As foreign investment in U.S. real estate continues to increase, experts say foreign investors, sellers and rival bidders alike should be wary of potential tax hurdles, differences in deal-making style and other cultural customs. U.S. gateway markets like New York, Los Angeles and Washington stand out as "safe havens" for cash from less economically stable regions around the world, and the trend of foreign investors picking up trophy properties in these cities continues to grow.
But experts say that each party to such a transaction — the investor, any potential rival bidders and the seller — should carefully consider the unique challenges that arise when parties from different countries do a deal.
Foreign Investors: Prepare for Financing and Tax Trip-Ups
Attorneys representing the foreign investors looking to purchase U.S. property often face the challenge of working with clients who are unfamiliar with U.S. financing and tax structure, experts say.
Tax consequences can vary widely from client to client, based on their tax status in the U.S. and in their own country and on the tax treaties between the two. Foreign individuals not considered U.S. tax residents may be subject to withholding taxes, either as estimates of taxes that they might owe or as flat tax amounts, regardless of a deal's profitability.
In practice, this can mean a foreign investor is subject to tax on interest, leases or dividends, impacting how property ownership is structured, according to Dana Newman, a partner with Pillsbury Winthrop Shaw Pittman LLP.
Getting the money back out of the U.S. after it's invested in a property here without paying a disproportionate amount of sales tax can also be a major hurdle, Newman said.
"The overall issue is tax planning for a foreign investor to maximize their ability to get profits free of U.S. income taxes," she said.
Financing can be a problem for foreign investors as well, according to Wei Min Tan of New York buy-side condominium brokerage Rutenberg Realty, because U.S. banks lend to them at higher rates and require larger down payments.
"The key is to work with an experienced mortgage broker who has done many foreigner transactions," he said. "Just because a bank offers a foreigner mortgage program doesn't mean all of its bankers are experienced working with foreign buyers, because that's a niche market."
And on some deals, it may be necessary to explain concepts that U.S.-based clients take for granted, such as the fact that a trusted third party, and not a family member, should conduct the deal, and that a deal must be written and signed in order to be binding.
"It's important to explain this to foreign buyers because in many countries verbal agreements are binding," Tan said.
Sellers: Anticipate Differing Needs and Customs
Many of the foreign investors that are currently flocking to the U.S. are attracted to properties with specific characteristics, and they also may not have a traditional way of going about acquiring them.
Because of the tax issues mentioned above, many foreign investors have a strong preference for buying property through acquiring real estate investment trust shares, according to John Sullivan, a partner with DLA Piper.
"If you're a U.S. seller and you want to maximize the potential buyers for your property, if you hold it in a private REIT, you make buying that property more attractive for certain non-U.S. investors," Sullivan said.
This trend has led to an increase in the number of properties companies will put into private REITs even if there is no immediate benefit to the company, with an eye toward attracting foreign investors in the future, according to Sullivan.
When it comes to making the actual deal, experts say there are also some things that most U.S. investors might do as a matter of course that do not work for many foreign investors, such as setting the deal up through limited liability companies. More typically, non-U.S. investors prefer to use offshore corporations.
"For some non-U.S. investors, [using an LLC] has a very adverse tax result," Sullivan said.
Rival Bidders: Beware Foreign Investors' Pricing Power
The biggest issue for attorneys representing U.S.-based investors looking to compete with foreign investors on major deals — an increasingly common situation — is the disparity in price constraints, experts say.
While many U.S. investors look to purchase a property in an effort to make a quick return, either because they are investing through a fund with a short life or because their investors expect to see the benefit of the deal quickly for other reasons, a great number of the foreign investors currently doing deals in the U.S. are more concerned about stability than yields.
"They're willing to pay a premium, and many times they are the top bidder because they will pay more for a certain type of asset," said Manny Fishman, a shareholder with Buchalter Nemer PLC.
But there are ways to beat out foreign bidders, even if an investor can't offer the same high price.
Having a good track record of closing deals and being able to do so quickly, can put a U.S. investor ahead of a foreign rival, according to Fishman.
"A seller is looking for someone that will close and has a track record of closing, and sometimes the foreign investor is not that person, even with the higher price," he said.
On one of the first rainy days that drought-stricken California has had in months, San Francisco Mayor Ed Lee stood out of the rain in an unfinished retail space on the city’s gentrifying Market Street. Exposed pipes ran past naked plaster and cold concrete floors, but the drab backdrop had shining significance: above the retail space were nearly two dozen brand new, below-market rate apartments, the kind of housing the land-constrained, soaringly expensive city desperately needs—and that the mayor has vowed to provide.
Housing in San Francisco has become the most costly in the nation, spurring an affordability crisis that has pushed protesters into the street and low-income earners out of their homes. It has also inspired a flurry of activity at City Hall, where politicians have been churning out proposals aimed at fixing housing problems and easing the city’s simmering class tensions. Lee’s latest effort, announced at a press conference in the retail space on Thursday, calls for cutting red tape in the cumbersome review process for new projects and giving priority to proposals that include units for lower-income residents.
