On July 13,2016
In today’s global economy, real estate is far more than a series of local markets whose prices are determined by local buyers—it is an interconnected, international market where the economic conditions in one nation can affect real estate values thousands of miles away. Foreign investment in U.S. real estate is now commonplace and has significant impacts on both commercial and residential market conditions.
Hearing this, a number of questions come to mind: Where is the money coming from and how much is there? Why do foreign nationals and companies want to invest in the United States? How does this investment work? What are the impacts on our economy and different real estate markets? What will happen if this investment slows down?
How much foreign investment is currently in U.S. real estate?
The overall percentage of real estate controlled by foreign buyers depends on whether you are talking about the commercial or residential business.
In 2015, foreign buyers accounted for at least 17% of commercial real estate acquisition by dollar amount (NAIOP, Source 1). The National Association of REALTORS® states that international buyers purchased 4% of existing U.S. homes sold April 2014 through March2015, but those sales added up to 8% of the dollar value (NAR, Source 2). This indicates that high dollar homes are often scooped up by foreign buyers.
Foreign investment in commercial real estate in 2015 totaled $94.3 billion. Foreign investment in residential real estate acquisition in 2015 totaled $104 billion--totalling more than $198 billion in foreign real estate acquisition in the U.S. last year (Asia Society, Source 3).
So who is investing all of this money?
Until very recently Canada was the number one source of residential real estate investment in the U.S., but last year China spent much more than our neighbor to the north in this sector with $28.6 billion to Canada’s $11.2 billion. India was third in residential real estate investment, with investors pouring $7.9 billion into acquisitions.
Commercial real estate acquisitions are still dominated by Canadian investors with $24.6 billion spent last year. Singapore was next with $14.6 billion in acquisitions. China and Norway tied at third with $8.5 billion each spent in commercial real estate acquisitions.
There is a common perception that China is dominating investment and buying everything in America, but these figures show that this is not at all the case, especially in the commercial markets. Canada is spending almost three times as much in commercial real estate investment. Singapore outspent China by $6 billion in U.S. commercial real estate acquisitions despite having a GDP 2.7% the size of China’s (World Bank, 4).
This is not to suggest that China’s purchasing power should be considered miniscule (realistically China will outdistance Canada, Singapore, and Norway in real estate investment before long); rather, it is important to recognize just how many foreign investors from around the world view the United States as a premier investment destination.
There are many reasons people want to invest in U.S. real estate.
The most obvious reason for foreign investment in U.S. real estate is financial gain. Real estate investors, wherever they are located, would like to profit and the U.S. has the world’s largest economy with the world’s largest real estate market that is recovering and growing. For example, Norway’s surprisingly enormous amount of money spent on commercial real estate is the action of the state-run Government Pension Fund of Norway--the largest sovereign wealth fund in the world. The fund spent $7.6 billion on property globally last year in what it describes as an attempt to attain “the highest possible return with a moderate risk level” as a “long-term investor” (WSJ, 5). The focus isn’t necessarily on profiting in the near-term on the income the property provides. One such purchase was a 45% stake in the 40-story tower at 11 Times Square in Manhattan in February 2015 for $401.9 million. The fund also purchased a 49.9% stake of the Foundry Square II property in San Francisco for $139.7 million (Norges Bank, 6).
The United States became the preferred investment destination for these funds because of perceived long-term stability and near-guaranteed long-run appreciation in trophy markets like New York City and San Francisco. The famed Waldorf Astoria Hotel in New York sold for $1.95 billion to a Chinese investment group in 2014. That same group bought Strategic Resorts and Hotels, which has luxury hospitality locations across the U.S. in major markets like Silicon Valley and New York, for $6.5 billion this year (NY Times, 7). For an example closer to home for our Southern California readers, think of the Korean Air Wilshire Grand development. Korean Air and its parent company, Hanjin Group, owned the old Wilshire Grand, tore it down, and is in the midst of building what will soon be the tallest building west of the Mississippi to house a new hotel, retail space, and office space at the cost of more than a billion dollars (Curbed, 8). From coast to coast, America’s big markets are attracting billions in real estate investment.
Insecurities and political issues in other markets drive some investors to purchase U.S. real estate as much for stability and security as profit. Many Chinese investors in U.S. real estate were motivated to move money away from a faltering stock market and slowing domestic growth.
According to some experts, others around the world want to protect their assets and get their funds out of their own country. Basically, the U.S. real estate market can act a bit like an offshore bank. From an investor’s perspective, sure the U.S. government taxes your money; but, your investment will never be seized by the state and will likely appreciate over time (US News, 9).
