Foreign investment in U.S. multifamily continues to accelerate, despite a 25-year-old tax law that imposes stiff penalties on crossborder investors.

In fact, foreign investors spent more than $2 billion on U.S. multifamily properties in the first seven months of the year, up from $1.13 billion for all of 2010, according to New York–based market research firm Real Capital Analytics.

“Because of the financial crisis, there's a perception among foreign investors that there are some deals to be found here,” says Jim Fetgatter, chief executive of the Association of Foreign Investors in Real Estate (AFIRE), based in Washington, D.C. “Traditionally, they've been largely office investors, but their preference right now is multifamily—they realize the multifamily industry is growing and that offices have not been filling up."

Despite this uptick, however, many argue that foreign investment volumes could be much greater, were it not for the biggest roadblock in the way, the Foreign Investment in Real Property Tax Act (FIRPTA), which requires foreign investors to pay a 35 percent tax, on top of state and local taxes, on any capital gain from U.S. commercial real estate. As a result, some U.S. developers are eyeing an alternative route in the form of a relatively unknown federal program to attract foreign equity.

Northern Exposure

Although a variety of foreign buyers is seeking out deals in the United States, much of this year's foreign equity investment activity, about $806 million worth, is coming from our neighbors to the north, as Canadian investors grow increasingly bullish on U.S. multifamily. The Canada Pension Plan Investment Board (CPPIB) has been particularly active this year, marking its first direct entry into the U.S. multifamily sector with a big splash. The pension plan invested $284 million in five separate multifamily transactions in August alone.

Among them, the CPPIB invested $92 million for a 45 percent interest in a new, 569-unit development being constructed in San Jose, Calif., by Palo Alto, Calif.–based Essex Property Trust. The pension plan is also partnering with Washington, D.C.–based Multi-Employer Property Trust on a new, 24-story high-rise complex in downtown Seattle called Sixth and Lenora.

In August, the pension plan struck a joint venture with Denver-based Archstone, a threeyear engagement focused on new development. At the same time, the CPPIB invested $108 million in two Archstone properties, taking a 40 percent interest in both the 426-unit Archstone North Point in Cambridge, Mass., and the 392-unit Archstone Woodland Park in Herndon, Va.

The joint venture with Archstone includes another foreign entity—German financial services titan Allianz, which also spent $108 million in taking a 40 percent stake in the Cambridge and Herndon deals. In fact, German investors have been the second-biggest spenders in U.S. multifamily, pumping in $323 million so far this year.

FIRPTA Blues

While cash-rich countries like Canada and Germany have certainly ramped up, industry observers say other foreign buyers seem hesitant to plunge in, deterred in large part by the FIRPTA tax penalties, which can make it cost-prohibitive to buy U.S. real estate.

Last year, the U.S. House of Representatives passed a slight modification of FIRPTA, allowing a foreign entity to own up to 10 percent of a U.S. publicly traded REIT, up from 5 percent previously, before hitting the FIRPTA tax threshold. But a year later, the Senate still has not taken up the legislation, though industry groups including AFIRE, the Real Estate Roundtable, and NAREIT continue to lobby for its passage.

“The bad news is, nothing concrete has really happened; there's been no change at all in FIRPTA,” Fetgatter says. “The good news is, we're talking about it. I've been doing this job for 20 years, and this is really the first time I've heard so much talk about FIRPTA, and that can only be good."

When the law was passed in 1986, the United States had little competition for foreign capital. But many international avenues have opened since then, and investors are now increasingly eyeing real estate in locales such as China, Great Britain, Brazil, Canada, Eastern Europe, India, and Japan.

“Repealing FIRPTA would basically put us on par with the U.K. and Singapore, which have modern capital-transfer laws,” says Dan Fasulo, managing director of Real Capital Analytics. “It could've been an easy way to recapitalize all of these bad loans—and bad banks, for that matter."

High Five

While FIRPTA continues to be frustrating, a little-known and rarely used federal program is starting to gain traction among U.S. developers.

The Immigrant Investor Program, known as EB-5 (for Employment-Based 5th Preference Visa), offers foreign citizens a U.S. green card if they'll invest at least $1 million in an American project that creates or preserves at least 10 jobs. If the development is in a designated targeted employment area—rural locations or places with very high unemployment— the minimum investment can be $500,000.

Most EB-5 capital is funneled through regional centers—matchmakers between foreign capital and local developers in need of funds. Interest in the program has ballooned since the credit crisis forced developers to get creative. In 2007, there were 11 such chartered centers—today, there are 147 nationwide.

Brooklyn, N.Y.–based Forest City Ratner Cos. has accessed about $249 million in debt through the EB-5 program for its planned Atlantic Yards project, which includes multifamily and commercial development, as well as a new basketball stadium for the NBA's New Jersey Nets. And earlier this year, the City of Dallas Regional Center used EB-5 capital to partially fund construction of Zang Triangle, a $30 million, 260-unit apartment development being built by Dallas-based Lang Partners in North Oak Cliff, Texas.

The Chicagoland Foreign Investment Group has been a designated regional center since 2009. The group targets assisted living centers, which work well with the program, given the high level of permanent jobs needed. “If you're putting the money into an apartment building, the major issue is the creation of jobs,” says Taher Kameli, principal of the Chicago-based firm. “You have to be creative.

If you have a mixed-use project, an apartment project with retail downstairs, that could work. But the people working in retail have to be employees of the management group." There are other stumbling blocks. Once investors are signed up, the capital sits in an escrow account until the U.S. government approves the foreign investor's application—a time line many developers have trouble dealing with.

“It's going to take the government between five months to one year to release that money," Kameli says. “But if a developer wants to build an apartment building, the land is available now, not a year from now. You need to have a bridge loan or a line of credit to pay the upfront expenses."

And as the pipeline of applications grows, the government's processing time slows. There were 1,955 applications for EB-5 visas all of last year, but through just the first half of 2011, 1,927 applications had already been submitted.

Still, the ongoing wave of visa applications speaks to the program's sudden success. “When the banks basically shut down during the recession, many people were looking for an inexpensive form of alternative financing," Kameli says. “The program is very attractive right now."