As institutional-quality real estate markets in both Europe and the United States continue to improve, both investment managers and real estate owners (including REITs) are experiencing a corresponding uptick in the inflow of institutional capital. One key difference from past cycles is the intensity and diversity of cross-border capital flows in both directions. We are witnessing increasing focus on allocating U.S. capital to European real estate, as well as healthy capital flows from Europe into the U.S. real estate market.
Deploying real estate capital across international markets can be a complex exercise. Business objectives, investor expectations and deal-specific circumstances often are each important considerations, because exit strategies and timing cannot always be anticipated and the structure must be both flexible and robust enough to accommodate changes at a variety of levels.
Structuring cross-border investments so that capital can be brought back efficiently adds to the complexity and, when capital from different types of investors is aggregated, the challenge is greater yet. For example, we have found that for U.S.-bound investments, the most efficient tax structure for non-U.S. investors continues to be a domestically controlled U.S. REIT. When deploying U.S. capital in Europe, U.S. investors, even those who enjoy tax-exempt status in the United States, need to be sensitive to the complexities of tax and non-tax rules in the European market where capital is invested as well as the tax rules to which they are subject in the United States. Accommodating the interests of both U.S. and non-U.S. investors in a single investment platform presents further complexities, and requires a great deal of care and technical expertise to optimize tax and other efficiencies on an all-in basis.
Goodwin Procter’s Real Estate Capital Markets Group operates across U.S. and European markets, and collaborates closely among our offices to adapt investment structures in each jurisdiction to the needs of cross-border investors. The following brief bullet points provide a high-level overview of key drivers to these structuring exercises when advising clients:
U.S. Investor into European Real Estate
- Target country will normally impose tax, even if it has a tax treaty with the United States.
- Widespread use of multi-tiered holding structures means that buying an asset in one country may involve corporate and tax due diligence on holding vehicles in other countries e.g. Jersey, Luxembourg.
- Taxable investors and REITs: will any holding vehicles be treated as pass-through for U.S. federal tax purposes, and will this require the filing of a check-the-box election?
- Tax exempts: use of leverage at asset level is common, creating risk of unrelated business taxable income (“UBTI”). Is there a UBTI blocker?
- Balancing needs of different investor constituencies.
- Raise any U.S. tax concerns which require the involvement of a counterparty early in the transaction process, allowing time for non-U.S. counterparties, who may have no other reason to consider U.S. tax rules, to get comfortable recognising that this may require them to obtain U.S. advice.
- The same facts may give rise to polar opposite tax answers in different European countries. Local advice, coordinated by a provider who understands your U.S. tax requirements, is essential.
European Investor into U.S. Real Estate
- The U.S. will normally impose tax, even if it has a tax treaty with the investor’s home country.
- U.S. corporate tax rates often higher than those in Europe, limiting scope for crediting U.S. taxes against home-country tax.
- Domestically controlled private REIT provides a potential solution, but requires a majority U.S. investor.
- Exit via sale of shares in REIT, converting a real estate deal into an M&A deal and requiring purchaser to due diligence the REIT as well as the asset.
- How will costs and liabilities associated with the REIT be born, given that the REIT is likely of no advantage to the U.S. investor?
- Understand the tax drivers of U.S. participants in the deal, even those described as tax exempt.
- Don’t forget state and local taxes.
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For additional information on U.S. and European cross-border real estate investment, please see the following publications written by Goodwin Procter real estate and tax partners:
“Bringing Non-U.S. Capital Into [and Back Out of] U.S. Real Estate”
RESource, Winter 2013-14
John M. Ferguson and Edward L. Glazer
“Taxation of US Investment in UK Commercial Property”
Tax Journal, January 24, 2014
Ben Eaton and Karen F. Turk