Recent changes in the federal spending bill could result in more foreign investments in U.S. commercial real estate, thereby putting global companies and pension funds on more equal footing with their counterparts in the United States.
Exploring the Law Change
In December, changes to the federal spending bill resulted in changes to the Foreign Investment in Real Property Tax Act. Signed into law by President Obama on December 18th, the Protecting Americans from Tax Hikes Act of 2015 includes changes to those tax laws that are relevant to real estate, private equity and mutual fund managers and investors. These changes affected the Foreign Investment in Real Property Tax Act by creating new exemptions for qualified non-U.S. pension funds. This is a major departure from the prior law, though these pension funds will still be subject to U.S. federal taxes.
The new act also increases the percentage of publicly-traded stock that a non-U.S. investor can hold in a public REIT from 5 percent to 10 percent. Even if this limit is exceeded, the new act provides an exemption for certain publicly-traded entities that are treaty-eligible. The act also increases the rate of tax withholding on properties held by non-U.S. investors from 10 percent to 15 percent. As a result of these changes, foreign investment in commercial real estate in those markets and sectors that are already experiencing record-breaking valuations is expected to increase.
The Effects of the Changes
During the fourth quarter of 2015, foreign direct investment in U.S. commercial real estate increased to $87.2 billion. This increase is nearly four times what the market saw just four years ago. Furthermore, foreign direct investment skyrocketed to the highest monthly level on record this past December, which most experts believe to be a sign that foreign investors started to take advantage of the new tax changes immediately.
While the changes do seem to have resulted in a surge of commercial real estate activity, some are concerned that the increase in foreign capital could elevate valuations in such a way that it crowds them out. Some investors are even concerned that a bubble may be developing within those markets that are preferred by foreign investors. Among those markets that have been particularly attractive to foreign investors of commercial property include Boston, Chicago, Los Angeles, Manhattan and Washington, D.C. Foreign investors have also been showing an increased interest in industrial properties, with those areas that have drawn the most attention being Chicago, northern New Jersey, Seattle, Los Angeles and California’s Inland Empire. Office submarkets favored by foreign investors are Chicago’s City West, Fort Worth’s Northwest and Rincon/South Beach in San Francisco.
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(all data current as of 11/20/2017)
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