and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation.

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. As of December 31, 2008, there was one property under
development in Tampa, Florida, which re-opened in March 2009 as the Crowne Plaza Tampa Westshore. As of September 30, 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 the three months and nine months ended September 30, 2009 totaled $0 and $270,555, respectively and totaled $287,916 and $1,212,576 for the three months and nine months ended
September 30, 2008, 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, LLC (MHI Hotels
Services) to operate the hotel under a management contract; and (iii) the entity that owns the $22.0 million 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 and
reserves for replacements of furniture, fixtures and equipment pursuant to certain requirements in the Companys mortgage agreements with MONY Life Insurance Company (MONY), which holds mortgages on the Hilton Wilmington Riverside
and the Hilton Savannah DeSoto; and PNC Bank, trustee for the mortgage holder on the Crowne Plaza Jacksonville Hotel. During the renovation of the property in Hampton, Virginia, TowneBank, which holds the mortgage on the Crowne Plaza Hampton Marina,
required the Company to maintain an operating reserve, which was returned to the Company 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, 2009 and December 31, 2008 were $324,040 and $359,352, respectively. Amortization expense for the three months and nine months ended September 30, 2009 totaled $13,727 and
$39,560, respectively and totaled $9,356 and $27,020 for the three months and nine months ended September 30, 2008, respectively.

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 the credit agreement and acts as a cash flow hedge involving
the receipt 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, 2009 and 2008, 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, 2009 and December 31, 2008, the Companys interest-rate swap agreement had an estimated fair value of
$(1,017,591) and $(1,871,762), 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 was valued by discounting future cash
flows based on quoted prices for forward interest-rate contracts. As such, this derivative instrument is 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 (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 120,263
shares including 60,000 shares granted under a deferred stock award to its Chief Operating Officer, 34,263 restricted shares issued to certain executives and employees, and 26,000 restricted shares issued to its directors. The 60,000 shares granted
under the deferred stock award vest over five years. Of the 60,000 shares granted to the Companys Chief Operating Officer, only 20,000 shares have vested; another 14,000 shares were issued January 14, 2008, but do not vest until
January 1, 2011. The 34,263 restricted shares issued to certain of the Companys executives and employees have all vested. 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, 2009, 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, 2009 totaled $2,100 and $6,300, respectively, and totaled $40,725 and $122,175 for the three months and nine months ended September 30, 2008, respectively.

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 InformationThe 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, including changes resulting from the adoption of authoritative guidance related to Accounting Standards Codification (ASC) Topic 810, Consolidation, on
January 1, 2009, as discussed below.

Recent Accounting Pronouncements On September 15, 2006, the
Financial Accounting Standards Board (FASB) issued authoritative guidance related to ASC Topic 820, Fair Value Measurements and Disclosures. This authoritative guidance establishes a framework for measuring fair value and expands
disclosures about fair value measurements. The changes to current practice resulting from the application of the new guidance relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair
value measurements. The authoritative guidance was originally effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years, but was amended on February 6, 2008 to defer the effective date for
one year for certain non-financial assets and liabilities. The Company adopted provisions of the authoritative guidance related to ASC Topic 820 on January 1, 2008, which had no material impact on its consolidated financial statements.



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MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)



In February 2007, the FASB issued authoritative guidance related to ASC Topic 825,
Financial Instruments.This authoritative guidance is effective for fiscal years beginning after November 15, 2007. The authoritative guidance allows entities to choose, at specified election dates, to measure eligible financial assets
and liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that items fair value in subsequent reporting periods must be recognized in
current earnings. The authoritative guidance also establishes presentation and disclosure requirements designed to draw comparison between entities that elect different measurement attributes for similar assets and liabilities. The Company adopted
the authoritative guidance related to ASC Topic 825 on January 1, 2008, which had no material impact on its consolidated financial statements.

In December 2007, the 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
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.



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##### Table of Contents

MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)



This adoption required all issued authoritative literature to be disclosed using
Codification Sections. Authoritative literature has been referenced within our third quarter report on Form 10-Q under these new Codification Sections.

3. Acquisition of Hotel Properties

There were no new acquisitions during
the nine months ended September 30, 2009.

4. Investment in Hotel Properties

Investment in hotel properties as of September 30, 2009 and December 31, 2008 consisted of the following (in thousands):



|                                  |  |                    |         |   |                   |   |         |  
|--------------------------------- |  | ------------------ | ------- | - | ----------------- | - | ------- | -
|                                  |  | September 30, 2009 |         |   | December 31, 2008 |  
|                                  |  | (unaudited)        |         |   |                   |  
|Land and land improvements        |  | $                  | 19,138  |   |                   | $ | 14,748  |  
|Buildings and improvements        |  |                    | 173,569 |   |                   |   | 139,752 |  
|Furniture, fixtures and equipment |  |                    | 30,477  |   |                   |   | 27,484  |  
|                                  |  |                    |         |   |                   |   |         |  
|                                  |  |                    | 223,184 |   |                   |   | 181,984 |  
|Less: accumulated depreciation    |  |                    | (33,356 | ) |                   |   | (27,688 | )
|                                  |  |                    |         |   |                   |   |         |  
|                                  |  | $                  | 189,828 |   |                   | $ | 154,296 |  
|                                  |  |                    |         |   |                   |   |         |  

5. Debt

Credit Facility.As of September 30, 2009, the Company had a secured, revolving credit facility with a syndicated bank group comprised of BB&T, Key Bank National Association and
Manufacturers and Traders Trust Company that enables the Company to borrow up to $80.0 million, subject to borrowing base and loan-to-value limitations. 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%. The Company had borrowings of approximately $78.7 million and approximately $73.2 million at
September 30, 2009 and December 31, 2008, respectively.

The facility matures during May 2011 and bears interest at
a floating rate of LIBOR plus additional interest ranging from 1.625% to 2.125% prior to February 19, 2009 and 2.75% to 3.25% thereafter. On September 30, 2009, LIBOR was 0.246%. In some circumstances, the revolving line of credit facility
may bear interest at BB&Ts prime rate plus additional interest of 1.0%. Any amounts drawn under the revolving line of credit facility mature at the expiration of the facility. The Company is required to pay a fee of 0.25% on the unused
portion of the credit facility. Under the terms of the agreement, the Company was required to purchase an interest rate swap in order to hedge against interest rate risk.

The 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, 2009, the five properties had a net
carrying value of approximately $121.9 million. Under the terms of the credit facility, the Company must satisfy certain financial and non-financial covenants. The banks that form the lender group, in connection with the third amendment to the
Companys revolving credit facility, waived the Companys compliance with its total leverage ratio for the quarters ended September 30, 2008 and December 31, 2008 and the Companys compliance with its restricted payment
covenant for the fiscal year ended December 31, 2008. The Company was in compliance with all required covenants as of September 30, 2009.

Mortgage Debt.As of September 30, 2009, the Company had approximately $72.8 million of outstanding mortgage debt. The following table sets forth the Companys mortgage debt obligations
on our hotels.



|                                     |                    |                           |                   |               |   |            |              |                             |        |                        |         |     |                     |               |     |  |  
|------------------------------------ | ------------------ | ------------------------- | ----------------- | ------------- | - | ---------- | ------------ | --------------------------- | ------ | ---------------------- | ------- | --- | ------------------- | ------------- | --- |  | -
|Property                             |                    | Balance Outstanding as of |                   | Interest Rate |   |            | MaturityDate |                             |        | AmortizationProvisions |         |     | PrepaymentPenalties
|                                     | September 30, 2009 |                           | December 31, 2008 |               |   |            |             
|Crowne Plaza Hampton Marina          |                    | $                         | 9,000,000         |               | $ | 8,256,168  |              | LIBOR plus 2.75Minimum 4.75 | %,%(1) |                        | 06/2011 | (2) |                     | Interest Only |     |  | N
|Crowne Plaza Jacksonville Riverfront |                    |                           | 18,000,000        |               |   | 18,000,000 |              | 8.00                        | %      |                        | 07/2010 | (2) |                     | Interest Only |     |  | Y
|Hilton Savannah DeSoto               |                    |                           | 23,000,000        |               |   | 23,000,000 |              | 6.06                        | %      |                        | 08/2017 |     |                     | 25 years      | (3) |  | Y
|Hilton Wilmington Riverside          |                    |                           | 22,837,675        |               |   | 23,000,000 |              | 6.21                        | %      |                        | 03/2017 |     |                     | 25 years      | (4) |  | Y
|                                     |                    |                           |                   |               |   |            |              |                             |        |                        |         |     |                     |               |     |  |  
|Total                                |                    | $                         | 72,837,675        |               | $ | 72,256,168 |              |                             |        |                        |         |     |                     |               |     |  |  
|                                     |                    |                           |                   |               |   |            |              |                             |        |                        |         |     |                     |               |     |  |  



