Regulation: Firming up foreign direct investment

The US government is poised to make sweeping changes to a committee that approves foreign investment, with major implications for real estate.

Two disparate pieces of real estate, New York’s flagship Waldorf Astoria hotel and a rural wind farm, are examples of recent real asset deals that have attracted recent US government scrutiny for foreign buyers.

Now, the government is poised to keep an even closer eye on international buyers through legislation to strengthen the Committee on Foreign Investment in the United States, a program long used to mitigate national security concerns. Real estate in particular will feel the government’s scrutiny, as a bipartisan bill explicitly adds the asset class to what the government can deem a national security risk.

“There are many areas where the government trend is toward deregulation,” John Carlin, a partner at law firm Morrison & Foerster who previously oversaw the Justice Department’s participation in CFIUS, tells PERE. “But this is an area where government scrutiny has been on a steady trend of increasing year over year. It’s a new world when it comes to CFIUS.”

From tanks to wind farms

Through executive order, President Gerald Ford founded CFIUS in 1975. What was then an executive panel focused on defense transactions such as companies that manufactured tanks and guns now encompasses 16 government bodies, including the Defense, Commerce and State Departments, and is chaired by the Secretary of the Treasury. CFIUS’s definition of national security has also widened to an array of industries. A 2007 law, for example, designated ‘critical infrastructure’ as an area of concern after a Middle Eastern company took ownership of several US ports. Critical infrastructure has since expanded to include sectors such as the food industry and biomedical companies.

More recently, a major CFIUS theme concerning the real estate industry stemmed from the second-ever deal veto recommended by the agency. In 2012, a Chinese-controlled buyer sought to buy a wind farm without filing for CFIUS review. The committee asked to see the case and stopped the transaction, citing national security risk from proximity to a naval air station that tested stealth fighter planes – 50 miles away.

“Fifty miles is a long way,” says Nicholas Spiliotes, who is co-head of Morrison & Foerster’s national security practice. “The original reference point for proximity was ‘line of sight,’ but now, to be prudent, you have to look further than just a few miles away.”

After the Chinese company’s appeal was vetoed by then-President Barack Obama, the company took the case to a federal court and settled the transaction confidentially. While the case’s exact outcome was not announced, the process signaled that CFIUS would use a wide definition for proximity, also believed to be a factor in Blackstone halting the sale of San Diego’s Hotel del Coronado in 2016 to Anbang because of its closeness to a major naval base.

Hotel del Coronado: transaction stopped because of CFIUS concerns

Clarifying CFIUS

A clearer definition for proximity and other issues should come in pending legislation, industry observers say.

In November, a bipartisan group introduced the Foreign Investment Risk Review Modernization Act (FIRRMA) to codify some of what CFIUS is applying already, such as considering proximity to sensitive sites as a national security risk, and to add more stringent protocols to the review process.

“With increased CFIUS scrutiny of real estate transactions, all of those things now become real considerations for US companies considering foreign investment”

Chris Brewster

“It’s always hard to gauge how legislation will move, but when it comes to this particular bill, it does have strong bipartisan support in both the House and Senate,” Carlin says. “It’s clear the Trump administration is making a big push to get this out.”

The bill is currently in hearings, and if it is not approved ahead of the fall election, the next window would be the lame duck session early next year. Real estate lobbying groups have so far remained quiet on FIRRMA, with a spokesman for the Real Estate Roundtable declining to comment for this story.

Chris Brewster, Washington, DC-based special counsel at law firm Stroock, tells PERE the final bill will change by the time it passes, but it will likely retain key provisions that target real estate transactions.

CFIUS historically has focused on mergers and acquisitions, but FIRRMA would extend the review to leases, which Brewster calls “unprecedented” and “hugely significant.”

“The CFIUS review could be triggered, for example, if a government agency is located on the 10th floor and a foreign interest wants to lease the 9th floor,” he says. “If you have an office building in which you have a lot of sensitive US government tenants, you may find you no longer have foreign or foreign-controlled prospective tenants interested in the building because they don’t want to have to go through the cost and delay of CFIUS review.”


Current CFIUS
filing fee

or 1% transaction value

Proposed fee under new legislation

CFIUS has also become more concerned about foreign groups’ access to communications. In the Waldorf transaction, for example, the committee was concerned that US presidents stayed at the property and that the US ambassador to the UN held residence there. Hotels in general can be a cause for concern because owners can access vast data troves of guest information.

“It remains to be seen how the industry moves toward smart technology,” Carlin says. “To the extent that property owners and managers collect, or have the potential to collect, personal identifier data, CFIUS will be interested.”

For the first time, FIRRMA adds filing fees to the CFIUS review: the lesser of $300,000 or 1 percent of the transaction value. FIRRMA also broadens CFIUS’s mandate to transactions that do not involve a buyer taking a controlling stake in a company, but do involve the transfer of critical technology. If a foreigner invests in a technology firm and gains access to its intellectual property, for example, that deal could require CFIUS review.

Even under current law, CFIUS can look at the national security implications of any transaction that would result in foreign control of a US business, including real estate. CFIUS gives “control” a broad reading – including transactions in which minority investors have veto rights over business decisions, such as the appointment of key managers. Accordingly, Brewster recommends factoring a CFIUS review into the process for anyone evaluating foreign investment in a US business – especially if the acquisition involves property in close proximity to a key government installation – even if the transaction involves an investor from a country closely allied with the US.

He adds that the investor’s foreign nationality is not the only concern. CFIUS will assess the investor’s record of compliance with US laws and if its investment portfolio includes, for example, properties involving persons, entities or countries under US trade sanctions.

“Maybe it has a lot of Russian properties, or business partners, which can change the security profile,” he says. “With increased CFIUS scrutiny of real estate transactions, all of those things now become real considerations for US companies considering foreign investment.”

Despite all of those considerations, Brewster says US policy continues to favor foreign investment. Most transactions clear CFIUS review, although sometimes under terms designed to mitigate any national security risk.

Real estate comprised only 10 percent of all CFIUS reviews in 2015, the latest year for which public data is available. But with FIRRMA on the horizon, dismissing CFIUS as unrelated to real estate could put major deals in jeopardy.

Blackstone, which declined to comment, added FIRRMA to its business risks in its annual report filed with the Securities and Exchange Commission in March. The private equity giant noted the legislation “may reduce the number of potential buyers and limit the ability of our funds to realize value from certain existing and future investments.”

However FIRRMA changes before it becomes law, the lawyers with whom PERE spoke agreed that for any deal involving foreign buyers, CFIUS must at least be a consideration on a standard M&A checklist.