Published by the CIPS Network of the National Association of REALTORS®

Fourth Quarter 2004

Foreign Direct Investment in U.S. Real Estate Today
By Mark Lee Levine, CIPS and Libbi Levine Segev

Investments from foreign sources into the U.S., particularly real estate investments, have continued to increase over the last several decades. To examine why investors outside the U.S. have chosen to invest in the U.S., recognizing that desire is only part of the answer, let’s look at these questions:
  • Which individuals and/or countries are choosing to invest in the U.S.?
  • What are the desired types of real estate investments?
  • What are the choice locations for those investments within the U.S.?
  • What other issues, areas, properties and interests are being targeted by foreign investors?

Who Invests in the U.S.?
As an international real estate practitioner, you may often focus on the financial considerations of your investor-clients, e.g., cash-on-cash positions and Internal Rate of Return (IRR) analyses. Other quantifiable criteria beyond return analyses may be very important to many investors. But, strong cultural issues—such as the importance of personal relationships—also influence and should be considered when dealing with foreign investors, who may be motivated differently when considering whether to invest in the U.S. or elsewhere. One investor may consider the purchase of a building mainly on financial considerations. Another investor may consider these issues as secondary, when compared to a personal relationship, a longterm position, an attempt to diversify funds, or the security of U.S. investments.

Even if your training has focused on financial analyses when seeking to satisfy investor motivation—including such issues as gross income produced from property, vacancy rates, effective gross income after reducing gross income for vacancies, operating expenses, Net Operating Income (NOI), conversion of an income stream to a value, and similar techniques and approaches—there are other areas that demand analysis. Many foreign investors leave other countries, e.g., Cuba, the Middle-East, parts of Africa and Hong Kong (after its return to China), to seek a refuge or an alternative place to live and invest because of real or potential political instability and safety issues that extend beyond the merely mechanical considerations of the financial analyses of a property.

Over the past several years, the primary focus of many investors in the U.S. has changed from a direct financial calculation of growth. Indeed, some investors “ran to the sidelines” and placed their capital in money-market funds, CDs, government bonds, and more secure, but limited, growth vehicles, being more concerned with the safety of capital, and return of capital, rather than a return on capital. Often—for those who may have taken capital out of investments and countries because of political instability, such as in Argentina—these decisions were based in part on financial issues, but also on political issues and refugee positions. The considerations of foreign investors when contemplating whether to invest or to continue to invest in the U.S. include criterion as diverse as return on investment, safety of capital, safety of individuals, refuge for funds or individuals, future citizenship, family considerations, diversity of capital investments, political instability, legal options, future opportunities, current economic conditions, quality of investments, hedge for the future, marketability of investments, movement of funds, and high-tech considerations, among others.

Opportunities for real estate investments within the U.S. attract capital so long as the applicable considerations listed above are favorable. Such factors, however, are shaped and modified by daily life. Major events, such as the World Trade Center attack, illustrate how circumstances can influence the direction of real estate investments and other investments, worldwide. From September 11, 2001, all factors, including immigration, have been influenced in some way. Travel restrictions have impacted potential immigrants and investments because of concerns for safety of persons and property. Changing reactions by U.S. leaders, such as a tightening of immigration standards and additional restrictions and controls, have weighed heavily on those seeking legal residency status within the United States. Such actions continue to influence the behavior of investors who seek opportunities in alternative markets. For example, after September 11, the New Zealand and Australian markets were favorably impacted by an increase in foreign students and investors, because of increased concern with the safety of person and property elsewhere, such as in the U.S. Such events by terrorists could take place in any country, and would certainly modify current government and investment positions.

What are the investments?
As reported in many sources, such as the NAR Research report, “Foreign Investment in U.S. Real Estate: Current Trends and Historical Perspective,” (October 2003)1, the amount of foreign investment in the U.S. continues to increase. The NAR report stated: “Foreign direct investment in U.S. real estate increased to $40.6 billion in 2002 from $38.3 billion in 2001.” The safety of the assets and the safety of the investors themselves are paramount. As compared with other countries, the historical low rate of loss on most U.S. assets would seem to encourage continued investment in the U.S. Examples include U.S. Treasury bonds and certain high-grade corporate bonds, as well as other investments, such as high quality U.S. real estate.

