CHICAGO -- Foreign investors, after increasing their direct investments in U.S. real estate during the 1980s, are likely to reduce those investments during the 1990s, a panel of lawyers specializing in taxes and in international real estate said this week.

"There's a trend toward higher taxation of foreign investors that makes it less attractive for them to invest directly in U.S. real estate," Dallas lawyer Timothy E. Powers said at a program on foreign investment in U.S. real estate at the American Bar Association's annual meeting in Chicago.

Indirect real estate investments remain free from taxes when created and structured correctly and so will attract an increasing amount of foreign investment, Powers said.

During the past decade, total direct foreign investment in U.S. real estate increased to $43.9 billion in 1989 from $2.1 billion in 1979, said Gary A. Goodman, a New York lawyer. Indirect foreign investment now totals $156 billion.

Indirect investments include partnerships, real estate investment trusts, trusts and shared appreciation mortgages and investments that enable investors to purchase part of the equity in a project, Goodman said.

However, he said the plans to eliminate tariffs within the European Community in 1992 and the soft U.S. real estate market have caused foreign investors to focus on European real estate but that investment in U.S. real estate markets should increase in a few years.

Powers said that indirect real estate investments, which still enable foreign investors to avoid paying U.S. taxes, remain attractive and are likely to increase.

Capital gains and other taxes on foreign investors' direct real estate investments increased throughout the 1980s and will increase again under legislation pending in Congress, Miami lawyer Robert F. Hudson Jr. said.

"Before 1980, foreign investors paid no tax on U.S. capital gains, and under {a tax treaty with the Netherlands Antilles} they could avoid withholding tax" on their profits, he said.

In 1984, a 10 percent withholding tax was imposed, Hudson said. And in 1986 other taxes partly aimed at foreign investors were adopted.

Other tax changes affecting foreign investors were adopted in 1988 and 1989 that further increased taxes and limited deductions on direct real estate investments, he said.

"The Foreign Equity Tax Act of 1990, which was introduced in the House in March and in the Senate in April, will impose a new capital gains tax on" direct investments by foreign shareholders, Hudson said. "This is going to increase the effective tax rate at the federal level alone from 34 percent to 56.5 percent. These are not rates that foreign investors are going to take kindly to.

"But this act is likely to be passed," he said. "The trend is clearly foreign-bashing right now. The trend is not to care whether it deters foreign investment."

Because of the increased tax burdens on foreign investors, those investors will "focus much harder on the financing alternatives out there," Hudson said.

While direct real estate investment by foreign investors is being discouraged through these increased taxes, indirect investments not only have escaped this trend but have received boosts that further benefit foreign investors, said Douglas K. Krohn, an Atlanta lawyer.

Krohn said the Securities and Exchange Commission in May adopted Regulation S, which establishes for the first time an exemption from registration under the 1933 Securities Act for foreign offerings of U.S. securities. Securities that are offered and sold outside the United States in accordance with Regulation S need not be registered under the 1933 act, he said.

"This is a new trend in foreign investment, and it is a regulation and a safe harbor that can be used well," Krohn said.

Powers said that during the coming years foreign investors in U.S. real estate will increasingly turn to such forms of indirect investment as limited partnerships and mortgage-backed securities and other debt instruments.

"Indirect investment can become much more attractive," he said. "If it's carefully structured, the investment can permit a significant degree of participation in the upside of any project.

"A debt instrument can be structured to carry an equity kicker that's tied to the underlying project. The equity kicker can be paid off through a sale or refinancing of the property without being subject to a tax on the capital gains."

He said that in the foreign debt market there still is a concern about U.S. intentions toward foreign investors.

"At least for now, the {tax exemption on interest earned on debt instruments} provides structuring alternatives and some tax incentives to invest in the U.S.," Powers said.