There are of course more reasons to invest in U.S. real estate. Some families have a child attending school in the United States and want to buy a house here. The U.S. can also act as a tax haven (depending on the nationality of the foreign investor), especially considering taxes will not be paid until the property is sold or earns income.
So how does this foreign investment work?
Unlike some other countries, the United States has almost no barriers to to foreign ownership of real estate. Investors are generally taxed on their property’s income or sale just like domestic investors (although some treaties with particular nations can ease this burden). However, recent revision of the Foreign Investment in Real Property Tax Act (FIRPTA) has actually removed some of this tax barrier. FIRPTA guarantees that foreign investors are taxed on their sale of U.S. real estate. The new reforms (which went into effect December 18th, 2015) add more exemptions for foreign pension funds, increases the ownership threshold on the amount of publicly traded real estate investment trust (REIT) stock that foreigners can own before being subject to FIRPTA taxation upon sale of said stock from 5% to 10%, and reforms the rules to determine if REIT is domestically controlled. A strong majority of foreign investors interviewed by the Association of Foreign Investors in Real Estate have said that this reform will lead them to invest more heavily in U.S. real estate (Skadden, 10).
Aside from taxation, unless the foreign buyer is subject to U.S. sanctions (for reasons such as being a war criminal in another nation; it is incredibly uncommon for the U.S. to place sanctions on an individual), there are no restrictions preventing U.S. citizens and organizations doing business with foreign nationals.
As for the actual funding, many international buyers come with cash (including 71% of Chinese buyers 2013-2015). But there are financing options available for these investments. Chinese banks alone have issued $8.5 billion in loans for commercial acquisitions. These same banks make residential loans as well, which are of obvious need for Chinese investors, since they invest more money in residential than commercial real estate acquisitions (Asia Society, 1). However, the Asia Society describes these loans as “limited, but growing”. Those needing lending for residential mortgages are thus more likely to connect with a domestic lending institution for their loan needs. This process is mentioned below.
Foreign buyers can also purchase a first property with cash, then take out a home-equity loan to make funds available for other purchases. With funds in U.S. bank accounts investors can begin to obtain credit and establish a credit history that will enable further investment.
There are also domestic lenders that have targeted foreign real estate investment. Some of these operate nationwide while others only grant these types of loans for specific states. There is a great deal of variance in products offered as well: minimum and maximum loans, LTV, credit reports (or lack thereof), property types, etc.
East West Bank is one of the best examples. Specializing in Chinese commercial investment, East West Bank grants loans (typically between $3 million and $30 million) to investors that might otherwise not be able to attain financing. This bank has chosen to be selective, rejecting some applicants, while employing a strong connection to Chinese culture to remain competitive and a noted voice in this type of investment (Commercial Observer, 11). As of 2013 East-West had an average LTV of 55% across their commercial real estate loan portfolio (we could not find a more recent stat on their LTV rates), making them a fairly conservative lender (East West Bank, 12). Note that this is not a set policy where all investors receive the same terms. East West is selective and adapts to their situation.
BofI Federal Bank is another major player that offers portfolio loans to foreign national borrowers (minimum $300,000, maximum $10 million) at up to 50% LTV. Borrowers have to come in with a large amount of cash, but credit scores are also not required for evaluation.
A&D Mortgage lends to foreign investors, but operates only in south Florida. They will lend up to 70% LTV on up to a $15 million loan on single family, condo, and condo-hotel property types (Scotsman Guide, 13).
The takeaway is that foreign ownership of real estate is a big business and lenders are carving out niches to capitalize on the opportunity. Some are willing to assume more risk than others with higher LTV ratios or proof of credit in their underwriting standards, but overall there are opportunities for foreign buyers to obtain the financing they need.
There are potential hurdles to investment in the form of capital controls in foreign nations. China, for example, typically only allows one of its citizens to take $50,000 out of the country in a given year (Bloomberg, 14). Exceptions for investment and pooling of money allow the substantial investment in real estate we see, but these types of regulations do inhibit some investment
So what are the affects of this foreign investment on U.S. real estate markets?
This external boost to domestic real estate markets can contribute to increasing prices in some cities, which makes sense. Healthy, competitive markets can create price inflation. Buyers may not appreciate the costs of these strong markets, but sellers obviously benefit.
This effect is more noticeable in some cities than others. Very expensive cities like San Francisco and New York see a substantial percentage of real estate transactions involving foreign investors. Chinese investors, for example, spent $9.56 billion on commercial acquisitions in New York City alone between 2010 and 2015 (Asia Society, 1). And while Chinese purchases still make up a small proportion of sales in the overall U.S., Chinese buyers do buy 1 in 14 homes sold for $1 million or more and Chinese buyers pay on average $831,000 for their homes in the U.S. as of last fall (more than three times as much as the median home price in the U.S., $239,700)(NY Times, 15; NAR, 16). It follows that these buyers are concentrating themselves in metropolitan areas like New York, Los Angeles, San Francisco, Seattle, Chicago, Los Angeles, and Miami (The Guardian, 17).
