The COVID-19 pandemic and the resulting economic turmoil have the potential to shake up the U.S. real estate market due to an anticipated influx of real estate investors looking to purchase heavily discounted, distressed assets and an expected increase in real estate foreclosures. Non-U.S. real estate lenders and investors need to be aware of the potential that the Committee on Foreign Investment in the United States (CFIUS) may have jurisdiction to review, and potentially disallow certain investments in real estate and mortgage default remedies where foreign persons are involved.
Recently Expanded CFIUS Jurisdiction Over Real Estate Transactions
CFIUS is the U.S. inter-agency committee responsible for reviewing foreign acquisitions and investments in U.S. businesses for their potential impact on national security. CFIUS jurisdiction has historically been limited to transactions where a foreign person obtains “control” over a “U.S. business” (“covered transactions”), which can include transactions where real estate held by the U.S. business is in close proximity to sensitive government sites. On February 13, 2020, new CFIUS rules went into effect that implemented the Foreign Investment Risk Review Modernization Act (FIRRMA) and expanded CFIUS jurisdiction to include “covered real estate transactions.” Under the new rules, CFIUS jurisdiction over “covered real estate transactions” is only implicated where the transaction is not a “covered transaction” under the traditional CFIUS framework. In other words, real estate transactions that involve an existing U.S. business (e.g., an investment in a company that owns solar farms) will initially be reviewed as a “covered transaction” under longstanding CFIUS rules, and will only be reviewed as a “covered real estate transaction” if the investment or acquisition is not a traditionally “covered transaction.”
“Covered real estate transactions” include purchases or leases by, or concessions to, a foreign person of “covered real estate” that affords the foreign person at least three of the following four property rights:
- The right to physically access the real estate;
- The right to exclude others from physically accessing the real estate;
- The right to improve or develop the real estate; or
- The right to attach fixed or immovable structures or objects to the real estate.
“Covered real estate” consists of two general categories of real estate: (i) real estate connected to airports and maritime ports, and (ii) real estate described by its proximity to U.S. military installments and other sensitive U.S. Government facilities that are listed in the annexes to the regulations.
CFIUS recently published a geographic reference tool that shows what military facilities and government sites are in proximity to a given address.
Excepted Real Estate Transactions
There are several notable exceptions when transactions involving “covered real estate” will not fall under CFIUS jurisdiction.
- “Covered real estate” in “urbanized areas” or “urban clusters” as defined by the U.S. Census Bureau, unless such real estate is located within an airport or maritime port, or within one mile of a military installment or other sensitive government facility listed in the annex to the regulations.
- The new geographic reference tool also identifies urbanized areas and urban clusters as designated by the U.S. Census Bureau.
- “Covered real estate” that is a “single housing unit.”
- The lease of or concession to a foreign person of “covered real estate” that is used only for the purpose of engaging in the sale of consumer goods or services to the public.
- “Covered real estate” that is commercial office space in a building where the foreign person does not have more than 10% of the commercial office space in a building.
While filing with CFIUS is a voluntary process for “covered real estate transactions,” obtaining clearance provides the parties with a regulatory safe harbor preventing CFIUS from later prohibiting or suspending the transaction for national security reasons.
CFIUS Considerations for Mortgage Defaults and Lending Transactions Secured by Real Estate
Generally, mortgages, lending transactions, and other real estate-secured financing arrangements do not fall under CFIUS jurisdiction since “covered real estate transactions” only include those that confer three of the four property rights listed above to a foreign investor or buyer. However, CFIUS may have jurisdiction to review a transaction where:
- A default or triggering event has occurred or is imminent; or
- The debt affords the lender three of the four aforementioned property rights in the real estate.
Note there may also be situations where acquiring a contingent interest in real estate is immediately reviewable, though this will depend on a case-by-case assessment of the facts, including the imminence of conversion; whether conversion depends on factors within the foreign party’s control, and whether the interest and rights that would be acquired upon conversion can be reasonably determined at the time of acquisition.
Recommendations for Foreign Investors and Lenders
Foreign investors looking to purchase an interest in undervalued and distressed real estate assets in the U.S. should be aware that CFIUS may have jurisdiction to review, and potentially disallow investments that afford the investor three of the four aforementioned property rights. Investors purchasing an interest in “covered real estate” may want to weigh the property rights they negotiate into an agreement against an increased risk of CFIUS review. Alternatively, foreign real estate investors may want to vest certain ownership rights, such as physical access to the property, in a third-party inspector that is not a foreign person.
Similarly, foreign lenders will need to consider the CFIUS implications of exercising a deed in lieu of foreclosure or contingent equity interests in real estate. Lenders may want to prioritize debt restructuring or non-default remedies if the transaction is likely to fall under CFIUS jurisdiction. Additionally, non-U.S. lenders entering into financing agreements should be cognizant of the risk that they may not be permitted to fully take advantage of vesting equity interests or the full scope of default remedies, including exercising a deed in lieu of foreclosure that was negotiated into an agreement, without going through CFIUS review.
Foreign lenders and equity investors should account for CFIUS in the early stages of a transaction and conduct comprehensive risk assessments that examine whether the real estate at issue would be “covered real estate” subject to CFIUS jurisdiction.