With over 51 million tourists visiting the United States in 2008 and the United States being ranked by the World Tourism Organization as the third most visited country in the world, resort and hotel properties in the United States have traditionally been, and remain to be, an attractive investment for foreign real estate investors, particularly Chinese, who have, of late, become very interested in all forms of U.S. real estate, including hotel and resort properties. While the recent economic crisis in the United States has caused headaches and sleepless nights among many resort and hotel investors and owners, for select foreign investors, this “crisis” has become a golden opportunity and an invitation to enter into the U.S. hospitality market. The market valuations of resort and hotel properties are currently at their lowest levels in a generation or more which presents a rare opportunity for foreign investors to acquire prime resort and hotel properties at bargain prices far below replacement cost. This is why an increasing number of Chinese and other foreign investors are traveling throughout the United States to evaluate resort and hotel properties in various locations.
As the Chinese proverb states: “In every crisis, there is opportunity.”
Although a crisis may create opportunity, that which appears so tempting may only be the façade hiding a dangerous trap. This is why the word “crisis” in Chinese is composed of two characters, “Wei Ji”, with the first word standing for “danger” and the second for “opportunity.” This suggests that foreign investors who are only familiar with other markets and legal structures should first familiarize themselves with basic legal concepts, potential legal issues, and market practices and customs relating to investment in resort and hotel properties in the United States. For U.S. owners, developers and lenders, it is essential to make sure the foreign investor appreciates our business and legal investment issues. Doing so enhances the likelihood of consummating a deal and avoiding disputes.
The following are brief answers for some of the important questions that Chinese and other foreign investors should understand before investing in U.S. resort and hotel properties:
1. What type of ownership can a foreign investor obtain?
The most common type of real estate ownership right in the United States is fee simple absolute, in which the property owner possesses all the “rights” relating to the real property. In contrast to many countries where the government owns the land and a property owner merely owns a right to use an interest in real property for a limited duration, a fee simple owner in the United States actually has full possessory rights of the property now and in the future for an infinite duration. This is one of the main reasons why many foreign investors choose to invest in U.S. real property, including resort and hotel properties. Although certain types of properties, such as agricultural land, can only be owned by U.S. citizens, foreign investors are generally permitted to own real property in the United States. In addition, a foreign investor who owns a resort or hotel property in fee simple may sell or transfer the property at any time and, generally, the profits derived from the sale may be freely repatriated out of the United States.
There are many other types of ownership and use rights in relation to real property. Use rights may be subject to restrictions under the recorded documents or the laws established by the applicable state or county governmental agencies. The type of rights owned by the property owner will depend on the type of instrument and the language in the instrument used to transfer the property. Therefore, when purchasing a resort or hotel property it is important for foreign investors to carefully examine the transfer instrument and the title of the property to ensure that all of the rights in connection with the transfer will be conveyed at closing.
2. What does a foreign investor need to know about the purchase and sale process?
In order to locate a resort or hotel property, a foreign investor should seek assistance from a licensed real estate broker who is familiar with the geographic areas of interest and, specifically, the hospitality market. Upon the foreign investor’s decision to purchase a property, the foreign investor’s lawyer, jointly with the real estate broker, will negotiate the terms usually with the seller’s lawyer, or sometimes with the seller directly. The foreign investor’s lawyer will then prepare the purchase and sale contract. Most often, a deposit from the foreign investor who is buying the property is required upon the execution of the purchase and sale contract. A due diligence period is usually provided in the contract so that the foreign investor may inspect the property, review title and survey, and conduct other relevant investigation of the property. If the foreign investor does not terminate the contract within the due diligence period, the foreign investor is obligated to proceed to closing, upon which the total purchase price and other costs in connection with the property must be paid. The seller will then deliver the fully-signed transfer instrument (such as the deed) and other relevant documents. The final step to consummate the closing is to record in the public records of the county where the property is located the fully-signed transfer instrument and other relevant documents. Depending on the property, the purchase and sale process can be very simple or extremely complex.
