March 8th, 2013

Law 360

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Sophia Lau Quoted in Law 360

Chinese RE Investments Require Cultural, Tax Savvy

Law360, New York (March 08, 2013, 8:52 PM ET) — With rumors of a housing bubble swirling and values down across China, real estate attorneys expect to see more and more wealthy Chinese families and corporations looking to the U.S. to diversify their real estate holdings, bringing with them unique tax, liability and cultural issues.

Chinese sovereign wealth funds and high net worth individuals have been increasingly making their way to the U.S. real estate market over the last several years, but experts say that worries of a potential Chinese housing bubble — borne out in dipping stocks — are pushing even more investors to put their money into U.S. property.

“Our properties present a better value for them right now; it makes sense for them to put their money here,” Sophia Lau, a partner at Early Sullivan Wright Gizer & McRae LLP said Friday.

No other recent deal may have exemplified this more than the reported arrangement between a group of Chinese real estate investors led by the family of billionaire Chinese CEO Zhang Xin with owners of the General Motors building in Manhattan for a 40 percent stake.

Zhang Xin hasn’t commented on the deal, but sources have said they expect it to value the 50- story building at a massive $3.4 billion.

This could be a harbinger of things to come, experts say, and while many are thrilled by the prospect of more, and in some cases bigger, deals, they say it also means more complicated structures and tax headaches and brings about a necessity for cultural sensitivity that might not exist in other deals.

In China, transactions are handled differently than they are in the U.S., and it can be easy to offend someone and potentially spoil a deal before it’s begun if the attorneys involved haven’t done their homework, according to Lau.

The aggressive nature with which many U.S. deals are approached and negotiated can be off- putting to a Chinese investor; the practice of laying all of one’s expectations for a deal out on the table at the outset is not accepted in China, where experts say investors like to get to know potential sellers and become comfortable with them before getting down to the details.

The speed with which U.S. deals — real estate transactions in particular — generally take place can also be off-putting, according to John Opar, a partner at Shearman & Sterling LLP.

“Those deals move very quickly. Sometimes people have to do diligence in a very short period of time, have to negotiate a contract literally overnight, and I think that is probably something that is not the norm in the home jurisdiction,” he said.

When it does come down to the details of the deal, McKenna Long & Aldridge LLP partner Andrea Chang said Chinese investors are generally worried about two main things: privacy and liability.

“They don’t want everybody to know who they are or how much money they have,” she said.

This is not an uncommon refrain from high net worth investors, but for cultural reasons it can almost be considered a staple of any real estate deal involving a Chinese investor, Chang said.

This generally means hiding the investor’s name by structuring the deal so that they buy the property through a trust with a generic name or through a limited liability company. LLCs are preferable over corporations, according to Chang, because there is more flexibility and there are better creditor protections.

When an LLC is registered with the secretary of state in the state where the property is located, however, the LLC officer’s identity is often exposed. Attorneys say they often create a structure in which a state LLC owns the real estate and a Delaware LLC acts as its manager, disguising fully the name of the Chinese individual, family or fund.

On the issue of liability, an LLC is also the best vehicle through which the make the investment from a Chinese perspective because it gives creditors zero basis for piercing the corporate veil, providing better asset protection, Chang said.

The biggest potential source of complex work in a real estate investment deal involving a Chinese player, however, is likely working around the tax issues that surround foreign investment, experts say.

There’s a flat tax of 30 percent on investments made by nonresident aliens, or foreigners with no green card who aren’t present in the U.S. for at least 183 days in a three-year period or 31 days in the current year. The tax applies to fixed or determinable income not connected to a trade or business, so attorneys on these types of deals say they often find themselves working out a structure that will allow a lesser tax burden.

Chinese investors typically aren’t looking for one-off deals, experts say, and they often invest in a piece of property in order to improve it and lease it later. Improvement plans can convey active investment status and free up deductions not available to passive property investors.

The number of real estate deals in major U.S. cities is likely to continue to rise, experts say, and those looking to take advantage of the trend should be sure they’re not only prepared to jump through complex liability and tax hoops but also have a sense of the cultural variations.

“It helps for a firm or attorney to either be familiar with those issues or have people of Chinese descent or who speak Chinese on their team to help facilitate that process,” Lau said.

Source: Kaitlin Ugolik, Law360