Challenges When Dealing Internationally

The United States has numerous federal guidelines concerning international in­vestment which serve as roadblocks to investment. Specifically, the Patriot Act created a host of issues. Specifically the taxation issues breakdown into three categories: taxation of operations, estate taxation and income taxation upon dis­position.

Here is an overview of each issue:

Taxation of Operations

A foreign person is subject to US income taxation on income that is connected with the conduct of a business in the US. Such income is subject to regular graduated rates of taxation on his net income and the foreign person is entitled to regular deductions in relation to the property operations, such as deductions for real property taxes, mortgage interest and maintenance expenses. The graduated rates for 2010 reach as high as 35% for both individuals and corporations and are scheduled to increase to 39.6% in 2011 for individuals. However, a for­eign corporation also is subject to a branch profits tax at a 30% rate on its after regular corporate tax profits. If the foreign person is a mere passive owner, such as with respect to triple net leased property, his activities may not be considered the conduct of a business in the US. In that case, the foreign person will be subject to a 30% withholding tax on the gross rental income and no deductions are allowed. However, the foreign person can elect to treat such rental income as connected with a business in the US, so that he can be subject to the graduated rates and receive the ben­efit of deductions.

Estate Taxation

The estate of a foreign individual is subject to US estate taxation on US assets that are held by the foreign individual at his death. US real prop­erty interests are US assets for this purpose. Although Congress allowed the US estate tax to expire in 2010, it is scheduled to return in 2011 and ap­ply at rates ranging from 18% to 55% of the fair market value of his US asset including real property.

Income Taxation Upon Disposition

When a foreign person disposes of an interest in US real property, he is subject to tax on his gain. If the US real property interest is a capital as­set (not inventory held for sale to customers in the ordinary course of business) that has been held for more than one year, an individual for­eign person will be subject to tax at a maximum rate of 15% (scheduled to increase to 20% in 2011) on his gain. A foreign corporation gets no tax rate benefit for such long term capital gain and therefore is subject to tax at a maximum rate of 35%.

In order to collect, in part, the US tax on a foreign person’s gain from the disposition of a US real property in­terest, the US requires the buyer of real property from a foreign person to withhold 10% of the foreign per­son’s amount realized from the dispo­sition of the US real property interest. The foreign person must file a US tax return declaring his full gain and may apply the withheld amount as a cred­it against his final tax liability. There is a procedure to apply to the US In­ternal Revenue Service to request a reduced withholding amount if the foreign person can demonstrate that the tax on his gain is less than the 10% of the amount realized that is required to be withheld.

The previous was excerpted from Calkain Research's recent Broker Opinion Report "International Entities". View the full text here.

Insiders Look at the First Net Lease Book

This text comes from the “Tenant Profiling” section in the new book, “The Little Book of Triple Net Lease Investing”.

Tenant Profiling

This is an extremely important task for the simple reason that there must be a good fit between the tenant and the building. For example, putting a pharmacy in a building originally built for, say, an industrial purpose and located away from the general public, would be a fatal mistake. That’s because pharmacies are all about health and cleanliness and easy access. Industrial sites, on the other hand, represent the exact opposite of that. Such a mismatch of tenant and property is tantamount to business suicide, both for you and the tenant.

The investment team must profile prospective tenants in depth to ensure that the final selection involves a tenant who’s likely to reach maximum potential within the building. It must obey one of the ironclad “laws” of commercial real estate: the market value of a property is measured solely by its worth to the tenant it services.

The range of tenant options spans the local tenant providing a local service and operated by a local one-unit vendor, to a national brand tenant that’s a public company and listed on a stock exchange and which has billions of dollars in revenues, and everything in between.

Most national brand tenants can easily be profiled because so much public information is available on them, plus they’re rated by respected national agencies such as Moody’s, Fitch, and Standard and Poor’s. A local tenant can be just as good an investment as a national one; however, you need to evaluate this tenant in a different way since information isn’t as readily available. Here’s what you (or your investment team) would look for:

For more, read the full text of “The Little Book of Triple Net Lease Investing”.

A New Take on FASB Rules from Richard L. Podos

Mention the acronym “FASB” in the halls of commercial real estate and you may start a veritable shouting match. Like some impending disaster, the fear that FASB will turn the CRE world upon it head (while leaving no prisoners) is rampant and pervasive. Fortunately for us, it’s simply not true. Unfortunately, many have not got the memo.

Here are concerns that are often voiced in connection with the proposed FASB rule changes and why they will NOT have the disastrous effects envisioned:

Calkain: Two major marketplace impacts being posited are shorter-term leases and more corporate ownership. Are either or both going to become the trend?

RLP: In a word, NO (with certain exceptions at the margin). First, lease term from a tenant’s perspective is about occupancy strategy and economics. No major tenant is going to start doing large leases for 5 year terms, with all of the expense entailed in tenant improvement (TI) and moving, not to mention issues such as employee attraction and retention, customer proximity, risk of exposure to landlord leverage on renewal, etc. That said, will a low-cap ex renewal be short... yes, probably. As to corporate ownership, there has been an inexorable worldwide trend towards leasing over the last 20 years based on core competency and capital deployment drivers... accounting doesn’t change any of that.

Calkain: How will the industry build the proposed new standard into pricing?

RLP: Believe it or not, it’s been happening for years. Just because the lease accounting changes haven’t been officially formalized doesn’t mean the industry is keeping its head in the sand. Again, economic drivers are paramount. We’ve all seen a move towards shorter lease terms by occupiers with greater uncertainty; on the other hand, certain tenants, especially retailers, make long-term commitments because they *know* they will remain at a given location for a long time. And again, deals involving heavy amounts of tenant improvements (TI) suggest longer terms to deal with amortization, whether funded by landlord or tenant or my firm. Renewals with minimal capital investment will tend towards short, but that’s about it.

Calkain: What (if any) unintended consequences will result from the standard?

RLP: It certainly won’t have a major impact on tenants’ financials... with certain exceptions (e.g., retail, airlines), the impact on corporate reporting and ratios will be de minimus. Most importantly, the credit ratings agencies and the equity analysts have been capitalizing leases for over 20 years, actually around 2X of what the new lease accounting will require, so no major impact. The largest unintended consequence we foresee will be the impact on sale-leasebacks. Over the next two years, we expect to see a slow-down in those transactions, simply due to uncertainty, except where there are strategic concepts driving portfolio re-positioning (a big concept for another day). However, once the new standards are better digested, that trend will level off, and transaction velocity will resume.

The key thing to remember with the proposed lease accounting is that it does not change the strategy and business drivers that underlie tenants’ real estate deals. Our motto? “Economics trumps accounting”.

Richard Podos is the CEO and President of Lance LLC, a New York-based finance and investment firm focused on TI funding and asset-intensive build-to-suits, and is a thought leader at CoreNet Global regarding lease accounting.