Other proposals have been more ambitious and far more controversial. Here’s a look at seven other plans for solving San Francisco’s housing crisis:
Build, build, build
One of the city’s biggest problems is that far more people now want to live here than can currently fit. In his “State of the City” address in January, Lee announced the ambitious goal of building or rehabilitating 30,000 new homes by 2020, the equivalent of 5,000 each year—and a massive increase from the rate that the city has been building. In 2011, a mere 260 units were completed in the City by the Bay. Lee has said he wants one-third of the new units to be “permanently affordable” to lower-income residents.
Make landlords pay for evictions
City Supervisor David Campos proposed a law on Feb. 4 that would require certain landlords evicting tenants from rent-controlled buildings to essentially subsidize the new, higher rents those people could be forced to pay. Landlords would have to pony up the difference between the controlled rents and whatever the going market rate for that apartment would be for the equivalent of two years. Unsurprisingly, developers and landlords have balked.
The issue of density has long been a lightning rod among city residents, and San Francisco places density limits on new building projects. But for developers, more apartments in a building generally means more income from that project. So, in an attempt to get developers focused on building affordable housing rather than luxury condominiums catering to new tech wealth, City Supervisor Scott Wiener has proposed that the city raise density limits for any project that is made up of at least 20% affordable housing units and completely eliminate density limits for any projects that are 100% affordable housing.
City leaders have also proposed legislation that would turn illegal “in-law” units into legitimate housing stock. These might be apartments that are actually converted garages, unglamorous but livable spaces that aren’t technically up to code. There are tens of thousands of such units in the city. “They house a lot of people. They tend to be much lower rent,” Wiener says. Legalizing them also causes uproar among NIMBY-types who don’t want buildings zoned as single-family homes suddenly becoming two-family homes.
Lee recently met with executives from the tech industry, many of whom supported his candidacy, and encouraged them to become much more engaged in local philanthropic causes. Anger from displaced residents has been aimed at many of those successful companies, which are drawing well-paid workers to town, who in turn give developers another reason to build those luxury condos. Some businesses are already making efforts to be seen as part of the housing solution rather than part of the problem: Twitter, which relocated its headquarters to the Mid-Market area after receiving a tax break from the city, has sent their legal staff to represent locals pro bono during eviction proceedings.
No more buyouts
Currently developers behind every new housing project in the city that has 10 or more units must price 12 percent of those units below market rate—or pay the city a fee to opt out. Peter Cohen, co-director at the Council of Community Housing Organizations, has suggested that the city eliminate the pay-not-to-play option, which developers may decide to use so that more apartments yield more rent in the long run, even if only the wealthy can afford them.
Protect what’s there
Under San Francisco law, most units built before 1979 are subject to rent control, and city leaders are working to keep residents who live in those buildings in place. On Feb. 4, the mayor said the city intends to make it more difficult to take existing housing stock off the market by requiring review hearings when a loss of housing is proposed. Another city supervisor put forward a controversial proposal late last year that would ban merging, converting or demolishing a property for 10 years after most evictions.
At the press conference, Lee took a forceful tone about the city’s housing problems. The city, he said, has to be “almost militaristic about building” for people who aren’t rolling in cash.
HOUSTON 2 The Houston real estate market ended 2013 as it began – in the fast lane. Surging home sales throughout greater Houston were largely driven by the addition of more than 86,000 jobs that drew buyers and renters from all around the country and world. December marked the 31st straight month of positive home sales and was a month in which prices again rose and housing inventory shrunk to new record lows.
According to the latest monthly data prepared by the Houston Association of Realtors, December single-family home sales increased 14.3 percent versus December 2012. Contracts closed on 5,813 homes, driving inventory down to 2.6 months supply, the lowest level of all time.
All housing segments saw gains in December except for the low end of the market – those homes priced at $80,000 and below. Homes priced from $250,000 and above registered the highest sales volume and accounted for another hike in prices.
“The Houston housing market had its best year on record in 2013, and those of us who work in real estate have never been busier,” said HAR Chair Chaille Ralph, with Heritage Texas Properties. “Stewart Title Chief Economist and former HAR Chairman Dr. Ted C. Jones forecasts positive sales to continue in the new year, but at a slower pace. He anticipates about a 5 percent increase in home sales and a 6 percent gain in pricing. However, all that hinges on having homes to sell, and the local inventory is running extremely low.”
The single-family home average price rose 10.3 percent year-over-year to $265,017, while the median price – the figure at which half of the homes sold for more and half sold for less – rose 10.9 percent to $188,500. Both figures represent historic highs for a December in Houston.
Sales of foreclosure properties continued their yearlong decline, falling 48.8 percent compared to December 2012, according to the HAR Multiple Listing Service. Foreclosures currently make up 6.5 percent of all property sales reported through the MLS, one-third of the share they comprised at the beginning of 2013. The median price of December foreclosures increased 8.3 percent to $91,000.
December sales of all property types in Houston totaled 6,987, a 14.2 percent increase over the same month last year. Total dollar volume for properties sold in December soared 24.2 percent to $1.8 billion versus $1.4 billion a year earlier.
