The Counselors of Real Estate
International Perspective September 2013
Market Competition and Tax Law Changes Expand Foreign Interest into Secondary US Real Estate Markets.
The demand for United States real estate remains robust amongst foreign buyers; year to date, foreign investors have acquired $22.8 billion in US real estate, accounting for approximately 13.0% of total real estate transactions in the US as compared to just over 9.0% in 2012, according to Real Capital Analytics. Canada was the largest buyer of US real estate assets over the past three years. China and Middle Eastern countries are stepping up their purchases of US real estate assets as well.
According the Association of Foreign Investors in Real Estate (AFIRE), the United States is the preferred country of choice by foreign real estate investors because it is perceived to provide a stable environment in which to invest and is the best market for capital appreciation. The preferred property types include multi-family rental housing, industrial assets, retail, office, and hotels. According to the survey by AFIRE, 81.0% of the survey respondents replied that they intend to increase their portfolio of assets in the United States.
Approximately 71.0% of AFIRE members surveyed noted that they believe economic fundamentals had improved to the point that make secondary cities (as opposed to “core” gateway cities) in the United States worth looking at for new real estate acquisitions. To date, many foreign investors have shied away from secondary US markets due to their relatively weaker economic base and/or the lack of strong asset appreciation. Improving economic conditions in these markets, as well as proposed changes to the Foreign Investment in Real Estate Tax Act of 1980 (FIRPTA), could enhance foreign purchases of real estate in these markets.
FIRPTA is a United States tax law that imposes an income tax on foreign entities selling real estate in the United States. The law requires that the buyer of the asset owned by a foreign entity withhold 10.0% of the sales price to ensure collection from foreign sellers of US properties. Prior to the enactment of this legislation, foreign entities were exempt from taxes on the sale US real estate assets.
President Obama recommended changes to the tax law earlier this year to make investment in US real estate more attractive to foreign investors. The specific legislative changes being proposed would eliminate the 10.0% withholding requirement on foreign pension funds, while other foreign entities would still be subject to the tax. The ability to achieve the full proceeds from a property sale by a foreign pension fund would be strong incentive to enhance investments.
The proposed changes in the legislation could benefit foreign real estate investments in secondary United States markets. To date, foreign real estate investment activity has been concentrated in the core “gateway” metropolitan areas of the United States. According to AFIRE, their members rank New York, San Francisco, Washington DC, and Houston as the top cities for foreign real estate investment. Because of the intense demand for residential and commercial properties in these core markets from both domestic and international investors, prices have been rising significantly and investment yields continue to be compressed. As a result, foreign investors are now looking into “secondary” markets in search of high quality real estate assets that provide a relatively better yield when compared to those that can be achieved in core, gateway markets. The elimination of the 10.0% withholding tax on foreign pension funds would go a long way in encouraging these institutions to invest in secondary markets because, at present, the 10.0% withholding tax could, in some instances, exceed the entire gain on the sale of the asset because the rate of property appreciation is relatively lower in secondary markets.
At this time, it is not clear as to whether the proposed changes to FIRPTA will be passed by Congress. Nonetheless, there are indications that some foreign investors are already seriously interested in investing in markets outside of New York, San Francisco, Washington DC, and Houston. A confidential interview was held with a German real estate investment fund that noted they were actively seeking to acquire assets outside of the core markets in search of higher yields; they noted that they are evaluating markets in Texas because that state generates more jobs than any other state in the country. Seattle has also been attracting foreign investors as evidenced by Canada’s Caisse de Depot’s acquisition of Wells Fargo Centre in Seattle.
In summary, the market for United States real estate continues to remain strong among foreign investors. In the near term, it is highly likely that there will be a continued interest by foreign investors in core markets; however, the real story to be told is the shift in foreign capital to well positioned secondary markets in the Unites States as economic fundamentals improve, and in particular if the proposed changes to FIRPTA are enacted.
The External Affairs Committee welcomes feedback on these issues as well as identification of issues you think are critical to real estate and/or of interest to Counselors and the broader industry.