By Christopher Bechard

James Fetgatter is the chief executive officer of the Association of Foreign Investment in Real Estate (AFIRE). Founded in 1988 and consisting of more than 150 members from 17 countries, AFIRE is devoted to promoting international real estate investment. By providing a forum for foreign investors through meetings, newsletters and its Web site, AFIRE has helped foreign investors gain the knowledge necessary to succeed in the U.S. real estate markets and others around the globe. Portfolio asked Fetgatter about the current state of foreign investment in U.S. real estate and REITs, as well as what we can expect in the future.

Portfolio: Capital has flowed into U.S. real estate, both into listed REITs and direct property investments, from all across the globe. From which countries is AFIRE seeing the most investment in U.S. real estate?
Fetgatter: Although accurate data are hard to come by, the most active foreign investors today appear to be the Germans and Australians. This was supported in the most recent annual AFIRE survey released earlier this year. In the survey, we asked our members who the most active foreign buyers of U.S. real estate would be in 2005. More than 90 percent of the respondents said it would be investors from Germany. Just under 6 percent thought it would be Australian investors, while under 2 percent said either Japanese or Mid-Eastern investors.

Portfolio: Have there been any countries where there has been a sizeable increase or decrease in terms of investment in the U.S. real estate market?
Fetgatter: Australian investment seems to have increased the most in the past few years, starting around 2000 and 2001. The Germans have been consistently active for about 10 years. The newest nationality to show up is the Irish, whose numbers are growing and whose appetite for the investment attributes of U.S. real estate is substantial.

Portfolio: Overall, foreign investment in U.S. real estate has risen in recent years. What deductions can be made about foreign investment in the first half of 2005? What can we expect at the conclusion of the year?
Fetgatter: I believe that foreign investment will hold steady for 2005, with some groups becoming cautious and others forging ahead. Many foreign investors are finding it difficult to buy U.S. real estate due to the fierce competition from our own U.S. investors, especially the private equity funds. The remainder of the year should hold the same unless there are rapid changes in interest rates, currency exchange rates, political upheavals, etc.

Portfolio: Does the desire to own U.S. real estate coupled with the limited supply make U.S REITs a more attractive investment option?
Fetgatter: It is possible that REITs might become more attractive since they already own U.S. property. However, often the foreign buyers have already made a strategic decision about owning public real estate securities or individual properties. This may have resulted from the specific tax treatment of these investments in their country’s tax treaty or from the original mandate for the investment fund. Individual, high net-worth investors, however, might be more flexible and adapt their strategies to fit the opportunities available.

The development of publicly traded REIT structures in other countries seems to be enticing investors into global funds which diversify their holdings into public companies throughout the world.

Portfolio: How has the development of REIT-like structures in other countries, similar to those of the U.S., impacted foreign investments in a wide range of countries?
Fetgatter: The development of publicly traded REIT structures in other countries seems to be enticing investors into global funds which diversify their holdings into public companies throughout the world. This is especially evident in Japan where the success of the J-REIT has encouraged further investment into these types of investment vehicles. The growing number of REIT structures has also further enhanced the importance of the FTSE EPRA/NAREIT Global Real Estate Index Series and index funds which track it.

Portfolio: Is the U.S. still the prime target for foreign investors looking at international real estate markets?
Fetgatter: The proportion of worldwide real estate investment allocated to the U.S. seems to be getting smaller. This decrease in the percentage of worldwide investment is partially due to the proliferation of other options now available, like the previously discussed new REIT structures. The U.S. continues to be attractive to foreign investors for many reasons, but we have some of the toughest taxation on foreign investment of any country. Our after-tax yields face strong competition from a variety of other countries.

Portfolio: Outside the U.S., which countries are seeing the most significant influx of foreign capital?
Fetgatter: The U.K. (specifically London) and France (specifically Paris) are both at the top of the list with European and U.S. investors. European investors have also invested heavily in Spain and Italy. Canada has seen strong investment from Germans, and Dubai is a favorite for Middle East capital.

Portfolio: What are the biggest advantages and disadvantages foreign investors see when considering investing in the U.S.?
Fetgatter: Some of the advantages are investing in the largest real estate market in the world, the depth of market, liquidity of market, transparency, diversity and a stable, growing economy. When an institution makes a decision that they should invest outside their own country, the U.S. is many times their first stop. Since the U.S. is the largest economy and largest real estate market in the world, it is a safe and conservative strategy to begin an international investment program here. The market is large enough to absorb large quantities of capital without disrupting the market. It is also liquid enough to turn an illiquid asset such as real estate into cash in a relatively short period of time should the need arise.

The disadvantages are taxes, litigious culture and the legal costs of doing business, currency risks, time and travel distance, and lack of planning controls in some markets. The U.S. is not particularly foreign-investment friendly, although there are few restrictions on their investments. Compared to some other countries who may, for instance, waive taxes on capital gains for foreign investors, the U.S. tax code offers no incentives for foreigners to invest here. Therefore, property yields must be high enough to offset the taxes in the U.S. On an after-tax basis, the U.S. sometimes struggles to compete.

Our laws are complicated and legal documents are onerous compared to other countries where a lease can be only a six-page document. The fear of lawsuit and liabilities is also strong among foreign investors who may not be used to the ease in which Americans file lawsuits. Currency risks speak for themselves. If you are a European investor and want to invest in Paris or London then you only need to worry about your real estate decision. To invest in the U.S., they also have to worry about repatriating their capital without suffering a currency loss.

Portfolio: To what extent do you see investors in the U.S. allocating their capital in other countries?
Fetgatter: Most U.S. investment abroad is done through opportunity funds sponsored by large investment houses and advisors. These funds have taken advantage of opportunities in various overseas markets. Recent funds have purchased bank debt in Germany and Japan. Some U.S. retailers are bringing their shopping center concepts to Europe. A few investor/developers are active directly in the European markets.

Portfolio: Looking forward, what trends do you foresee in regard to foreign investment in real estate?
Fetgatter: I expect investor appetite for international investments will continue to grow. The U.S. will continue to get its share of this increased capital although the ease of investment and higher yields of Asia are enticing some investors to that region. However, as the largest and most stable real estate market in the world, the U.S. will always be on an investor’s checklist for places to invest.

We at AFIRE believe that even as investments from one country ebb, others will replace them in a fluid, ever-changing environment. The Japanese were replaced by the Germans who are now being challenged by the Australians. In the future, I see more capital deriving from Ireland and Scandinavian countries.