Real estate investments for sovereign wealth funds



FW moderates a discussion on real estate investments for sovereign wealth funds between partner John L. Opar, managing partner Domenico Fanuele and partner Michael B. Shulman at Shearman & Sterling.

FW: Reflecting on the last 12 to 18 months, could you provide a general overview of sovereign wealth fund investment activity in the real estate markets?

Opar: It’s been a very dynamic period for investment by sovereign wealth funds in US real estate. We’ve seen major new entrants into the market, with billions of dollars being invested, in most cases in joint ventures with US operators. We’ve also seen initial forays into the market by sovereign wealth funds of countries not previously active in the US market. Some sovereign wealth investors that have traditionally only invested in funds have also begun to move toward direct investment in US real estate.

Fanuele: In the last 18 months in Europe, sovereign wealth funds have continued the investment trends of recent years and have played a fundamental role in the real estate market. Sovereign funds have been particularly active in Italy, where the real estate market in general has been recovering. They have been constantly targeting all major investment opportunities in Italy, competing against private funds. Completed key deals include the acquisition by Qatar’s sovereign wealth fund of the entire ownership of the units of an Italian real estate fund holding Milan’s €2bn Porta Nuova finance district. Over the last few months, new major entrants such as Abu Dhabi Investment Authority and the State Oil Fund of the Republic of Azerbaijan have signed important deals in the Milan and Rome markets.

Opar: We’ve also seen sovereign wealth funds targeting investment opportunities in Latin America and Asia, particularly China.

FW: What types of real estate assets do SWFs seem to be targeting? Are there any regional hotspots?

Opar: Addressing regional preferences first, sovereign wealth funds have, as with most non-US investors, targeted so-called ‘gateway cities’, which certainly include New York and Washington, DC and, with perhaps less unanimity, San Francisco, Boston and other cities along the east and west coasts. In our experience, sovereign wealth funds that have been investing the longest in the US, some since the 1970s, are more likely to look beyond the gateway cities to other US markets. Funds driven by yield more so than pure capital appreciation will almost certainly have to look beyond the traditional hotspots. But we should also note that sovereign wealth funds investing in large portfolios will necessarily have exposure to a significant number of US markets. As to classes of real estate assets, we are seeing surprisingly little uniformity. Office investments in the gateway cities have been perhaps most prominent, but multi-family, retail and industrial have all attracted their share of sovereign wealth dollars. Hospitality is also particularly attractive to some sovereigns. Perhaps the only common denominator is a preference for investing alongside strong US operators or in assets such as hotels, where third-party management, through the major ‘flags’, is available.

Fanuele: In Europe, London and Paris remain the strongest markets for real estate. However, there is a trend of sovereign funds exploring diversification opportunities in rebounding markets, such as Southern Europe, including Italy. In Italy, investments are mostly concentrated in major cities in the North and Central regions, with Milan being by far the main focus, particularly with respect to office spaces, and Rome for trophy assets which are to be converted into luxury hotels. As to classes of real estate assets, in Europe there appears to be a shift from the traditional focus of SWFs on trophy assets and hospitality to office spaces, with a preference for latest-generation state-of-the art complexes, and retail. The latest deals signed by sovereign funds in Italy show interest in office buildings to undergo complete renovation.

In the last 18 months in Europe, sovereign wealth funds have continued the investment trends of recent years and have played a fundamental role in the real estate market.
— Domenico Fanuele

FW: In addition to making direct investments, are you also seeing SWFS provide finance for real estate and construction projects? How are such deals typically structured?

Shulman: We do see sovereign investors making loans to finance real estate projects, typically in the form of mezzanine financing. One benefit of such arrangements is that interest paid on such loans, including interest in the form of an ‘equity kicker’, generally is exempt from US income and withholding tax. Care must be taken, however, to ensure that such loans are respected as debt for US tax purposes – which includes making sure that the borrower and its subsidiaries aren’t leveraged beyond market levels and having an expected return on the loans that is less than the expected returns on the borrower’s equity.

FW: More generally, what are some of the tax considerations on structuring investments by SWFS in US real estate? In Italy?

Shulman: Section 892 of the US tax code generally exempts a sovereign wealth fund from US federal tax on certain income, including interest, dividends and gains on the sale of securities. There are two significant situations, however, where this exemption is unavailable. First, the exemption does not apply to interest, dividends or gain with respect to securities if the sovereign fund has actual or effective control of the issuer of such securities. Second, the exemption does not apply to income from commercial activities, which includes not only income and gain from a direct investment in US real property, but also dividends from a US REIT that is attributable to underlying real estate gain. The bottom line is that a sovereign wealth fund can generally structure its investment in US real estate to avoid any US income or withholding tax by investing into a real estate investment trust that the SWF does not control and that will be structured not to sell any US real property it holds. In such a case, the REIT is not itself subject to any tax, and ordinary dividends paid by the REIT benefit from the SWF exemption. In addition, the sovereign fund’s exit from the investment must be structured as a sale of REIT shares – rather than a sale by the REIT of underlying real property assets – so that all of the SWF’s gain can benefit from the exemption. Such a non-controlled REIT structure is not available – or is difficult to implement – with respect to certain types of assets, such as dealer property and hotel investments. In those cases, a sovereign fund will typically structure its investment through a leveraged US corporation. Such a structure does not benefit from a complete exemption from tax, because the corporation is subject to tax, but the leveraging of the corporation with debt should serve to reduce its effective tax rate.

