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catching the wave on international capital flows: matthew real estate magazine


co/ miu miu

co/ miu miu

If you live in a major city such as Los Angeles, San Francisco, Chicago or New York, you have more than likely witnessed the abundance of outbound capital flows coming in from China and other foreign investors. These international buyers have become major players in real estate, buying in both residential and commercial markets. Some believe the growth in U.S. commercial real estate will soon fall flat, but the current trends suggest otherwise.

With a worldwide low-interest rate and and an imploding Chinese real estate market, it’s time to catch the wave while heavy capital is still flowing into the U.S.

Here’s the breakdown on capital flows.

Just like any other transaction you might make, international purchases between two global parties require monetary payments. With the help of the Library of Economics and Liberty, we can break down international capital flows with simple math. If the exports of a country are equal to the imports, then the balance is net zero. Pretty simple. However in the real world, a country’s imports are generally never equal to the exports. This creates a scenario where the balance can vary, so a country’s deficit or surplus is known as the capital account balance.

When a country imports more than it exports, the foreign trading partner can use the country’s deficit to purchase other assets such as currency, equities or real estate. According to the Library of Economics and Liberty, “Net capital flows comprise the sum of these monetary, financial, real property and equity claims. Capital flows move in the opposite direction to the goods and services trade claims that give rise to them. Thus, a country with a current account deficit necessarily has a capital account surplus.”

Simply put, capital flows are the movement of monies with the purpose of investment.

Most capital flows are transactions that take place between the wealthiest of nations. Over the past 200 years, the majority of global investors have been dominated by Western European nations. Primarily, investments have come from countries such as the Netherlands, Switzerland and the United Kingdom. However, the tides are changing with our current global and economic climate.

Foreign inflows and domestic outflows contract in a systematic way, depending on a variety of factors including global financial stress. With the declining value of its currency and slowing growth, China has become a major player in U.S. foreign investments.

Chinese investment in U.S. real estate is absolutely groundbreaking.

China has a sordid and complicated economic history. In 1997, the Asian foreign exchange crisis resulted in an unprecedented downfall of the foreign exchange rates of five Asian countries. Only China and Taiwan were able to escape the crisis and experienced a reasonable level of economic growth. Conditions in China were different because of its trade surplus, a positive account balance that contributes to a huge foreign reserve and relative economic growth.

China was not immune to the Asian crisis, but the rise in industrial production from growing exports did not cause inflation. It has been reported by the real estate services firm Newmark Grubb Knight Frank that in the last year, foreign investors have spent  $19.1 billion on U.S. commercial real estate. Of that number, Chinese investors have contributed $7.68 billion. Canada came at a distant second, spending a mere $1.22 billion.

China’s tech titans and venture capitalists are attracted to U.S. real estate because it is a relatively easy asset to understand. This trend is somewhat new, but as foreign investors become more experienced, capital flows will continue to be directed into U.S. real estate and other investment assets. All of this is quite interesting, particularly because the capital is coming from a country with only state-owned property. The Chinese government poses a potential problem for investors if they decide to put controls in place that make it difficult for capital to leave the country.

When it comes to foreign cash flows, get to know foreign tax credits.

Changes in technology and the world’s political climate have expanded the growth of international capital flows. The experts at Investopedia have noted that today’s investors seek to diversify their portfolios by adding securities from different parts of the globe. To really maximize your earning potential, you have to understand the tax treatment of international securities. When an American purchases an investment asset overseas, it is evidently subject to U.S. taxes. However, the government from where the asset was purchased can also take a slice.

It is called, double taxation; and you want to avoid it at all costs. That is why understanding the U.S. tax code and the “Foreign Tax Credit” can help offset some of those expenses. Every country has its own laws, some of which do not have any capital gains taxes at all. The IRS offers a way to avoid this double taxation – including dividends, interest and income – by claiming it as a credit or a deduction on your tax return. If you qualify, you can reduce your U.S. tax liability as either a deduction or a credit. In most cases, it would be in your advantage to take the foreign income taxes as a credit.

There is, however, a limit on the amount you can claim. According to the IRS, your foreign tax credit is the amount of the foreign tax you paid or accrued or, if smaller, the foreign tax credit limit. It cannot be more than your total U.S. tax liability multiplied by a fraction. This denominator is your total taxable income from U.S. foreign sources. However, if you have a credit but cannot use it because of the foreign tax credit limit, you can carry it back to the previous tax year and forward to the next 10 tax years.  

These laws are more complex than simply itemizing your deductions, so be sure to do your research by referring to the IRS for details or consult an expert.

Foreign capital flows won’t be slowing down anytime soon.

Last year, the New York City-based research firm Real Capital Analytics found that foreign real estate investors acquired a record-breaking $91.1 billion in properties all across the U.S. This is double the amount that was spent in 2014, and the surge doesn’t seem to be slowing down. U.S. real estate is attractive for capital preservation and an opportunity to create yield. Canada has been one of the most dominant investors, but we are seeing a consistent flow of foreign capital coming in from all over Europe, Singapore and Korea. Of course, China is leading the pack.

Changes to the U.S. Foreign Investment in Real Property Tax Act (FIRPTA) could be another factor that will drive more foreign capital into the U.S. It involves a lift of a tax penalty on pension funds. This makes real estate cheaper because of fewer taxes. This opens up the market for investment in alternative assets as well. Traditionally, foreign investmentors have been actively buying in four specific property types - retail, industrial, office and multifamily. We are now starting to see a trend of buying across student and senior housing.

U.S. real estate is likely to continue attracting foreign attention, which is why China has been such an aggressive buyer over the last few years. Some of their investments include the purchase of the One Chase Manhattan Building, General Motors Tower, the Detroit Free Press Building, the Waldorf Astoria and the list goes on. Our property market is one of the most stable and notably, one of the most transparent. The U.S. is strong and reliable, which provides lower overall risk to foreign investors. As China’s economic problems are resolved, Chinese buyers will continue to increase purchasing U.S. real estate. In combination with low interest rates, many experts believe that global capital flows will continue to grow U.S. commercial property.  

It’s all about timing. If the changing tides give any indication on the continued swell of foreign investments, you can bet that this is the time to catch the wave.