Real Estate Is Best Place for Japanese Money

The Japanese are major real estate owners in the United States. In the past three years, they have invested an average of more than $10 billion a year in U.S. buildings. At this rate, Japanese ownership of real estate will soon exceed that of any other foreign country.

Until recently, other foreign investors, such as the British and the Dutch, acquired much more U.S. real estate than the Japanese without public attention or concern. Why the current uproar? Because Japanese investment is substantially more visible.

The Japanese are buying landmark buildings in the central business districts of our most well-known cities. Generally, they offer more than U.S. buyers in open bidding. Nearly every transaction is well publicized, and many have set records for square-foot prices.

The real issue is whether Japanese investment in U.S. real estate is better or worse than the alternatives.

The U.S. trade deficit with Japan is about $50 billion a year, making U.S. dollars, in essence, our largest export to Japan. Since the Japanese have no ultimate use for our dollars in Japan, the excess dollars must find their way back into the U.S. economy.

What investments are available to the Japanese for their surplus dollars?

They can buy government securities; create, buy or finance businesses in the United States, or buy or finance U.S. real estate. Given that the Japanese trade surplus with us must be recycled into the United States, the question becomes which way we prefer to see it invested.

Analyzing Risk, Vulnerability

Should we object to having 20% of this Japanese trade surplus invested in U.S. real estate?

When it comes to acquiring existing buildings, the answer should be no. With respect to real estate development, the answer is not as clear-cut. The real test of what type of foreign investment is most desirable is answered by analyzing risk and vulnerability.

Suppose the entire Japanese trade surplus were invested in government securities. The Japanese would control a huge part of our government credit system. That type of investment would lend enough power to foreign investors to materially and rapidly affect the interest rates of our nation--interest rates for all types of borrowing, not just government borrowing.

This power over interest rates would place our economy in a very risky and vulnerable position.

For example, some time ago the United States imposed punitive tariffs on certain Japanese products. This action triggered strong irritation in Japan, and we were concerned about Japanese retaliation. Japan acted very responsibly, however, and everything worked out well.

But the mere contemplation of non-participation by Japanese bidders in U.S. government securities auctions caused a significant overnight increase in domestic interest rates. Our system can tolerate systematic changes to financial markets, but such large overnight changes are chaotic and have negative effects in many sectors.

We rely heavily on foreign participation in our government securities markets. However, excessive concentration may endanger our economy. If foreign investment in the securities market is balanced through investments in real estate, the risk is reduced, and we benefit.

The other alternative, investing in U.S. businesses, also harbors risk and creates vulnerability. When the mode of investment is publicly traded debt or equity securities, the danger lies in the risk of the investors “dumping” those holdings. This could have dire consequences for all financial markets.

For example, in her May 7 Speaking Out article, Catherine Collins pointed to an interesting theory, expressed by Treasury Secretary Nicholas Brady, that the dumping of long-term traded bonds by the Japanese (which caused their price to fall and their yields to rise) created such an attractive bond market that there was a major movement out of stocks to bonds. This was theorized to have caused the October, 1987, stock market crash.

I don’t want to overstate the power of any single group to influence our security exchanges; it probably is not that great. I merely want to point out the need for balance in the way foreign trade surpluses are recycled, so that we lessen the risk to our nation.

National Defense Risks

The influx of foreign dollars into U.S. business by takeovers or direct investment creates different risks. When the Japanese own businesses in the United States, they may directly control labor resources, production, research and development, natural resources and innumerable other economic factors.

An unbalanced level of ownership could expose us to risks in areas such as national defense and local economies. Again, balancing such investment is necessary to create a natural counterweight to excessive foreign investment in our domestic production and employment.

Why is developed real estate a good alternative for a large part of the recycled foreign surpluses?

Real estate is an illiquid long-term investment, so the opportunity to disrupt the market through short-term activities is lessened. Additionally, the real estate market is more efficient than many other industries--the opportunities to manipulate prices or rents are minimized by the large number of competitors.

In many ways, foreign investment in developed real estate is the most stable and most difficult investment for the owner to control, even when it represents a significant market share, as in downtown Los Angeles.

Level Playing Field

For example, the Japanese have been accused of bidding up the price of buildings. In many cases, they were willing to pay 3% to 4% more for a premier building in a prime location. This enables them to outbid U.S. investors.

The phenomenon of high bidding is restricted to that one small market segment of premier buildings; the Japanese compete on a level playing field in all other markets. U.S. institutions, such as pension funds, are often successful competitors with Japanese investors when both are interested in the same properties.

The winning offers are only slightly higher than the losing bid. In the final analysis, the Japanese influence has had only a minor impact on the price of developed buildings.

What about tenant vulnerability in foreign investment in U.S. real estate? The nature of the real estate market should act as a natural governor on such risks.

For example, if the Japanese controlled 50% of the commercial buildings in downtown Los Angeles, could they control the rents and services to tenants? The answer is no. Commercial buildings must compete with other buildings to attract tenants. Charging rents that aren’t governed by supply and demand would result in movements to other buildings or to other business districts or locations.

Joint-Venture Projects

As far as foreign development of U.S. real estate is concerned, a foreign-developed project represents one less to be built by a U.S. developer, and therefore, such activities deserve more attention. But so long as the practice of joint-venture development by the Japanese with U.S. partners continues, this should not be a major concern.

Considering the alternatives, we should welcome the recycling of our trade deficits into United States real estate. It balances the U.S. “portfolio” of the Japanese, and it is the least risky and least vulnerable avenue for foreign dollars.

The bottom line is that Japanese investment in the United States is a result, not a cause, of America’s current economic position. As long as these conditions persist, foreign investment should be channeled into those areas where it has the potential to cause the least market disruption, and developed real estate must play an important role in accomplishing the objectives.