Foreign Investors Eyeing US Real Estate
Foreign Investors Meeting in Cannes, but Eyeing US Real Estate
Sam Chandan PhD FRICS Real Capital Analytics and the Wharton School Even while congregating in Cannes for this week's MIPIM conference, foreign investors remain keen on acquiring high-quality assets in the most liquid US real estate markets. In the 18th annual Foreign Investment Survey of the Association of Foreign Investors in Real Estate (AFIRE), released in mid-January, 51 percent of survey participants identified the United States as the market offering the best opportunity for long-term capital appreciation. Markedly higher cap rates than in Europe and Asia have enhanced perceptions of the US value opportunity, pushing the Survey's positive response rate to its highest level since 2003. In 2006 and 2007, in contrast, when domestic cap rates were at their cyclical lows, only one in four respondents identified the United States as the leading market for capital appreciation. Legislative Support for Foreign Investors In a departure from the negative perceptions of Japanese investment in decades past, foreign investors in commercial real estate are finding support in Washington DC. According to the Senate Office of Public Records, the Coalition to Reform the FIRPTA of 1980 spent half a million dollars on lobbying activities in 2009. House Resolution 4539, the Real Estate Revitalization Act of 2010, was introduced on January 27 and subsequently referred to the House Committee on Ways and Means, where it now sits. The proposed act seeks to eliminate the Real Property Holding Corporation provisions of FIRPTA and to treat REIT capital gains and liquidating distributions to foreign investors as ordinary income. As part of its soon-to-be-refreshed 2009 policy agenda, the Real Estate Roundtable (RER) includes revisions to the 1980 Foreign Investment in Real Property Tax Act (FIRPTA) among its key objectives. Under FIRPTA's current provisions, foreign entities are subject to taxes on gains from the sale of US real estate assets. The Roundtable points out the distinct treatment of real estate in this regard: "Unlike all other asset classes, this protectionist tax provision creates a disincentive for non-US investors to invest in US commercial real estate. With a few technical exceptions, FIRPTA is literally the only major provision of U.S. tax law which subjects non-US investors to taxation on capital gains realized from investment in US assets." Putting FIRPTA in Perspective This past December, Martin Neil Baily (the Brookings Institution) and Matthew Slaughter (Dartmouth College) - both of whom have served on the Council of Economic Advisors - released their own analysis of FIRPTA's impact on investment inflows. In their report, entitled "How FIRPTA Reform Would Benefit the US Economy," the authors recommend reforming the current system: "... outright repeal or, less dramatically, an initial holiday could be implemented: e.g., declare that new foreign investments in US commercial real estate over the next five years would be exempt from FIRPTA. We think that the sizable economic benefits of reforming FIRPTA would exceed the small fiscal costs it would entail." The basic notion that a relaxation of FIRPTA will, all things being equal, enhance the returns to foreigners' investments in the United States is sound. Taxes on commercial real estate gains will undoubtedly impact the attractiveness of US investments. In practice, however, it is difficult to quantify the negative impact of FIRPTA or to conjecture that its repeal would open the floodgates to foreign capital inflows. There is every reason to think that other issues dominate investment outcomes and that FIRPTA only contributes on the margin. It is apparent that foreign investors find the American market attractive in spite of FIRPTA. And as long as investors maintain a positive discount rate, the discounted valued of the tax impediment will diminish as the anticipated asset sale moves further into the future. For Foreign and Domestic Investors Alike, an Absence of Product Where they have failed to bring more dollars into the US, foreign investors are more likely to cite an absence of investment opportunities than the tax code. AFIRE Chairman Werner Sohier describes foreign investors' conundrum as follows: "Although foreign investors expressed every intent to resume investing in 2009, like everyone else, their plans were sidelined by a paralyzed marketplace with no precedent and limited investment opportunities." And so, while efforts to level the tax code certainly deserve our industry's support, we can afford to be cautious in our conjectures about the impact of a change. According to AFIRE, foreign investors will increase their activity in the US market in 2010, even in the absence of changes to FIRPTA: "investors say they plan to increase US allocations above 2009 levels by 62 percent for equity and 83 percent for debt; at least half the survey respondents report a stronger appetite for both debt and equity investments in the US than in other countries." Even so, because foreign investors typically direct their capital to just a handful of cities - New York, Washington DC, San Francisco, Boston, and Los Angeles among them - many of the metropolitan areas that are most starved for capital will remain wholly dependent on domestic investors and lenders.