The Rise of the Foreign Investor

A couple of years after I rocked up at Baker & Botts as a newly minted associate in August 1976, I found myself working on my first Hines deal.

It started with a meeting in the offices of the venerable Ford Foundation in Midtown New York City. I was asked to attend along with a couple of other lawyers from our firm together with Hines officers, including Gerry’s closest aide, his chief financial officer.

The backstory was that in 1972, Hines and the Ford Foundation had partnered up to buy 7500 acres of land in Fort Bend County, located southwest of Houston.

This land had been part of the original land grant that the Spanish government contracted in 1821 to convey to Stephen F. Austin, with the idea being that Austin would turn around and offer tracts of that land as an inducement to lure Americans to come and settle in what, to the government way down south in Mexico City, was a vast, distant, empty wilderness. In 1972, that land was still vast and mostly empty, but it was a century and a half later, finally in what real estate guys call “the path of growth”.

Specifically, Houston was growing by leaps and bounds during the 1970s and a lot of that growth was headed southwest down the Highway 59 corridor toward Fort Bend. With typical foresight, Hines realized that the old Spanish land grant land wouldn’t be that empty for that long, so he turned to the Ford Foundation for the money he needed to buy it.

But a few years later, having thought better of the idea of owning raw land in a part of the world that, as New Yorkers, they would have been hard-pressed to find on a map, the good people of the Ford Foundation let it be known that they’d appreciate it if Gerry would buy them out. Hence my attendance at that meeting, at which Hines’s top finance guy negotiated the purchase of those 7500 acres for an amount that, with the benefit of hindsight, seems like chicken feed today.

Unlike his investments in his Houston development projects such as the Galleria and One Shell Plaza, Hines wasn’t looking to raise the capital for this transaction from the rich guys who could commonly be found huddled up around the bar at the River Oaks Country Club.

Instead, he hunted that capital up from a Dutch source—the pension fund for the Shell Oil Company.

 

Not long after that meeting in Midtown, I found myself in the main conference room in our Houston offices locked in a prolonged, tense negotiation with the Shell pension fund and their New York lawyers over the terms of their investment in the said 7500 acres. Hines’ chief deal lawyer at that time was a senior Baker & Botts partner named Ben White, a white-haired gentleman of the old school, a man of great dignity, presence and accomplishment—certainly as compared to me, the lowly puppy associate in the $150 suit and the cheap haircut.

At one point in the negotiations, Shell’s counsel asked a question pertaining to Texas law on business trusts. In response, Mr. White leaned back in his seat, cleared his mighty throat, and treated this New York lawyer to a very erudite discourse on the subject.

After which he suddenly turned and looked straight at me.

He intoned, “See how readily I share my valuable years of study and experience of the law with our guests here, Hime, the better to help them understand it and thereby advise their client accordingly. Yet I do not seek to charge one thin dime for this valuable service. Now, what do you suppose that advice is worth?”

As it happens, one of my failings is that I sometimes have a tendency to be too literal when interpreting a question posed to me as directly as that one was, and, unfortunately, I succumbed to that tendency in this instance.

I mentally speculated that Mr. White must charge around $600 an hour—a king’s ransom of a billing rate at that time and place—and further estimated that he had spent about five minutes total on his discourse.

I quickly did the math in my head.

“About fifty dollars,” I blurted out.

The instant I uttered those words, I realized how incredibly cheap that amount of money sounded and wished with all my might I could reach into the air and grab those words with both hands and stuff them back into my mouth.

While the Dutch and their counsel laughed uproariously, Mr. White recoiled and looked down his nose at me for a long minute.

Then he said, in a studied tone of great indignity, “Well, I’m sorry I asked you!”

The Fort Bend land deal was not the first time Hines had turned to a foreign investor for capital. A few years earlier, he had raised a reported $100 million from funds sponsored by the German bank Deutsche Bank by selling them interests in three of his downtown Houston office projects. He did so at a time when capital markets conditions for private real estate were the worst they had been in years and he was consequently experiencing extreme liquidity pressure.

Indeed, but for that investment by the Germans, Hines would probably have been financially ruined. No amount of country club capital could have spared him from that fate.

Then, in 1979, Hines raised all the capital that he required to develop the Dallas Galleria mixed-use center—an enclosed mall, office building and hotel, essentially replicating in Dallas his Houston project from 10 years before—from a sovereign wealth fund based in a Middle Eastern petrostate. He went on to tap that same capital source for several more development projects during the ‘70s and ‘80s, including office developments in San Francisco, Houston, Washington, D.C., and New York City.

The reasons why foreign investors—German banks, Dutch pension funds, and Middle Eastern sovereign wealth funds were among the many—turned to private real estate investments in the United States during the decade of the 1970s were numerous:

• Because of the quadrupling of oil prices after the 1973-74 oil shock, petrodollars accumulated rapidly in the Middle East and these funds needed to be invested in safe, stable, dollar-denominated assets;

• The U.S. dollar was cheap compared to other currencies thanks to the abandonment of the gold peg in 1971, thus effectively causing U.S. assets to be “on sale”;

• U.S. PRE (private real estate) offered higher yields relative to other global PRE alternatives, such as those in Europe and Japan, a valuation gap that to a certain extent has continued to this very day;

• U.S. financial markets were deep, transparent and institutionally mature;

• Developers were regularly bringing to market more modern, investment-grade office towers and retail centers that were a good fit for their portfolios; and

• PRE offered a plausible hedge against inflation and political instability.

Moreover, these foreign investors were largely able to structure their investments in such a way as to reduce if not eliminate any U.S. federal income tax drag, under the tax laws and treaties then in force, by investing through holding companies formed in tax havens like the Netherlands Antilles. Consequently, they would often invest as equity the entirety of the capital required for an acquisition or development project, without the need to go to a bank or insurance company for debt capital. (This was particularly important from 1973-1975, when debt capital markets for private real estate essentially ceased to function.)

These tax planning techniques met their demise for the most part in 1980 when Congress passed the Foreign Investment in Real Property Tax Act, or FIRPTA, but there yet remain even today certain planning techniques that can mitigate the effects of taxation on a foreign investor’s return, particularly in the case of certain agencies and instrumentalities of foreign governments (such as sovereign wealth funds).

In any event, foreign direct investment in U.S. PRE has continued to this day and has occasionally seen such periods of intense activity that it has generated public outcry, such as the tsunami of Japanese capital that flooded these shores in the late 1980s. But it first began to get serious traction in the 1970s and has continued to be a healthy source of capital for U.S. PRE ever since, thereby enhancing liquidity for the asset class as a whole.

That being said, the large role played by foreign investors in PRE during the 1970s would in later years pale by comparison to that played by an even larger source of capital.

That is the story to which I will turn in my next post.

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