EB-5 Real Estate Financing: Trends, Misperceptions, and Outlook
Over the last ten years, the EB-5 Program has emerged as an extremely popular but widely misunderstood alternative financing method for commercial real estate development. Although the EB-5 Program has incurred a somewhat negative reputation in recent years, this has mostly been due to a handful of high-profile fraudulent EB-5 schemes. In reality, EB-5 continues to be an attractive financing option for commercial real estate developers who understand its intricacies, especially as the industry continues to implement reforms.
This article is intended to examine trends when deploying EB-5 capital, clarify misperceptions surrounding the EB-5 Program, and explore the future of the EB-5 industry. In analyzing the outlook of the EB-5 Program, we consider new regulatory reform as well as the rise of third party consultants who can help improve accountability and efficiency to the EB-5 financing Process.
We extend a special thanks to Young Kim, Managing Director of 8th Bridge Capital, an LA based investment management firm specializing in Asian EB-5 and private equity funding, for his contribution.
Overview of EB-5 In Commercial Real Estate Development
The EB-5 Program is a USCIS (United States Citizenship and Immigration Services) employment-based visa program allowing foreign investors to gain permanent residency through a $500,000–$1,000,000 investment in a new commercial enterprise that creates at least 10 full-time jobs.
Although the EB-5 Program was formed in 1990, it remained in relative obscurity until the economic recovery that followed the 2008 financial crisis. In 2009, the USCIS ruled that construction jobs created from EB-5 funded developments would fulfill the program’s job-creation requirement. This catapulted EB-5 into the mainstream as a viable funding option for commercial real estate developers. In 2010, less than 2,000 visas were issued through the EB-5 program, but by 2014, that number had reached its annual USCIS-mandated maximum of approximately 10,000 visas.
Over 75% of EB-5 visas issued in 2017 were issued to Chinese investors. China and Vietnam are now the two most popular countries for EB-5, and currently the only 2 that have a visa backlog due to over-subscription.
Today, commercial real estate developments attract the lion’s share of EB-5 funding. One of the primary forces driving the growth in EB-5 real estate investment was the improved accessibility to funds that regional centers offered.
Regional centers now account for over 90% of all EB-5 projects, but some have begun to face criticism for lack of transparency in recent years. Several regional centers, for instance, have been formed by real estate developers in order to secure funding for their own developments, resulting in a potential conflict of interest in which the project developer is acting as both the borrower and the lender. These types of issues have prompted the USCIS to begin implementing reforms aimed at improving the transparency of the EB-5 process.
Most Popular Project Types Among EB-5 Investors
Century Plaza, a major $1B expansion and renovation project in LA with condo, retail, and hotel components was partially financed with EB-5 funding. MGAC is providing independent cost consulting services to the owner.
Foreign EB-5 investors have a strong preference for commercial real estate projects because of the transparency and consistent demand of the market, as well as the expectation that their investments will be secured by a tangible asset. It is important to remember that EB-5 investors are primarily concerned with satisfying the program’s requirements and gaining permanent residency status, rather than maximizing return on investment. Thus, EB-5 funding is characteristically risk-averse and gravitates towards the safest potential projects with the highest likelihood of successful completion.
According to Young Kim, who spends nearly half of his time in Asia with prospective EB-5 investors, investors are attracted to projects that have:
- Gateway City Locations – EB-5 projects concentrate in coastal “gateway” cities such as Los Angeles, New York, Seattle, Washington DC, and San Francisco. Foreign investors have more experience and exposure to these large coastal cities and regard them as safe, desirable destinations for investment. This parallels trends for non-EB-5 foreign investment in US real estate.
- Condominium or Commercial Office Components – According to Kim, “In the past, developments in the hospitality sector were most common. However, EB-5 funding is moving towards the condominium and office space sectors as these developments are currently easier to offload upon completion.”
- $100-250 Million Total Project Cost – In order to leverage projects sensibly, EB-5 funding will normally fall within a “sweet spot” of 20-30% of a project’s total capital stack either in the form of mezzanine debt or equity. “A 20-30% EB-5 financing piece,” says Kim “is not only attractive to investors, who want to avoid overleveraged projects, but also easier to fund in a more predictable timeline. We’ve found that a $20-75 million EB-5 raise [20-30% on a $100-250 million project] is more manageable given that the two largest EB-5 markets, China and Vietnam, have slowed down in recent months.”