Annual Market Comparison
The Houston housing market concluded calendar year 2013 with strong gains in sales volume and pricing versus 2012. The heaviest one-month sales volume of the year was recorded in May, with 7,705 closings. By contrast, the lightest one-month sales volume of 2013 took place in January, with 3,889 closings. However, January also marked the greatest year-over-year percentage sales increase, with a 28 percent gain over January 2012.
Single-family home sales rose 17.4 percent for the year and sales of all property types increased 18.8 percent. On a year-to-date basis, the average price climbed 10.3 percent to $248,591 while the median price increased 9.4 percent to $180,000. Total dollar volume for full-year 2013 reached a record high, jumping 30.2 percent to nearly $21 billion compared to $16 billion in full-year 2012.
Monthly Market Comparison
December delivered positive results across all sales categories compared to December 2012. On a year-over-year basis, total property sales, total dollar volume and average and median pricing were all on the rise. Active listings, or the number of available properties, at the end of December declined 16.1 percent from December 2012 to 28,147.
Housing inventory in Houston has been below a four-month supply since November 2012. It fell below a three-month supply in November 2013, dropping in December to a 2.6-month supply from 3.7 months a year earlier. That is the lowest level ever recorded locally. Inventory consisting of a six-month supply is typically regarded as constituting a balanced real estate market. For perspective, the national inventory of single-family homes is 5.1 months of supply, according to the National Association of Realtors.
Broken out by housing segment, December sales performed as follows:
• $1 to $79,999: decreased 29.4 percent
• $80,000 to $149,999: decreased 7.7 percent
• $150,000 to $249,999: increased 19.6 percent
• $250,000 to $499,999: increased 40.7 percent
• $500,000 to $1 million and above: increased 29.8 percent
The average price of a single-family home rose 10.3 percent from last year to $265,017, the highest level ever for a December in Houston. At $188,500, the median sales price for single-family homes also achieved an historic high for December, up 10.9 percent year-over-year.HAR also breaks out the sales performance of existing single-family homes throughout the Houston market. In December 2013, existing home sales totaled 4,890, a 17.9 percent increase from the same month last year. The average sales price rose 11.9 percent year-over-year to $248,072. The median sales price increased 11.4 percent to $171,500.Townhouse/CondominiumDecember sales of townhouses and condominiums jumped 15.4 percent from one year earlier.
After year of struggles, the housing market roared back to life in 2013. The rebound will continue in 2014, but the pace will slow.
Experts say 2014 will be a year of continued growth and stabilization in the housing market with rising home prices, fewer foreclosures and greater activity among underwater homeowners. But this year’s market faces strong headwinds as inventory remains tight and both homebuyers and builders face tough lending standards.
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To buy a home in today’s market, you either need impeccable credit or the ability to make an all-cash purchase. The average FICO credit score on conventional loans used to purchase homes in November 2013 was 756, according to the most recent data from Ellie Mae, a company that produces mortgage underwriting software. The average score for denied applications was 729.
"To put that in perspective, the normal average acceptance score historically is around 720," says Walter Molony, a spokesman for the National Association of Realtors (NAR). "Right now, the average rejection score is now what the acceptance score was historically."
Don’t expect credit standards to ease up any time soon. This month, new Dodd-Frank regulations aimed at preventing risky borrowers and equally risky mortgage products from entering the market take effect. The new changes require lenders to closely evaluate such factors as a borrower's debt-to-income ratio, employment status, income, assets and credit history before underwriting a loan.
Home Prices Continue to Climb
In addition to tight credit, rising interest rates and home prices may discourage buyers from purchasing in 2014, says Jed Kolko, chief economist for Trulia.com, the real estate site. Average 30-year mortgage rates bounced from 3.34 percent last January to their current 4.48 percent rate, with many expecting further increases of up to a full percentage point in the New Year. Home prices nationwide have risen 11.2 percent on average over the past year, according to the S&P/Case-Shiller home price index. Sunbelt cities in places like California and Arizona have seen home values surge in excess of 20 percent.
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While it remains a sellers’ market, price gains aren’t all bad news for buyers. First-timers may be discouraged, but increasing prices are music to the ears of current owners, many of whom are watching their formerly underwater homes gain value. More than 85 percent of homeowners with a mortgage in the second quarter have some equity in their home, up from less than 75 percent in the fourth quarter of 2011, according to CoreLogic.
"We saw a period where the first-time buyer was sort of a driving force," says Robert Denk, senior economist for the National Association of Home Builders. "We expect that to reverse.... As house prices rise, as fewer mortgages are under water that should bring the more established [buyers], the trade-up market, back to some degree."
How much the housing market bounces back in 2014 also depends on construction activity. With builders still fiscally cautious and facing the same tight lending environment as buyers, expect a small increase in the number of new homes on the market. As buyer demand picks up, the pace of new home construction should follow.
"The [housing] bust was basically a five-year period where we produced and sold a fraction of the homes we would see in that normal market," Denk says. "We’re going to see a lot of that pent-up demand turn into realized demand. That will be an important driving force in 2014 and 2015."