Foreign investment in the U.S. commercial real estate market soared in 2015 and continues strong this year. Transactions made by foreign investors accounted for 17 percent of all deal volume in 2015, up from an average of 10 percent in the last four years. A total of $91.1 billion in direct property purchases, the bulk of it coming from Canada, Singapore, China, and Norway, is a key driver in the economic recovery of states like California. But how long will this trend continue, and what effect will it have on commercial real estate market as we know it?
The Reason Foreign Investors Are Drawn to U.S. Commercial Real Estate
Most foreign entities invest in the U.S. real estate market because the process is transparent, and this country is both economically and politically stable. Canada, a leading foreign investor, is an excellent example. Few areas of urban development and increased oil revenues led Canadians to pour nearly $30 billion dollars into the U.S. commercial real estate market in 2015. Singapore and China, following on Canada’s heels as the second and third largest foreign investors last year, have an added incentive — prime coastal real estate in the United States is less expensive than comparable investments in Singapore, Hong Kong,Taipei, and Beijing.
Another significant factor in the rush to snatch up U.S. commercial properties has been changes to the Foreign Investment in Real Property Tax Act (FIRPTA) in late 2015. FIRPTA now treats foreign pension funds the same as U.S. funds for real estate investments, and it also allows foreign pensions to purchase up to 10 percent of a publicly traded real estate investment trust without being liable to taxation. These changes provide added tax incentives for foreign entities to invest in the U.S and will further facilitate the flow of capital from East to West.
How This Trend Has Affected the U.S. Commercial Real Estate Market
One impact is that foreign buyers are looking outside traditional primary markets like Manhattan, Boston, Chicago, Los Angeles, and Washington D.C. in order to find investments. Last year, the second largest market, a region known as the “tertiary West,” was made up of smaller cities like Bakersfield, California and Reno, Nevada.
Investors are also moving outward into regions next to primary markets. Record growth in the commercial real estate market in Orange County, California in 2015 illustrates this phenomenon. While the struggle to find high-quality inventory has even led investors to buy portions of existing assets, the movement outside the prime coastal markets also reflects a tendency on the part of some foreign investors, particularly China, to diversify their commercial holdings into new sectors and more rural areas of the country.
In spite of these shifts, California’s prime markets, San Francisco and Los Angeles, continue to get their share of the money flowing in from foreign investments in commercial real estate. China, for instance, has tended to focus on investments in the technology sectors and hospitality sectors nationwide; in 2015, they spent nearly two billion dollars on these sectors in California.
Nor does China appear ready to pull back. It is responsible for the largest single commercial real estate deal thus far in 2016, Dalian Wanda Group’s $3.5-billion acquisition of Legendary Entertainment, the Hollywood production company. According to Rhodium economist Thilo Hanemann, Chinese investments could top $200 billion by 2020.
The Bottom Line?
Strong growth in the commercial real estate is likely throughout 2016 and beyond. However, there is also a potential risk of overvaluation, particularly in markets outside the prime areas. Just as some analysts have warned that foreign investors are creating residential real estate bubbles in cities like San Francisco and Vancouver, so should commercial real estate investors proceed with caution.
Peak 1031 Exchange, part of the Peak Corporate Network, is a leading national provider of tax-deferred 1031 exchange services. A qualified intermediary and member of the Federation of Exchange Accommodators, Peak 1031 Exchange handles all like-kind exchanges in accordance with Section 1031 of the Internal Revenue Code, including Simultaneous, Delayed, Reverse, Improvement, and Personal Property exchanges. Its clientele is mostly based in Southern California, but the company is able to deal in properties nationwide.