Expanded provisions for national security review of real estate transactions involving foreign investors in the United States were among the biggest changes under draft regulations released by the U.S. Treasury Department last week.

The proposals for expanded review by the Committee on Foreign Investment in the U.S., the interagency panel at the Department of the Treasury, could catch some real estate investors and funds off-guard, international trade and national security lawyers said.

"Even in non-control real estate transactions where an investor has minority investment with certain rights, if they fall within the categories that CFIUS has laid out, CFIUS will have jurisdiction," said Mario Mancuso, an adviser to corporate boards and international trade and national security practice leader at Kirkland & Ellis in Washington, D.C.

"They will have to think about it unless they want to run the risk of CFIUS unwinding the deal. Real estate gets a lot of attention in these proposed regulations," Mancuso said.

The proposed rules cover real estate located in or near scores of airports, maritime ports, military bases and national security installations across the U.S., many concentrated near the Washington, D.C./Northern Virginia metro area and in Southern California.

David Hanke, an international trade and national security partner at Arent Fox in D.C., said, "the rule-makers were clearly trying to maximize certainty and predictability for investors, but it's possible this newfound jurisdiction over real estate could impact investment near these specific facilities."

The draft rules implementing the Foreign Investment Risk Review Modernization Act reflect the federal government's growing concern about purchasing and leasing of properties that could be used for surveillance or intelligence-gathering by foreign actors, lawyers said. They were released Sept. 17 in a 135-page document as proposed rule 31 CFR Part 802.

The real estate rules are far more expansive than the ones that existed prior to FIRRMA, which was enacted with bipartisan support in Congress last year. CFIUS already had authority to review for national security concerns transactions where a foreign acquirer had the ability to gain control of a U.S. business. But now, under FIRRMA, CFIUS's authority is expanded to review non-control investments and real estate transactions that previously fell outside its jurisdiction.

Covered real estate transactions include any in which a "foreign person" purchases, leases or is granted a concession of covered real estate that affords a foreign person certain property rights as detailed in the draft regulations, as summarized in client memo released by Stroock & Stroock & Lavan on Monday. A "foreign person" is defined in the regulations, however, as a "foreign national," "foreign government," "foreign entity" or any entity over which control is exercised or exercisable by any of these.

A CFIUS review could result in a transaction being cleared, blocked with a presidential order or required to take mitigation steps such as selling off a particular property in order to win approval. Filing for national security risk review of real estate transactions is voluntary, not mandatory; however, CFIUS can call for review of a transaction where the parties haven't voluntarily filed.

A relatively recent example of a real estate deal that was terminated because of CFIUS objections under the prior rules occurred in 2016 during the Obama administration, when CFIUS rejected China's Anbang Insurance Group Co.'s bid to purchase the Hotel del Coronado in San Diego from the Blackstone Group, which then scuttled the deal. The committee was concerned about the property's proximity to U.S. Navy installations.

More recently, CFIUS ordered HNA Group to sell its majority holding last year in a Manhattan building whose tenants included a police precinct assigned to protect Trump Tower, according to news reports.

Tatiana Sullivan, an attorney who recently joined Stroock from the Department of Defense, where she was responsible for FIRRMA development, said: "If implemented in their current form, the new rules will require foreign investors and foreign-controlled companies in the United States to do much more due diligence as part of their transactions."

Sullivan also said some industries such as oil and gas, where companies engage in purchase and lease arrangements as a regular part of their business, may be more affected than others. Entities that are already under foreign control also could come under scrutiny and that would include their U.S. subsidiaries, she said.

A spokeswoman for the Real Estate Roundtable, a trade group in Washington, D.C.,  representing real estate owners, managers, developers and lenders, said the group is studying the proposed regulations and plans to file comments before the Treasury Department deadline.

The U.S. Treasury has requested comments in writing by Oct. 17. Final rules are expected early next year.

Covered Real Estate and Transactions

Under the proposed regulations, "covered real estate" includes certain large airports and maritime ports, and properties within a mile of any of more than 100 military installations identified in the regulation, or within extended range—99 miles of the one-mile "close proximity" boundary—of 32 military installations; as well as any part of 23 named military installations and located within 12 nautical miles of the U.S. coast; and real estate on or near missile fields spread out over Colorado, Montana, Nebraska, North Dakota and Wyoming. The sites are listed in a lengthy appendix.

Many of the installations on the list are in Virginia and Maryland, and several are near San Diego, Santa Barbara and Los Angeles in California. Bases outside Las Vegas and in Florida also are on the list along with others across the country.

