The Long-term Impact of FIRPTA on CRE Pricing

The deal environment could see a boost this year after a change to the FIRPTA tax rule will likely result in more foreign money flowing into U.S. real estate.

The tax change, combined with certain strong fundamentals, should keep commercial real estate deal volume rolling along at a steady pace, John Chang, first vice-president in research services at Marcus & Millichap, told VTS. However, macro factors might interfere with a market that is still going strong.

A FIRPTA-related uptick

“The increased liquidity should support more transactional activity,” Chang said about changes to the Foreign Investment in Real Property Tax Act (FIRPTA), some of which took effect when President Barack Obama signed them into law in December.

One of FIRPTA’s biggest changes is that it treats foreign pension funds the same as U.S. pensions, exempting these funds from paying taxes on gains from the sale of U.S. real estate, according to a brief from law firm Paul Hastings LLP. This change, which took effect in December, is expected to motivate foreign pensions to invest more in U.S. real estate.

“The FIRPTA changes should have a positive impact on U.S. commercial real estate prices, particularly for high-quality buildings in gateway cities, because they will make it easier and more tax efficient for offshore investors to own U.S. real estate,” said Jim Sullivan, managing director of Green Street’s Advisory group.  

Swimming upstream

A few things to consider: any impact on the deal environment will be over the long-term. The impact is unlikely to manifest “in a quick and obvious way,” according to Sullivan.

Also, it’s hard to ignore what is going on in the broader economy, with volatility in the public markets spurred by the continuing depression in oil prices and uncertainty in China. These factors could certainly slow transaction volume that would otherwise ramp up with an influx of motivated buyers from countries outside the U.S.

Commercial real estate does not seem to have been affected yet by all the uncertainty. Chang commented that a wide range of economic indicators — jobs, retail sales, wage growth — are all looking favorable at this point.

“Liquidity is high, access to capital is high, the cost of capital is still restrained,” he said. “That’s a combination that leads to increased transaction activity and sales activity and value gains.”

The FIRPTA changes are expected to boost an area of investment that has already been regaining strength since the Global Financial Crisis. Cross-border investment in U.S. real estate spiked to $87.3 billion in completed transactions in 2015, compared with $5 billion in 2009.

The liquidity impact

Another of the numerous changes to FIRPTA will affect, perhaps in a minor way, liquidity. The key change is an increase from 10 percent to 15 percent to the tax withholding on gross proceeds on any real estate sold except for properties of $1 million or less the purchaser wants to use as a residence, according to Harvey Berenson, managing director at FTI Consulting.  (There is no FIRPTA withholding on residences of $300,000 or less.)

The withholding increase, which kicked in last week, is relatively minor, but could affect foreign investors by tying up capital they had planned to use for other purposes, Chang said.

That withholding has been increased in part as a way for the IRS to make sure they get taxes from entities not based in the U.S., Berenson said. “Whatever is withheld, that is the last chance the IRS has to get the money,” he said.

Billy Fink
Billy Fink
Billy Fink is a former member of the VTS team. Subscribe to the VTS blog:
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