It is no secret that a major factor in the activity in the New York city real estate market is demand from overseas. This began with the construction boom before the Great Recession. In representing hundreds of foreign nationals over the years, I have learned the factors they consider when investing in property in New York City.
The first factor I have always found to be significant is the play on exchange rates. Going back to 2008, 1 Euro was equivalent to 1.60 U.S. dollars (in April of 2008 to be precise). Having this benefit in the exchange rate helped create the appearance that New York city real estate was a bargain in comparison to other major markets such as London, Paris, and China.
If anything, this benefit for foreign nationals helped drive up property prices as domestic buyers could not necessarily compete in the same manner in pricing nor could they justify inflated valuations in the same manner that foreign investors could given the exchange rate benefit they had.
Fast forward to present day and 1 Euro is now only equivalent to 1.12 U.S. dollars. The strengthening dollar is obviously good for our economy as a whole; however, foreign investors no longer have such a steep discount in investing in property. An interesting observation in comparing the mindset of a foreign investor from 2005 through 2009 versus 2011 (when they began reentering our market) to present, is that in the time period when the exchange rate was to their benefit, they were nowhere near as concerned with tax implications for investing in the U.S. (namely the estate tax).
The mindset during that era was just to invest in property as fast as possible. The fiscal cliff negotiations in 2012 highlighted several changes to our tax code, many of which caught the eye of the foreign investor as estate tax was heavily emphasized and the federal capital gains tax rates increased. This is when you started seeing more creative tax planning for foreign investors in utilizing off-shore corporations, LLCs, and other vehicles to mitigate their risk from a tax perspective.
The second factor is Chinese investors. China has been one of the countries that was most active in investing in New York city over the past 10-plus years. It has been well documented that money coming from China has more or less vanished in the last two years. The main reason for this is that China has always had a restriction on how much capital can exit the country on an annual basis. That number is $50,000, and this rule has been in place for as long as I can remember.
While China’s economy was booming, this rule was ignored for the most part and you saw an influx of billions of dollars enter our market from China. As their economy has cooled as of late, the Chinese government has decided to strictly enforce the $50,000 limit on how much capital that can leave the country, and this has had a detrimental impact on the New York city real estate market.
These two factors also led to a sharp increase in property values which many have called into question. The New York city real estate market has been in a correction phase for the past two years, and there is no end in sight for this at the moment.
Even investors from overseas are seeing that the bull run had been taking place for far too long and are waiting for property values to decline before reentering the market. If you were to compare the construction boom pre-recession to post-recession, the main difference is that in the post-recession era, construction was tailored to the ultra-luxury market (referring to the residential market). This created a glut in supply in that segment of the market, the demand for which was mainly from overseas.
When considering the markets where foreign capital was coming from, Europe and China stand out. In Europe, there has been turmoil over the last several years with the economies of countries such as Greece teetering on the brink of collapse and then Brexit. In China, economists have been predicting that their economy was in a bubble and about to burst at any minute.
Additionally, politically the U.S. has been viewed to be more stable than most countries in the world. These are additional factors for interest coming from overseas. The issue now is that the sentiment overseas is that we are no longer perceived to be as stable as we once were given the current administration.
Every day in the news there is a headline that is of concern to any investor from abroad. Whether it is the on-going trade wars with China—which have the potential to be disastrous—the impacts of tax reform, Russia, and just the general negative reaction to the political divide in our country.
All this negativity is overshadowing positive aspects such as the recent news that unemployment is at a 50-year low, interest rates remain at historic lows with the Fed halting any substantial increases, and the stock market performing at record levels as well.
All of these factors have created a wait and see mindset from foreign investors, and that does not appear to be changing any time soon.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Pierre E. Debbas is a partner and founding member of Romer Debbas LLP. His practice focuses on the purchase and sale of commercial and residential real estate in New York City, commercial leasing, real estate related financing matters, representation of cooperative and condominium boards, foreign investors and small businesses.