Smaller U.S. real estate investments—such as single-family homes, condominiums, or other personal-use residences, whether for an immigrant or U.S. citizen, as a direct or indirect investment—are generally allowed without many restrictions. In the U.S., new home sales and existing home sales have continued strong over the last few years. Increased values of such properties attract additional investments, including parents buying homes for their children and immigrants or persons with visas living in the U.S. Many groups, including NAR, NAHB (National Association of Home Builders), and the U.S. Bureau of Census, have continued to support these positions, based on recent statistics over the past few years showing record growth in the assets.

According to the NAR Report, foreign investment in the U.S. outpaced that of U.S. investment outside the country in the late 1990s. This has generally continued, although it was slowed somewhat since September 11. Private investors or companies, and public investment of governmental capital outside the U.S., invest within the U.S. Both private and public investments within the U.S. have continued to grow and have set records over the last two decades. The NAR report found that foreign direct investment in the U.S. increased from $38 billion in 1997 to over $40 billion by 2001, and has rebounded after a slight decline in 2001. For 2002, the Report lists the dominant countries with direct investment positions in real estate in the U.S. as Japan with 21 percent, Canada with 12 percent, and the UK, The Netherlands and Germany with 10 percent each. Most indicators are that foreign direct investments in the U.S. will continue to increase.

The Annual Survey prepared by the Association of Foreign Investors in Real Estate (AFIRE), from polling AFIRE members, noted that opportunities within the U.S. for capital appreciation, secure and stable real estate investments, and risk adjusted potential return on real estate investments all made the U.S. extremely attractive and in a first-posture position. Many other countries were also considered attractive for real estate investments. However, the U.S. was clearly the leader in attracting real estate capital, with low risk to investors and a system that protects the investor. The U.S. market was deemed the most stable market, worldwide.

Where are they investing?
If you look only at the geography of foreign investment in U.S., rather than at the type of investment, you see that it generally clusters in costal areas. Asian or European investors seem to focus on larger, well-known U.S. cities. The size and quality of investment opportunities, the convenience of location, the familiarity with city names, and business or family ties make the cities very attractive to foreign investors.

Asian investment has tended to go to Hawaii and the West Coast, especially to California, Washington and Oregon. European investors often have chosen the major eastern cities in states such as New York, Washington, D.C., Virginia, and New Jersey, as well as in the Carolinas, Georgia, and Florida. Latin American and Caribbean investors are also generally attracted to the coastal areas, especially in the southern parts of the U.S.

Other major U.S. cities are attractive because of other attributes, such as the well-known nature of the city, and the size and quality of the investment climate. Chicago is a paradigm for this scenario.

When specific types of property are matched with geographic location, sometimes the nature of investments expands from U.S. coastal areas and major U.S. cities to other areas where unique types of investments are present, such as the ski resorts in Colorado and Utah, or the golf havens in Arizona.

In an article in Journal of Property Management, Institute of Real Estate Management (March 1, 2003), author Nancy Pekala indicates that San Francisco continues to be very attractive to investors and that a recent survey showed that two thirds of the respondents found that the U.S. commercial real estate market was the most attractive of any country.

The “2003 AFIRE Annual Survey”2 indicates that, in order of preference, foreign investors preferred Washington, D.C., followed by London, Paris, New York City and Los Angeles.

What investments are favored?
According to the AFIRE Newsletter (January 2003), multi-family real estate investments were the number one choice of types of property to invest in within the U.S. in 2002. However, the attractiveness for this type of investment appears to be declining. In 2002, office property was the second most favorable type of investment, followed by industrial, retail, and hotels.

From 1995 through 2000, investments in office buildings led the way as the number one choice for the type of property. However, office-building investments declined to number two in 2001, when the number one position was industrial investments. These indicators illustrate the fact that types of property preferred by international investors will vary, depending on a number of factors including, for example, the general marketplace for real estate and the return.

