by Charlie Cai
In the past year, the EB-5 industry has faced increased scrutiny and pressure. With 824 approved regional centers and over $13 billion of foreign direct investment injected into the U.S. economy through EB-5 since 2008, EB-5 has become an increasingly popular method for individuals and entities to find cheap capital to fund their projects.
This article aims to provide the reader with a regional center-based real estate project due diligence checklist at the level of sophisticated analysis used by experienced real estate underwriters. Of course, having project due diligence done by an independent third party is always recommended, but the substantial cost involved most likely will make engaging such third party due diligence economically unfeasible for the EB-5 applicant or migration agent. Thus, EB-5 applicants and migration agents may use this article as guidance to better evaluate projects.
The due diligence analysis centers around two overarching considerations: (1) project due diligence, and (2) due diligence of the regional center and developer. Through careful evaluation of the factors of these two considerations, EB-5 applicants may better ensure that their I-526 and I-829 petitions are approved and their investment principal is returned.
Project Due Diligence
For an EB-5 applicant and their family, the right project can be life-changing. Although I-526 and I-829 petitions continue to maintain high approval rates, we’re also noticing various projects nationwide failing to develop as planned, thereby substantially harming and disrupting the lives of associated EB-5 applicants. This section proposes five project due diligence factors to guide the EB-5 applicant to a project that can achieve the EB-5 applicant’s immigrant investment objectives.
Job creation is one of the core factors that is absolutely necessary from start to finish. When looking at projects, the EB-5 applicant should note what the estimated total number of jobs will be and what percentage of the estimated total number is needed to satisfy job creation requirements for all EB-5 applicants in the project. That is, the larger the buffer between estimated total EB-5 jobs needed versus estimated total jobs created, the less likely it will be that an EB-5 applicant’s I-829 will be denied due to inflated job creation estimations.
In addition to the number of jobs created, we also recommend evaluating the types of jobs created and the relevant job creation methodology that was used. As suggested by Professor Jeanne Calderon and Scholar-in-Residence Gary Friedland at the New York University Stern School of Business, the current trends in EB-5 continue to focus on real estate development. As such, when looking at job creation details, the EB-5 applicant should check the following:
1. Construction-Related Jobs
- How many jobs are related to hard construction expenditures? Specifically, into which expenditure categories? The less detailed hard construction expenditures are documented, the more risky such a project may be in achieving the EB-5 applicant’s EB-5 goals.
- How many jobs are attributed to contingency and reserve funds? In general, USCIS considers contingency and reserve funds that adhere to acceptable industry practices to be permissible inputs into an economic model for estimating job creation. At the I-829 stage, USCIS will review whether contingency and reserve funds have actually been spent on eligible expenses. As such, if too many jobs are attributed to contingency and reserve funds, that may increase the risk at the I-829 stage, prompting USCIS to question such an allocation and deny an EB-5 applicant’s I-829 petition.
- How many jobs are allocated to furniture, fixtures, and equipment (“FF&E”)? While it may be challenging to determine what is a reasonable number of jobs created in relation to FF&E, given the project-specific nature of such a determination, a careful EB-5 applicant may still be able to identify whether FF&E job creation is disproportionately high in comparison to primary job creation categories.
- Is there job creation related to purchase of the project land? Generally, USCIS does not recognize funds spent on real estate acquisition. As such, a red flag should be raised if a project attributes job creation to land acquisition.
2. Guest Expenditure-Related Jobs
- Guest expenditure, in short, is when an EB-5 applicant establishes that a hotel, and consequently, hotel and associated hotel revenues, are creditable for job creation. In general, whether USCIS accepts guest expenditure jobs and how many jobs are accepted, is a fact-specific determination based on the reliability of the underlying market study and supporting evidence, and the manner in which that information or data is used in the economic analysis and job creation projections.
Project Capital Structure
The capital structure of a project is another factor that can provide strong hints about the degree of risk involved with a project. There are several aspects that the EB-5 applicant should take note of here:
1. What is the total cost of the project, and what percentage of that total amount is EB-5 capital? Recent trends indicate that EB-5 capital represents a small percentage of total project costs. Although there is no threshold, an EB-5 applicant may be at risk if a substantial percentage of a project’s total costs are intended to come from EB-5 applicants. A project that relies too much on EB-5 capital to begin or continue its development puts itself at risk of substantial uncertainty and failure to meet its projected timelines. On the contrary, a project that has sufficient capital ready, derived from sources other than EB-5, will still be ready to move forward and meet its job creation projections in a timely manner, thereby ensuring that the EB-5 applicant’s interests are protected.
2. Is there a senior loan and is it committed? With the U.S. economy’s recovery and availability of cheap capital, more and more projects have opted to use EB-5 capital as a supporting loan such as a mezzanine loan. As such, when reviewing the project documents, the EB-5 applicant should see if the project includes a senior loan or depends substantially on EB-5 capital (whether it is a loan or equity).