12



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##### Table of Contents

MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)





|(1) | At September 30, 2009 and December 31, 2008, the variable rate in effect for the mortgage on the Crowne Plaza Hampton Marina was 4.75%.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------

|(2) | The mortgages on the Crowne Plaza Hampton Marina and the Crowne Plaza Jacksonville Riverfront may each be extended for one 12-month period.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------

|(3) | The mortgage on the Hilton Savannah DeSoto has a 36-month interest-only period that expires in July 2011. Thereafter, the debt will amortize on a 25-year amortization
schedule.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | The mortgage on the Hilton Wilmington Riverside has a 24-month interest-only period that expires in March 2010. Thereafter, the debt will amortize on a 25-year
amortization schedule.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

On June 30, 2008, the Company closed a $9.0 million refinancing of the mortgage on
the Crowne Plaza Hampton Marina. Approximately $5.5 million of the proceeds were used to satisfy the existing indebtedness and pay closing costs. The remaining portion of the proceeds totaling approximately $3.5 million has funded a product
improvement plan for the hotel in connection with its Crowne Plaza licensing. The new mortgage matures June 30, 2011 and may be extended for one 12-month period. The loan requires monthly payments of interest at a rate of LIBOR plus 2.75%, but
no less than 4.75%.

Total mortgage debt maturities as of September 30, 2009 without respect to any loan extensions for
the following twelve-month periods were as follows:



|                        |  |   |           
|----------------------- |  | - | ----------
|September 30, 2010      |  | $ | 18,473,041
|September 30, 2011      |  |   | 9,842,984 
|September 30, 2012      |  |   | 896,199   
|September 30, 2013      |  |   | 952,774   
|September 30, 2014      |  |   | 1,012,922 
|Thereafter              |  |   | 41,659,755
|                        |  |   |           
|Total future maturities |  | $ | 72,837,675
|                        |  |   |           

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 payments equal to 50.0% of any distributions it receives from the joint venture. The mortgage to which the loan is tied matures in August 2010, but may be extended for two
additional one-year periods, pursuant to the terms of the loan.

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 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. The 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, 2009 totaled $16,513 and $52,159, respectively and totaled $18,835 and $47,425 for the three months and nine months ended
September 30, 2008, 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.



13



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##### Table of Contents

MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)



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 the three months and nine months ended September 30, 2009 totaled $23,871 and $71,612, respectively, and
totaled $23,871 and $71,612 for the three months and nine months ended September 30, 2008, 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 $64,250 and $161,750 for the three months and nine
months ended September 30, 2009, respectively, and totaled $42,034 and $126,103 for the three months and nine months ended September 30, 2008, respectively.

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 for the three months and nine months ended September 30, 2009 totaled $1,240 and
$3,720, respectively, and totaled $1,240 and $3,720 for the three months and nine months ended September 30, 2008, respectively.

The Company leases 3,542 square feet of commercial office space in Williamsburg, Virginia under an agreement that commenced September 1, 2009 and which expires August 31, 2015. Prior to September 1, 2009, the Company leased
1,842 square feet of commercial office space under a separate lease that expired August 31, 2009. Rent expense for the three months and nine months ended September 30, 2009 totaled $11,935 and $33,992, respectively, and totaled $10,814 and
$32,228 for the three months and nine months ended September 30, 2008, respectively.

On October 8, 2009, the
Company agreed to lease 1,632 square feet of commercial office space in Rockville, Maryland commencing January 1, 2010. The agreement, which expires December 31, 2016, 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.

The Company leases a parking lot in close proximity to the Sheraton Louisville Riverside 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 its 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 for each
of the three months and nine months ended September 30, 2009 totaled $8,400 and $25,200, respectively, and totaled $8,400 and $14,000 for the three months and nine months ended September 30, 2008, respectively.

The Company has agreed to lease 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 for the three months and nine months ended
September 30, 2009 totaled $405.

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



|                                    |  |   |          
|----------------------------------- |  | - | ---------
|September 30, 2010                  |  | $ | 589,349  
|September 30, 2011                  |  |   | 571,315  
|September 30, 2012                  |  |   | 461,579  
|September 30, 2013                  |  |   | 254,153  
|September 30, 2014                  |  |   | 228,765  
|Thereafter                          |  |   | 360,207  
|                                    |  |   |          
|Total future minimum lease payments |  | $ | 2,465,368
|                                    |  |   |          

Management Agreement  Each of the operating hotels that the Company
owned at September 30, 2009 operates under a ten-year management agreement with MHI Hotels Services, which expires between December 2014 and March 2019 (see Note 8).

Franchise Agreements  As of September 30, 2009, 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.



14



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##### Table of Contents

MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)



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 to 1/12of 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.

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, $.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
January 1, 2008 and January 14, 2008, the Company issued 10,000 non-restricted shares and 14,000 restricted shares, respectively to its Chief Operating Officer in accordance with the terms of his employment contract, as amended. On
January 1, 2009, the Company issued another 10,000 non-restricted shares to its Chief Operating Officer in accordance with the terms of his employment contract, as amended. On February 6, 2008 and February 9, 2009, the Company issued
18,613 shares and 14,650 shares, respectively, of restricted stock to certain executives and independent directors. As of September 30, 2009 and December 31, 2008, the Company had 6,964,263 and 6,939,613 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, 2009, 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, 2009, the total number of
Operating Partnership units outstanding was 3,737,607, with a fair market value of approximately $8.2 million based on the price per share of the common stock on that date.

8. Related Party Transactions

As of September 30, 2009, 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 2.6% of the Companys outstanding
common stock and 59.4% of the units in our Operating Partnership. The following is a summary of the transactions between the Company and MHI Hotels Services:

Accounts Receivable At September 30, 2009 and December 31, 2008, the Company was due $80,122 and $53,795, 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, 2009 totaled $160,000 and $480,000, respectively, and totaled $160,000 and $480,000 for the three months and nine months ended
September 30, 2008, respectively.

Sublease of Office Space  The Company subleases office space in
Greenbelt, Maryland from MHI Hotels Services. Rent expense was $12,320 and $32,420 for the three months and nine months ended September 30, 2009, respectively, and totaled $9,510 and $28,530 for the three months and nine months ended
September 30, 2008, 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.



15



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##### Table of Contents

MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)



Management Agreements Each of the hotels that the Company owned at
September 30, 2009, 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.

Management fees paid by the Company to MHI Hotels Services totaled $454,490 and $1,375,604 for the three months and nine months ended September 30, 2009, respectively, and totaled $518,768 and $1,558,220 for the three months and nine
months ended September 30, 2008, respectively. In addition, no estimated incentive management fees were accrued for the three months and nine months ended September 30, 2009 or 2008.

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 totaled $449,595 and $1,368,809 for the three months and nine months ended September 30, 2009, respectively, and totaled $429,241 and
$1,291,715 for the three months and nine months ended September 30, 2008, respectively.

9. Retirement Plan

The Company began a 401(k) plan for qualified employees on April 1, 2006. The plan is subject to safe harbor provisions
which require 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 $10,870 and $33,179 for the three months and nine months ended September 30, 2009, respectively, and totaled $8,894 and $38,275 for the three months and nine months ended September 30, 2008, respectively.

