Tax Change Could Spur Foreign Buyers

NEW YORK CITY-A proposed change in the taxation of foreign investors’ capital gains from real estate could generate even more interest from overseas than the market is already seeing, says real estate advisor Savills US. This occurs as major domestic players have begun competing for deals.

With competition for core properties on the rise, 2010 will be remembered as the start of the recovery, says Borja Sierra, executive managing director of New York City-based Savills US. “How else can you explain this ‘who’s who’ roster of investors that are back in the market looking to buy both assets and portfolios on US soil?” Sierra adds that if new legislation is passed to lighten the tax burden on foreign investors buying into the US market, “this should also drive increased demand.”

That pending legislation, the Real Estate Revitalization Act of 2010, was introduced by Rep. Joseph Crowley (D-NY) in January. It’s intended to amend the Internal Revenue Code of 1986 to modify the treatment of foreign investments in US real property. Currently, those investments are governed by the Foreign Investment Real Estate Property Tax, which imposes a levy of up to 55% on on any capital gains realized from the sale of US commercial property or shares in REITs and real estate operating companies.

The levy under FIRPTA is not always as high as 55%, Savills’ John Lyons tells GlobeSt.com. He adds, “There are situations where specific treaties reduce the amount of the tax or make the tax not applicable.” Even so, RERA is meant to encourage foreign investors, “especially at a time when we want as much foreign capital to come into this country as possible.”

RERA or no, foreign investors are casting a more eager eye on domestic commercial assets, says Lyons, CEO and president of Savills US. “They believe the US property market has probably hit bottom,” he says. “Depending on the asset class and location, values are down anywhere from 25% to as high as 40% from their 2007 peaks.”

Another reason is the relative weakness of the dollar against foreign currencies. Although lately it has strengthened somewhat, “on a historic basis, the dollar is still very low,” says Lyons. “So foreigners are buying with their stronger currency into a very weak currency.” Moreover, real estate has provided “a much higher yield” when compared to other risk-adjusted vehicles such as Treasuries.

There’s also foreign investors’ desire to diversify their portfolios, and that extends to would-be buyers whose holdings aren’t necessarily concentrated in real estate. Lyons says Savills has seen capital from both Asia and Latin America “which has been amassed through a number of alternative businesses: retail, cable, chips. They’re looking to diversify their holdings into different categories, and real estate, let alone US real estate, represents the gold standard.”

Interest is also being juiced due to the higher profile maintained lately by blue-chip companies such as Sam Zell’s Equity Residential, which bought three Macklowe Properties apartment towers for $475 million, and the competition for control of the General Growth Properties portfolio. “Any time you see more capital coming into the market, it raises interest from other potential investors,” says Lyons. “They want to know what’s going on and what they could be missing out on.” The same dynamic applies when high-profile foreign entities, such as sovereign wealth funds and China Investment Corp., are getting involved domestically.

“There’s been a limited amount of product on the market,” Lyons says. “So the competition for those few assets has been very intense. You’re seeing multiple bids and increased pricing on highly sought-after properties. It will be interesting to see how much appetite there will be when more product comes out and there’s greater stratification among class A, B and C.”