Cross-border investment in U.S. hotels is a storyline that is not going anywhere quick. Foreign buyers are emboldened by the perceived safety of U.S. assets, particularly trophy properties in the top markets, which is why foreign investments into hotels could reach a record high this year.
To be sure, an attractive U.S. market coupled with some foreign governments relaxing laws that historically impeded foreign investment are the impetus for all this foreign direct investment, but investors still need to be cautious and understand U.S. laws and customs, so that their investment is safeguarded, particularly at the time of disposal.
Here are five considerations for foreign investors investing in U.S. hotels:
1) Know the U.S. tax code
Taxes, like death, are inevitable. But while death is final, there are ways to make sure you aren't ravaged by the tax code. Currently, the U.S. does not tax, or impose a filing obligation on, the acquisition or ownership of U.S. real property by a foreign person. And, generally, a foreign person is not subject to U.S. capital gains tax on the sale of U.S.-situated capital assets.
However, the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) created an exception to that rule for U.S.-located real property. Under FIRPTA, a foreign person’s gain on the sale of U.S. real property is treated as income effectively connected with a U.S. trade or business. As such, a gain is subject to regular U.S. income tax rates. When a foreign person disposes of U.S. real property, 10 percent of the amount realized must be withheld by the transferee, regardless of the amount of the foreign person’s gain. The withheld amount is not the final tax obligation but is treated as an advance payment.
There is discussion that Congress may lift the tax on foreign real estate investors. As Robert Ivanhoe, chair of law firm Greenberg Traurig's global real estate practice, points out: "It would be a big change. Foreign buyers have had to set up a tortured structure to invest in real estate here. It's not only complicated, but also expensive from a legal perspective. If the change takes place, [the foreign funds] will be treated like domestic funds. It will give major pension investment funds much more freedom to do deals here."
Bottom line: Know the tax laws.
2) Get a good lawyer
While lawyers are often the butt of jokes, you won't be laughing when a deal goes awry and you don't have attorney worth his salt.
Hotels are complex because they are both operating businesses and real estate. For that reason, a foreign buyer needs counsel on the ins and outs of not only real estate acquisition, but also business acquisition.
3) Choose the right management
You've acquired the perfect hotel—now, who is going to run it? Without a strong operation team, that can wring out every last dollar, your investment won't be a viable one. After all, the management company has a fiduciary duty unto the owner.
So, do your homework. Know the market where you are buying and what management companies have had success there. Understand that not all management companies are the same. Some have expertise running select-service hotels; others, luxury.
Structure the management company so that it's as equitable for you as it is the management company involved. You are a team, after all.
4) Do your due diligence
Foreign buyers with oodles of cash may be in a hurry to get a deal done, but not going through the due diligence process is never a good idea. There are environmental issues, energy-efficiency concerns, feasibility studies to pore over—is the asset landmarked?
You may be a foreign buyer, but the hotel business is a local one. Know what the competition is on your block, down the street and in the further areas surrounding you.
5) Understand your exit strategy
The divestment of your asset is just as important—if not more vital—to the overall deal. Ok, you may be a long-term investor with a 30-year-hold strategy. Maybe I'm not talking to you, but to the many investors who look at investments as a three- or five-year window. If you have a hold of your exit strategy going into the deal, you'll have a better roadmap as to how to make your asset more profitable and valuable at the time of sale.