10. Unconsolidated Joint Venture

The Company owns a 25% 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; and (iii) the entity that owns 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, 2009 |            | December 31, 2008
|                                               |  | (unaudited)        |            |                  
|ASSETS                                         |  |                    |            |                   |   |           
|Investment in hotel properties, net            |  | $                  | 72,478,179 |                   | $ | 74,244,478
|Cash and cash equivalents                      |  |                    | 683,936    |                   |   | 1,110,474 
|Restricted cash                                |  |                    | 2,156,966  |                   |   | 1,026,166 
|Accounts receivable                            |  |                    | 198,848    |                   |   | 193,907   
|Prepaid expenses, inventory and other assets   |  |                    | 1,335,391  |                   |   | 1,532,291 
|                                               |  |                    |            |                   |   |           
|TOTAL ASSETS                                   |  | $                  | 76,853,320 |                   | $ | 78,017,316
|                                               |  |                    |            |                   |   |           
|                                               |  |                   
|LIABILITIES                                    |  |                    |            |                   |   |           
|Mortgage loans, net                            |  | $                  | 35,600,000 |                   | $ | 35,600,000
|Accounts payable and other accrued liabilities |  |                    | 1,673,250  |                   |   | 1,112,040 
|Advance deposits                               |  |                    | 312,401    |                   |   | 380,450   
|                                               |  |                    |            |                   |   |           
|TOTAL LIABILITIES                              |  |                    | 37,585,651 |                   |   | 37,092,490
|TOTAL MEMBERS EQUITY                          |  |                    | 39,267,669 |                   |   | 41,014,825
|                                               |  |                    |            |                   |   |           
|TOTAL LIABILITIES AND MEMBERS EQUITY          |  | $                  | 76,853,320 |                   | $ | 78,017,316
|                                               |  |                    |            |                   |   |           



16



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##### Table of Contents

MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)



|                               |  |                                      |           |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|------------------------------ |  | ------------------------------------ | --------- | - | ------------------------------------ | - | ---------- | ----------------------------------- |  | - | ----------------------------------- | - |  | - | ---------- | -
|                               |  | Three Months EndedSeptember 30, 2009 |           |   | Three Months EndedSeptember 30, 2008 |   |            | Nine Months EndedSeptember 30, 2009 |  |   | Nine Months EndedSeptember 30, 2008 |  
|                               |  | (unaudited)                          |           |   | (unaudited)                          |   |            | (unaudited)                         |  |   | (unaudited)                         |  
|Revenue                        |  |                                      |           |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Rooms department               |  | $                                    | 1,928,707 |   |                                      | $ | 1,785,268  |                                     |  | $ | 7,182,096                           |   |  | $ | 7,750,367  |  
|Food and beverage department   |  |                                      | 340,402   |   |                                      |   | 355,284    |                                     |  |   | 1,317,775                           |   |  |   | 1,329,580  |  
|Other operating departments    |  |                                      | 237,384   |   |                                      |   | 205,030    |                                     |  |   | 749,339                             |   |  |   | 951,951    |  
|                               |  |                                      |           |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Total revenue                  |  |                                      | 2,506,493 |   |                                      |   | 2,345,582  |                                     |  |   | 9,249,210                           |   |  |   | 10,031,898 |  
|                               |  |                                      |           |  
|Expenses                       |  |                                      |           |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Hotel operating expenses       |  |                                      |           |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Rooms department               |  |                                      | 566,372   |   |                                      |   | 520,954    |                                     |  |   | 1,713,801                           |   |  |   | 1,758,986  |  
|Food and beverage department   |  |                                      | 325,713   |   |                                      |   | 452,405    |                                     |  |   | 1,144,836                           |   |  |   | 1,408,165  |  
|Other operating departments    |  |                                      | 156,440   |   |                                      |   | 135,626    |                                     |  |   | 379,900                             |   |  |   | 386,990    |  
|Indirect                       |  |                                      | 1,357,991 |   |                                      |   | 1,631,583  |                                     |  |   | 4,392,639                           |   |  |   | 4,774,261  |  
|                               |  |                                      |           |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Total hotel operating expenses |  |                                      | 2,406,516 |   |                                      |   | 2,740,568  |                                     |  |   | 7,631,176                           |   |  |   | 8,328,402  |  
|Depreciation and amortization  |  |                                      | 545,475   |   |                                      |   | 545,726    |                                     |  |   | 1,635,161                           |   |  |   | 1,636,544  |  
|General and administrative     |  |                                      | 14,091    |   |                                      |   | 1,118      |                                     |  |   | 128,919                             |   |  |   | 68,949     |  
|                               |  |                                      |           |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Total operating expenses       |  |                                      | 2,966,082 |   |                                      |   | 3,287,412  |                                     |  |   | 9,395,256                           |   |  |   | 10,033,895 |  
|                               |  |                                      |           |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|                               |  |                                      |           |  
|Operating (loss                |  |                                      | (459,589  | ) |                                      |   | (941,830   | )                                   |  |   | (146,046                            | ) |  |   | (1,997     | )
|Gain on extinguishment of debt |  |                                      |          |   |                                      |   |           |                                     |  |   |                                    |   |  |   | 3,000,000  |  
|Interest expense               |  |                                      | (173,048  | ) |                                      |   | (395,792   | )                                   |  |   | (539,631                            | ) |  |   | (1,971,732 | )
|Interest income                |  |                                      | 867       |   |                                      |   | 4,875      |                                     |  |   | 5,733                               |   |  |   | 20,219     |  
|                               |  |                                      |           |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  
|Net income (loss)              |  | $                                    | (631,770  | ) |                                      | $ | (1,332,747 | )                                   |  | $ | (679,944                            | ) |  | $ | 1,046,490  |  
|                               |  |                                      |           |   |                                      |   |            |                                     |  |   |                                     |   |  |   |            |  

11. Income Taxes

The components of the income tax provision (benefit) for the three months and nine months ended September 30, 2009 and 2008 are as follows (in thousands):



|          |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  
|--------- |  | ------------------------------------ | ---- | - | ------------------------------------ | - | ---- | ----------------------------------- |  | - | ----------------------------------- | - |  | - | ------ | -
|          |  | Three Months EndedSeptember 30, 2009 |      |   | Three Months EndedSeptember 30, 2008 |   |      | Nine Months EndedSeptember 30, 2009 |  |   | Nine Months EndedSeptember 30, 2008 |  
|          |  | (unaudited)                          |      |   | (unaudited)                          |   |      | (unaudited)                         |  |   | (unaudited)                         |  
|Current:  |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  
|Federal   |  | $                                    |     |   |                                      | $ |     |                                     |  | $ |                                    |   |  | $ |       |  
|State     |  |                                      | 13   |   |                                      |   | 10   |                                     |  |   | 101                                 |   |  |   | 153    |  
|          |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  
|          |  |                                      | 13   |   |                                      |   | 10   |                                     |  |   | 101                                 |   |  |   | 153    |  
|          |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  
|Deferred: |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  
|Federal   |  |                                      | (434 | ) |                                      |   | (514 | )                                   |  |   | (875                                | ) |  |   | (976   | )
|State     |  |                                      | (81  | ) |                                      |   | (99  | )                                   |  |   | (253                                | ) |  |   | (187   | )
|          |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  
|          |  |                                      | (515 | ) |                                      |   | (613 | )                                   |  |   | (1,128                              | ) |  |   | (1,163 | )
|          |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  
|          |  | $                                    | (502 | ) |                                      | $ | (603 | )                                   |  | $ | (1,027                              | ) |  | $ | (1,010 | )
|          |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  

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



|                                                 |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  
|------------------------------------------------ |  | ------------------------------------ | ---- | - | ------------------------------------ | - | ---- | ----------------------------------- |  | - | ----------------------------------- | - |  | - | ------ | -
|                                                 |  | Three Months EndedSeptember 30, 2009 |      |   | Three Months EndedSeptember 30, 2008 |   |      | Nine Months EndedSeptember 30, 2009 |  |   | Nine Months EndedSeptember 30, 2009 |  
|                                                 |  | (unaudited)                          |      |   | (unaudited)                          |   |      | (unaudited)                         |  |   | (unaudited)                         |  
|Statutory federal income tax provision (benefit) |  | $                                    | (533 | ) |                                      | $ | (479 | )                                   |  | $ | (963                                | ) |  | $ | (167   | )
|Effect of non-taxable REIT income                |  |                                      | 99   |   |                                      |   | (35  | )                                   |  |   | 88                                  |   |  |   | (809   | )
|State income tax provision (benefit)             |  |                                      | (68  | ) |                                      |   | (89  | )                                   |  |   | (152                                | ) |  |   | (34    | )
|                                                 |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  
|                                                 |  | $                                    | (502 | ) |                                      | $ | (603 | )                                   |  | $ | (1,027                              | ) |  | $ | (1,010 | )
|                                                 |  |                                      |      |   |                                      |   |      |                                     |  |   |                                     |   |  |   |        |  