Another consideration is the job requirements of EB-5 funding. Depending on the asset types being developed, there may only be enough eligible jobs created by the project to raise up to 20-30%. According to Kim “Condominium developments tend to create less jobs for any given investment amount, while hotels tend to create more jobs for the same amount”
Misperceptions When Deploying EB-5 Funding
Although the EB-5 program has attracted increasing attention and demand, many US developers still have an incomplete or outdated understanding of the program as a whole. EB-5 is unique compared to other traditional sources of funding, and brings with it a special set of benefits and limitations. Some of the most common misperceptions in the market are:
EB-5 Is Just An Immigration Product
Many developers focus on the program’s immigration feature, while failing to understand the full scope of hurdles involved with the investment process. In reality, EB-5 is considered a security and is regulated as such. Immigration is just one aspect of the EB-5 program, and is accompanied by complex financial features that require very specific financial preparation. Often, developers only seek immigration attorneys, when experienced securities attorneys are also necessary to successfully navigate the EB-5 process.
EB-5 Is Fast Money
Some developers believe that EB-5 offers a relatively quick way to attain funding when compared to other lending sources. The fact is that EB-5 is “slow money”, both in terms of disbursement and maturity time, meaning that it is not suitable for all types of projects or developers.
It is possible to use EB-5 funding at the beginning of a project, but this can unnecessarily complicate the project’s capital stack. The project will likely require bridge financing during the period in which the EB-5 funds are being raised as the program typically requires funds to be consolidated, processed, and disbursed.
More commonly, developers will incorporate EB-5 funding when construction of the project is already underway. In this strategy, EB-5 funding is used to refinance more expensive construction loans, partially replacing the fully capitalized developer’s equity with cheaper, long-term EB-5 funding. “In most cases, following this strategy can help lower the overall cost of capital to 6 or 7%” says Kim.
EB-5 funding has traditionally been used with a 5-year investment timeline. However, with mandated “waiting lists”, some countries now require longer investment periods. “Specifically, the Chinese timeline has grown from about 5 years to around 10-15 years, while the Vietnamese timeline now averages around 7 years.” However, Kim goes on to explain, “Developers can use this long timeline to their advantage. They might propose projects with longer timelines when they know they are targeting Chinese or Vietnamese investors.”
EB-5 Is Free Money
Although EB-5 is relatively affordable when compared with traditional forms of financing, there are still costs due to the unique nature of EB-5. While it is true that EB-5 interest rates are rising as it becomes more popular, these rates will likely remain below 10%, which still makes it an attractive form of financing. In using EB-5, developers can fix their interest rate at the time of funding to hedge against inflation.
Foreign governments’ restrictions and other issues with transferring funds across borders can complicate the EB-5 process and increase the cost of capital. In countries with capital controls such as China or Vietnam, foreign brokers are often necessary to move funds out of the country – a risky process that comes with relatively high transaction fees.
The Future of EB-5: Greater Transparency
Considering the popularity of the EB-5 Program, regulation and enforcement within the industry has been surprisingly hazy. One such area of uncertainty is the issue of redeployment: the process of reinvesting the capital of investors whose immigration petitions are still pending. For countries with significant backlogs such as China, investors must have their investments “at risk” while their immigration petitions are awaiting approval – a process that can add an additional 5 to 10 years onto the 5-year period most real estate development projects require capital for. In the past, regional centers and EB-5 fund managers have only written loose language around how redeployments will be handled. But as the first wave of redeployment nears, the USCIS has begun to have discussions around implementing more concrete guidelines.
More reform and regulation are being implemented as the program matures. The USCIS has recently mandated several Integrity Measures for the EB-5 Program to improve accountability. These include conducting random audits of Regional Centers and requiring more comprehensive documentation and transparency for Regional Center activities and foreign investors.
Independent fund managers and loan monitors can offer improved transparency and risk management to the EB-5 process.
Beyond improvements in USCIS regulation, the industry is taking internal steps to improve transparency. Some foreign investors are starting to look outside of regional centers to independent third-party players consultants to structure, manage, and monitor their EB-5 investments. Independent investment managers are neither limited to projects in certain geographic regions nor restricted to projects with certain developers. Consequently, these independent investment managers can help mitigate potential issues arising from conflicts of interest while offering the widest selection of investment opportunities. Some third-party consultants come from backgrounds in commercial banking and can provide an institutional-grade due diligence and risk management process when sourcing and structuring investment opportunities.
Construction loan monitors provide another opportunity to improve risk management by complementing the Lenders’ expertise in financing and structuring. At MGAC, our lender services team can work closely with regional centers or independent fund managers to provide detailed, extensive oversight of the development process. Our team reviews various reports to confirm work is being completed in accordance with approved plans, specifications, budgets, local regulations and applicable Building Code.
At MGAC, our Lender Services team has been tracking the evolution of the EB-5 industry with great interest. Moving forward, we believe it will be essential for regulators, developers, investment managers, and construction monitoring specialists to collaborate in order to push greater accountability and transparency throughout the industry. EB-5 financing is a complex process that requires the synchronization of various moving parts in order to succeed. Despite the various challenges, hurdles, and interests competing through the entire process, EB-5 funding can still be an attractive source of funding for the right project type.
If you’d like to learn more about our perspective on EB-5 or our lender services, reach out to us on our contact page.