The US has become more popular with European investors but protectionism - or the perceived threat of protectionism - will stem foreign investment in US real estate just when it is most needed. Sam Chandan reports
Following their financial crisis hiatus, cross-border investors have signalled a new readiness to pursue aggressively opportunities to acquire assets on the global stage. For many of these investors, the fragile global recovery, and the buffeting of that recovery by new geopolitical and macroeconomic shocks, has re-emphasised the appeal of diversifying across the most liquid and stable markets in western Europe, the Americas, and the advanced economies of Asia Pacific.
At the same time, the search for yield has necessarily pushed more risk tolerant investors farther afield, principally to Asia-Pacific's rapid-growth and investment-hungry emerging economies. Across this array of destinations, cross-border acquisitions of significant commercial properties measured $37bn (€24.7bn) in the fourth quarter of 2009, representing roughly 17% of all activity. That amount represents a near four-fold increase over the $10bn in cross-border sales at the nadir of global capital flows in the first quarter of 2009.
Shifting foreign investment policies
Apart from the currency and repatriation risks that layer on top of investment considerations in the domestic environment, investors seeking to acquire properties abroad have also had to contend with shifting attitudes towards foreign investment inflows. Where policymakers have adjusted the legal or regulatory context of cross-border investment or have sought to dampen the inflationary impact of capital market imbalances, foreign investors are apt to encounter barriers to acquisitions or an erosion of returns on current investments. In many emerging markets, protectionism may take the form of explicit limits on foreign property ownership. In the advanced nations, disincentives to cross-border investment may be subtler but are nonetheless a feature of many markets.
In the two largest commercial property markets, the US and China, current policies towards foreign investment are diverging, reflecting very different stages of the market cycle. In China, where policymakers have taken increasingly aggressive steps to curb speculation and rising land and property values, the avenues of access for foreign investors and lenders are far fewer than before. In this regard, China is the exception, however.
For the economies hardest hit by the financial crisis, relative shortfalls of capital outside of primary markets have forced new thinking about the efficacy of cross-border investment. In the US, the change in orientation is apparent in prospective adjustments to the 1980 Foreign Investment in Real Property Tax Act (FIRPTA), which has served as a disincentive to foreign investment in American properties and real estate investment trusts.
With property investment outside of major US markets still well below its historical norms, foreign investors seeking to invest in American property are finding new support in policy circles. The Real Estate Roundtable, a leading industry group based in Washington, DC, includes revisions to FIRPTA among its key policy objectives and has met with some success on the legislative front. Under the act's provisions, foreign entities are subject to taxes on gains from the sale of US real estate assets.
According to the Roundtable: "Unlike all other asset classes, this protectionist tax provision creates a disincentive for non-US investors to invest in US commercial real estate. With a few technical exceptions, FIRPTA is literally the only major provision of US tax law which subjects non-US investors to taxation on capital gains realised from investment in US assets."
Of course it is because FIRPTA's disincentive is perceived as effective, either in mitigating foreign investment or in bolstering the protectionist credentials of its legislative sponsors, that it came into law in the first place. In practice, however, it is difficult to quantify the impact of FIRPTA or to conjecture that its repeal would open the floodgates to foreign capital inflows.
In a report by Martin Neil Baily (Brookings Institution) and Matthew Slaughter (Dartmouth College) - both of whom have served on the US President's Council of Economic Advisors - the authors recommend reforming the current system: "... outright repeal or, less dramatically, an initial holiday could be implemented... We think that the sizable economic benefits of reforming FIRPTA would exceed the small fiscal costs it would entail."
Whether in the US or elsewhere, the penchant for protectionism or openness relates in part to a country's need for capital. Given the slower pace of capital formation in the advanced economies following the financial crisis, policymakers in many countries have sought to accommodate cross-border inflows.
Foreign investors remain mindful, however, that each market's openness has the potential to change over the capital cycle and, on unfortunate occasion, in response to negative perceptions of visible foreign acquisitions.
For many investors eyeing the US market, the potential for a xenophobic response to high-profile acquisitions of the most coveted assets remains a consideration, even as policymakers seem poised to remove impediments to investment.
Sam Chandan, global chief economist, Real Capital Analytics