As of September 30, 2009, the Company had a net deferred tax asset of
approximately $4.1 million; primarily due to current and past years net operating losses. These loss carryforwards will begin to expire in 2024 if not utilized by then. As of September 30,



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MHI HOSPITALITY CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)

(unaudited)



2009, approximately $0.2 million of the deferred tax asset is attributable to the Companys share of start-up expenses related to the Crowne Plaza Hollywood Beach Resort that were not
deductible in the year incurred, but are being amortized over 15 years. In addition, approximately $0.2 million of the deferred tax asset is attributable to the 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 deferred tax asset is attributable to year-to-year timing differences for accrued, but not deductible, vacation
and sick pay. 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, 2009 |           |   | Three months endedSeptember 30, 2008 |   |           | Nine months endedSeptember 30, 2009 |  |   | Nine months endedSeptember 30, 2008
|                                                          |  | (unaudited)                          |           |   | (unaudited)                          |   |           | (unaudited)                         |  |   | (unaudited)                        
|Net income (loss)                                         |  | $                                    | (692,813  | ) |                                      | $ | (523,773  | )                                   |  | $ | (1,175,442                          | ) |  | $ | 337,639  
|Basic:                                                    |  |                                      |           |   |                                      |   |           |                                     |  |   |                                     |   |  |   |          
|Weighted average number of common shares outstanding      |  |                                      | 6,964,263 |   |                                      |   | 6,939,613 |                                     |  |   | 6,962,170                           |   |  |   | 6,936,435
|Net income (loss) per sharebasic                         |  | $                                    | (0.10     | ) |                                      | $ | (0.08     | )                                   |  | $ | (0.17                               | ) |  | $ | 0.05     
|Diluted:                                                  |  |                                      |           |   |                                      |   |           |                                     |  |   |                                     |   |  |   |          
|Dilutive awards                                           |  |                                      | 26,000    |   |                                      |   | 36,000    |                                     |  |   | 26,000                              |   |  |   | 36,000   
|Diluted weighted average number common shares outstanding |  |                                      | 6,990,263 |   |                                      |   | 6,975,613 |                                     |  |   | 6,988,170                           |   |  |   | 6,973,100
|Net income (loss) per sharediluted                       |  | $                                    | (0.10     | ) |                                      | $ | (0.08     | )                                   |  | $ | (0.17                               | ) |  | $ | 0.05     

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

13. Subsequent Events

The Company has evaluated subsequent events through the time the financial statements were available for issuance on October 30, 2009.

On October 1, 2009, the Company filed a registration statement on Form S-3 (the Registration Statement) with the Securities
and Exchange Commission for a rights offering relating to non-transferable subscription rights to purchase shares of the Companys common stock at a par value of $0.01 per share. Under the rights offering, each stockholder as of the
October 14, 2009 record date will receive one subscription right for each share of common stock owned on the record date, and each right will entitle the rights holder to purchase one share of the Companys common stock (the
basic subscription privilege) at a subscription price equal to $1.60 per share. The rights offering will also include an over-subscription privilege which will entitle rights holders that exercise their basic subscription privilege
in full to purchase shares not purchased by other subscription rights holders at the same subscription price of $1.60 per share (the over-subscription privilege). The total number of shares issuable upon exercise of both the basic
subscription privilege and over-subscription privilege is subject to reduction by the Company so that the aggregate market value of the common stock issued pursuant to the rights offering does not exceed the limitation applicable to our use of Form
S-3. Assuming the rights offering is fully subscribed, the Company will receive gross proceeds of approximately $6.9 million. The Company will contribute the net proceeds to the Operating Partnership in exchange for units in the
Operating Partnership. The Operating Partnership intends to subsequently use the net proceeds received from us for additional working capital, which may be used at the Companys discretion to reduce or purchase existing or
future indebtedness, or for other general corporate purposes. The Registration Statement was declared effective on October 28, 2009.



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

Overview

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

Our wholly-owned hotel portfolio currently consists of nine full-service, upper-upscale, upscale and mid-scale hotels with 2,110 rooms, which operate under well-known brands such as Hilton, Crowne Plaza,
Sheraton and Holiday Inn. We also own a 25% indirect non-controlling interest in the Crowne Plaza Hollywood Beach Resort through a joint venture with The Carlyle Group and we have a leasehold interest in a resort condominium facility in Wrightsville
Beach, North Carolina.

As of September 30 2009, we wholly-owned the following hotel properties:



|                              |  |                |  |                    |  |                    
|----------------------------- |  | -------------- |  | ------------------ |  | -------------------
|Property                      |  | Numberof Rooms |  | Location           |  | Date of Acquisition
|Crowne Plaza Hampton Marina   |  | 172            |  | 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 |  | 181            |  | Jeffersonville, IN |  | September 20, 2006 
|                              |  |                |  |                    |  |                    
|Total                         |  | 2,110          |  |                    |  |                    
|                              |  |                |  |                    |  |                    

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

To qualify as a REIT, we cannot operate hotels. Therefore, our operating partnership leases our hotel properties to
MHI Hospitality TRS, LLC, our TRS Lessee, which then engages a hotel management company to operate the hotels under a management contract. Our TRS Lessee has engaged MHI Hotels Services 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 Developments

Recent Portfolio Changes

On April 24, 2008, we completed the purchase
of the 172-room Hampton Marina Hotel in Hampton, Virginia for approximately $7.8 million, including transfer costs. To facilitate the purchase, we assumed $5.75 million of existing indebtedness, which bore a rate of 6.50% and was set to mature on
July 1, 2016. The remainder of the purchase price as well as closing costs was funded with borrowings on our credit facility. On June 30, 2008, we refinanced the indebtedness drawing approximately $5.5 million on a three-year $9.0 million
mortgage loan from TowneBank with one 12-month extension. The loan requires monthly payments of interest and bears a rate of the greater of LIBOR plus 2.75% or 4.75%. The remainder of the proceeds, totaling approximately $3.5 million, funded a
product improvement plan (or PIP) for the hotel in connection with its Crowne Plaza licensing. In October 2008, the Company completed the hotels conversion to the Crowne Plaza Hampton Marina.

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

On March 6, 2009, we re-opened the Crowne Plaza Tampa Westshore after completing a $23.5 million renovation.

Rights Offering

On October 1, 2009, we filed a registration statement on Form S-3 (the Registration Statement) with the Securities and Exchange Commission for a rights offering relating to non-transferable subscription rights to purchase
shares of our common stock at a par value of $0.01 per share. Under the rights offering, each stockholder as of the October 14, 2009 record date will receive one subscription right for each share of common stock owned on the record date,
and each right will entitle the rights holder to purchase one share of our common stock (the basic subscription privilege) at a subscription price equal to $1.60 per share. The rights offering will also include an
over-subscription privilege which will entitle rights holders that exercise their basic subscription



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privilege in full to purchase any shares not purchased by other subscription rights holders at the same subscription price of $1.60 per share (the over-subscription
privilege). The total number of shares issuable upon exercise of both the basic subscription privilege and over-subscription privilege is subject to reduction by us so that the aggregate market value of the common stock issued pursuant to
the rights offering does not exceed the limitation applicable to our use of Form S-3. Assuming the rights offering is fully subscribed, the Company will receive gross proceeds of approximately $6.9 million. We will contribute the net
proceeds to the Operating Partnership in exchange for units in the Operating Partnership. The Operating Partnership intends to subsequently use the net proceeds received from us for additional working capital, which may be used
at our discretion to reduce or purchase existing or future indebtedness, or for other general corporate purposes. The Registration Statement was declared effective on October 28, 2009.

