The Japs capture Rockefeller Center.” So wrote William Buckley, the conservative commentator who died two years ago this month, in his December 1989 column for The National Review. Buckley’s story followed news in late October 1989 that the Rockefeller Group, at that time still the owner of the Rockefeller Center and Radio City Music Hall, would sell a 51 percent interest in the iconic asset to Mitsubishi Estate Company of Tokyo.
Buckley’s anachronistic comments, harking back to America’s wartime confrontations with the easternmost of the Axis Powers, were intended to challenge rather than embrace a rising tide of xenophobia. And while the Rockefeller sale would prove more complex than initially anticipated, popular and political resentment was rising in response to a broad-based increase in Japanese investment in notable American assets.
In late September 1989, Sony acquired Columbia Pictures from the Coca-Cola Company. Earlier in the year, the Japanese government reportedly vetoed a potential sale of Chicago’s Sears Tower out of concern about a backlash. “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,” The New York Times reported then.
Times change. Following years of economic stagnation, Japan has been superseded by another Asian power as the source of Americans’ anxiety about the nation’s position. Similarly, concerns about the Middle East’s economic prowess rise and fall with the price of oil. Of course, nations including Canada, Britain and Germany-longtime sources of investment inflows into U.S. commercial real estate-rarely draw a similar level of attention.
WHILE THE ROSTER OF nations might change, the constant appears to be the attractiveness of American assets to foreign investors, who have a world of opportunities to choose among. In the 18th annual Foreign Investment Survey of the Association of Foreign Investors in Real Estate (AFIRE), 51 percent of survey participants identified the United States as the market offering the best opportunity for long-term capital appreciation. Declining prices have enhanced perceptions of value, pushing the survey’s positive response rate to its highest level since 2003. In 2006 and 2007, at the peak of the commercial real estate cycle, roughly one in four respondents identified the United States as their top national market.
With investment markets still hamstrung, foreign investors in commercial real estate are finding new support in policy circles. As part of its 2009 policy agenda, the Real Estate Roundtable, based in Washington, D.C., includes among its key objectives revisions to the 1980 Foreign Investment in Real Property Tax Act (FIRPTA). Under the provisions of FIRPTA, foreign entities are subject to taxes on gains from the sale of U.S. real estate assets. According to the Roundtable: “Unlike all other asset classes, this protectionist tax provision creates a disincentive for non-U.S. investors to invest in US commercial real estate. With a few technical exceptions, FIRPTA is literally the only major provision of U.S. tax law which subjects non-U.S investors to taxation on capital gains realized from investment in U.S. assets.”
This past December, the Roundtable focused attention on the issue again, citing the findings of a report by Martin Neil Baily (Brookings) and Matthew Slaughter (Dartmouth). Messrs. Baily and Slaughter have served on the Council of Economic Advisors. In their report, titled “How FIRPTA Reform Would Benefit the U.S. Economy,” the authors recommend reforming the current system: “… outright repeal or, less dramatically, an initial holiday could be implemented: e.g., declare that new foreign investments in U.S. commercial real estate over the next five years would be exempt from FIRPTA. We think that the sizable economic benefits of reforming FIRPTA would exceed the small fiscal costs it would entail.”
Taxes on commercial real estate gains will undoubtedly make foreign investment here less attractive. It is difficult to quantify the impact of FIRPTA, however, or to conjecture that its repeal would open the floodgates to foreign capital inflows.
It is apparent that foreign investors find the American market attractive in spite of FIRPTA. And as long as investors maintain a positive discount rate, the discounted value of the tax impediment will diminish as the anticipated asset sale moves further into the future. To the extent they have failed to bring more dollars into the U.S., foreign investors are more likely to cite an absence of investment opportunities than the tax code.
And so, while efforts to level the tax code are worthy of our industry’s support, we can afford to be cautious in our conjectures about the impact of a change. Of course, there are reasonable arguments to be made on both sides of this debate. According to Real Capital Analytics, just 10 percent of U.S. properties are purchased by cross-border entities. This contrasts with more than 20 percent for Japan and China, more than 40 percent for the United Kingdom and just under 60 percent for Germany.
According to AFIRE, foreign investors will increase their activity in the U.S. market in 2010, enabled by an easing of the market’s paralysis and absent any anticipated change in FIRPTA: “investors say they plan to increase U.S. allocations above 2009 levels by 62 percent for equity and 83 percent for debt; at least half the survey respondents report a stronger appetite for both debt and equity investments in the US than in other countries.” Even so, because foreign investors typically direct their capital to just a handful of cities-New York and Washington, D.C., among them-we shouldn’t necessarily anticipate a broadening of investment into the metropolitan areas most starved for capital.
Sam Chandan, Ph.D., is global chief economist and executive vice president of Real Capital Analytics and an adjunct professor of real estate at Wharton.