Restrictions on foreign ownership of U.S. real property: a political winner no matter who wins

We recently wrote about this particular movement in American politics, and how it could lead to expanded restrictions on foreign ownership of U.S. real property. Regardless of the outcome of the 2024 elections, we expect that the momentum behind further restrictions on foreign ownership will continue unabated, and we urge Canadian real property investors (even on an indirect basis) to remain vigilant.

Canadians are the largest foreign holders of U.S. land, and restrictions on ownership that ostensibly target hostile foreign actors sometimes are drafted broadly enough to apply to our friends to the North. We also expect that this surge may lead to an increased mandate for the Committee on Foreign Investment in the United States (CFIUS), which could impact inbound Canadian deal activity in many sectors (although Canadians remain on the “whitelist” of excepted foreign states).

1031 exchanges: ready for their last rites?

One of the great challenges for the new President and Congress will be how to handle the expiration of the 2017 “Trump Tax Cuts”. Fiscal accounting will have a large impact on whether it is politically realistic to extend all (Republican) or a majority (Democrat) of those tax cuts in a “revenue neutral” package. 1031 exchanges (named for the relevant section of the tax code) allow sellers of real property to defer paying capital gains tax where they reinvest or “exchange” real estate sale proceeds into a similar property. While we expect that a Trump administration would leave Section 1031 alone (Mr. Trump is a real estate developer, after all), 1031 exchanges are squarely in the repeal crosshairs of the Biden administration to help bridge the gap from a revenue perspective. Given that the 1031 rules were put in place to allow for greater liquidity and transaction volume in the real estate industry, we would expect that a 1031 repeal would create a sustained period of friction in the market while impacts on transaction volume and pricing shake out.

While it is difficult to predict all consequences of repeal, a few potential impacts are worth highlighting.

1. Potential sellers may opt to avoid sales of property and instead take advantage of debt-financed “cashout” transactions, ideally refinanced in perpetuity (there is no tax on debt, after all). This could present an opportunity for credit investors interested in investing in these types of loans given the expected increase in demand.
2. Our private equity (PE) clients often buy companies that own real estate as an ancillary part of the business (often the property is owned by the business owner rather than the business itself). These individual owners, who are the most likely parties to engage in 1031 exchanges, may now be less likely to want to sell property as part of the broader sale of the business. Canadian PE can view this as a great opportunity to avoid owning real estate (often not something they want to do anyway) and simply negotiate a long-term lease as part of the transaction. This also presents a potential way to improve negotiating leverage because the incentives to the seller/property owner relating to the real estate would be dramatically changing.
3. UPREITs, or umbrella partnership REITs, may see a renewed and invigorated appeal. UPREIT transactions involve a property owner contributing their property to a REIT in exchange for ownership in the REIT. It is similar to a 1031 exchange in that it can defer the current recognition of taxable income to the property owner. These structures have been used for decades but may see increased volume as an alternative to the more commonly used 1031 exchange.

Are you not infra-tained?

Large federal appropriations take time to go from the stroke of the President’s pen to the actual deployment of funds. As a result, big headline laws like the Infrastructure Investment and Jobs Act (the IIJA), signed by President Biden in November 2021, have a continuing material impact. The IIJA provided for US$550 billion in new infrastructure spending over five years, including US$110 billion for new roads, bridges and major projects, and US$66 billion for rail improvements. Discretion is afforded to federal agencies to allocate this capital based on various factors, and political factors certainly play a part. A new Trump administration, for example, might be more willing to redeploy funds earmarked for green energy improvements somewhere else, or more likely to rebuild a bridge in Birmingham than Boston. Alternatively, a Democratic election victory would suggest there is a mandate for a Democrat President to continue the former Biden administration’s acceleration of green investments, including electric charging stations (US$7.5 billion already allocated in the IIJA) and solar farms.

Given that access to infrastructure is a major element driving real property development, where these funds get deployed will define the types of corollary projects that become viable. Two examples are instructive.

1. The IIJA includes a US$22 billion direct investment in Amtrak to repair and rebuild stations and modernize the fleet. This will have direct impacts on real property at or near Amtrak hubs. A large investment in a multifamily development located adjacent to a rail station looks much more attractive if that rail station is about to get a major facelift.
2. With major repairs and expansions in the queue for roads and bridges, we expect these projects could lead to a dramatic expansion of opportunity in the industrial and warehousing sector. These classes have remained resilient in the face of the interest rate environment due to their “mission-critical” role in fulfillment, logistics, etc. Repairing and rebuilding roads, bridges and ports will support the development of even more of these assets. There is often no replacement for a place to put a bunch of boxes, after all.