Tips for lending to foreign nationals in the current environment

During the economic boom of the late 1980s, foreign investors poured in and snatched up real estate across the country. During that land rush, Japan went on a buying spree. However, like all spending sprees, it eventually come to an end. By 1992, Japanese property buyers dropped by 61 percent as their nation’s economy slipped into a recession.

In California, foreign buyers’ impact on real estate ebbs and flows with changing economic conditions. After the recession of 2008, foreign investors, primarily Chinese nationals, took advantage of a slumping real estate market and began buying up perceived bargains. By 2013, foreign investor purchases made up 8 percent of total real estate sales.

Why the Slow Down?

As the real estate market in California started to recover, values started to rise as available inventory was squeezed and bargains became harder to find. This change in conditions ushered in a cooling down period for foreign buyers.

Foreign investment has been slowly declining for about five years now. But, starting a few years ago, the number of international buyers dropped sharply, by more than 3 percent from the previous year. Last year, foreign buyers made up only 3.1 percent of all real estate sales.

According to the California Association of Realtors, the median price for homes that foreign investors purchase has also seen a decline. The median price for homes in 2015 was $812,500. By 2017, that median price dropped to $667,500. The numbers indicate investors are moving away from high-priced locations such as the Bay Area and looking to more affordable housing in the Central Valley and Southern California.

Some of the slowdown is attributable to tightening monetary restrictions under Chinese laws. These laws restrict the amount of money a person can invest outside of the country. That number stands at $50,000 per year, per person. As a result, Chinese homebuyers are getting more creative so they can continue to invest in U.S. properties.

As the amount of potential domestic homebuyers shrink, realtors are taking classes to learn how to attract more foreign buyers to other regions, such as Atlanta and Seattle.

In California, brokers continue to see the Golden State as a desirable destination for new foreign buyers, mainly Chinese immigrants, remaining second in the nation behind only Texas and Florida.

Lending to Foreign Nationals

Below are some of the unique issues lenders will incur when making a loan to a foreign national borrower.

Anti-Money Laundering // Anti-money laundering is an issue with all borrowers, and it is particularly acute with foreign national borrowers. Certain countries are particularly problematic, for example, Iran and Cuba. The Office of Foreign Assets Control (OFAC), which is a U.S. Treasury organization, primarily targets individual participants rather than countries as a whole. OFAC offers a free search tool available at: sanctionssearch.ofac.treas.gov. Any lender considering making a loan to a foreign national borrower should, at a minimum, run an OFAC search.  Lenders should consider running a more detailed background check in addition to the OFAC search. Lenders should absolutely require that borrower funds are sent through an American bank account, as the banking system in the U.S. is under strict regulatory control regarding anti-money laundering. Finally, lenders should require that all borrower funds are sent through a single wire to the title company rather than through numerous smaller wires, because the smaller wire transactions tend to have a higher incidence of underlying illegal activity.

In California, more than 100 illegal cannabis grow houses were seized by the federal government recently. The loans were exclusively financed by private lenders. The fact pattern revolved around foreign national borrowers who stated they were residents of states outside of California. When the time came to wire in closing funds to the title company, small wires were sent from numerous accounts and
participants throughout the country. While there is nothing per se illegal about the use of numerous small wires, such a practice should raise alarm bells to a potentially larger fraud or scheme.

Recourse // Reduce the loan-to-value ratio when making loans to foreign nationals. Even though the foreign national is likely a very high net worth individual, enforcing a personal guaranty will be extremely difficult, if not impossible. Typically, most of the sponsor’s assets are held outside the country, and seizing a foreign asset is very impractical and expensive. Effectively, these types of loans should be treated as nonrecourse, and the collateral is all the lender will have. This is particularly important in states with long foreclosure horizons such as New York and New Jersey, where the foreclosure process takes years, eroding any potential equity cushion built into the underlying loan. If the borrower has any assets located in the U.S., a lender would be wise to cross-collateralize those assets as part of the loan.

Quasi-Consume // Many lenders fail to ask why the foreign national is purchasing the property and automatically assume the loan is for a business purpose or that it is not owner occupied. Contrary to popular belief, most second homes and vacation rentals are considered owner occupied from a statutory perspective. The Truth-in-Lending Act deems properties as “owner-occupied” if the borrower resides in the property 14 or more calendar days per year. When lenders ask how often the borrower intends to reside in the home, the answer tends to be a few months out of the year, turning the loan into a consumer purchase subject to the myriad state and federal lending and licensing laws. The same rules would apply if the intent is to have the children of the foreign national live in the property while they attend school in the states. The loan should be treated as a consumer loan, even though the borrower technically does not reside in the property. It is paramount to confirm the borrower will use the property for a legitimate business purpose such as a rental property.

Foreign national purchases may be down, but historical data show us that the tide will flow again. ∞