Asset Management Group

During the third quarter 2009, we formed a new entity, MHI Asset Recovery, LLC, to pursue asset management assignments from special servicers and other entities involved in distressed hotel loans and
workouts. As asset manager, we will provide asset management services including, but not limited to, property management, receiver services, litigation and contract support, franchise selection, construction management, value optimization, and
project management on a fee-for-service basis.

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, 2009 and 2008 for the properties we owned during each respective reporting
period (actual properties) as well as the six properties in our portfolio that were not under development and were under our control during all of 2008 and the nine months ended September 30, 2009 (same-store
properties). Accordingly, the same-store data for the three months ended September 30, 2009 does not reflect the performance of the Crowne Plaza Tampa Westshore. The same-store data for the nine months ended September 30, 2009 does not
reflect the performance of the Sheraton Louisville Riverside, the Crowne Plaza Tampa Westshore, or the Crowne Plaza Hampton Marina.



|                             |  |                                      |        |   |                                      |   |        |                                     |  |   |                                     |   |  |   |        |  
|---------------------------- |  | ------------------------------------ | ------ | - | ------------------------------------ | - | ------ | ----------------------------------- |  | - | ----------------------------------- | - |  | - | ------ | -
|                             |  | Three months endedSeptember 30, 2009 |        |   | Three months endedSeptember 30, 2008 |   |        | Nine months endedSeptember 30, 2009 |  |   | Nine months endedSeptember 30, 2008 |  
|Actual Portfolio Metrics     |  |                                      |        |   |                                      |   |        |                                     |  |   |                                     |   |  |   |        |  
|Occupancy %                  |  |                                      | 63.5   | % |                                      |   | 59.6   | %                                   |  |   | 61.7                                | % |  |   | 64.2   | %
|ADR                          |  | $                                    | 103.63 |   |                                      | $ | 116.43 |                                     |  | $ | 107.90                              |   |  | $ | 120.13 |  
|RevPAR                       |  | $                                    | 65.85  |   |                                      | $ | 69.41  |                                     |  | $ | 66.58                               |   |  | $ | 77.09  |  
|Same-Store Portfolio Metrics |  |                                      |        |   |                                      |   |        |                                     |  |   |                                     |   |  |   |        |  
|Number of Properties         |  |                                      | 8      |   |                                      |   | 8      |                                     |  |   | 6                                   |   |  |   | 6      |  
|Occupancy %                  |  |                                      | 65.7   | % |                                      |   | 59.6   | %                                   |  |   | 66.2                                | % |  |   | 68.0   | %
|ADR                          |  | $                                    | 106.04 |   |                                      | $ | 116.43 |                                     |  | $ | 110.32                              |   |  | $ | 120.25 |  
|RevPAR                       |  | $                                    | 69.65  |   |                                      | $ | 69.41  |                                     |  | $ | 72.99                               |   |  | $ | 81.80  |  

Comparison of the Three Months Ended September 30, 2009 to the Three Months
Ended September 30, 2008

Revenue. Total revenue for the three months ended September 30, 2009 increased
approximately $0.8 million or 4.6% to approximately $18.0 million compared to total revenue of approximately $17.2 million for the three months ended September 30, 2008. Incremental revenue of approximately $0.9 million from our property in
Tampa, Florida which was not open for the three months ended September 30, 2008 accounted for the increase while increases in revenue at our properties in Savannah, Georgia; Jeffersonville, Indiana; and Hampton, Virginia, which were either
under renovation or emerging from renovation during the three months ended September 30, 2008 offset losses in revenue at our other properties which have been severely affected by the economic downturn.

Room revenue for the three months ended September 30, 2009 increased approximately $0.7 million or 4.6% to approximately $12.8 million
compared to room revenue of approximately $12.1 million for the three months ended September 30, 2008. Incremental room revenue from our property in Tampa, Florida as well as increases in room revenue at our properties in Savannah, Georgia;



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Hampton, Virginia; and Jeffersonville, Indiana, which were either under renovation or emerging from renovation during the three months ended September 30, 2008, exceeded losses in room
revenue at our other properties. For the three months ended September 30, 2009, the eight same-store properties experienced a 0.4% increase in room revenue through a combination of a 10.2% increase in occupancy and an 8.9% decrease in ADR as
compared to the same period in 2008.

Food and beverage revenues increased approximately $0.1 million to approximately $4.1
million for the three months ended September 30, 2009 compared to food and beverage revenues of approximately $4.0 million for the three months ended September 30, 2008. Contributions to food and beverage revenues from our properties in
Tampa, Florida; Savannah, Georgia; and Hampton, Virginia, which were either closed or under renovation during the three months ended September 30, 2008, exceeded losses at our properties in Jacksonville, Florida; Raleigh, North Carolina;
Wilmington, North Carolina; and Philadelphia, Pennsylvania which have been adversely affected by the effects of the weakened economy.

Revenue from other operating departments for the three months ended September 30, 2009 remained at the same level of other operating revenue for the three months ended September 30, 2008, or approximately $1.1 million.

Hotel Operating Expenses. Hotel operating expenses, which consist of room expenses, food and beverage expenses, other direct
expenses, and management fees, were approximately $14.2 million, an increase of approximately $0.3 million or 2.1% for the three months ended September 30, 2009 compared to approximately $13.9 million for the three months ended
September 30, 2008. Hotel operating expenses at our eight same-store properties decreased approximately $0.9 million or 6.4% for the three months ended September 30, 2009 compared to hotel operating expenses for the three months ended
September 30, 2008. Lower expenses as a result of cost-cutting efforts put in place at all our properties were offset by hotel operating expenses at our newly-opened property in Tampa, Florida.

Rooms expense for the three months ended September 30, 2009 increased approximately $0.3 million or 8.4% to approximately $3.8 million
compared to rooms expense of approximately $3.5 million for the three months ended September 30, 2008. Rooms expense at our eight same-store properties remained approximately the same for the three months ended September 30, 2009 compared
to rooms expense for those properties for the three months ended September 30, 2008, despite a 10.2% increase in occupancy at those properties. Lower expenses as a result of cost-cutting efforts put in place at all our properties were offset by
rooms expenses at our newly opened property in Tampa, Florida.

Food and beverage expenses for the three months ended
September 30, 2009 decreased approximately $0.2 million or 8.2% to approximately $3.0 million compared to food and beverage expenses of approximately $3.2 million for the three months ended September 30, 2008. Lower volumes of food and
beverage sales, decreased food cost and cost-cutting at our established properties more than offset the additional cost of food and beverage sales at our newly-opened property in Tampa.

Indirect expenses at our properties for the three months ended September 30, 2009 increased approximately $0.3 million or 4.1% to
approximately $7.3 million compared to indirect expenses of approximately $7.0 million for the three months ended September 30, 2008. Sales and marketing costs, franchise fees, utilities, repairs and maintenance, insurance, management fees,
real and personal property taxes as well as general and administrative costs at the property level are included in indirect expenses. Indirect expenses at our eight same-store properties decreased approximately $0.4 million or 5.5% for the three
months ended September 30, 2009 compared to indirect expenses for the three months ended September 30, 2008. Lower expenses as a result of cost-cutting efforts put in place at all our properties were offset by indirect expenses at our
newly-opened property in Tampa, Florida.

Depreciation and Amortization. Depreciation and amortization expense for the
three months ended September 30, 2009 increased approximately $0.4 million or 19.8% to approximately $2.2 million compared to depreciation and amortization expense of approximately $1.8 million for the three months ended September 30,
2008. The increase in depreciation and amortization was attributable to the renovations placed in service during the latter part of 2008 at the Hilton Savannah DeSoto and the Crowne Plaza Hampton Marina, as well as the depreciation and amortization
expense related to the Crowne Plaza Tampa Westshore, which opened in March 2009.

Corporate General and Administrative.
Corporate general and administrative expenses for the three months ended September 30, 2009 increased approximately $0.1 million to approximately $0.7 million or 15.1% compared to corporate general and administrative expense of approximately
$0.6 million for the three months ended September 30, 2008. Higher legal costs constituted the majority of the increase in general and administrative expense.