A consequence of this foreign demand is that housing becomes less affordable for domestic buyers. According to the California Association of REALTORS®, as of the the fourth quarter of 2015, only 30% of households in California could afford to purchase the median priced home (39% the median priced condo or townhouse), compared to the 58% U.S. average (CAR, 18). While foreign buyers are obviously far from the only factor creating such a competitive housing market, they do play a role.
This influence is actually most visible in the highest end of real estate. Although housing affordability issues impact lower and middle income individuals the most, the immediate impact of a drop in funding for foreign investment is most visible in expensive markets like Silicon Valley. Despite still having some of the lowest average days on market (DOM) stats in the country, a recent slowdown in investment from China is visible. With China’s faltering stock market and new controls on capital leaving the country coinciding with a 20% decrease in venture capital investments in Silicon Valley in the first quarter of 2016 from Q1 2015, the high end market slowed significantly (WSJ, 19). In April 2016 the average DOM was 16 days, compared to 11 in 2015 and 10 in 2014. The average DOM rose to 30 days in May (Bloomberg, 20). While still a fast market, that is an enormous proportional increase in DOM.
While this is a small market where a handful of lingering properties can impact the statistics, the example is there: high end markets have become more dependent on foreign investment than other markets. Other high end markets could be susceptible to similar problems.
Another impact is on cap rates in commercial real estate. The steep competition that foreign investment is contributing to has “kept cap rates suppressed” between five and six percent on average as foreign investors continue to perceive retail assets as “long-term stability” investments. (Globest, 21) As demand for investment real estate increases and prices keep getting pushed up, cap rates will continue to decrease.
Cap rates are staying low because expensive buildings--even with expensive leases and high operating income--are not seeing rents increase quickly enough to raise cap rates. Part of this is investors buying buildings that already have tenants with set leases. Until the lease is up the investor cannot negotiate higher rent to increase cap rates.
Demand is another significant factor. Investors are willing to pay a high price for a property with long-term appreciation in mind. This means paying higher prices than one would pay if they were solely using income to evaluate the investment. Consider the example of the Government Pension Fund of Norway from earlier. Their focus is so much on income - it was purchased at a 2.9% cap rate. But that return provides some short-term benefit while the overall value of the property provides the long-term investment incentive.
While some of these effects seem negative, consider a few benefits. Foreign investment helped the housing market recover after the crash as valuable dollars continued to flow into the market. It may not have been a comfort to those losing their homes, but it was beneficial to the economy. And foreign investment also generates tax revenue. While this may not be a benefit that many people think of, a strong real estate market does provide valuable tax revenues (with benefits such as funding public schools).
So what happens if the foreign investment dries up?
If foreign investment in real estate has become a significant factor in the strength of the market, it follows that there should be concern about the longevity of this investment.
First, there is little reason to fear foreign investment ceasing. Even with China’s increased internal controls on capital leaving the country, there is enormous demand for American real estate. This demand is created in a number of ways (mostly explained above). As long as the U.S. is a major economic player on the global stage (which is inevitable for the foreseeable future), there will be demand. Abundant coastline and large metropolitan cities that create high prices for domestic buyers also draw foreign buyers.
If there are fluctuations in this foreign demand they should act just as a fluctuation in domestic demand. Days on market could increase and thus draw down prices, but as foreign investment is still far from a majority of investment, this effect should not be as strong as when domestic demand falters. In some cities there could be less effect as domestic buyers find they can afford homes when competition is slightly decreased.
At the end of the day there will always be people concerned about foreign outsiders buying their cities or driving up prices for the local population. Calls for higher taxes on foreign investment and other restrictions will never cease. But it is our position that barriers to the influx of foreign dollars into real estate markets other is not a sound decision. Without foreign investment the last recession and housing market crash would have dragged on longer, harming the same people that investment controls would allegedly protect. Strong real estate markets do create affordability issues in some cases, but also the potential for job creation with new construction and the subsequent affected industries and buying power of employed workers. And while some may not approve of this influence, it is a difficult position to tell property owners that they should receive lower selling prices when they sell their property because international buyers are not investing in the market.
The U.S. real estate market is not completely dependent upon foreign investment, but it is significantly influenced by it (in some local markets much more than others). It is unlikely that this will change in an increasingly globalized economy.