Diversifying and Growing with your Investors – How Private Equity Real Estate Complements EB-5
By John-John Harounian
As the EB-5 industry becomes more heavily scrutinized in both the U.S. and global media, a new set of challenges has emerged requiring a shift in how savvy foreign investors and their advisors approach commercial real estate investment opportunities in the United States. As such, the EB-5 world has begun to identify complementary methods for clients to buy stable assets that can offer dependable yields and consistent growth levels while providing geographic and sector diversification for portfolios. One emerging opportunity is the alignment of large immigration agencies and regional centers that traditionally facilitate EB-5 investment with Private Equity Real Estate Funds (PERE).
Why PERE? Timing and Diversification
Timing and diversification are key components to any successful investment strategy. After many years of business as usual, the EB-5 industry is anticipating significantly higher hurdles for investors in the coming year in addition to the fierce competition that already exists.
While the U.S. Congress has extended the EB-5 visa through September 30, 2016 with no changes, pressure continues to mount on lawmakers to reform existing parameters for the industry. One fundamental change that could reshape the program is the review by congress of locations where projects are currently being funded. At present, significant urban developments in major U.S. markets like New York, San Francisco and Los Angeles – including mega-profile projects like Hudson Yards and Hunters Point Shipyard – are being financed by EB-5 investment. These projects are attractive to overseas investors who feel secure committing funds to locations they are acquainted with or cities where they may have familial ties, although they may have never stepped foot in the city themselves. The debate in congress over reform has highlighted the need for similar funding in rural areas where sustainable job creation is a top priority, with southern state senators and Midwestern representatives vying for opportunities to please their constituents. Foreign investors are likely to think twice about shipping their money overseas if they are being pitched projects in little-known, rural areas of Alabama or Indiana out of nowhere.
In addition to the redrawing of Targeted Employment Areas (TEAs) where EB-5 funds are viable, almost all proposed changes to the program call for an increase in the minimum investment from $500,000 to $800,000. While still relatively inexpensive compared to similar programs in other countries, the increase may be even more significant when other costs, like fees from working with immigration agencies and regional centers, are taken into consideration.
Regardless of the potential shifts in the EB-5 program, the United States stills presents the strongest commercial real estate investment opportunity to foreign investors seeking to insulate their portfolios from the volatility of global markets. Industry reports anticipate another strong year ahead for inflows of foreign capital. So while the EB-5 program will inevitably see some restructuring, the ways in which foreign investors safely invest their money will adapt – and in turn EB-5 professionals will need to get nimbler and diversify how they help their clients manage their capital and how they package and facilitate these deals.
The Natural Evolution of the EB-5 Industry
After their initial investment many EB-5 visa recipients, unfamiliar with the private equity landscape in the United States, return to their advisors at regional centers and immigration agencies looking for additional opportunities and guidance. This creates a natural transition for EB-5 professionals to link with local PERE funds, enhancing their position as trusted financial advisors with their longstanding clients and solidifying long-standing relationships, diversifying their own business model, and expanding their client base to non EB-5 investors.
For agents looking to identify strong PERE funds for their clients, the industry is remarkably transparent with industry news sources and reports readily available to help vet which PERE funds are well-established in the market and have a proven track record of success with U.S.-centric investment strategy.
PERE Funds Explained
PERE funds worldwide are considered to be one of the most-favored methods of real estate investing because their values are not affected by the volatility of the public markets. To shed light on the size of the worldwide market, the assets under management (AUM) for worldwide PERE industry was reported at over $742 Billion in 2014. By aligning with a PERE fund locally in the United States, immigration agencies and regional centers unlock an host of new benefits for their investors, introducing a more sustainable business and investment model not dependent on government regulation.
A partnership with a local PERE fund provides investors with a professionally-managed asset that is overseen by a dedicated investment fund manager who possesses a deep understanding of the nuances to that particular marketplace, minimizing risk and opportunity for mistakes. Should an unforeseen event affect any one asset negatively, diversification safeguards a partner’s investment by creating balance with other over-performing assets in the portfolio.
A private equity fund can also set up a U.S. feeder corporation, known as a blocker corporation. The foreign investor can invest through the blocker corporation; then they are no longer personally considered to be partners in the eyes of the Internal Revenue Service (IRS), as it is the foreign corporation that is the owner of equity in the fund. This helps to avoid trade or business income tax, significantly reducing their taxable income basis.