A number of research projects have examined foreign direct investors who contemplate investing in various types of property within the U.S. One source, Real Capital Analytics (November 2003), indicated a strong proclivity for foreign investors to acquire quality office buildings. The type of product will vary, depending on the purchaser, the country, and the location.

The Note, Real Estate Weekly (January 15, 2003), states that condominiums continue to be among the most sought-after U.S. investments, but that many are purchased by resident investors, rather than by foreign investors. It also indicates that office buildings have been popular with both institutional and foreign investors. Foreign acquisition of U.S. commercial real estate was almost double in 2002 from the prior year. More than 80 percent of 2003 foreign real estate investment was directed to offices investments, located mainly in Central Business Districts.

In an interesting article by Ray Smith, Wall Street Journal (June 12, 2003), Thomas McWhirter, who oversees Prudential Real Estate Investors, TMW Funds Management, was quoted as saying that German investors, who normally invest about $750 million in U.S. real estate, are beginning to look elsewhere, speculating that in 2003, this amount might be reduced to half and that, for the first time in 20 years, this capital might be invested in Asia where there were some very attractive opportunities.

One concern when investing in the U.S. is the weakening U.S. dollar. Some hesitancy remains as to whether to invest in the U.S.—notwithstanding the fact that some foreign monies will purchase more U.S. property because of the weakened dollar—while there are still concerns about the stability of the U.S. dollar.

Cultural differences influence placement of funds and investments within the U.S. Sometimes long-term relationships in a relationship-based society, such as in South America or Asia, affect decisions on foreign investments in ways that seem more important than mathematical calculations that focus on pedantic fundamentals of income, vacancy, Net Operating Income (NOI), expenses, and cost of capital.

The Crystal Ball
What is likely to happen with future foreign direct investment in the U.S.? Recently, the U.S. economy has not behaved in a traditional way. Historically, when rents and NOI go down, capitalization rates go up, indicating a lesser value paid because of the reduced NOI. Recent sales involving foreign or domestic investors in the U.S., however, indicate a trend toward falling NOI, caused by increased vacancy rates, reduced rents, etc. This has been true in office buildings and apartment buildings. Yet, prices have increased! It could be argued that part of this rise in prices has occurred because of the potential that the property may have when the market adjusts; the lack of alternative placement for the investment funds; and the attractive nature of the lower investment return today, as compared to what was considered a sufficient return on capital only a few years ago.

The fundamentals of real estate planning and projections are adjusting. This point was emphasized in NAIOP’s (National Association of Industrial and Office Properties) “Vital Signs Survey: Economy Looks Brighter, But Fundamentals Haven’t Caught Up,” from Development (Winter 2003).

Foreign direct investment in real estate will continue to grow within the U.S. There are many important reasons for investors to choose the U.S. Market stability—reasonable return; historically favorable interest rates relative to inflation; a lack of deflation; legal protections for the investor; the leading economic market with the largest GDP—all support investment in property in the U.S.

In her article, “Fast Forward - How Real Estate Will
Look and Function in The Next 5-10 Years,”3 Development (Winter 2003) author Sheila Vertino, quotes Alan Kay: “The best way to predict the future is to invent it.” Part of that future is being invented today.

Mark Lee Levine, Ph.D., JD, LLM, CIPS, is Director and full Professor of the Burns School of Real Estate and Construction Management, Daniels College of Business, at the University of Denver. He is President and Chairman of Levine and Pitler, P.C., and Chairman of the Board of Directors of Levine, Ltd., REALTORS®, a real estate management and brokerage firm in Denver. He has lectured throughout the world on such topics as international real estate, law, estate planning, syndication, investment, appraisal and tax. You can reach him at +1.303.871.2142 or at

Libbi Rose Levine, JD, MS Real Estate & Construction Management, LLM, is an adjunct professor at the University of Denver. She is a practicing attorney and a real estate broker in Colorado.

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