Cross-Border Buyers Hungry for US Distressed Properties

As the industry gears up for more transactions to hit the market over the next six to 12 months, another buyer class is emerging to take advantage of the distressed market Foreign investors are said to be showing a strong interest in the US, and a few have even pulled the trigger on select deals. Meanwhile, plenty of others are stockpiling their war chests to pounce once properties start trading. Cross-border buyers have accounted for no more than 9% of US commercial acquisitions over the past decade. And in this global recession, their market share has fallen by roughly half that, according to New York City-based Real Capital Analytics. But brokers are reporting significant interest from foreign buyers as distressed assets continue to stack up.

"Foreign players are certainly one of the growing classes of investors," says Steven E. Pumper, executive managing director for Transwestern in Houston. "There's an increasing sentiment to invest here and they will start buying in the next year."

Thomas A. Fink, senior vice president and managing director of Trepp LLC in New York City, notes, "A number of our clients and people in the industry who work for foreign investment vehicles are gearing up for a higher level of activity in the US market."

So far this year, there has been a small amount of activity by crossborder buyers. Back in August, Canadian firm Condo-Condo Holdings picked up the Biltmore Palms, a 37-unit condominium in Phoenix, from Corus Bank for $4 million. In the same month, another Canadian buyer, Nash and Chinder Gill, paid $2 million to Bankers Bank for the 170-room Park Plaza Hotel in Oshkosh, WI. And earlier in the year, the Whitney, a 141-unit apartment complex in West Palm Beach, FL, traded for $24 million to ABG Sundal Collier, a Norwegian firm.

Other buyers are amassing funds to take advantage of the deals when they come on the market. China Investment Corp., a $300-billion sovereign wealth fund from China, for example, is raising a fund to acquire distressed US real estate, according to the Wall Street Journal. CIC is said to be eyeing mortgage securities backed by office buildings, hotels, strip malls and other classes of real estate.

"While it may not be of the same scale as we experienced through 2007, there is a sense that some markets are at, or close enough to, the bottom and investors, both foreign and domestic, are getting interested," says Robert J. Hellman, managing director of real estate in the Dallas office of David Landau & Associates, LLC. "My sense with regard to foreign investors is that first we will see all-cash buyers, such as sovereign wealth funds or the China Investment Corp., and perhaps foreign pension funds that have not had their allocations disrupted like many of the US funds. Debt financing remains problematic for private investors, foreign or domestic." Meanwhile, some foreign owners of US properties have found themselves on the troubled end of the distressed asset quagmire. One Federal St., a 1.1-million-square-foot office tower in Boston owned by a joint venture between Tishman Speyer and the Abu Dhabi Investment Authority, a sovereign wealth fund from the United Arab Emirates, has been identified as a potentially distressed asset by RCA, citing ownership bankruptcy problems. The asset was acquired in '06 for $514 million.

Cross-border investors here have some distinct advantages over domestic entities, including the drop in value of the US dollar. "Cash is king, and foreign investors, particularly sovereign wealth funds and their ilk, hold lots of dollars they have to invest somewhere, and US real estate may look like a good buy," Hellman says. "There may also be tax advantages not available to domestic investors. Finally, if the dollar weakens relative to other currencies, as some analysts seem to indicate, US assets will become even cheaper vis-a-vis foreign investors."International buyers may also have a holding advantage over US players, says Fink. "Some of these foreign funds have a more long-term view on when these assets have to return value," he says, noting that REITs, for example, have quarterly and annual profit pressures to return yields. "They're [foreign investors 1 more patient with capital."Yet they may face competition on hat front from US pension funds and sheltered vehicles, which also tend to have longer holding patterns, he explains. "The main advantage you'll see is that some of these institutions don't have a mark-to-market requirement in terms of their financial measures," Fink says. "It effectively doesn't influence their buy-sell decisions."

As for the tax advantage, if carefully planned, their investments could face minimal US income tax, according to Dorothy L. Alpert, national managing director of real estate, hospitality and construction for Deloitte LLP. "Foreign investors' income is broadly subject to US Federal income tax in cases of ECI, income generated in connection with a US trade or business," Alpert wrote in a column in the May/June issue of Real Estate Forum. "There's an exception to the law where trading in stocks or securities, including debt instruments, is concerned. Foreign investors could structure their real estate debt investments to take advantage of this statutory exemption from ECl."While interest income received by a foreign investor from a US debtor is generally subject to a 30% gross basis withholding tax, many treaties can reduce this tax significantly and can even eliminate it for qualified residents of the treaty country, she added.

The key to success for cross-border investors is finding the right local partner. A partner that is experienced both geographically and by asset class, has a strong reputation in the market and is well-capitalized is best, Hellman says. One key change this time around and just another hurdle for investment is that the boards of these foreign vehicles will be making the final acquisition decisions. "They won't just give managers X numbers of dollars," Fink says. "Final investment decisions are being retained by folks at various foreign opportunity and sovereign wealth funds." Overseas players' appetite for distressed assets is expected to focus on the gateway coastal cities and the top US markets, including Manhattan, Los Angeles, San Francisco, Boston, and Washington, DC. There may also be some interest in Chicago, Miami and Seattle. Pumper thinks some cross-border players may tap into some Sunbelt markets as well, since those are the areas that are expected to do well with job growth. The types of assets set to attract foreign money are office, multifamily, possibly industrial and retail, when it rebounds. So far this year, office has been the largest draw for cross-border buyers accounting for 12% of all office deals by volume, although the number of properties acquired has been very small, according to an August report by RCA. Surprisingly, the lodging sector, which has spooked many US investors because of its volatility, has accounted for 9% of properties that have gone into foreign players' portfolios. But as with the office sector, the number of assets that have been acquired has been small. Retail, at its peak, attracted about 20% of cross-border activity here. This year, there have only been two international buyers in the sector, representing just three deals.

Everyone is watching the multifamily market as it has started to show an uptick in investment activity. The sector accounted for about 5% of cross-border deals this year. And industrial, which has never been a very strong draw for foreigners, has seen virtually no activity in that regard, according to RCA.

Investments are expected to pick up early next year, as more property holders and lenders will be forced to sell at the same time that investors prune their portfolios of non-strategic assets. Investors are evaluating the market and will be poised to be buyers by the second quarter or six months into 2010. As Pumper relates, "It'll be a once-in a-lifetime opportunity to buy core New York City real estate valued at $1,000 per square foot for $500 a foot."

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