Interest Expense. Interest expense for the three months ended September 30, 2009 increased approximately $0.6 million or 31.8% to approximately $2.5 million compared to interest expense of
approximately $1.9 million for the three months ended September 30, 2008, primarily due to higher levels of borrowings on the credit facility and higher levels of mortgage debt. The increased interest expense relates to borrowing used to fund
the purchase and renovations of our newly-opened or recently acquired properties in Tampa, Florida; Hampton, Virginia; and Jeffersonville, Indiana as well as renovations at the Hilton Savannah DeSoto.



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Equity in Joint Venture. The equity loss in joint venture for the three months ended
September 30, 2009 decreased approximately $0.1 million or 52.6% to approximately $0.1 million compared to an equity loss of approximately $0.2 million for the three months ended September 30, 2008 and 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, 2009, the hotel reported occupancy of 72.8%, ADR of $92.61 and RevPAR of $67.41. For the three months ended September 30, 2008, the
hotel reported occupancy of 54.9%, ADR of $113.71 and RevPAR of $62.40.

Income Taxes. The income tax benefit for the
three months ended September 30, 2009 decreased approximately $0.1 million or 16.8% to approximately $0.5 million compared to an income tax benefit of approximately $0.6 million for the three months ended September 30, 2008. 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, 2009 was less than the net operating loss for the three months ended September 30,
2008.

Net Income (Loss). The net loss for the Company for the three months ended September 30, 2009 increased
approximately $0.2 million or 32.3% to approximately $0.7 million as compared to a net loss of approximately $0.5 million for the three months ended September 30, 2008 as a result of the operating results discussed above.

Comparison of the Nine Months Ended September 30, 2009 to the Nine Months Ended September 30, 2008

Revenue. Total revenue for the nine months ended September 30, 2009 increased approximately $0.8 million or 1.6% to approximately
$54.0 million, compared to total revenue of approximately $53.2 million for the nine months ended September 30, 2008. Incremental revenue of approximately $6.0 million from our properties in Tampa, Florida; Hampton, Virginia; and
Jeffersonville, Indiana, which were not open for all or a portion of the nine months ended September 30, 2008, offset losses in revenue at several of our established properties which have been severely affected by the economic downturn.

Room revenue for the nine months ended September 30, 2009 increased approximately $0.7 million or 2.0% to approximately
$37.4 million, compared to room revenue of approximately $36.7 million for the nine months ended September 30, 2008. Incremental room revenue from our properties in Tampa, Florida; Hampton, Virginia; and Jeffersonville, Indiana, which were not
open for all or a portion of the nine months ended September 30, 2008, offset losses in room revenue at our other properties. For the nine months ended September 30, 2009, the six same-store properties experienced an 11.1% decrease in room
revenue through a combination of an 8.3% decrease in ADR and a 2.7% decrease in occupancy as compared to the same period in 2008. Room revenue decreased at all our same-store properties with the exception of our property in Laurel, Maryland.

Food and beverage revenues decreased approximately $0.1 million to approximately $13.2 million for the nine months ended
September 30, 2009 compared to food and beverage revenues of approximately $13.3 million for the nine months ended September 30, 2008. Contributions to food and beverage revenues from our newly-opened or recently acquired properties in
Tampa, Florida; Hampton, Virginia; and Jeffersonville, Indiana were exceeded by decreases at our properties in Jacksonville, Florida; Raleigh, North Carolina; Savannah, Georgia; and Philadelphia, Pennsylvania which have been adversely affected by
the effects of the weakened economy.

Revenue from other operating departments for the nine months ended September 30,
2009 increased approximately $0.2 million or 8.4% to approximately $3.4 million compared to other operating revenue of approximately $3.2 million for the nine months ended September 30, 2008. Lease revenue from a new restaurant tenant at the
Hilton Wilmington Riverside as well as other revenue from our newly opened property in Tampa, Florida and incremental revenue from our properties in Hampton, Virginia and Jeffersonville, Indiana, which were not open for the entire nine month period
ended September 30, 2008, constituted most of the increase.

Hotel Operating Expenses. Hotel operating expenses,
which consist of room expenses, food and beverage expenses, other direct expenses, and management fees, were constant at approximately $41.7 million for the nine months ended September 30, 2009 compared to hotel operating expenses for the nine
months ended September 30, 2008. Hotel operating expenses at our six same-store properties decreased approximately $5.4 million or 14.3% for the nine months ended September 30, 2009 compared to hotel operating expenses for the nine months
ended September 30, 2008. Lower expenses as a result of cost-cutting efforts put in place at all our properties were offset by hotel operating expenses at our newly-opened property in Tampa, Florida as well as incremental costs at our
properties in Hampton, Virginia and Jeffersonville, Indiana which were not open for all or a portion of the nine months ended September 30, 2008.

Rooms expense for the nine months ended September 30, 2009 increased approximately $0.3 million or 2.7% to approximately $10.5 million, compared to rooms expense of approximately $10.2 million for
the nine months ended September 30, 2008. Rooms expense at our six same-store properties decreased approximately $1.3 million or 13.3% for the nine months ended September 30, 2009 compared to rooms expense for the nine months ended
September 30, 2008. Lower expenses as a result of 2.7% lower occupancy at our same-store properties and cost-cutting efforts put in place at all our properties were offset by rooms expenses at our newly-opened property in Tampa, Florida as well
as incremental rooms expenses at our properties in Hampton, Virginia and Jeffersonville, Indiana which were not open for all or a portion of the nine months ended September 30, 2008.

Food and beverage expenses for the nine months ended September 30, 2009 decreased approximately $1.0 million or 9.8% to approximately
$9.0 million compared to food and beverage expenses of approximately $10.0 million for the nine months ended



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September 30, 2008. Lower volumes of food and beverage sales, decreased food cost and cost-cutting at our established properties more than offset the additional cost of food and beverage
sales at our newly opened property in Tampa, Florida as well as incremental food and beverage costs at our properties in Hampton, Virginia and Jeffersonville, Indiana which were not open for all or a portion of the nine months ended
September 30, 2008.

Indirect expenses at our properties for the nine months ended September 30, 2009 increased
approximately $0.8 million or 3.7% to approximately $21.7 million compared to indirect expenses of approximately $20.9 million for the nine months ended September 30, 2008. Sales and marketing costs, franchise fees, utilities, repairs and
maintenance, insurance, management fees, real and personal property taxes as well as general and administrative costs at the property level are included in indirect expenses. Indirect expenses at our six same-store properties decreased approximately
$2.1 million or 11.3% for the nine months ended September 30, 2009 compared to indirect expenses for the nine months ended September 30, 2008. Lower expenses as a result of cost-cutting efforts put in place at all our properties were
offset by indirect expenses at our newly opened property in Tampa, Florida as well as incremental indirect expenses at our properties in Hampton, Virginia and Jeffersonville, Indiana which were not open for all or a portion of the nine months ended
September 30, 2008.

Depreciation and Amortization. Depreciation and amortization expense for the nine months
ended September 30, 2009 increased approximately $1.3 million or 28.7% to approximately $6.1 million compared to depreciation and amortization expense of approximately $4.8 million for the nine months ended September 30, 2008. The increase
in depreciation and amortization was attributable to the renovations placed in service during the latter part of 2008 at the Hilton Savannah DeSoto and the Crowne Plaza Hampton Marina, as well as the depreciation and amortization expense related to
the Crowne Plaza Tampa Westshore, which opened in March 2009.

Corporate General and Administrative. Corporate general
and administrative expenses for the nine months ended September 30, 2009 increased approximately $0.2 million or 7.7% to approximately $2.5 million compared to corporate general and administrative expense of approximately $2.3 million for the
nine months ended September 30, 2008. Higher legal costs constituted the majority of the increase in general and administrative expense.

Interest Expense. Interest expense for the nine months ended September 30, 2009 increased approximately $2.3 million or 48.3% to approximately $7.1 million compared to interest expense of
approximately $4.8 million for the nine months ended September 30, 2008, primarily due to higher levels of borrowings on the credit facility and higher levels of mortgage debt. The increased interest expense relates to borrowing used to fund
the purchase and renovations of our newly-opened or recently acquired properties in Tampa, Florida; Hampton, Virginia; and Jeffersonville, Indiana as well as renovations at the Hilton Savannah DeSoto.

