Foreign Investment In U.S. Real Estate
The total value of all the property in the world is estimated at $217 trillion, of which about 75% is residential. Given its immense overall value and the fact that, with very few exceptions, the entirety of human existence takes place on property owned by some entity, it is no surprise that that the industry acts as a metric for economic stability and is an attractive target for investors. The U.S. housing market alone is estimated at $33.3 trillion and the U.S. commercial real estate market is estimated at $17 trillion. This substantial position within the global market certainly plays a role in why foreign investment in U.S. real estate is so popular, but does not tell the whole story.
Not all land is equal, and the value can vary to a staggering degree based on location, natural resources, agricultural viability, existing structures on the property, or even local politics. To give some perspective, the average price of land in Manhattan is $1,773 per square foot as of 2017, equivalent to $77.2 million per acre. Meanwhile the rural desert town of Gerlach, Nevada has land available for $157 per acre, approximately 492,000 times cheaper. With this in mind, we can easily speculate as to why certain real estate investments might be more attractive than others.
In 2018, Chinese nationals purchased over 40,000 U.S. homes, accounting for 15% of the 284,000 foreign U.S. home sales by number and 25% by dollar amount. The next most prevalent purchasers were Canada, Mexico and the UK. Foreign buyers accounted for only 3% of total U.S. home sales, but these figures have been steadily rising since the 2008 financial crisis. On the commercial side, foreign purchases of properties over $2.5 million totaled nearly $95 billion in 2018. Canada accounted for 51% of this, Europe accounted for 24%, and Asia 19%. Foreign purchases totaled 17% of these mid- and large-cap commercial property sales, a dramatic 72% increase from 2017. Unsurprisingly, the vast majority of both residential and commercial properties were in major metropolitan areas such as New York City, San Francisco and Chicago.
Out of 195 countries the U.S. consistently leads in receipt of foreign direct investments, with over $450 billion received in 2016, a large part of which was in real estate. So why is foreign investment in U.S. real estate in particular so attractive to foreign property buyers?
Two of the most important factors are stability and liquidity. United States real estate is considered a mature market that provides safe, slow returns. It allows those in more tumultuous markets like Asia or even Europe with the unrest of Brexit, to reliably store and grow their money. The size and popularity of the U.S. market also make it highly liquid compared to other real estate opportunities, allowing investors to buy and sell with relative ease.
There are some noteworthy downsides for foreign buyers as well. One in particular is the Foreign Investment in Real Property Tax Act (FIRPTA). FIRPTA was passed in 1980, and required foreign owners to pay U.S. capital gains tax on realized gains from the sale of real estate investments. In 2015 the act was revised to allow foreign investors to hold larger FIRPTA-exempt positions in U.S. Real Estate Investment Trusts (REITs), and exempted foreign pension funds entirely. This revision further incentivized foreign investments in the U.S. real estate market, but not to the degree of the tax-free pre-1980 market. Additionally, it is very difficult for foreign purchasers to get decent rates on mortgages for U.S. property. Fannie Mae and Freddie Mac, the institutions backing most mortgages, will not guarantee those of non-citizens. As a result, the original lenders must assume all risk, which subjects the purchasers to a higher required down payment and a higher interest rate. This is, of course, not an issue for the 47% of foreign purchasers who pay the full amount in cash.
So why should Americans care whether we allow foreign investment in U.S. real estate or not? The practice has implications for the country as a whole. As a net effect, more foreign investment means there is more money coming into the country. This produces a positive effect on GDP and tax revenue. Higher demand for both residential and commercial real estate drives further development of these properties, which requires more workers for construction and maintenance efforts. Local businesses attract wealthier customers as the area becomes more developed, and the development of commercial properties allows these businesses to grow and provide more opportunities for local workers. The net result of this is more available homes and business spaces, more job opportunities, and higher wages.
Of course, there is no guarantee things will go so smoothly. Foreign investment also directly impacts property in a manner that is to be expected in any market – higher demand leads to higher prices. This can be good or bad for individuals depending on whether they are selling or buying at the time. It is likely to increase rental costs as property values increase with demand, which is good for landlords but bad for tenants. The net result of this is higher living expenses and property values which benefits the rich at the expense of the poor and middle class.
So are the potential benefits worth the risks? Do the new job opportunities and wealthier customers elevate local residents’ wages enough to keep up with rising living expenses? Or do foreign investors simply price locals out of their own neighborhoods?
New Zealand recently banned most non-residents from purchasing homes after a dramatic increase in prices due to a housing shortage, despite foreign home buyers accounting for just 3% of sales. The reasons cited were exactly those described above, locals being priced out of their neighborhoods by foreign buyers. Dave Platter, the spokesman of a Chinese international real estate company commented “Is the ban wise or useful? We think it’s neither.” His perspective is clearly biased, however the IMF agreed, and cautioned New Zealand’s government that the ban would eliminate the foreign funds necessary to build additional homes and correct the housing shortage. As of this writing, the policy has been in effect for 8 months, and New Zealand’s average home prices have reached new all-time highs, although the regions responsible for the increase have changed. It is likely too early to draw conclusions about the long-term effects of this policy change, but so far it appears to have had the opposite of its intended effect.
It seems to me that in general, foreign investments have a positive effect on the receiving country. In certain areas the increased demand may temporarily worsen an existing problem of skyrocketing property prices while supply struggles to catch up, but eliminating foreign funds seems to prevent supply from catching up at all. Besides this, a net increase in the nation’s wealth benefits everyone, even if the lion’s share of that increase goes to those who are already wealthy.