How PERE Funds Are Growing in China: Domination by China Foreign Currency Funds
To date, investment by Chinese nationals accounts for nearly 80 percent of all EB-5 visas issued by the U.S. government. After a stock market correction in summer 2015 and the devaluation of the renminbi by the Chinese government, Chinese investors have become even more cautious in the ways that they invest. However, capital remains abundant and private equity real estate funds continue to attract high levels of investment interest. The industry darling seems to be the limited number of foreign currency private equity real estate funds which have raised more than the large number of their domestic investment private equity fund counterparts collectively. According to a Ping AN Bank report, in terms of currency, RMB RE funds still dominated in number, with 128 funds established in 2013. Only four foreign currency-dominated (FC) funds were set up. In terms of fundraising capacity, the average size of FC RE funds was 9.82 times that of RMB counterparts – the four FC funds together raised $2.5 billion, accounting for 23.6 percent of total. The 128 RMB funds together raised $8.15 billion, accounting for 76.4 percent. This sheds light on the increased desire of Chinese investors to look for a professionally-managed diversified investment strategy that acts as a safe haven for capital.
Preferred Partners: Why Consultants Just Won’t Cut It
While on the search for a strong PERE fund partner, EB-5 professionals have many factors to consider and may be drawn to work with a consultant with whom they have an established relationship or rapport. While most likely incredibly strong in their particular area of expertise, a consultant such as a residential real estate broker or property management company does not have a vertically integrated team experienced with executing the complex investment strategy associated with the life cycle of an investment. As a result, consultants may outsource to a network of additional single-focused specialists throughout the process of acquiring and maintaining the asset. This introduces a greater chance for potential risk with the investment, because the consultant does not have a personal stake in the project and is likely juggling a variety of clients. Also, their respective objectives and attention to detail can wane, jeopardizing the management of the asset.
By identifying and partnering with a local PERE fund, an investor is assured that they have an absolute alignment of interest with the fund manager. A partner PERE fund brings along four key attributes that are of great benefit to investors:
- an ideal perspective; as an owner, you look at an investment in a multifaceted fashion in comparison to tunnel-vision consultants
- a clear objective; with their vested interest, the PERE partner is completely focused on the success of the asset
- a breadth of cycle-tested experience; based on a proven track record riding through the ebb and flow of the real estate market successfully
- an expansive skill set; earned over time by shepherding an asset from unprofitable to profitable.
An established fund manager can provide a proprietary deal flow, dealing principal to principal, relying on established relationships and eliminating the need for a broker. This results in streamlined communication and off-market deals, ensuring the asset is acquired at the best possible price. In addition, a strong PERE fund manager will be singularly focused on real estate. With this concentration on investment type, an investor can rest easily knowing that their money is being properly managed.
A strong PERE fund manager will also offer a vertically-integrated solution that encompasses everything from sourcing the asset, underwriting the asset, escrow, design, construction, repositioning, accounting, investor relations and property management, and consolidating the entire process to a single operation, which again minimizes risk and room for error.
Finally, foreign investors will gain a high level of trust and confidence that PERE fund partners not only must have audited financials for their transparent reporting practices, but the PERE fund partners are overseen and scrutinized by two different governing bodies: the Securities and Exchange Commission (SEC), a public government sponsored regulating agency, and Financial Industry Regulatory Authority, Inc. (FINRA), a private corporation that acts as a self-regulatory organization.
At its core, the relationship between investors and their partners is based on trust, something that can only be established with transparency. An ideal PERE fund investment partner will be incentivized on the back end to ensure the success of an acquisition through the disposition. Once an asset is profitable and investors have received the return of their investment plus interest, the fund manager should then, and only then, collect their share of the earned profits.
Chinese investors have become increasingly sophisticated, and given the variety of options for investment and impending restrictions being considered for the existing EB-5 program, are seeking to partner with experts in the United States who can diversify their investments while achieving significant risk-adjusted returns. By shifting away from consultants and partnering with PERE funds, the EB-5 industry can bridge the gap, enhance their position and further solidify the success of their clients’ investment.