"Covered real estate transactions" include any purchase, lease or concession to a foreign person or a change in the rights that affords them a minimum of three of the following rights: 1) the right to physical access to the property; 2) the right to exclude physical access; 3) the right to develop the property or improve it; or 4) the right to attach fixed or immovable structures or objects.

The regulations, however, provide general exceptions for real estate within "an urbanized area or urban cluster," single housing units, certain retail concessions, certain commercial office buildings and certain tribal properties.

Penalties for withholding information or providing misleading information carry a civil penalty of up to $250,000 per violation. As with the rest of the new CFIUS draft regulations, there is a proposed "white list" of countries or investors that can be excepted from the requirements.

Corporate partner Nevena Simidjiyska, co-chair of the international trade practice group at Fox Rothschild in Philadelphia, said she believed that in terms of the expansion of CFIUS jurisdiction over real estate transactions, the leasing provision would have the greatest reach.

"There is a lot of leasing going on to foreign parties the way it is defined so that is going to be the biggest change. Whenever a U.S. party is considering leasing to a foreign party it is going to have to make sure it doesn't fall within the regulated real estate here," she said.

But Simidjiyska also said that the fact the rules only call for voluntary filing may reduce the overall impact, at least as compared to the draft regulations regarding TID businesses: critical technologies, infrastructure and sensitive personal data that require mandatory filings in certain cases under the new rules.

Whether dealing with M&A, investment or a real estate transaction, addressing clients' concerns often involves structuring the transactions in a way that doesn't trigger CFIUS jurisdiction, she said. For example, making sure that foreign real estate acquirers don't have certain rights related to the property.

Hanke said CFIUS should try to make the process as user-friendly as possible for real estate investors.

"Allowing the use of short-form declarations is a smart way to do that. Pure real estate deals can be more straightforward than technology or data-related transactions, for example, so hopefully most can be reviewed and cleared relatively quickly."

An indirect effect of the proposed rules, however, could be on real estate financing, even though that is not actually stated in the regulations, said Richard Matheny, a litigation partner and head of Goodwin Procter's global trade practice in Washington, D.C.

Even though the proposed regulations don't require mandatory filing, "lenders may push borrowers to go through the CFIUS process in order to protect their security for the land," he said.

"I anticipate that lending institutions will be taking a look because they want to make sure that their security is protected, so I expect CFIUS provisions to be put into their lending for real property."

Draft Rules Address Growing Security Concerns

Lawyers familiar with the evolution of FIRRMA legislation said the new real estate regulations are in response to a rising number of situations such as the one in 2012, when the Chinese-owned Ralls Corp. bought four U.S. wind farm properties in Oregon, including one located near a U.S. naval base that trained drone aircraft pilots.

After the U.S. Navy objected, CFIUS contacted Ralls Corp. and suggested the company voluntarily file a notice with the committee. Ralls did so, and on CFIUS' recommendation, President Barack Obama, under the regulations then in effect, ordered the company to divest the property within 90 days and to remove concrete bases it had installed for wind turbines within 14 days. He also blocked the sale of the project to any third party unless it also complied with conditions. Before Ralls, the last time a president had blocked a deal for national security reasons was in 1990 under President George H.W. Bush.

Ralls Corp. then filed a lawsuit against CFIUS charging a lack of due process. The company initially lost in federal district court, but won a partial victory in the D.C. Circuit on appeal that would have remanded the case back to district court and forced CFIUS to disclose additional information about its decision-making process. But CFIUS and Ralls negotiated a settlement in October 2015, the terms of which weren't disclosed.

In 2017, Cosco Shipping Holdings Co.Ltd., an ocean container shipping company incorporated in mainland China, announced plans to acquire shares of Hong Kong-based company, Orient Overseas International Ltd., which held a 40-year concession to operate a large container-shipping terminal in Long Beach, California, triggering a CFIUS review.

In that case, Cosco executives met with CFIUS officials in April 2018 and proposed to divest the Long Beach terminal to satisfy U.S. officials' national security concerns. They signed an agreement in July 2018 to transfer the ownership of the terminal to a trust whose principal trustee is a U.S. citizen.

Mancuso said CFIUS had signaled its thinking about foreign real estate investments by its agency practice in the last couple of years.

"Real estate has long been a refuge for foreign investors, not just institutional investors, because U.S. real estate was seen as a refuge from a dangerous and volatile world," he said. "But with respect to the most dynamic parts of the real estate market, the government is saying we welcome foreign investment, but we think foreign investment in real estate can be a real risk, and we are going to expand our jurisdiction so you investors should think about the risks before you engage in those transactions."