Properly evaluating the risk profile of an EB-5 project can seem daunting, as every project has immigration and financial risks. As a project progresses, these risks change throughout the three EB-5 stages: I-526 application, conditional residency period, and permanent residency. It is imperative for project sponsors and investors to have candid conversations about risk. To help guide those conversations, let’s explore the nine most prevalent risk factors.
STAGE 1: I-526 APPLICATION
USCIS reported a sharp decline of I-526 approvals in the third quarter of 2019. The approval rate fell to 58%, the lowest in 14 years. It is vital that project sponsors and investors properly prepare the petition with the help of an experienced immigration attorney. It is the project sponsor’s responsibility, with the assistance of their EB-5 professional team, to provide substantial documentation in order to ensure the Matter of Ho standard is met. Investors should ensure the project has credible documentation including, but not limited to; third party market studies, verifiable job creation inputs, and corroborated construction contract, bid, and timeline documents.
For investors, hiring an immigration attorney with extensive EB-5 knowledge is equally important. If a project has preferred counsel, investors should still verify the attorney’s experience before moving forward. Once retained, investors must be prepared to provide various source of funds documentation. With source and path of funds being the most common reason for an I-526 denial, it is imperative investors work with immigration counsel to properly document their investment capital prior to investing. Similarly, project sponsors should also work with immigration counsel to review and verify investors’ source and path of funds documents prior to investing.
The most common way to manage financial risk during the application stage is with an I-526 denial guarantee. While these have become ubiquitous they are not all created equal. The investor, with the help of their attorney and investment advisor, should look for three things when evaluating these guarantees: who, how, and when. First, check to see who is signing the denial guarantee. Then evaluate the signatory’s assets or financial capabilities to make a repayment to the EB-5 investors. If the party, or person, is not credit worthy, the guarantee is not worth more than the paper it is printed on. Next, consider the language in the guarantee describing how and when the investor’s capital will be returned. Many projects contemplate finding a replacement investor or other “commercially reasonable efforts” to return the investment during a denial. The strongest I-526 denial guarantees set a time limit on these activities and outline a backup plan if that does not return the investor’s full investment.
Another tool to manage financial risk, in this early stage, is an escrow account. Previously, escrow accounts were structured to release investor capital only after I-526 approval. As USCIS adjudication times become lengthier, the practice shifted to utilizing partial holdback accounts. These are useful tools to reduce the financial risk of denial; however, it often creates challenges for the project including delays. On occasion an investor may still come across projects that use a holdback account. In these cases, remember this only provides certainty that a portion of the principal will be readily available in the event of a denial. Investors should still inquire as to what, if any, other protective measures are in place to ensure financial risks at this stage are properly managed.
STAGE 2: CONSULATE INTERVIEW AND CONDITIONAL RESIDENCY
As with each stage, investors are required to show they are admissible during the consulate interview or adjustment of status process. Investors need to be mindful of their prior immigration history, as a lapse in status or having a prior visa revoked may put EB-5 immigration plans at risk. Further, any arrests or convictions anywhere in the world may jeopardize the ability for an investor to immigrate to the U.S. Investors must be open and honest with their attorney, prior to investing, to identify any potential issues with their immigration or personal history in order to improve their chances of securing residency.
Investing in a good project is the best way to manage market risk. This involves evaluating the market conditions in a particular geographic area, demand, competition, and financials.
It is important to first take into consideration the physical location of the project. The U.S. is a large country and market conditions vary from city to city. For example, a luxury high rise condo building may not be feasible in a city with a population of 40,000 and an average income of $75,000. However, that same city may have substantially unmet demand for senior housing resulting in favorable market conditions for that particular asset class. The risks of those two projects, in the same city, will differ greatly.
To scope out the market conditions, investors and their advisors should thoroughly review the project’s market study. Before diving into the data, check to make sure the market study is completed by a reputable third party, conducted on behalf of the project (public data alone does not provide sufficient details), and that it is current. Once in the report, look for indicators that the market is stable, shows strong signs of growth, and that the project will benefit from various demand drivers that will continue to push customers to the project. For example, a hotel would benefit from being located near a university or international airport, since both have a broad base of users frequently looking for hotels. The market study, in addition to the business plan, should also discuss competition. Look for signs that the project has a reasonable plan regarding how it will compete.
Market studies should also include operational finance information. Cross-reference the financial assumptions with those used in the project’s business plan. For example, if a market study determines a hotel in that location will have an expected occupancy rate of x and average daily rate of y, make sure those are the same figures used by the project. If not, run a stress test on the financials to see how it performs at these determined market rates.
The investor should assess a developer to see if they are creditworthy. Look for developers and operators with a trusted and extended track record. This helps show they can manage their business both when times are good and also during downturns. Ask about their previous work and give preference to firms who have a portfolio in the same asset class as the EB-5 project. A good hotel developer new to senior housing is more risky than a developer whose portfolio may be smaller but has exclusively completed senior housing facilities. Additionally, verify if the past experience is ground up construction, value add, or management of a project. Do not assume someone who has been successful acquiring, managing, and growing a real estate portfolio is equally capable of a ground-up construction project. Investing with an experienced developer should provide confidence the project team can properly see the construction to completion, secure all necessary permitting, and ultimately manage the financial health of the project.
STAGE 3: PERMANENT RESIDENCY AND RETURN OF PRINCIPAL
In order to receive permanent residency, USCIS must confirm the investment was sustained during the conditional residency period. The best way to provide safety around the investment sustainment is by seeking projects that have checks and balances, such as those with an independent fund manager. If the project is under common control of one entity, or person, it is easier for fraud or misuse of funds to take place. Regional centers and fund managers play critical roles, and together should help improve performance, transparency and accountability of the project. Complete background checks on key principals and have upfront discussions on the relative experience that each of these groups bring to the project.
Job Creation Risk
At this final stage, the job creation must be verified. Initial economic studies are based on predictions, which can fluctuate. When comparing the job creation between projects, consider the types of jobs counted in addition to the buffer. Construction jobs are the safest jobs to rely on, because they are easier to predict than operational jobs. If a project utilizes operational jobs, an investor should check to see if construction jobs can fulfill the job creation obligations for all investors. If not, investors should inquire to understand how jobs are allocated and where in line they are likely to be in order to make an educated decision. Investors should also keep in mind it is not necessarily the lack of job creation itself that creates issues at the I-829 stage, but often the lack of verification from the developer to prove the jobs. Regional centers and fund managers should have procedures in place to track, collect, and report job information to the investor and USCIS.
A looming concern for most investors is the return of their investment. Working with their financial advisor, investors should run financial models to see if a refinancing event or sale of the project will generate enough cash to pay back existing debt and investors. Assumptions in the project’s exit plan, such as the anticipated sale price or cap rate, should be cross referenced with the market study or other available data to ensure it is reasonable.
Special consideration should be given on how capital may be redeployed. Seek to understand exactly who has redeployment authority and how future projects will be evaluated, by reviewing the redeployment language in the offering memorandum. Projects and investors can collaboratively manage this risk with the use of a fund manager with independent authority over redeployment, input from a registered investment advisor, and an opportunity for investors to provide input during the process.
All investments have risk, and EB-5 is no different. Ask yourself these questions: what risk can be minimized, what risk can be managed, and what risk are you willing to take? With the help of professionals, investors should consider the risks at each stage of EB-5 prior to investing. An experienced sponsor should have readily deployable mitigation tools custom-tailored to any project and should be able to discuss those measures in detail. These tools allow investors and sponsors to work collaboratively to increase the overall likelihood of success.