By Phil Cohen and Rohit Kapuria
To paraphrase Heraclitus of Ephesus, the one constant within the EB-5 world is the perpetual evolution of the program’s policies and interpretations of its regulations, particularly over the last few years. One such evolution stems from the explosion of the EB-5 Program’s popularity in China, which accounts for at least 85 percent of all EB-5 investors.
With the ever increasing United States Citizenship and Immigration Services (USCIS) adjudicatory times and retrogression concerns sliding into daily break room laments, one issue that has been a source of grievance relates to the EB-5 program’s requirement that an investor’s funds remain “at risk” until his or her I-829 petition is fully adjudicated.
When a new commercial enterprise (NCE) loans money to a job creating enterprise (JCE) or related affiliate, the JCE, typically, successfully completes the project and is in a position to repay the loan to NCE within 4 to 5 years of an investor’s I-526 petition filing.
Given the current retrogression climate, when dealing with investors from mainland China, the question arises as to how the NCE should go about keeping the funds “at risk” when the current, lengthy, adjudication/retrogression process prevents an investor, from mainland China, from becoming eligible for an I-829 petition for at least another 4 to 5 years. Enter the opportunity to redeploy such repaid EB-5 investment proceeds.
The challenge with this situation is partly caused by the absence of definitive guidance and final policy pronouncements from USCIS and partially from the obstacles associated with finding and managing new “at risk” redeployment opportunities.
Indeed, in discussions about redeployment with regional center operators and NCE managers, it can be found that many had not given this issue much thought. It might be argued that with appropriate guidance and planning, redeployment could turn into an opportunity.
REDEPLOYMENT TO ANOTHER ‘IN-HOUSE’ PROJECT
Some NCEs view the need for redeployment as an opportunity to recycle early-repaid funds with a borrower’s subsequent development project. However, such approach may face resistance from investors given the likelihood of a new, illiquid venture that has its own un-reviewed risks. In the absence of language contemplating such a ‘recycling' possibility, investor and broker consent may be required.
There are also a large number of corporate, securities and reputational considerations to take into account prior to simply recycling the funds into a new, un-studied, illiquid investment. After all, every investment is subject to a range of risks, necessary disclosures and possibly, even, investor consent.
WHAT DO THE RULES SAY?
USCIS has yet to issue concrete guidance on this issue, short of a brief non-agency binding comment during a stakeholder call and a USCIS Draft Policy Memo in 2015 (Draft Policy Memo), which generally state that the EB-5 investments must remain at risk, cannot be returned to investors prior to I-829 adjudication and which further contemplates that as long as the NCE undertook the commercial activities initially contemplated in the original business plan and that the requisite jobs were created, the NCE may redeploy capital to a new venture without cause for a petition denial or revocation.
Such guidance also notes that there is no further requirement for job creation following a possible redeployment of the EB-5 investment proceeds.
Nonetheless, given that such guidance has not been formalized, the industry awaits a definitive policy that will address basic issues such as the limitations on types of investments and the permissible time period between return of funds to the NCE and redeployment of such funds.
WHAT INVESTORS SHOULD PRIORITIZE
In order to assess redeployment options, it is important to first understand what EB-5 investors might consider to be their priorities. Investors understand that the investments they make in EB-5 projects have a degree of risk that is inherent in the creation of a new business. Once these requirements are met, however, it should be anticipated that investor priorities will shift if redeployment becomes necessary. At that point, the initial hurdle for I-526 approval has, hopefully, been overcome.
Therefore, the investor’s risk tolerance/priorities are likely to be modified to align with the following formula: Preservation of immigration status by keeping investment funds at risk, preservation of capital contributions, maintenance of consistent returns on investment; and possibly, creation of an upside opportunity which is better than the originally anticipated returns.
IMPORTANT ISSUES FOR THE NCE
In a redeployment scenario, the NCE will be in a position where it must also reframe its priorities, both to reflect its investors’ changing priorities as well as to minimize the cost and effort required to satisfy the redeployment requirement while creating the best-possible outcome for all concerned. NCE priorities include: compliance with EB-5 policies, ensuring investor success at the I-829 stage, preservation of capital/minimized risk associated with a redeployment investment, minimizing redeployment costs and efforts associated with its oversight; paying returns to stakeholders, and generating new minimal-risk redeployment revenue opportunities that are liquid enough to match the investors’ I-829 time horizon.
