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Outbound Chinese real estate investors need to have eyes wide open
Chinese and other Asian investors are seeking opportunities in countries that offer economic and political stability, transparency and a predictable legal system, says Joel Rothstein, partner, international real estate practice, Paul Hastings
Joel Rothstein 19 Jan 2015
 
   
There is no denying the fact that Chinese outbound investment into real estate is set to accelerate as investors look to diversify beyond their domestic market, counter sluggish growth in their home economies and fulfill global ambitions. According to one recent study, global Chinese outbound transaction volumes increased from US$5.6 billion in 2012 to US$11.3 billion in 2013 and experts are forecasting this figure to reach US$15 billion by the end of this year.
 
While these figures indicate a huge market potential for outbound real estate investment they can easily gloss over the potential risks and challenges that lie ahead for real estate investors before they seal the deal.
 
Over the past 12 months we have seen capital flows come from not only individual investors, but also from cross-border institutional investors who are stepping up and becoming actively involved in commercial real estate transactions.
 
Chinese and other Asian investors are seeking opportunities in countries that offer economic and political stability, transparency and a predictable legal system. 
 
Investors lack critical knowledge
 
Investors seeking opportunities are also encountering challenges. A basic problem facing many Asia-based players is that they simply lack overseas experience, knowledge and execution capability.  An investor may be experienced in its domestic market, but may lack critical knowledge and real deal experience in a foreign market. 
 
This critical knowledge is not just the knowledge of laws and regulations, but also familiarity with market standards and practices.  These are the unwritten rules of the game from negotiating the deal, to establishing appropriate and market acceptable good faith deposits and transaction closing conditions, to understanding and dealing with the expectations of joint venture partners, tenants, contractors and other deal participants.
 
A useful source of market knowledge is the investor’s own employees.  Many first time and repeat cross-border investors, however, often lack professional staff on the ground to guide the deal.  It is extremely hard to successfully execute a deal when you have a small team focusing on international deals sitting halfway across the world. 
 
As such cross-border investors should focus on recruiting local employees or at least utilizing professional real estate advisors with extensive networks to fully capitalize on local market intelligence.  There is a whole range of real estate advisors from attorneys to accountants to appraisers to construction and engineering consultants, all with local knowledge and expertise that are really ready, willing, and able to assist and ensure a deal is done properly. 
 
Tax and legal issues: ignore at your peril
 
In many respects, the hardest part of executing a deal in the US and other developed markets as a foreign investor is devising and implementing a proper tax and legal entity structure.  The rules are complex and there is no one size fits all solution for foreign investors. 
 
Unfortunately, some cross-border investors rush into a deal, sign a term sheet, or even a purchase agreement, without first investing the necessary time upfront to think about the legal and tax structuring to optimize tax efficiencies and minimize legal risks. 
 
The advice we most often give to foreign investors that are looking at their first deal in the US or other developed markets is always consult with investment, legal, and tax advisors early in the process before there is a firm deal on the table.
 
The rules are very detailed, but can be worked through and understood. With the optimal structure predetermined in advance, it is possible to move quickly when the time comes to execute the deal. 
 
It is also important not to underestimate the importance of legal due diligence.  A considerable amount of time and effort is spent on legal due diligence in the US and other developed markets in comparison to what is typically done  in Asia.  There are certain areas which are simply not areas of  focus  in many Asian transactions, which are really important in developed markets such as property title and survey review or environmental due diligence. 
 
In addition, there are a whole range of laws and regulations that could be triggered in a developed market transaction which simply do not come up in the typical transaction in China and in many Asia markets. There could be issues relating to labor laws, consumer protection laws, intellectual property laws, anti-money laundering regulations, and anti-bribery and anti-corruption laws. 
 
Proper and thoughtful  legal due diligence can help the investor identify and manage risk, as well as help the investor assess practical issues such as appropriate deal pricing or developing closing and post-closing requirements and procedures. 
 
Home bias battles for Chinese investors
 
A further challenge that Asian investors face is competition.  In the last year, domestic players in developed markets have become more active as their economies have begun to stabilize and grow and financing has become more widely available. 
 
Local players possess many advantages when buying a property or executing a transaction in their own market.  Asian investors are facing stiff competition, particularly for the most prime assets.
 
As such, foreign investors should consider not going it alone.  They should consider choosing suitable, local joint venture partners or participating in deals where they can leverage on the experience of partners or managers that already have an overseas presence and can guide a transaction and help avoid mistakes. 
 
Despite all the challenges attractive opportunities exist for Chinese outbound investment into real estate in the US and other developed country markets.  Asian cross-border real estate investment is entering into a new, expanded and exciting phase.  The cross-border investors that will reap the most benefits in the long term will be the ones that enter markets with their eyes wide open, seek out local advice and guidance and successfully navigate local laws and market practices.
 
 

Joel Rothstein is a partner, international real estate practice, Paul Hastings 

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