"The Japs capture Rockefeller Center.” So wrote William F. Buckley Jr., the conservative commentator who passed away two years ago this month, in his December 1989 column for the National Review. Buckley’s story followed news that the Rockefeller Group, at that time still the owner of Rockefeller Center and Radio City Music Hall, would sell a 51% interest in the iconic asset to Mitsubishi Estate Co. of Tokyo.

At the time, popular and political resentment were rising in response to a broad-based increase in Japanese investment in American trophy assets. Earlier that year, the Japanese government reportedly vetoed a potential deal for Chicago’s Sears Tower out of concern about a backlash. The New York Times reported that, “In private, many Japanese officials say they are increasingly fearful that their country’s huge increase in American investments is creating a perception of Japan as less a partner than a rival.”

While the roster of leading investor nations changes, the attractiveness of US assets remains a key feature of the global marketplace. In the 18th annual Foreign Investment Survey of the Association of Foreign Investors in Real Estate (AFIRE), 51% of participants - perhaps pushed by declining prices and rising cap rates - identified the US as the market offering the best opportunity for long-term capital appreciation; it was the highest positive response rate since 2003. As reported in last week’s Global Capital Trends, cap rates in the Americas have climbed to just under 9%. For value-conscious investors, this compares favorably with average cap rates between 6% and 6.5% in Asia Pacific and below 7% in Europe, where geopolitical challenges to the Eurozone’s fiscal stability and program are rising.

With domestic credit markets hamstrung, potential foreign investors in US commercial real estate are finding new support in policy circles. As part of its 2009 policy agenda, the Washington, DC-based Real Estate Roundtable includes revisions to the 1980 Foreign Investment in Real Property Tax Act (FIRPTA) among its key objectives. Under FIRPTA, 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… FIRPTA is literally the only major provision of US tax law which subjects non-US investors to taxation on capital gains realized from investment in US assets.”

The Roundtable’s activities coincide with preliminary legislative efforts to amend FIRPTA. Under the terms of the proposed Real Estate Revitalization Act of 2010 (RERA; H.R. 4539), various aspects of the original 1980 Act would be relaxed. In particular, shares in REITs would no longer be treated as U.S. real property interest. In the proposal’s current form, direct investment in real property would be unaffected.

In a new report by Martin Neil Baily of the Brookings Institution and Matthew Slaughter of Dartmouth College, entitled “How FIRPTA Reform Would Benefit the US Economy,” the authors argue that there would be “sizable economic benefits” from either an “outright repeal” or a five-year moratorium exempting new foreign investors in US commercial property from FIRPTA’s taxing provisions.

Taxes on commercial real estate gains undoubtedly impact the attractiveness of US investments. It is difficult to quantify the impact of FIRPTA, however, or to assume that its repeal would open the floodgates to foreign capital inflows. More likely, a permanent tax change would support an increase in investment on the margins and only over the long term. Other considerations, including long-term expectations for asset price appreciation, and property income, inflation and currency trends dominate foreign investors’ decision calculus.

Clearly, foreign investors find the American market attractive in spite of FIRPTA. Where they have failed to bring more dollars into the US over the last year, foreign investors are more likely to cite an absence of investment opportunities than the tax code. But there is ample room for growth in foreign capital inflows; fewer than 10% of US properties are purchased by non-North American entities. According to AFIRE, foreign investors will increase their activity in the US market in 2010, enabled by an easing of the market’s paralysis and absent any change in FIRPTA: “at least half the survey respondents report a stronger appetite for both debt and equity investments in the US than in other countries.”

—Sam Chandan, PhD, FRICS

A version of this article appeared recently in The Commercial Observer.

Data subject to future revision; based on properties & portfolios $10 mil and greater.
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