Editor: Please tell our readers about your professional background and experience.
Arnold: I graduated from Michigan Law School in 1975 and came directly to King & Spalding in Atlanta. Bill graduated from the University of Virginia Law School a year earlier and like me joined the firm's real estate practice in Atlanta.
Our growing practices started in the developer-oriented real estate world but evolved more towards real estate capital markets as the real estate business matured. That growth benefited to a certain extent from our location. We began practicing around the time that the Sun Belt, the southern region of the U.S. stretching from Georgia to southern California, erupted with a lot of growth and real estate development. Many global investors, particularly those from the Netherlands, UK, and Germany viewed Atlanta as the gateway into the Sun Belt. This phenomenon expanded our practice beyond traditional local real estate practice.
Fryer: The real estate practice underwent significant changes during our professional careers. In 1974, the passage of ERISA required institutional investors to diversify their holdings beyond the traditional stock and bond investments they had been making. More and more institutional investors began to seek real estate as an alternative investment vehicle.
In addition, there was a period of time when investing in real estate was motivated by tax advantages that certain investment structures provided. That ended in 1986 as a result of a significant recession and amendments to the Internal Revenue Code. The next big phenomenon was securitization of real estate. This process transformed an asset-based business focused on individual projects to a corporate business that depended on the capital markets. The result was a need to engage in transactional matters that characterized other parts of the capital markets industry such as securities issuances, M&A and private equity.
The physical locations of King & Spalding offices reflect that evolution as we have deployed our services to the areas where investments are being made and where the capital sources are located. Therefore, we have offices in New York, London and Dubai. Investments are increasingly being made on a global basis which is a result of economies becoming integrated on a global scale.
Editor: Do you have foreign offices working on these matters?
Arnold: Our offices in London, Dubai, and Riyadh work with real estate clients. Our work is much more heavily related to U.S.-outbound transactions because of our ability to execute and add value outside the U.S. We are particularly active in Latin America. We tend to represent Middle Eastern investors all over the world.
Editor: What types of clients does the real estate capital markets group work with?
Fryer: King & Spalding's client base has a large concentration of U.S.-based and non-U.S.-based operating companies in diverse industries. It consists of developers, public REIT fund sponsors, traditional investment managers, investment banks, and private sponsors. It includes tax-exempt and taxable non-institutional and institutional and retail placement investors.
Editor: Tell us about recent projects in which you have been involved?
Arnold: The work we do in our real estate capital markets group falls into three categories.
First, Bill is very active in the public to private phenomenon that has been taking place over the last year and a half on behalf of GE, Morgan Stanley and its Prime Property Fund and ING Clarion. There were transactions involving the acquisition of publicly traded REITs by private investment funds. For instance, GE acquired Arden Realty, an office building REIT; Morgan Stanley acquired Amli, a multi-family REIT; and ING Clarion acquired Gables, another multi-family REIT. We have also represented a number of unsuccessful bidders in some of the other public to private transactions which have been highlighted in the Wall Street Journal in the last 18 months.
The second area involves working with investors in major commercial real estate sectors across all categories, including a number of the funds we have helped form as well as with ongoing major real estate investors like GE. We also do similar work for German-based investors investing inbound as well as for Middle Eastern investors. Middle Eastern investors have been a major source of investment capital coming into the U.S. in recent years.
Finally, our group has also been active in representing sponsors of major real estate investment funds in the U.S. as well as those that target Europe, Asia and Latin America as investment destinations. Macquarie Global Property Advisors, a London and Hong Kong based private equity real estate fund management company, is one such client.
Fryer: Macquarie Global Property Advisors has been very active as an investor in the U.S., Europe and Asia. They are illustrative of the type of investment capital that is U.S. originated and non-U.S. originated that is being invested in Europe and in Asia.
Editor: Scott, you work with foreign investors seeking investment opportunities in U.S. real estate. What challenges do these investors face when entering the U.S. market?
Arnold: Our tax regime is not the most attractive to foreign investors. The U.S. is at a competitive disadvantage compared to other jurisdictions in that respect. New York is probably the most expensive market in the U.S. in terms of property taxes, but it is the most attractive market for foreign investment. This indicates that property taxes are not as much of a concern as federal income taxes.
Middle Eastern clients have expressed a growing level of concern for inbound investment because of the perceived hostility to that source of investment capital. The other factor is that U.S. markets are becoming perceived as overpriced because of the greater transparency and availability of readily accessible property elsewhere.
Editor: Would you comment on King & Spalding's expertise in Islamic law and how it assists your representation of Middle Eastern clients?
Arnold: It does make a difference. We have developed an Islamic financing specialization which is a fairly recent development in the financial environment. This gives us access to any Middle Eastern client who wants to invest in that way. There are widely varying levels of acceptance of those structures around the world, but in Asia there is growing receptivity.
Editor: What are the implications of the weakened U.S. dollar for your practice?
Fryer: In the 1980s, currency fluctuations were frequently cited as a reason for not investing in a particular real estate opportunity. Today, the dollar is relatively weak against the Euro and Pound Sterling, but most of the big institutions are deployed in sufficient quantities of various currencies around the world. In terms of the relative pricing, I do not think that currency fluctuation is as significant a factor in the decision to invest, as was the case 20 years ago. It would be a much more relevant concern if the disparity in pricing reflected an underlying issue with the economy of the country where the investment is made.
Editor: What about accessibility to capital?
Fryer: The world is in a liquidity glut. We are in a world where there is a lot of capital flowing around. The pricing of that capital in the debt market is in general very favorable. Generally, debt is cheap and, as long as that continues, it will support the property market in a positive way. The only place where there is a real play in terms of the debt capital is in Japan where the rates are so low that you have significant positive leverage.
Editor: Are there particular investment vehicles or transaction structures that are receiving increased attention in this environment?
Fryer: In the U.S., the basic REIT structure has become a characteristic feature of an overall fund partnership. Outside the U.S., the basic fund structure is a function of the source of your capital. Where you are combining different sources of capital with different tax and regulatory considerations, you try to build a structure that will accommodate these different sources of capital, with an eye to individual regulatory and reporting requirements and achieving tax efficiency.
Arnold: Derivative structures are new on the horizon. Derivatives include investments on the equity side in real estate through a derivative instrument. There is a lot of conversations about them here, but they have not yet taken hold in the U.S.
Editor: What are the investment opportunities attributable to the growing importance of India and China?
Fryer: There are a few notable Indian and Chinese investors who are active in New York. However, most of the activity involves foreign and domestic investors seeking opportunities in both countries. We represent a number of institutional sources of capital active in those markets. Over time, there will be a lot more investing, but at the moment the number of projects is relatively low, at least compared to the U.S.
Editor: Bill, what trends are affecting the decision investors make about where and how they will finance their transactions?
Fryer: We are in an environment where there is an emphasis on privatization. Private capital formation is more prevalent in the U.S. real estate market today than are the public markets. The opposite is true for a market like Australia where the public markets have a momentum which attracts investors. Property trust companies holding non-Australian assets are listing in the Australian markets. In the UK and in Germany, the REIT phenomenon is taking off. Germany recently enacted REIT legislation. Around the world there are securities exchanges that are listing new public real estate companies, reducing the market share for U.S. markets which might have theoretically traded those securities.