By Ilaina Jonas - Analysis
NEW YORK (Reuters) - Tax breaks may not be enough of a sweetener to bring foreign buyers back into the flailing U.S. commercial real estate market, where falling rents, rising vacancies, a scarcity of debt financing and lack of property for sale have acted as deterrents.
Congress is considering a move to lower or eliminate U.S. taxes currently imposed on foreign investors of U.S. commercial real estate, where the number of sales has fallen off a cliff over the past two years.
The Real Estate Revitalization Act of 2010 is designed to stir demand by foreigners and in turn lift prices and encourage even more buying by alleviating the U.S. tax burden imposed upon foreign sellers. The number of commercial property deals fell by 55 percent in 2009 after diving 62 percent the previous year.
Yet many current owners are hanging on to their property despite values that are often less than the mortgages because lenders are extending the loans rather than take the loss from a foreclosure.
But if lawmakers hope that rejigging the tax laws for foreign sellers will suffice to kick-start the U.S. commercial property market, they may be in for a letdown.
Both foreign and U.S. investors are keeping a massive amount of money parked on the sidelines. They are spooked not by taxes but by falling rents, rising vacancies and a lack of debt financing. There is also a dearth of well-leased, financially stable office, retail, hotel apartment or warehouse buildings for sale.
The Real Estate Revitalization Act of 2010 seeks to unwind some of the provisions under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), which imposes U.S. capital gains taxes on foreign sellers of U.S. real estate. Such taxes are not imposed on foreigners who sell U.S. stocks and bonds.
But FIRPTA is not what is keeping foreign investors out of the market and is more of a good will gesture, said Andrew Weiner, a partner at Morrison & Foerster.
“There’s an overwhelming desire by non-U.S. investors to buy U.S. real estate right now,” he said. “I‘m representing them, and not a single one of them is obsessed by FIRPTA.”
For the U.S. government to forgo revenue in the form of taxes on foreigners at a time when it is grappling with a ballooning budget may not be politically popular right now.
FIRPTA, sponsored by then-Wyoming Sen. Malcolm Wallop, was a response to a wave of German investors who bought up ranch property in Western United States. Prior to that, when a foreigner sold U.S. property, he generally was not taxed where the real estate was located, but rather was taxed in his home country.
But FIRPTA did not inhibit foreign owners from buying property during the U.S. commercial real estate boom of 2004 to 2007. They used complicated legal structures to mitigate the taxes.
Although the 2010 legislation seeks to make things a bit easier for foreign sellers, it would not change taxes on direct ownership, a popular form of investment. It chiefly affects the taxes on selling shares of companies that own the property.
If a foreigner owns shares of a company in which real estate comprises more than 50 percent of its assets, that investor would not be subject to U.S. capital gains taxes upon the sale of that stock.
Under the Real Estate Revitalization Act, the sale of property by a Real Estate Investment Trust (REIT) would no longer be treated as capital gains for a foreign investor but as ordinary dividends. Although those face a 30 percent dividend distribution tax, many countries have treaties with the United States that reduce or eliminate that tax.
That would apply to holders of shares of all REITs -- listed or not, public or not -- and would eliminate a 5 percent ownership cap.
The new bill also would treat the sale of stocks by foreigners of a REIT that is less than half foreign-owned as a stock sale and not subject to U.S. taxes. Currently, when such a REIT sells all its property and liquidates, it is treated as a property sale and subject to U.S. capital gain taxes -- a 35 percent hit and up to 55 percent if a “branch profits tax” applies. That tax treats U.S. operations of a foreign company as a separate subsidiary, another source of taxes.
WASHINGTON ‘NOT PLAYING FAIR’
The Real Estate Revitalization Act of 2010, introduced to Congress in January and sponsored by Rep. Joseph Crowley of New York, has been referred to the U.S. House Committee on Ways and Means and is now seeking a larger bill to which it can attach itself, a Crowley spokeswoman said.
Supporters of the bill say it would put commercial real estate on par with investment in stocks and bonds.
“The United States is not playing fair on this issue,” said Dan Fasulo, managing director of real estate research firm Real Capital Analytics. “It has the ability to flush public REITs with billions of additional dollars of capital that will eventually filter down to the direct property market.”
The Real Estate Roundtable, an industry trade group, said it hopes the changes would lure about $100 billion sitting on the sidelines back into the U.S. commercial property market.
“That combined with even 50 percent debt financing would bring enormous purchases and thereby stabilize what have been falling values of U.S. commercial real estate,” said Robert Schachat, vice chairman of the Real Estate Round Table Tax Policy Advisory Committee.
Andy Short, a tax attorney and partner at Paul, Hastings, Janofsky & Walker, said that many attorneys representing foreign funds are interested in the changes because the funds often own their real estate through private REITs.
“I think it will help, it will help in the margins,” Short said.
Reporting by Ilaina Jonas, editing by Matthew Lewis