By Jeff Campion
We can all enjoy a great magic show. Whether it is David Copperfield making the Statue of Liberty or an airplane disappear, we love the illusions because they take us to another place, a place where belief and disbelief meet — a fantasy world.
And that’s just it. Fantasy is fine when we know that we are willingly participating in the story. But what happens when common misconceptions for EB-5 investors change people’s lives and immigration journeys?
MISCONCEPTION 1: ALL EXEMPLARS ARE CREATED EQUAL
It wasn’t long ago I heard a project representative say if you are investing in a project with an exemplar approval, there must be something wrong with it because it has been on the market so long. Now, that project has an exemplar and is still on the market. Times have changed. But this was a tactic to spin the truth. The truth of an exemplar is that they are great to have but not all are created equal.
An exemplar approval means that a set of project documents — including the private placement memorandum, an economic report, business plan, operating (or partnership) agreement, escrow agreement, subscription documents, sample I-526 and supporting documents — has been submitted to and approved by the USCIS. It does not mean that the project is good or bad from a financial perspective. It also does not go to the merits of the project. It does not mean that USCIS believes the project will actually start or finish. It simply means that the documents submitted are EB-5 compliant. This is helpful. No one can argue this. But is it dispositive of a good project? No!
A recently approved exemplar project may be great. But it would be wise to consider some additional factors that will make the exemplar more valuable, such as: whether the project has started as of the date of the approval (and, if so, how much is completed); how many investors the project has subscribed; whether there is a minimum amount of investors for the project to take EB-5 money; and when the deadline is to subscribe the investors. If the answers to these issues are not favorable, an exemplar-approved project may not be too valuable. If the answers are favorable, then the exemplar may be much more valuable than other exemplars in the market. Many have aged well. In fact, an older exemplar could be the strongest project on the market based on those factors.
MISCONCEPTION 2: ALL COLLATERAL IS THE SAME
Another misconception is that all collateral is the same. While most developers intend to pay the investors back through the NCE, the reality is that it is a belief or hope but not a plan. Reputation is not collateral. Don’t make that mistake.
Some projects in the EB-5 space are, in all reality, credit card debt in which the investor is hoping that the developer is too big to fail. Simply put, when you place your money with an entity that loans or invests it down the chain, and that entity has no assets, you have no collateral to pay back the NCE in the event of a default. It is critical that the investor ask the question of which entity is responsible to pay back the loan (or equity contribution) and what is the collateral guaranteeing repayment.
For example, a first lien would be the strongest position for collateral, assuming the loan-to-value is sufficient to ensure repayment (for example, a loan-to-value of 75 percent, depending on asset class). This way, if the asset loses value and is foreclosed on by the NCE, there is still equity left to pay back the money. The next position for debt would be a second lien, though these are not common. Once again, look to the total debt-to-equity, making sure there is a cushion in case of having to force a sale. The position that follows is mezzanine debt. The same analysis for second lien applies, ensuring that the total debt-to-equity is sufficient in case of having to force a sale.
In terms of equity, the NCE could purchase an equity interest in the project (normally, preferred equity). It is important once again to ensure that there is common equity that will be lost in the case of a forced sale. Preferred equity could be weaker than a first but also could be stronger than mezzanine financing, depending on the deal terms. It is used many times in historical buildings to take advantage of historical tax credits in lieu of mezzanine financing. Below are some worst-case scenarios.
Imagine that the developer suffers from an economic recession and is forced to sell a project for less than its value. A couple of things could happen. In the first lien scenario, the NCE could actually be foreclosing on collateral or forcing the sale. It is in control. In the other scenarios, the NCE would be part of the process, but with sufficient collateral and debt-to-equity ratios, there exists the chance to be made whole. However, if the entity the NCE made a loan to (or invested in) has no collateral to speak of, the NCE could lose all the money.
One final note: Be aware that some collateral positions can change based on the amount of EB-5 money raised. Be sure to ask this question to know what collateral will be given in all possible scenarios. Do not believe the illusion that all collateral is equal. It isn’t, and it could cost you hundreds of thousands of dollars.
MISCONCEPTION 3: A REGIONAL CENTER IS PRIMARILY RESPONSIBLE FOR PAYING BACK THE INVESTOR
Another misconception is when a regional center shows an investor its track record for paying back investors. Let’s be clear on two points: One, the regional center does not pay an investor back, the NCE does; and two, the NCE can only pay back once it is paid back. Being a project in a regional center that has paid back investors has no impact on your investment unless you were considering investing with a regional center you think could be dishonest. Who would consider that?
The NCE agreements should all state that the investor will be paid back once the financing facility is paid back to the NCE (and all USCIS requirements are met). Based on that, the only reason an investor would not be paid back from the NCE when the NCE is paid back would be because the NCE is refusing to honor the NCE agreement. The NCE is normally controlled by a person who also controls the regional center. But it is the NCE that has to pay back the investor.
Therefore, project viability is what will determine whether the investor will be paid back. And the manner to be protected is to analyze the project itself and the collateral. Do not believe the illusion that a regional center is primarily responsible to pay back the investor. While it is easy to be overwhelmed by historical evidence of other investors being paid back associated with the regional center, do not believe that misconception.
MISCONCEPTION 4: ALL JOBS ARE CREATED EQUAL
Since there are two basic issues in EB-5 — capital at-risk and job creation — it is prudent to turn the discussion to job creation. It is normally stated that a project has a certain job cushion. This is to entice investors to invest based on potentially a very large job cushion. This gives the illusion that all jobs are created equal (and the corollary that a large job cushion ensures a margin of error). The problem with this analysis is that it assumes all jobs are created equal. They are not.
As most know, there are direct jobs (I-9, payroll jobs) and model-derived jobs (direct construction jobs, indirect construction jobs and operational jobs). For direct jobs, these are shown through payroll evidence and I-9s at the I-829 phase. Clearly, the challenge with these jobs is that the position must be in existence for at least two years and the evidence must be able to demonstrate this.
Now, contrast this with model-derived jobs, which are considered to be created if based on reasonable methodologies. The models used are called input/output models. Thus, models can have many types of inputs to give the outputs (the jobs created). Normally, construction expenditures are used as an input to demonstrate the jobs that have been created. Note that USCIS requires that construction last at least two years to be able to count model-derived direct construction jobs.
While this seems straightforward, there could be some challenges at the I-829 phase when jobs have to be proven. For example, let’s assume that a project stalls and the three-year projected construction timeline approved at the I-526 phase is actually one continuous year, then stops and starts for two years before finally ending. I assume USCIS could argue that the model-derived direct construction jobs do not count. This is where model-derived, direct construction jobs could be a little risky. Operational jobs only exist if the business opens. If the business does not open, very few operational jobs are created. Therefore, these are the riskiest jobs.
When analyzing jobs for the purposes of job creation it is best to rely on model-derived indirect construction expenditure jobs first. Second, an investor could count mode- derived direct construction expenditure jobs (and if construction has already lasted for two years then this would be extremely safe). Lastly, an investor could count operational jobs. One overarching point here is that job creation relies on project viability. If the project will not proceed, there will be no jobs created.
It is clear that all jobs are not created equally. Avoid the illusion that all jobs are created equal and focus on model-derived indirect construction expenditure jobs and, thereafter, model-derived direct construction expenditure jobs.
Unfortunately, EB-5 has many misconceptions. Be skeptical. Ask questions, because this isn’t an illusionist show. It’s your life.