Fanuele: From a tax standpoint, due to the favourable tax regime, the preferred investment structure is the asset acquisition made by a real estate investment fund managed by a regulated management company in which the investor invests as unit holder. Thanks to a recent reform, real estate listed companies (SIIQs) also benefit from a favourable tax regime and are attracting interest from the market.

FW: What are other potential issues and challenges associated with SWFS? How might concerns such as national security, for example, influence the way SWFS approach real estate investments?

Opar: Confidentiality is preferred by many sovereign investors. While investments in or with publicly traded vehicles are necessarily visible, many investments receive little or no publicity. Timing of execution can be a challenge for sovereign investors, as approval processes are necessarily more complex and time-consuming than is the case with private US real estate operators and investors. Particularly in the auction context, operators should take care not to get out ahead of their co-investors.

Attention from CFIUS, the inter-agency Committee on Foreign Investment in the US, is possible. However, we would expect it to be a consideration more so with infrastructure than with pure real estate investments – witness the well-publicised issues with the Dubai Ports investment. We would not expect mere investment in real estate assets proximate to government operations to be of concern.

Fanuele: We haven’t come across or experienced any particular concerns related to national security. Actually, Italy has favoured and encouraged sovereign wealth fund investments, not only in real estate, but also in other asset classes. I agree that timing of execution can be a challenge sometimes.

We do see sovereign investors making loans to finance real estate projects, typically in the form of mezzanine financing.
— Michael B. Shulman

FW: What strategies are SWFS using to identify potential investments and source target assets in the current market?

Opar: We would suspect that sovereign funds are on the radar screen for most operators seeking capital. To that extent, more opportunities are likely presented to sovereign funds than they could possibly execute. Again, the desire of many funds to co-invest alongside operators has the added benefit of enhancing the funds’ ability to source investments.

Fanuele: In Italy, sovereign wealth funds tend to develop relationships with experienced local operators having a deep knowledge of the internal market which then present investment opportunities.

FW: The US just announced amendments to the Foreign Investment in Real Property Tax Act (FIRPTA), and the rules related to REITs. What impact would you expect the amendment to have on sovereign investors?

Shulman: We don’t expect the recent amendments to have a significant effect on real estate investment by sovereign investors into the US. The most substantial change contained in the recent amendments is an exemption from tax under FIRPTA for foreign pension plans, which is likely to be unavailable to all or most sovereign investors. The other amendments that were enacted – such as changes to the exemptions for investments in domestically controlled REITs and interests in publicly traded REITs and other US real estate investment companies – are unlikely to apply to the types of investments typically made by sovereign investors.

Absent overriding macroeconomic issues, I would not expect a slowdown in sovereign investment in US real estate.
— John L. Opar

FW: What are your expectations for future SWF investment in the real estate space? Are there any particular developments and trends you expect to see over the coming months and years?

Fanuele: Despite the drop in oil prices, and an anticipated general reduction in capital, we believe deals signed and closed over the last few months prove the investment activity of SWFs in Italy is likely to remain strong and possibly increase in line with expected continuing recovery of the market. Furthermore, the Italian government has been actively encouraging participation of sovereign investors in the market and a favourable political, fiscal and legislative environment may work as a further stimulus to sovereign investments in Italy.

Opar: Absent overriding macroeconomic issues, I would not expect a slowdown in sovereign investment in US real estate. Certainly, the significant drop in oil prices will affect some capital sources. But real estate has performed quite well over the past several years, and resultant increased allocations to real estate may more than compensate for any absolute reduction in investment capital. Especially as real estate markets become more accessible and transparent, I would expect real estate to continue to attract its fair share of sovereign capital.

John L. Opar is a partner in the Real Estate Group at Shearman & Sterling and has extensive experience in all areas of commercial real estate law, including foreign investment in US real estate. Recent work includes advising sovereign wealth funds and other foreign investors on significant acquisitions in New York City and across the country, working with sponsors in the formation of real estate investment funds, and assisting developers with purchases and joint ventures for development opportunities. He can be contacted on +1 (212) 848 7697 or by email:

Domenico Fanuele is the managing partner of the Milan and Rome offices of Shearman & Sterling and the head of the Italian corporate practice. His practice focuses on private and public M&A, real estate transactions and strategic joint ventures. He regularly represents investment banks, corporate clients, sovereign wealth funds, property companies and private equity funds in a broad range of transactions. Mr Fanuele is dually qualified as a US and Italian lawyer. He can be contacted on +39 06 697 679 210 or by email:

Michael Shulman is a partner and co-head of Shearman & Sterling’s Tax Group. He regularly represents domestic and foreign issuers and underwriters in connection with the offering of debt, equity and other financial instruments and has been extensively involved in the development of new financial products. Mr Shulman works extensively in the areas of corporate acquisitions, dispositions, restructurings and spin-offs. He also represents regulated investment companies and onshore and offshore investment funds on a broad range of organisational and transactional matters. He can be contacted on +1 (202) 508 8075 or by email:

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John L. Opar

Domenico Fanuele

Michael B. Shulman

Shearman & Sterling

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