By Jim Butler and the Global Hospitality Group®
Part two of our recent article in Westlaw Today explores the opportunities available to developers and investors now that the EB-5 program is back on track. For part 1, click here.
This article was originally published on Westlaw Today on April 14, 2022.
What the 2022 Revitalization of EB-5 Financing Means
for Real Estate Developers and Other Entrepreneurs: Part 2
What are foreign investors looking for?
Experts expect to see a flood of interest in the EB-5 program, both from foreign investors anxious to immigrate to the US, and from real estate developers with shovel-ready projects seeking capital.
There is no limitation in the law as to the type of project that can be funded with EB-5 financing. The critical requirement is that the minimum number of 10 new US jobs for each investor will be created within a specified period of time.
In the past, up to 70 or 80 percent of all EB-5 investors selected real estate-related investments, particularly those that create a large number of new US jobs such as hotels, restaurants, night clubs, resorts, hospitals, and senior living. Alternate energy projects and a host of other new businesses, however, could tap this financing source as the program comes back online.
Under the new law, it appears that retail and office projects may also be feasible, because new jobs created by tenants of a project appear to satisfy the job creation requirement. Previously, the law excluded jobs created through “tenant occupancy.”
Before the EB-5 program lapsed, investors showed a strong preference for hotel projects. New hotels create a lot of jobs, and a large number of jobs means a larger pool of investors and capital, as well as a higher degree of certainty that the project will meet all requirements for the investors’ visas.
The dynamics of hotel value and financing create a generally reliable source of repayment to the EB-5 investors in five to seven years, which is a common maturity date for EB-5 financing. This is because hotels typically take two to four years after the completion of construction to “ramp up” operations from a dead stop to full, sustainable levels. After opening and stabilizing, the value of the hotel typically jumps a substantial amount above the project cost.
The lodging industry is sophisticated, with a plentiful supply of brands, independent third party managers, and industry-specific professional advisors. The involvement of such highly-professional and experienced independent parties provides an additional layer of underwriting, validation, and oversight separate from the developer. Most such players use their experience, resources and insights to avoid risky deals. This can be a valuable perspective, and this may provide investors more comfort that the proposed project and business plan are viable.
What do EB-5 funds cost developers?
Prior to the reauthorization, EB-5 financing for “preferred” developers typically cost seven to eight percent per annum to the developer on an all-in basis. The typical immigrant investor usually received one percent or less on an investment, and much of the rest of the per-annum cost went to pay for all the infrastructure and personnel involved in selling the project, raising the money, maintaining EB-5 compliance, and overseeing securities compliance. With all the increased regulation and oversight requirements of the EB-5 Reform Act, it is unlikely that the cost of EB-5 money will go down.
EB-5 financing is an important and viable source of construction financing for hotels, mixed-use, and other development projects. For most developers, EB-5 financing is best structured as mezzanine debt or preferred equity, to optimize the total amount of financing and reduce the cost of the capital stack.
Normally, senior construction debt (secured by a first priority lien) will be cheaper than EB-5 money, but senior lenders (particularly if the project is a hotel) rarely lend more than 50 to 55 percent of the total cost of construction.
Potentially, developers could begin with this cheaper, senior debt and then add low-cost EB-5 mezzanine debt on top of it to bring the total loan-to-cost ratio closer to 75 percent or more. This structure is also popular with the most experienced and reliable regional centers in the business.
Should developers form their own regional center?
In the past, many developers were encouraged to obtain their own regional center designation, hoping to shave a point or two off the cost of funds or to get into a new business. For most, this was not a good move, and they either abandoned their regional center quest or would not do it again given the chance.
A regional center is an entity that has received formal approval by the US immigration service to be designated as such. As of October 2021, there were more than 600 approved regional centers listed on the immigration service website — but only a small percentage of those have ever raised significant EB-5 financing, much less gotten their immigrant investors’ permanent visa approvals through the I-829 process. Virtually all of the successful EB-5 financings to date have been handled by the top ten percent of the regional centers.
In other words, there is an extreme concentration of experience and success amongst a very small number of the regional centers. The EB-5 Reform Act substantially increases the annual cost, legal liability and responsibility of regional centers. Experienced EB-5 players believe this increased regulation will significantly reduce the total number of regional centers and will discourage amateurs from getting into the game.
Why have a virtual handful of regional centers raised such a vast portion of the EB-5 funding? The strongest regional centers that have successfully closed EB-5 deals have been committed to the business for years. They also have a long line of developers who want to employ their services. These veteran organizations have established (and maintained) a regular operating presence in relevant countries. They have built a strong and permanent marketing organization in these countries, grown investor demand for their offerings based on their track record of getting visas for investors, and delivered funding on their promises.
Newcomers to EB-5 funding will find competition with the established regional centers to be daunting. The EB-5 investors want to know the track record of the regional center marketing a project. What percentage of their investors have gotten their green card? How many have failed? How many have been deported after moving to the US?
In short, there are too many regional centers already, and most of them — particularly the new ones — have no organization or proven ability to raise EB-5 financing, much less to do so in a timely, cost-effective or reliable way. Immigrant investors prefer records of success, and so do smart developers.
An extraordinarily high percentage of developers who initially believe they want to build their own EB-5 infrastructure will ultimately abandon their path. Developers need to understand that this alternative involves setting up an entirely new business — the immigration business. It takes a long time to get regional center and project approvals, and even longer to push projects all the way through the EB-5 pipeline so that you can show new investors that all your prior investors got their green cards.
Looking ahead
There are so many issues that could affect an EB-5 development project or an EB-5 capital raise. Certainly, stakeholders will have to make some fast adjustments to satisfy the new requirements of the EB-5 Reform Act; RCs in particular will need to scramble to establish or renew their status and get approval of projects under the new law. Regional Centers and investors will have to comply with the stricter new rules governing TEAs, minimum investment amounts, and compliance with numerous provisions designed to ensure the integrity of the program.
With proper guidance from unbiased experts, there is a relatively easy path to explore EB-5 financing and to reliably execute on it. It requires relatively nominal cost and risk; the cost can be incurred on an “incremental” basis — meaning you start with very low cost and risk to see if there is a litmus test for a stop-or-go indication. Many common mistakes can be avoided if developers bring in an experienced advisory team early in the process, to help document the intention to raise EB-5 funds and select the best Regional Center or investor for the project.
