What the revitalization of EB-5 financing means for real estate developers and entrepreneurs

12 minute read

U.S. dollar banknotes are displayed in this illustration taken, February 14, 2022. REUTERS/Dado Ruvic/File Photo

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April 14, 2022 - After being sidelined for the last few years by circumstances culminating with the pandemic and the lapse of the Regional Center Program in June of 2021, the EB-5 foreign investment program looks like it has returned as a viable option for developers seeking low-cost funding for new construction projects.

On March 15, President Biden signed the Omnibus Spending Bill, which included the "EB-5 Reform and Integrity Act of 2022," sponsored by Senators Pat Leahy (D-VT) and Chuck Grassley (R-IA). This bipartisan bill restores viability to EB-5 by reauthorizing the lapsed Regional Center Program, a component essential to the success of EB-5.

EB-5 refers to a program that is authorized by Section 203(b)(5) of the Immigration and Nationality Act. EB-5 is the fifth "Employment-Based" immigration program set forth in Section 203 and provides expedited visa processing for foreign investors making a minimum required investment in a project that directly creates at least 10 new jobs in the United States.

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In short, it is both an immigration program for foreign investor immigrants, and a program that requires substantial capital investment in new business enterprises creating jobs in the United States.

The character of available financing and the projects most desirable for EB-5 investment are directly influenced by program requirements that must be met to qualify investors for a green card. For example, lower program investment minimums ($800,000 vs. $1,050,000) make projects more desirable in targeted areas of high unemployment and rural areas.

In addition, there is "expedited" visa processing for investments in rural areas. Immigrant investors want to invest the minimum amount of money and be approved for their visas as quickly as possible, encouraging investors to prioritize infrastructure or projects in rural areas or areas with high unemployment.

Ten thousand visas per fiscal year are set aside for applicants to the EB-5 program, and the new law sets aside or reserves 20 percent of those visas for projects in rural areas, 10 percent for targeted areas of high unemployment, and 2 percent for infrastructure projects

Although the EB-5 immigrant visa program has been active since 1990, the current trend of using it as a source of financing real estate development and construction started 20 years later — around 2010. The popularity of the program exceeded all expectations for several years in the 2010s, particularly with Chinese applicants, until a marked slowdown near the end of 2017.

Partisan politics during the Trump administration, strained U.S.-Chinese relationships, and the Chinese government's strict new limits on exporting capital from China, combined with the economic panic and lockdowns of the pandemic, stopped virtually all new EB-5 investments from Chinese residents.

The Regional Center (RC) program, which allows investors to pool their money to finance new ventures, was added to the EB-5 program in 1993 and extended repeatedly until June 2021, when it was allowed to lapse. RCs are formally designated by the U.S. Immigration service and have different job creation requirements; rather than counting only the jobs directly created by a project, indirect and induced jobs tallied by approve economic methodologies also qualify.

Regional Centers offer benefits both to investors and to developers seeking funding: when more jobs qualify under immigration rules, more investors can get visas. With more available visas, more money can be raised. It is also easier to use EB-5 when there is a substantial margin of safety in the job count in case anything goes wrong. As a practical matter, regional centers have historically offered immigrant investors a buffer of 20 to 30 percent more jobs than the law requires, to protect against contingencies.

The EB-5 Reform Act reauthorizes the Regional Center program, which has proven to be essential to the viability of EB-5 overall. The demand generated by the revitalized RC program is expected to bring the EB-5 program out of its long hibernation.

While the basics of the program remain the same, some aspects of the Regional Center program have changed.

The EB-5 Reform Act raises the minimum investment in qualified projects to $1,050,000 from $1 million, except in federally-designated Targeted Employment Areas (TEAs) where the investment minimum was raised to $800,000 from $500,000. The new minimum investment requirement will hold for the next five years, assuring the availability of this type of financing through September 2027.

The bill also puts a premium on investment in rural areas or TEAs by expediting visa applications for investors involved in those projects; thirty percent of EB-5 visas are set aside for these investors. Infrastructure projects are also subject to lower minimum investment requirements, but do not qualify for expedited visa processing.

The Regional Center program offers a regulated structure industry of approved RCs, who are now subject to greatly increased regulatory scrutiny, oversight and audits as outlined in the EB-5 Reform Act. RCs are also now the only way for investors to pool their resources, and existing centers will need to refile to comply with new requirements. Experts suggest that these changes will greatly reduce the number of regional centers to those who truly intend to be active in the program.

Now that the EB-5 Reform Act has been signed, prior Regional Center law has been repealed. No new RC filings can be filed until 60 days after enactment, so applications cannot be submitted until May 14, 2022. It's not yet clear, but it's possible that every RC must start over with a new application, or at least an amendment to confirm the identity of all persons "involved with" the RC and to provide policies and procedures reasonably designed to ensure compliance with the new integrity rules.

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.

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.

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.

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.

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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias. Westlaw Today is owned by Thomson Reuters and operates independently of Reuters News.

Jim Butler is a founder of the Jeffer Mangels Butler & Mitchel LLP law firm and chairman of its real estate department. He founded and chairs the firm's global hospitality group and its EB-5 finance group, which provide business and legal advice to owners, developers and investors of commercial real estate. Butler is a member of the Public Policy Committee of the IIUSA, the industry trade association. He is based in the firm's Los Angeles office and can be reached at jbutler@jmbm.com.