It is worth noting that, in general, such senior lenders also perform substantial project due diligence. Thus, a binding commitment by the senior lender to loan capital to the project denotes that the project has passed the sophisticated due diligence of the senior lender, which in turn adds a layer of assurance for the EB-5 applicant.
3. What is the amount of non-EB-5-based equity, if any, already invested in or committed to the project? A project that already has, or is soon to have, equity invested in it—excluding equity used to purchase the land—is a sign that the developer believes in the market demand for the project and thus wants to see the project completed. Based on our experience, developer equity ranges from 10-30 percent.
4. How does the amount of EB-5 capital compare to the amount of equity? A project whose equity percentage is reasonably proportional to its percent of EB-5 capital is another factor that demonstrates the commitment of the developer to complete the project, and thus provide another layer of assurance to the EB-5 applicant.
5. Who is investing the equity? In addition to developer equity, certain projects will also include equity from a co-developer or major investor. As such, the EB-5 applicant may be able to assess the stability or success of the project from knowing who the developer and equity partners are. Developers and equity partners with prior success investing in real estate development in their targeted local market are more likely to succeed.
A project’s location is a highly useful factor in determining whether the project will fulfill its job creation projections and whether it can execute its exit strategy as stated.
1. Is the project in a Target Employment Area (“TEA”)?
Although a vast majority of regional center projects are in TEAs, there are projects that require each EB-5 applicant to invest $1 million.  To be sure, being a non-TEA project on its own should not be a determinative factor in deterring the EB-5 applicant from investing. However, there are additional hurdles to overcome, including (a) proving the lawful source of $1 million; (b) transferring such funds from overseas; (c) putting twice as much capital at risk; (d) gathering the intended number of EB-5 applicants; (e) returning the EB-5 applicant’s investment.
2. Is the project located in a core or non-core real estate market?
In summary, core market projects are real estate projects located in a top-tier U.S. metropolitan location, such as Los Angeles, New York, San Francisco, Seattle, Chicago, Miami, etc. Core market projects are known for their long-term stability and low risk. Generally, a core market project will be in high demand but generate lower internal rates of return (“IRR”). On the other hand, non-core projects rely on their property appreciation or gains realized upon disposition of the properties. Consequently, non-core projects may have higher IRRs than core market projects, but also carry more risk.
3. After determining which market the project will be in, the follow-up question is: Will the project succeed in that market? That is, is the type of project feasible in the local market? What may succeed in one core market may not be as successful in a different core market.
The readiness of a project is critical to ensuring that EB-5 applicants will qualify for conditional permanent resident and permanent resident statuses. Given the extensive I-526 and I-829 processing times, as well as the visa backlog for Chinese nationals, a delay or failure in project development may create a ripple effect with severe consequences for EB-5 applicants and their families. Therefore, EB-5 applicants should determine the development status of their interested project. In general, a project that is under construction or nearing construction contains much less risk than a project that is still in the entitlement process, design and drawing phase, permitting process, or other pre-construction processes. Of course, if a project that is in its pre-construction stage is being developed by a developer experienced in developing projects within that market, then that adds a level of assurance even if the project is in its early stages.
Exit strategies have become fairly standardized in recent years. For real estate development projects, prevailing exit strategies are (a) generating sufficient cash; (b) refinancing; (c) receiving equity investment; and (d) sale or disposition of the project.
Regional Center and Developer Due Diligence
A detailed understanding of the regional center and project developer is essential to making an informed EB-5 investment. This section endeavors to provide the EB-5 applicant with a roadmap for vetting good regional centers and developers from potentially risky ones. In summary, this article suggests evaluating the following six factors: (i) experience of the regional center; (ii) experience of the developer; (iii) relationship between the regional center and developer; (iv) representations and promises made by the regional center; (v) regional center transparency; and (vi) outside professionals supporting the project offering.
Regional Center Qualifications
An experienced regional center is critical to developing a good project, protecting the rights and interests of EB-5 applicants, and keeping abreast of legislative and administrative developments. Here are some factors to help the EB-5 applicant choose a good regional center.
1. Track Record
Has the regional center received any I-526 or I-829 approvals? What are the approval rates for the I-526 and I-829 petitions? What is the total number of EB-5 applicants approved in association with the regional center? Which projects did the regional center sponsor? A good regional center is a gatekeeper for both EB-5 applicants and the project/developer. A regional center with a high approval rate—and a large number of approved EB-5 applicants—demonstrates its credibility, experience, and commitment to long-term success.
To be sure, being a new regional center does not automatically disqualify it. If the new regional center is directed by experienced leaders and/or developers, and the project is an exemplar, then the regional center and project may still be a credible opportunity.
2. Experience of Principals
In connection with a positive track record, an experienced team of regional center principals is a significant factor in ensuring the success of an EB-5 applicant’s immigration and investment. Characteristics to help evaluate the principals include:
- Background of the principals. Prior to establishing or overseeing the regional center, what professions were the principals in?
