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CRE Finance World, Winter 2014

Japanese investors have been active in U.S. real estate since the 1980s. They first invested in flagship properties in primary markets, which were often purchased at peak prices. Many Japanese investors experienced very public real estate losses as the market waned and liquidity diminished (including record losses after the purchase of Rockefeller Center). Currently, the Japanese prefer to invest in REITs for their high levels of transparency, liquidity, and opportunity for appreciation. Japanese investors generally prefer to commit larger sums of money to an investment platform. When it comes to overall capital commitments in the U.S., however, China is quickly exceeding its neighbors. A tremendous amount of capital belonging to Chinese businesses sits offshore in US and Hong Kong currencies. Much of this capital will not be brought back, since Chinese investors often prefer to keep their international business profits abroad rather than repatriate funds. This tendency reflects a desire for both diversification and capital preservation (Henri Arslanian. UBS Hong Kong. May 17, 2012.) Chinese investors will consider US real estate for several reasons. First, there is a shortage of real estate investment opportunities in their country. Second, many Chinese investors consider real estate, as an asset, to be a wealth creator. They are especially comfortable investing in residential real estate, a more common investment alternative in China. In investing in U.S. and similar economies, these investors are deploying profits from their high-growth economy into assets that are part of more mature economies. This strategy highlights conflicting investment perspectives. While investors in mature economies typically view real estate as a hedge against inflation, investors from emerging economies will examine real estate opportunities as potential wealth creators, sources of income rather than value-preservation. Because Chinese investors are relatively new to international real estate investment, they are still developing familiarity with U.S. markets. This general lack of familiarity may limit Chinese investors’ in secondary markets. It also leads to an abundance of caution. In Asia, businesses are often driven by close relationships. Most businesses start as family businesses and evolve into larger enterprises. The emphasis of relationships, of trust, informs Chinese investment decisions as well. Regardless of an opportunity’s transparency, it seems, many Chinese investors will spend a tremendous amount of time getting to know the opposite party. They must develop mutual trust and respect before any contract is signed. When it comes to foreign investments, Chinese investors are cautious about taxes, and may prefer strategies that limit tax liabilities. For example, they are extremely conscious of the United States’ FIRPTA policy (Ian Gobin, Appleby Global) and will often make CRE Finance World Winter 2014 76 use of BVI (offshore) financial structures. In general, they seem to prefer stand-alone investments over co-mingled funds. Challenges to Foreign Investment in the U.S. When pursuing potential foreign investors, there are several considerations that principals must anticipate. First, principals must understand the necessity of educating a prospective investor about their organization, specific asset class, and submarket — the ways and means of value creation. In exploring the possibility of investing in U.S. real estate, an investor will bring a host of preferences — many unwarranted — with regard to location and property types based upon their own experiences or second-hand accounts of investment activities. The second and most significant challenge concerns the U.S. Tax code as it pertains to foreign capital. Specifically, the Foreign Investment in Real Property Tax Act, which was passed in 1980. Popularly known as “FIRPTA,” this law allows the IRS to tax foreign investors’ U.S. real estate investments upon their disposition. The tax law treats all gains from the sale of U.S. real estate as income derived from U.S. trade or business. If the seller of real estate in the U.S. is a foreign person, the buyer must withhold a tax equal to 10% of the gross purchase price at sale. This law applies to all direct and indirect real estate investment interests, (“FIRPTA Made Simple.” Association of Foreign Investors in Real Estate (AFIRE) 2011). Also subject to FIRPTA laws are foreign interests in REITs, sales of interests in real property, and shares in certain U.S. corporations whose underlying assets are real property. The Foreign Capital “Marriage” The decision to buy and sell real estate, however, is time-consuming, costly, and intimately involved just like a marriage. As in any marriage, it is best to choose a spouse whose values and goals are aligned with your own. When considering foreign capital, a principal needs to identify potential investors whose strengths and competitive advantages appropriately match the principal’s own interests. Foreign capital may not be an appropriate choice for every organization. Remember, domestic sources of private and public capital are extensive, and many investors and institutions are gradually increasing their allocations to the investment class. In the quest to diversify capital sources, examining the perspective, risk tolerance, return expectations, and other attributes from foreign investors requires additional attention by an operator in order to develop a mutually successful relationship. In comparing international capital to domestic capital in U.S. real estate, there are several noticeable trends. First, European investors are gradually pulling back their commitments, as they shift capital home. Second, Asian investors are increasingly invested in U.S. The Foreign Capital Marriage: Prenuptial Considerations


CRE Finance World, Winter 2014
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