Equity in Joint Venture. Equity in joint venture for the nine months ended September 30, 2009 shifted to an equity loss of
approximately $0.2 million from equity income of approximately $0.3 million for the nine months ended September 30, 2008 and 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, 2008, the joint venture was able to restructure the mortgage on the property by purchasing a $22.0 million junior participation at a price of $19.0 million resulting in a $3.0 million gain on extinguishment of debt to
the joint venture. If the joint venture had not reported any gain on extinguishments of debt for the nine months ended September 30, 2008, the Company would otherwise have reported an equity loss in the joint venture of approximately $0.5
million. The equity loss in the joint venture would have decreased approximately $0.3 million for the nine months ended September 30, 2009 compared to the equity loss in the joint venture for the nine months ended September 30, 2008. For
the nine months ended September 30, 2009, the hotel reported occupancy of 69.6%, ADR of $121.53 and RevPAR of $84.59. For the nine months ended September 30, 2008, the hotel reported occupancy of 59.0%, ADR of $154.22 and RevPAR of $90.95.

Income Taxes. The income tax benefit for the nine months ended September 30, 2009 remained constant at
approximately $1.0 million compared to the income tax benefit for the nine months ended September 30, 2008. The income tax benefit is primarily derived from the operations of our TRS Lessee. The net operating loss of our TRS Lessee for the nine
months ended September 30, 2009 was approximately the same as the net operating loss for the nine months ended September 30, 2008.

Net Income (Loss). The net income (loss) for the Company for the nine months ended September 30, 2009 shifted from net income of approximately $0.3 million for the nine months ended
September 30, 2008 to a net loss 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



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

The following table reconciles net income to FFO for the three months and nine months ended September 30, 2009 and 2008 (unaudited):



|                                                 |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |           
|------------------------------------------------ |  | ------------------------------------ | ---------- | - | ------------------------------------ | - | ---------- | ----------------------------------- |  | - | ----------------------------------- | - |  | - | ----------
|                                                 |  | Three Months EndedSeptember 30, 2009 |            |   | Three Months EndedSeptember 30, 2008 |   |            | Nine Months EndedSeptember 30, 2009 |  |   | Nine Months EndedSeptember 30, 2008
|Net income (loss) attributable to the Company    |  | $                                    | (692,813   | ) |                                      | $ | (523,773   | )                                   |  | $ | (1,175,442                          | ) |  | $ | 337,639   
|Noncontrolling interest                          |  |                                      | (371,894   | ) |                                      |   | (282,336   | )                                   |  |   | (631,031                            | ) |  |   | 181,933   
|Add depreciation and amortization                |  |                                      | 2,152,350  |   |                                      |   | 1,797,075  |                                     |  |   | 6,148,408                           |   |  |   | 4,777,680 
|Add equity in depreciation of joint venture      |  |                                      | 135,935    |   |                                      |   | 136,432    |                                     |  |   | 407,814                             |   |  |   | 409,244   
|Add/(Subtract) loss/(gain) on disposal of assets |  |                                      | 51,740     |   |                                      |   | (2,010     | )                                   |  |   | 42,870                              |   |  |   | 114,962   
|                                                 |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |           
|FFO                                              |  | $                                    | 1,275,318  |   |                                      | $ | 1,125,388  |                                     |  | $ | 4,792,619                           |   |  | $ | 5,821,458 
|                                                 |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |           
|Weighted average shares outstanding              |  |                                      | 6,964,263  |   |                                      |   | 6,939,613  |                                     |  |   | 6,962,170                           |   |  |   | 6,936,435 
|Weighted average units outstanding               |  |                                      | 3,737,607  |   |                                      |   | 3,737,607  |                                     |  |   | 3,737,607                           |   |  |   | 3,737,607 
|                                                 |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |           
|Weighted average shares and units                |  |                                      | 10,701,870 |   |                                      |   | 10,677,220 |                                     |  |   | 10,699,777                          |   |  |   | 10,674,042
|                                                 |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |           
|FFO per share and unit                           |  | $                                    | 0.12       |   |                                      | $ | 0.11       |                                     |  | $ | 0.45                                |   |  | $ | 0.55      
|                                                 |  |                                      |            |   |                                      |   |            |                                     |  |   |                                     |   |  |   |           

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. We expect that the net cash provided by operations will be adequate to fund our continuing operations, debt service 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.

Cash flow used in operating activities for the nine months ended September 30, 2009 was approximately $0.6 million. Approximately $1.1 million of cash was used to establish working capital for and
pay pre-opening expenses associated with the opening of the Crowne Plaza Tampa Westshore as well as fund the initial losses related to the propertys opening.

Investing Activities. Approximately $8.3 million was spent during the nine months ended September 30, 2009 on renovations and capital improvements. Approximately $2.3 million was spent on
renovations at the Hilton Savannah DeSoto and the Crowne Plaza Hampton Marina in order to bring those projects to completion. Approximately $5.0 million was spent on renovations at the Crowne Plaza Tampa Westshore, which opened in March 2009. To
date, we received reimbursements from our restricted reserves for replacement of furniture, fixtures and equipment of approximately $2.5 million.

Financing Activities. During the nine months ended September 30, 2009, we borrowed a net $5.6 million on our credit facility and $0.7 on the mortgage on the Crowne Plaza Hampton Marina in
order to fund the investing activities discussed above, as well as provide working capital. We also borrowed $4.75 million from the Carlyle Affiliate Lender for the purpose of improving liquidity.

Capital Expenditures

Since mid-2004, we have completed product improvement plans (PIPs) in connection with the licensing or re-licensing at eight of our nine 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 March 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



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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 will be funded by our replacement reserve accounts, other than costs that we incur
to make capital improvements required by our franchisors. With respect to three 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 both the Hilton Savannah DeSoto and Hilton Wilmington Riverside and 4.0% of room revenues for the Crowne Plaza Jacksonville Riverfront. Our intent for the capital expenditures at all hotels is to maintain overall capital
expenditures at 4% of gross revenue.

Liquidity and Capital Resources

As of September 30, 2009, we had cash and cash equivalents of approximately $5.3 million, of which $0.8 million was in restricted
reserve accounts and real estate tax escrows. As of September 30, 2009, our revolving credit facility, under which we may borrow up to $80.0 million, had an outstanding balance of approximately $78.7 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, as well as scheduled payments of principal and
interest.

In light of the tightening of the credit markets and the weakness in the economy that began in 2008, we undertook
several measures to enhance our liquidity position earlier this year. On February 9, 2009, we borrowed $4.75 million from the Carlyle Affiliate Lender. We also amended our credit agreement with BB&T, as administrative agent and lender. We
amended our agreement in February 2009 to, among other things, ease our total leverage ratio test by increasing our total maximum permitted leverage from 55.0% to 62.5% of the total value of our assets and establish new methodologies for valuing
certain of our hotel properties through April 2010. We also sought to improve our liquidity position by adding our hotel property in Laurel, Maryland to the credit agreements collateral pool against which we may borrow. The amendment also
resulted in a modification of our dividend policy limiting our annual dividend distribution level to 90% of taxable income, consistent with the level necessary to maintain our REIT status until certain liquidity thresholds within the credit
agreement are met. We entered into a subsequent amendment in May 2009, which modified the tangible net worth covenant with which we must comply. This amendment permits us to pay with respect to a given fiscal year a dividend in an amount minimally
necessary to maintain our REIT status, provided that no dividend may be paid during the first three quarters of such fiscal year. We anticipate the amount of such a dividend will remain at 90% of taxable income. Notwithstanding this limitation, we
were permitted to pay the dividend declared on or about April 20, 2009. If certain liquidity thresholds and other conditions are met, we may be able to declare and pay additional cash dividends in any fiscal year.

Our ability to maintain existing levels of debt on our credit facility is dependent on our ability to comply with the loan-to-value
requirements of the credit agreement as well as the various financial covenants. The loan-to-value requirements of the credit agreement as well as the leverage covenants contemplate valuations of our encumbered properties based on varied
methodologies. Established properties that have not undergone renovation are valued at a multiple of their operating margin. For encumbered properties that have undergone renovation, especially those for which we are employing a
deep-turn strategy, the value of such properties is fixed during the construction and ramp-up phases, after which time such properties will be valued in a similar manner to other established properties. The ramp-up phase for
our three recently renovated properties will end in April 2010. 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 minimum levels of net worth. In addition, our credit agreement imposes limitations on our ability to incur
additional debt.