- Understanding of the EB-5 market and applicants. Do the principals understand the respective countries where they are soliciting EB-5 applicants, including understanding the market trends; applicant behaviors, interests, and concerns; migration agents; laws and regulations; and cultural and social values? In other words, have the principals successfully promoted any EB-5 projects in the intended foreign country?
Similarly, the success of a project relies deeply on the qualifications of the developer. The following are factors that help evaluate the experience and credibility of the developer:
1. Track Record
How long has the developer been in real estate development? What projects has the developer completed or been involved in? Has the developer developed a similar project before? Has the developer developed other projects in the same market?
2. Experience of the Core Members
What are the backgrounds of the core members? How long have the core members been in real estate development? Prior to joining the current developer, what past experiences related to real estate development do the core members have? Are any of the core members recognized in the industry or by media?
Regional Center-Developer Relationship
Understanding the relationship between the regional center and developer can help the EB-5 applicant make an informed decision.
Currently, there are four prevailing types of regional center-developer relationships: (i) affiliated; (ii) independent; (iii) for-lease; and (iv) a combination of the previous three. The affiliated model is characterized by a common ownership between the regional center and developer. The independent model is a relationship between the regional center and the developer where the regional center actively promotes the developer’s project. In a for-lease model, the developer “borrows” the regional center’s designation and promotes the project using its own efforts while the regional center is likely taking a passive role.
Although there is no right or wrong model, we believe an independent working relationship between regional center and developer is in the best interest of the EB-5 applicant. In this setup, the regional center would typically have an independent team of professionals to perform due diligence of the project so that the regional center feels comfortable promoting the project on behalf of the developer. Thus, the project would have already gone through a layer of due diligence before reaching the EB-5 applicant.
Regional Center Representations and Promises
The representations and promises made by the regional center may be an important factor in assessing the regional center’s credibility. With the huge number of projects in the market competing for EB-5 applicants, it is understandable when a regional center wants to stand out from its competitors. One way of doing so is to make impactful and memorable statements. However, such representations must be grounded in law and fact. For example, a senior executive of a now-terminated Seattle regional center once claimed that the regional center “is the only official center that is authorized to use photographs with President Obama and Vice President Biden for their [sic] marketing or presentation materials.” If something sounds too good to be true, it probably is.
Regional Center Transparency
Following up on the preceding point, a regional center that hesitates or evades requests by an interested or committed EB-5 applicant to produce project-related documents to the applicant may be more susceptible to wrongdoing. Although there is no legal obligation for the regional center to provide confidential documents to an interested applicant, this can be resolved by having both parties sign a non-disclosure agreement (“NDA”). Consequently, EB-5 applicants should be wary of regional centers that demonstrate unwillingness to sign an NDA or produce documents.
Knowing who supports or supported the regional center and developer can also help the EB-5 applicant choose a good project. Which law firms, economists, business plan writers, design professionals, general contractors, subcontractors, etc. were/are part of the project? How much experience do the professionals have in their respective fields? Have they worked on similar documents/projects? Are there any independently produced studies?
Thorough due diligence is understandably challenging and costly. However, with current USCIS processing times and visa backlogs, one misstep by the EB-5 applicant could result in substantial loss and severe hardship, as well as overwhelming liability for migration agents. Thus, we hope to share our experience in EB-5 and real estate development, and help EB-5 applicants navigate the complexities of EB-5 due diligence towards becoming an EB-5 success story.
 Please note, reference to the EB-5 applicant throughout this article also refers to the migration agent associated with the EB-5 applicant.
 I-526 approval rates for FY 2015 and Q1 FY2016 are 89.3% and 77.2% respectively. https://www.uscis.gov/sites/default/files/USCIS/Resources/Reports%20and%20Studies/Immigration%20Forms%20Data/Employment-based/I526_performancedata_fy2016_qtr1.pdf
 I-829 approval rates for FY 2015 and Q1 FY2016 are 99.0% and 98.8% respectively. https://www.uscis.gov/sites/default/files/USCIS/Resources/Reports%20and%20Studies/Immigration%20Forms%20Data/Employment-based/I829_performancedata_fy2016_qtr1.pdf
 Based on the projects surveyed in “EB-5 Capital Project Database: Revisited and Expanded” and from our own sources, EB-5 capital represents less than 30% of total project costs in a majority of these projects.
 Such uncertainties may include, among others, (1) the challenges of subscribing the intended number of EB-5 applicants in today’s highly competitive market; (2) delays in releasing EB-5 capital held in escrow due to long I-526 processing times; and (3) difficulties related to foreign exchange regulations of the EB-5 applicant’s home country.
 It is worth noting that all 27 projects surveyed in “EB-5 Capital Project Database – Revised and Expanded” are located in core markets.