New Regulations Allow Closer U.S. Scrutiny Of Foreign CRE Investments

The U.S. Treasury Department has proposed new regulations to tighten government scrutiny on foreign investments in the United States, including a wide range of real estate deals.

The rules will take effect early next year.

The question now is whether the new guidelines will discourage investment in U.S. commercial real estate, particularly from China, where investment volume has already contracted as the trade war grinds on.

Though the details are complex, the thrust of the new rules is straightforward: they give stronger authority to the Committee on Foreign Investment in the United States — an interagency body led by the Treasury Department with members from the departments of Justice, Homeland Security, Defense, Commerce and State — to put the kibosh on business transactions in areas that the government deems protected.

Much of the new authority given to CFIUS doesn't involve real estate deals, but rather investment transactions that involve critical technologies, critical infrastructure and data. Those sort of deals have received widespread attention, especially when Chinese investors buy, or try to buy, companies with access to cutting-edge information technology.

On the other hand, part of the new rules specifically address non-U.S. entities doing real estate deals in the United States.

“Along with many real estate investors both inside and outside the U.S., we're monitoring the current period of public comment for CFIUS," said Gunnar Branson, the CEO of AFIRE, which represents international investors in U.S. real estate. 

Branson added that whether the intention is there or not, the new rules might discourage investment. 

The new regulations represent entire new categories of transactions previously not subject to CFIUS jurisdiction, Goodwin partner Richard Matheny said. He advises clients on a broad range of U.S. regulatory issues concerning international trade and investment, including CFIUS reviews.

"The real estate provisions of the proposed rule are significant, as they dramatically expand CFIUS’ jurisdiction to review even certain leases of property to foreign persons, even of vacant property with no U.S. business attached, assuming certain conditions apply," Matheny said.

CFIUS will have the right to review such deals, for example, if a property is within one mile of any of more than 100 specific military installations, or within about 100 miles of 32 other military installations. Also covered is real estate within, or which functions as part of, airports and ports.

There are some exceptions. CFIUS will not (in most cases) exercise jurisdiction over real estate investments in single housing properties or office space in a multi-unit commercial office building. Also, the committee won't be involved in deals in census-designated “urbanized areas” or “urban clusters,” unless the real estate is within an air or maritime port or within a mile of a military installation.

"The rules identify scores of particular military facilities and establish a perimeter, whether one mile or 100 miles, within which foreign person control of real property can confer CFIUS with jurisdiction to review and, where appropriate, take action to counter the transaction," Matheny said.

The new rules, which are now in their comment period, give more teeth to the Foreign Investment Risk Review Modernization Act, which was signed into law by President Donald Trump last year. Although the increased oversight applies in theory to any non-U.S. investor, the clear intent of the bill was to scrutinize Chinese investors more than before.

"By exploiting gaps in the existing CFIUS review process, potential adversaries, such as China, have been effectively degrading our country's military technological edge by acquiring, and otherwise investing in, U.S. companies," Sen. John Cornyn (R-Texas) said when the bill was introduced.

Originally created as an advisory body, CFIUS took on more regulatory functions in the 1980s, when Congress gave the president authority to suspend or prohibit certain types of foreign investments. (CFIUS' authority is thus delegated from the executive branch.) In the Foreign Investment National Security Act of 2007, Congress further refined its structure and purpose. 

Robert Williams, executive director of the Paul Tsai China Center at Yale Law School, describes CFIUS as an interagency committee that reviews "covered transactions" — mergers, acquisitions and takeovers by or with any foreign entity — that could result in foreign control of a U.S. business to determine the effect of the proposed deal on U.S. national security.

The new regulations refine the committee's role even further, perhaps with unintended consequences.

"One important development not stated in the rules, but which we anticipate, is that financial institution lenders are likely to pay much closer attention to real property acquisitions they finance, to understand whether the borrowers have filed with CFIUS," Matheny said. "This could impact the value of the security those lenders take for the loan, so we expect a proliferation of reps/warranties about CFIUS in real estate-associated loan documents."

Since the tighter rules focus more on China than other nations, the near-term impact might be to further depress Chinese investment in U.S. commercial real estate. But the pullback of Chinese dollars from the U.S. is already happening.

Mainland Chinese investors spent $3.8B on real estate outside the country in the first six months of 2019, the lowest figure since 2012, and down 66% from the first half of 2018, according to data from Cushman & Wakefield and Real Capital Analytics. 

China's pullback isn't related to a lack of appetite for U.S. real estate. AFIRE's most recent annual investor survey, released in the spring, found that overseas investors are generally confident in a strong U.S. economy, solid real estate market fundamentals, and continued capital inflow to U.S. real estate. 

The Chinese government placed strict controls on Chinese nationals and companies moving money out of China in 2017, which effectively turned off a spigot of money that fueled years of record-breaking deals in 2014 and 2015, particularly in New York.

Foreign investors, Chinese and otherwise, are paying close attention to potential near-term risks, such as changing interest rates, global political considerations and policy concerns, AFIRE's survey showed. The proposed new rules clearly fall into the latter category. 

"While all the long-term impacts of the proposed regulatory changes are difficult to forecast, the concern with any regulatory expansion is the potential unintended consequence of dampened benign cross-border investment activity," Branson said. 

"As global institutions hold assets over an extended time, often in excess of 10 years, they adjust their strategies accordingly," he added. "It is essential for regulators to be specific and aware of the significant contribution of global institutional investments to the U.S. economy."