The general economic slowdown has significantly affected both our cash flows and operating profits and
curtailed the margins by which we satisfy the loan-to-value requirements as well as various financial covenants. During the third quarter 2009, lower levels of operating profits at the properties securing the credit facility obligated us to reduce
the outstanding balance on the credit facility by $0.75 million in order to comply with the loan-to-value requirements. We project that we will be required to make additional payments over the next four months ranging from $2.3 million to $3.3
million in order to remain compliant with the loan-to-value requirements. In order to improve our current working capital position, we are currently undertaking a rights offering which, if fully subscribed, will generate net proceeds of
approximately $6.7 million.

Should the current economic slowdown and weakness in the lodging industry intensify and further
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
significant payments on all or a portion of the outstanding debt. We also may be required to make significant payments should our recently renovated properties not realize sufficient operating performance to meet the loan-to-value requirements or
comply with financial covenants once their ramp-up phase is complete.



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We believe that as the economy nears the bottom of the economic cycle and begins to recover,
there will be numerous opportunities to acquire properties at attractive prices. However, with the constraints of the covenants in the credit agreement, we have limited, if any, ability to incur additional debt in order to take advantage of such
opportunities. Given the prospect of a required reduction in our leverage and the potential for attractive acquisitions emerging from the current economic downturn, we intend to pursue additional equity financing in the future to enable us to take
advantage of such opportunities as well as enable us to make a significant payment on our credit facility, if necessary. However, should an equity offering not be successful, we may not be able to raise capital to replace or repay our credit
facility if necessary. Sources of additional capital to fund any required reductions in the amount outstanding on the credit facility or to acquire additional properties may include a combination of some or all of the following:



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



| |  |  | 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.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Beyond the funding of any required principal reduction on our existing credit facility 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 some or all of 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;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The incurrence by the subsidiaries of the operating partnership of mortgage indebtedness in connection with the acquisition or refinancing of hotel
properties;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | The issuance of additional units in the operating partnership;
| | - |  | --------------------------------------------------------------



| |  |  | The selective disposition of 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 contributions.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Based on current market conditions, we anticipate that our available cash and cash equivalents and cash flows from operating activities, with cash available from borrowings and other sources, will be
adequate to meet our capital and liquidity needs in both the short and long term. However, if these sources of funds are insufficient or unavailable, our ability to satisfy cash payment obligations and make stockholder distributions may be adversely
affected.

Dividend Policy

In December 2008, in the interest of capital preservation within the current economic environment, and based on the expectation that the U.S. economy, and in particular the lodging industry, will continue
to face declining operating trends through 2009, we amended our dividend policy. We have since entered into two amendments to our revolving credit facility which impose additional restrictions on the timing of the payment and the amount of cash
dividends but permit us to pay, with respect to a given fiscal year, that amount of cash dividends necessary to maintain REIT status, providing certain conditions are met before additional distributions can be made. We are permitted to pay with
respect to a given fiscal year a dividend in an amount minimally necessary to maintain our REIT status; provided that no dividend may be paid during the first three quarters of such fiscal year. We anticipate the amount of such a dividend will
remain at 90% of taxable income. If certain liquidity thresholds and other conditions are met, we may be able to declare and pay additional cash dividends in any fiscal year. This may result in a reduction in the level of dividend payouts compared
to the level of dividend payments we have made in recent years.



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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 directors, including, among other things, the Internal Revenue Codes annual distribution requirements, 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 Carlyle, we own a 25.0% indirect non-controlling interest in an entity (the JV Owner) that owns the
311-room Crowne Plaza Hollywood Beach Resort in Hollywood, Florida. We have the right to receive a pro rata share of operating surpluses as well as an obligation to fund our pro rata share of operating shortfalls. We also have the 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 equity interest. Adjacent to the Crowne Plaza Hollywood Beach Resort is a three-acre hotel development site that is leased by a
joint venture entity. The lessee, in which we 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 Hollywood hotel. The purchase option expires in August
2011 and allows the site to be purchased for fair market value as determined by independent appraisal, but not less than $5.0 million or more than $10.0 million. Carlyle owns a 75.0% controlling interest in this entity as well as the JV Owner and
the Joint Venture Lessee. 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 both the JV Owner and the Joint Venture Lessee under the equity method of
accounting.

The acquisition of the Crowne Plaza was funded in part by a mortgage loan in the amount of $57.6 million. The
mortgage, which originally had a two-year term maturing on August 1, 2009, was restructured on June 13, 2008 so that the first $35.6 million bears interest at a rate of LIBOR plus additional interest of 0.98%. The remaining $22.0 million
bears a rate of LIBOR plus 3.50%. Upon the restructure, another 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 has been extended until August 1, 2010
and can be extended for two additional one-year periods, pursuant to certain terms and conditions. Monthly interest-only payments are due throughout the term. The Crowne Plaza Hollywood Beach Resort secures the mortgage. We have provided limited
guarantees to the lender with respect to this mortgage.

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 the 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. We expect that the Crowne Plaza Tampa Westshore will also be strong during this same period. The remaining months are generally good, but are subject to the 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 we
have adopted are described below. We consider these policies critical because they involve difficult management judgments and assumptions, are subject to material change from external factors or are pervasive, and are significant to fully understand
and evaluate our reported financial results.

Investment in Hotel Properties.Hotel properties are stated at cost, net
of any impairment charges, and are depreciated using the straight-line method over an estimated useful life of 7-39 years for buildings and 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



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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.

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, 2009 or 2008.

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, 2009. 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;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  |  | 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 real estate investment trusts.
| | - |  | --------------------------------------------------------------------------------------------------------------

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 prices 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. Our credit facility required us to hedge at least one-half of the maximum borrowing amount with an
interest-rate swap, which we purchased on August 8, 2006 on a notional amount of $30.0 million. As of September 30, 2009, derivatives with a fair value of approximately $(1.3) million were 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
these derivative contracts for trading or speculative purposes.

As of September 30, 2009, we had approximately $63.8
million of fixed-rate debt and approximately $92.4 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  to the extent that the 30-day LIBOR exceeds 4.75%  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 August 8, 2006. 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 $92.4
million, the balance at September 30, 2009, the impact on our annual interest incurred and cash flows of a one percent change in 30-day LIBOR, which was 0.246% on September 30, 2009, would be approximately $624,000.

As of December 31, 2008, we had $64.0 million of fixed-rate debt and approximately $81.4 million of variable-rate debt. The weighted
average interest rate on the fixed-rate debt was 6.66%. At that date, our variable-rate debt was exposed to changes in interest rates, specifically the change in 30-day LIBOR, but was limited to the effect on our mortgage on the Crowne Plaza Hampton
Marina and the gap between the balance on the credit facility and the $30.0 million notional amount of the interest-rate swap. Had the amount outstanding on our mortgage on the Crowne Plaza Hampton Marina and the amount outstanding under the credit
facility remained at approximately $81.44 million, the balance at December 31, 2008, the impact on our annual interest incurred and cash flows of a one percent change in 30-day LIBOR would have been approximately $514,000.



|Item 4T. | 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.



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As of September 30, 2009, 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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##### Table of Contents

PART II



|Item 1. | Legal Proceedings
|------- | -----------------

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



|Item 1A. | Risk Factors
|-------- | ------------

There have
been no material changes in our risk factors from those disclosed in our most annual report on Form 10-K for the year ended December 31, 2008.



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

Not applicable.



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

Not applicable.



|Item 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------

None.



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

None.



|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: October 30, 2009 |  | By:                         |  | /S/    ANDREW M.
SIMS                            
|                       |  |                             |  | Andrew M. Sims                                   
|                       |  |                             |  | Chief Executive Officer and Chairman of the Board
|                       |  |                            
|                       |  | By:                         |  | /S/    WILLIAM J.
ZAISER                         
|                       |  |                             |  | William J. Zaiser                                
|                       |  |                             |  | Chief Financial Officer                          



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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).
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



33