Tags: denis | kleinfeld | us | economy | real | estate | second

Real-Estate Investors Flock to Second-Tier Cities

Monday, 21 Mar 2011 08:26 AM

By Denis Kleinfeld

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With all that is going on around the world, the United States is looking to be one of the most desirable places for people to invest with confidence.

As the United States economy recovers, and other global economies have problems of various sorts, investors are taking aim at real estate opportunities.

These opportunities exist both in the few major core cities but also throughout the cities in the United States where the economy and job growth are recovering. The result is that for investors — U.S. and foreign — real estate in America is again being viewed as an investment class that has safety.

As a result, foreign investors are competing with their U.S. rivals to invest in real estate.

Investors are asking themselves whether sustainable wealth can be reliably built on the volatility of stocks and bonds — or if real estate is a better bet.

Wall Street and the world of financial and portfolio managers primarily focus on investments that are publicly held vehicles, such as stocks and bonds.

Real estate investment trusts, or REITs, however, have gained in popularity as an investment class because of the ability for smaller investors to efficiently get into real estate. Changes in the tax code also have made REITs attractive, as has the fact that somebody on Wall Street can still make money selling them.

At the recent MIPIM industry meeting in Europe, the importance of second-tier cities was highlighted at the session on the opportunities in the U.S markets. While other newspaper and industry articles have focused on the core gateway cities — New York and Washington — the fact is that buying in those cities is a hard strategy to carry out.

The report at the MIPIM conference noted that not all property sectors were covered but that the commercial office market and higher-echelon multi-family were good bets. But the basic investment point was that in the second-tier cities of the United State, the cap rates are just not that compressed.

In my view, with the U.S. working itself out of the recession, the states which promote job growth in terms of real industry are the ones that will benefit the most from increasing real estate value.

Another recent industry conference, in Miami, revealed that private equity, REITs, and foreign investors are driving the turnaround in U.S. real estate investment. A survey taken at the conference shows that it is expected that the most active markets would include those outside the few core cities.

It is expected that most of the financing would be from essentially private sources or funds that organize private money. Only 10 percent of the respondents to the survey at the Miami conference felt that a significant amount of financing would come from banks and 25 percent felt that money would come from the U.S. pension funds.

Clearly, demographics drive real estate demand. Population and labor-force growth are the essential drivers of the property markets. Without a growing population, there is no point in erecting office buildings, multi-family housing, or new construction in the other property sectors.

In the case of the United States, this population growth distinctly comes from the tremendous amount of actual immigration of people from every corner of the globe. The Unites States is where a lot of people want to be. People and job growth translate into creating value in real property investment.

Foreign investors also will have to deal with the U.S. tax system. It is complex for everyone. However, the United States encourages foreign investment by allowing foreign investors to lend money in the United States and be paid interest, which is free of any withholding tax.

While there are certain criteria which must be met, the fact is that it is one of the few areas of the U.S. tax law where a transaction can be structured with confidence that the tax benefits the tax code provides will actually be allowed.

A number of foreign investors look to investing through a REIT. When a REIT is structured as a domestic REIT, then the foreign investor can dispose of the shares on a tax free basis.

However, the largest group of foreign investors is those that individually invest directly. For that group of investors, they need experienced U.S. tax counsel as the applicable tax law then gets quite complex rather quickly. But then again, it's good business for the U.S. tax lawyer.

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