By John Roth
The EB-5 project landscape has changed significantly in recent years as the financial professionals in the industry have learned to lower the risk to EB-5 investors. So, mixing traditional techniques with the new, the best projects now will include all or most of the following risk-lowering characteristics.
An EB-5 project that is “pre-approved” has been adjudicated by the USCIS and found to be conforming with EB-5 law and practice. A pre-approval occurs when the first I-526 petition of an investor in the project is approved, or when an “exemplar” petition – essentially, an I-526 petition filed by the project sponsor without petitioner documents– is approved by the USCIS. As long as there is no material change to the project since pre-approval, the USCIS examiners will defer to the earlier project approval in all subsequent adjudications of I-526 petitions filed by investors in the same project. Half of the I-526 battle is already won, as these following petitioners can only be denied if there are defects in their own source and path of funds documentation. Unfortunately, the long processing times for EB-5 petitions has caused pre-approved projects to become rather scarce. I-526 and I-924 exemplar petitions are both taking an average of 21 months to be adjudicated. Only projects open for a very long time – sometimes because the project ran into difficulties – are likely to gain preapproval status. Still, such projects do exist and can be found by a research team that’s well connected in the industry.
CONSTRUCTION HAS BEGUN
Investing in a project that has already begun construction typically involves less risk than investing in a project that hasn’t yet begun construction. Most serious problems and delays in any project typically occur during the pre-construction or early stages of construction. Permitting problems, zoning problems, material or labor problems can all cause a construction project to come to a halt, and may even, in worst cases, lead to the project being abandoned by the developer. The further along the project is, the more de-risked it is from a construction standpoint, and the more likely it is that the business plan objectives will be realized. This progress is important not only in terms of the project generating the cash flow needed to pay back investors, but it is critically important in generating the jobs that will be required by EB-5 investors for their I-829 petition.
Using so-called “bridge financing” is an especially effective way of starting construction on a project while providing EB-5 investors with maximum jobs creation. The USCIS clarified its position on bridge financing in its May 30, 2013 Policy Memorandum, stating that a project may begin construction by using short-term “bridge” financing that is later replaced by EB-5 capital, and the investors will receive full credit for all jobs created by the bridge financing, even if the EB-5 capital is invested after the project has begun construction.
IF A DEVELOPER HAS INVESTED A SIGNIFICANT AMOUNT OF ITS OWN EQUITY IN THE PROJECT
One doesn’t have to be a financial analyst to understand that a project developer that has none of its own money invested in the project is hedging its bet in a way that does not inspire confidence in the project. In addition, creditors in a deal (most EB-5 investors), are always interested in an “equity buffer” protecting their investment. Because equity investors absorb losses before creditors, any significant amount of equity will cushion creditors against underperformance of the business plan. Another issue is, without its own money in the deal, the developer has less of an incentive to bring the project in on time and under budget, since the developer’s money is not sitting idly in the project during periods of delay.
SPONSOR AND DEVELOPER ARE INDEPENDENT, OR THERE IS 3RD PARTY OVERSIGHT OF PROJECT
If sponsor and developer are affiliated parties, the risk that funds will be misappropriated increases. A third-party monitoring firm, hired by the project, can mitigate this risk and lessen the concern of investors by independently monitoring the project’s progress and providing regular reports to the EB-5 investors regarding the status of construction and financing of the project. It can also keep an eye on payments made to and from the EB-5 investment fund and whether or not the EB-5 project is in compliance with the terms of the investment made by the EB-5 investment fund in the project.
PROJECT MANAGER HAS STRONG TRACK RECORD
The project may have excellent characteristics, but if the project manager lacks experience with projects, it’s probably not a wise choice to invest in the project. Most EB-5 instances of fraud have been associated with first projects of new entrant EB-5 project managers. If no prior EB-5 projects have been completed, the manager has yet to be tested in terms of moral character, nor has it yet demonstrated the management ability to manage and administer unique challenges of an EB-5 project.
Note that the Regional Center is not always the project manager. In recent years, numerous EB-5 project management firms have arisen that search various geographic areas to find projects that are good matches for EB-5 financing, and then they “rent” a regional center that is authorized to sponsor a project in the geographical area where the project management firm will set up and manage the EB-5 project. Obviously, the track record of the regional center means very little when evaluating a project run by a separate company. The focus, instead, must be on the EB-5 project management company that will be in charge of day-to-day affairs.
When evaluating the track record of a Regional Center or Project Management firm it is essentially to dig beneath the surface of the statistics that the regional centers throw at potential investors. As Mark Twain noted “There are three kinds of lies: lies, damned lies, and statistics." EB-5 petition statistics can be misleading because they do not say anything about projects that failed and were withdrawn after investors were on board, and also because some of the regional centers have found ways to make I-526 and I-829 denials disappear in a narrow technical sense through litigation and settlement with the USCIS.
INDEPENDENT REVIEW OF THE PROJECT BUSINESS PLAN
Business plans contain multiple assumptions about competition, market and economic trends, occupancy rates, cash flow, refinance possibilities, etc. If the regional center has hired a nationally recognized and fully independent project appraisal firm, and that firm has corroborated the business plan assumptions, then there is less risk that the project managers were overoptimistic in their business plan projections.
RELATIVELY LOW LEVEL OF EB-5 FUNDING IN THE PROJECT CAPITAL STACK
The more dependent the project is on EB-5 funding, the more likely it is that the project will fail to generate sufficient funding to move the project forward to completion. Most of the best projects nowadays use EB-5 capital for 25 percent or less of the total raise, lessening the risk of a financing shortfall. Most top projects will have commitments from all equity and credit contributors by the time the project is offered to EB-5 investors, but the EB-5 capital raise is always prospective, and so is never a certainty. The well of EB-5 investors could run dry at any time for the project marketers, or EB-5 visa reform could render the project ineligible for future EB-5 investments, or other issues could intervene to cause a big shortfall in EB-5 investors, perhaps even enough to kill the project if alternative sources of capital cannot be found. The best project will manage this risk by limiting the amount of funding they will seek from EB-5 investors, and planning for alternative sources of capital if the EB-5 raise doesn’t develop as planned.
STRONG MANAGEMENT TEAM
As in any financial investment, you are investing not just in “brick and mortar,” or in a business plan, you are also investing in people. “People” is important here, because if you are investing in a person – a one-man autocratic ruler, and there are such types in the EB-5 universe – you are asking for trouble. The fact that a single person rule, with no one contesting the ruler’s judgement, can lead to reckless decisions. It’s also true that most fraud cases in EB-5 history were run by an individual with full control of the regional center as well as the development project. Too much control in one person’s hands can lead to too much temptation for the owner to divert funds to his or her own purposes rather than keeping the funds working in the best interests of investors. It is essential for investors to run background checks on the principals of the project manager before investing. There are various online services that can research public records and generate information about an individual’s financial history, including information about tax deficiencies and government liens, and other records might indicate that the individual is under financial stress or has a checkered record of business honesty.
Finding a project that features all of the characteristics listed above will not guarantee that the project will succeed, but it will significantly reduce the risk that the project will fail to deliver the two prime objectives of the EB-5 investor: issuance of a permanent green card and return of the investor’s principal.