3. What are the options for financing?
In the United States, real estate finance is largely a creature of individual state (as opposed to federal) common law and not statute. Each loan document is individually negotiated. Typically, a resort and hotel property is owned by a separate legal entity that has no other assets to limit the potential liabilities. Therefore, lenders usually request a credit-worthy guarantor of the loan. Although there are many options for financing, it may not be easy for foreign investors to obtain financing in the United States in connection with the real property acquisition because many lenders require a foreign national to have a non-immigrant work visa or a green card in order to obtain a mortgage.
4. What are some of the issues relating to the construction and development of a new resort or hotel?
If a foreign investor purchases vacant land and plans to construct and develop a resort or hotel on the land, the foreign investor must evaluate potential issues relating to several tasks which must be completed. These tasks include the following:
- obtain governmental approvals and permits
- satisfy extensive land use requirements imposed by local, state and federal governments
- draft a local growth management ordinance, amendments to portions of comprehensive plans in municipalities and counties, and revisions to impact fee ordinances
- identify and engage licensed design professionals, such as architects and engineers
- resolve latent defects in the constructed work post construction
- obtain adequate insurance policies to protect the foreign investor’s interests arising during and after the design and construction process
5. What are some of the issues relating to purchasing an existing resort or hotel?
Rather than dealing with potential headaches in connection with the construction of a resort or hotel, many foreign investors prefer to purchase an existing hotel or mixed-use resort project, especially with the bargain prices and the variety of choices in the current hospitality market. However, before making the decision to proceed ahead with the purchase, a foreign investor must fully comprehend the implications and restrictions of the terms in the existing legal documents in connection with the property, including the license agreement, management agreement, and any governing documents, such as the Covenants, Conditions & Restrictions (CC&Rs) or declarations. For example, if the resort or hotel property is currently managed and branded by a third-party hotel management company and the foreign investor does not plan to continue with the engagement of the hotel management company, the foreign investor should require the seller to pay any termination fees required under the hotel management agreement prior to closing. Furthermore, if the foreign investor plans to purchase a mixed-use resort project which contains residential components, the governing documents – especially the CC&Rs or declarations – must be carefully reviewed to ensure that the terms within all these documents will not hinder the foreign investor’s plan for development and usage of any portion of the project. Changes to the existing governing documents generally are difficult to accomplish because, among other requirements, they must have the approval of the majority of the residence owners of the residential components.
6. What are some of the tax issues relating to selling a resort or hotel property?
Foreign investors should be aware that although the United States permits foreign investors to sell their resort or hotel properties at any time, any gain realized by foreign investors on the sale are subject to federal income tax under the Foreign Investment Real Property Tax Act (FIRPTA). In fact, FIRPTA requires that a foreign investor who sells a real property must deduct and withhold a tax equal to 10 percent of the amount realized on the disposition. The foreign investor is required to report the transfer to the U.S. Internal Revenue Service (IRS) and remit the amount withheld within 20 days of the closing. Additionally, the amount withheld is counted as a credit against the foreign investor’s tax liability if the foreign investor actually incurred a loss in the sale.
7. When should foreign investors engage lawyers and what services can lawyers provide in connection with investing in a resort or hotel property?
Unlike lawyers in many countries, lawyers in the United States play an active role in business and real estate transactions. In fact, in most negotiations in the United States, lawyers representing the parties are the ones who lead the discussions. With the complexity of the U.S. legal system and the issues involved in purchasing resort or hotel properties, foreign investors will find that involving U.S. lawyers early on in their investment strategy for entering the hospitality market will greatly contribute to a smooth market entry and successful implementation of their plan. Not only will lawyers facilitate the negotiations and the purchase and sale process, lawyers will also assess potential legal risks and mitigation methods in connection with the investment and provide advice regarding the most favorable investment structure to achieve each foreign investor’s objectives with respect to their investments in the hospitality real estate market. Hiring an experienced lawyer and involving that lawyer in all stages of the investment can save many legal headaches and economic hardship in the future.
Whether investing in U.S. resort and hotel properties is a danger or an opportunity will depend on foreign investors’ appreciation of the complexity of the U.S. legal structure, potential legal issues, market practices and customs, and market development in connection with the investment. This article highlights only a small portion of the issues for foreign investors. For a more in-depth discussion and analysis of the legal issues and risks of investment in U.S. real estate, including resort and hotel properties, you may request a copy of our Introductory Guide to Investment in United States Real Estate for Chinese Investors.