Foreign Investment in US Real Estate

Editorial team of TFX

• 15.09.21 • 5 min read

While it may be difficult to find any reason to be optimistic in the midst of the Covid-19 gloom, one bright spot is that foreign investment in US commercial real estate hasn't waned. Some overseas investors' appetites may be even more voracious than they have ever been.

Yes, concessions are awash in the retail and office segments, which are in turmoil. Despite rent holidays and eviction moratoria, the residential and multifamily markets are heated to the point of being unaffordable. Yes, renters are waiting to see what happens, holding on to leases and negotiating hard on extensions. Despite this, foreign investment in US commercial real estate will keep climbing for some time.

Why is it profitable for foreigners to invest in US real estate?

Can foreigners invest in US real estate? Not only are they allowed to but they remain bullish on US real estate. Here are the primary reasons why:

1. Advantageous Debt Terms

Investors in the United States often overlook how fortunate they are in the American real estate loan market. The mortgage loan terms they get are virtually unheard of almost everywhere else in the planet!  The long-term fixed-rate mortgage is far from universal. Short-term, extendable loans are the standard in several nations, including the United Kingdom and Canada.

On the other side, American lenders give the option of locking in a low interest rate for 10 to 30 years, with payment periods ranging from 15 to 40 years. Stabilized-asset mortgages of $1 million or more from agency creditors like Fannie Mae or Freddie Mac are even more appealing, as they come with non-recourse guaranty and interest-only terms. With interest rates in the United States at record lows, international investors are more interested than ever in using leverage.

2. Low Property Valuations

When it comes to housing costs, Americans may experience sticker shock, but that's nothing compared to their foreign peers. A price of $200 per square foot may sound excessive, but consider the London investor who is dealing with costs in the thousands of pounds per square foot.

Property is ample in the United States, and new construction is practically continual. In the center of the country, some of the most stable marketplaces are also some of the least expensive and have the lowest entrance barrier. European and Asian real estate investors, on the other hand, must pay a premium for such security. When international investors are looking for a comparable deal on premium property, they turn to the United States but exclude markets like New York, San Francisco, and Los Angeles.

3. Progressive Cash Flow

On the global property stage, the two points mentioned above are already game-changers. It's also worth noting that cheaper rates and favorable financing combine to generate a big additional benefit: they establish the conditions for cash flow. It is quite easy for landlords of US rental property to have a monthly cash surplus due to a low debt-service load and a low purchase price compared to market rent.

Even heavily leveraged real estate assets can generate cash flow — even large cash flow — according to American investors. This isn't the case everywhere. In the sweltering London real estate sector, investors are content with the bare minimum of cash flow. Negative cash flow is not only acceptable, but expected in Australian markets. Property investors in Sydney actually expect to lose several hundred dollars per month. Foreign interest for U.S. real estate is fueled by the prospect for not only sustainability, but also cash flow and even appreciation.

4. Relative Stability

As in many other countries, the United States reserves the right of eminent domain — the right to lawfully confiscate property for any reason — based on the ancient truth that land belongs to the state wherever it is found; landlords only exploit it at the state's leisure. However, the United States uses eminent domain sparingly, usually for the public interest, such as a highway or utility development project, and has a mission of producing fair compensation for seized property. The United States also opposes attainder, which is the seizure of a criminal's property.

What are the types of ownership/investment?

When it comes to investing in the United States, foreign investors have a variety of options. They are as follows:

1. Direct Investment

Foreign investment in US real estate is totally acceptable. There are no income tax restrictions on foreign individuals owning real estate in the United States. Most sophisticated international investors, on the other hand, have avoided holding property in their own names because doing so compromises anonymity and, more crucially, subjects the foreigner's estate to US estate tax and probate upon death. Individual ownership also limits the amount of tax planning that may be done.

2. Corporate Investment

The most desired—but not always the best—manner of owning title to real estate continues to be corporate ownership by a foreign investor. Once the decision to invest through a corporation has been made, the question of whether the corporation should be domestic or international emerges. If the corporation is overseas, the investor may be able to avoid paying inheritance taxes in the United States, but the corporation may be liable to U.S. branch profits taxes, which can be quite high.

3. Limited Liability Company Investment

Limited liability companies have been legalized in every state and a number of foreign governments. Limited liability firms combine the laws of corporations and partnerships. While a limited liability company may have enticing business attributes, they are often viewed as disregarded entities for tax reasons. This means that real estate owned by a foreign investor through a limited liability company is treated as if it were held directly by the investor for tax reasons. Although it is not recommended to hold real estate through a single limited liability company for tax purposes, multi-tier limited liability corporations can be a very compelling investment option.

4. Investing Through a Trust

Because it subjects the real estate asset to the estate tax in the case of the foreign investor's death, a foreign grantor trust is generally not a good choice for owning U.S. real estate. When a foreign investor has the only authority to abolish a trust that holds real estate, or when the trust's income is only distributed to the foreign investor or the foreign investor's spouse, the trust is known as a grantor trust. When a foreign grantor trust owns the real estate, it is considered part of the foreign investor's estate. A foreign trust that is not taxed as a grantor trust, on the other hand, is taxed as an irrevocable trust. Because one of the main difficulties for an individual investing in U.S. real estate is the estate tax risk, a foreign investor may find the usage of an irrevocable trust beneficial for estate tax purposes.

What a foreigner needs to know about US investment tax

Many foreigners have made real estate investments in the United States. There are unique tax implications in the United States that must be properly studied. When it comes to real estate investing in the United States, it's important to strike a balance between federal income tax considerations on the one hand and federal gift and estate tax considerations on the other. While the federal income tax for foreign investor rates on an individual foreign investor's taxable income are the same as for a U.S. citizen or resident, the federal estate and gift tax, when implemented on foreign investors, can result in substantially higher tax burden on a taxable U.S. estate or gift transfer than for a U.S. citizen or resident.

A non-resident foreign investor's gross estate (all U.S. property in which the decedent had an interest at the time of death) is taxed at 18% to 40% of the amount of the estate over a $60,000 exemption. As a result, the most important U.S. federal tax concern for many overseas investors is U.S. federal estate and gift taxation.

Meanwhile, the U.S. upholds bilateral tax treaties with 68 different countries.

Residents in foreign nations are taxed at a lower rate or are excluded from U.S. taxes on some items of money they generate from sources within the United States, such as real estate. Tax treaties can have a big influence on a client's bottom line by lowering income and withholding taxes in the United States.

Some treaties, for example, completely eradicate the United States' withholding tax on earnings repatriation (payments of U.S.-source dividends). Others lower the appropriate withholding tax rate to 15%, 10%, or 5%, respectively.

A foreign person may gain from leveraging its investment in U.S. real estate under an appropriate bilateral treaty in addition to profit repatriation.

For example, bilateral tax treaties between the United States and the United Kingdom, Canada, France, Norway, Germany, Russia, Ukraine, and a number of other nations exclude U.S. withholding tax on payments of interest to a foreign person, regardless of the borrower-lender relationship.