MAKING REDEPLOYMENT PAY
Once stakeholder priorities are taken into account, it quickly becomes clear that the ideal return may be beyond the reach of the safest investment opportunities available in today’s market. The “at risk” requirement creates a hazy picture. The Draft Policy Memo, when paraphrased, indicates that for capital to be deemed “at risk,” there must be a possibility of loss or opportunity for gain.
As such, municipal bonds that are backed by the full faith and credit of, say, the U.S. government, may not be interpreted to fit in line with USCIS’s interpretation of the “at risk” requirement. So, what are the options?
KEEP IT IN THE FAMILY
An investor might be resistant if the NCE redeploys the funds into another project related to the original borrower. Such new ventures may be illiquid unless, there is a short time horizon associated with each new project. For example, the JCE requires the initial EB-5 project to work on phase 1 of a project. Phase 1 gets completed in record time and all required jobs are created. JCE, following the terms of the offering project and appropriate consent, as may be required under the offering, from the NCE and investors, utilizes the proceeds for phase 2 and then phase 3 and so on. If an EB-5 issuer is able to contemplate a multi-phase project with short life spans allocated to each phase, this could allow the funds to remain within the NCE/JCE family.
PURCHASE OF EQUITY INVESTMENTS
Some have interpreted the draft policy rules to permit the purchase of equities as a feasible alternative. Redeploying EB-5 capital to equities provides advantages, including liquidity, transparency and flexibility, assuming that the asset mix can be adjusted over time as needed.
On the other hand, equities are subject to market and business cycle volatility, in addition to company-specific risks, all of which must be factored in when it comes to a defined, short-term investment. With markets at all-time highs, and many professionals predicting a bear cycle, short term investments in equities can pose a level or uncertainty that investors must become comfortable with.
This issue raises another concern. Using equities as a redeployment option means that investors and/or NCEs may decide to reduce risk by hedging their investment with a counter-investment (e.g. shorting a stock against a long play) to mitigate risk. USCIS may determine that such an action may cancel out the ‘at risk’ requirement. While this would not be a recommended course of action, it raises the question as to whether USCIS would allow equity purchases as a redeployment alternative, given that it would, theoretically, be impossible for the Agency to know if the investment has been hedged by an investor.
In addition, how equities are managed and what management fees arise in such strategy, are important considerations in determining the costs and benefits of the equities approach.
THE OPTION OF REAL ESTATE INVESTMENT TRUSTS
Real Estate Investment Trusts (REIT) may be a viable redeployment alternative that might satisfy many foreign investors’ desire to participate in the real estate market. Redeploying directly to a REIT may be of mutual benefit to both parties. REITs can be either public or private and each type should be considered separately.
Public REITs include many of the same concerns as public equities, including market and business volatility. Additionally, given that interest rates expected to rise and cap rates are at near-historic lows in some areas, shares could come under pressure in the form of deploying capital into low cap rate deals, meaning that effective property values could decrease should interest rates go up. The benefit of a public REIT is liquidity; although investors must be aware that a number of smaller publicly traded REITs may be too small for large scale investments.
On the private side, finding a REIT that can use debt capital on a short-term basis, with timelines matching those of NCEs, may be challenging as this asset class often relies on long-term capital investment. The benefit of a private REIT is that volatility is muted and managers may be more inclined to add value and therefore be more selective and strategic in deploying capital into various properties that offer value–add or opportunistic circumstances, which can offer a higher return.
ALTERNATIVE INVESTMENTS IN PRIVATE MARKETS
Alternative investments, most notably private markets, present another interesting type of redeployment opportunity. In recent years, the private markets have spawned a number of investment firms run by industry veterans that focus on value-added methods of capital deployment. By way of example, in the research conducted for this article, the authors have come across several investment management firms that deploy debt capital to stable businesses with strong balance sheets to finance cash flow needs for growth or specific near-term events. Many of these investments are significantly collateralized and therefore present some very strong risk mitigation benefits. Several of the teams explored had surprisingly strong and consistent return records.
Private market investments are well positioned to meet program requirements and offer a number of benefits, including potentially less volatility and higher returns than comparable public markets. These investments are often tailored, shorter-term strategies designed to deliver absolute and relative returns, and with risk mitigation tactics in the form of professional analysis and investment selectivity. The challenge with these investments is again in the timing. Alternative investment managers do not always have deals at the ready. For a single deal, it is also relatively difficult to find and vet these operators without some third party assistance. Another challenge relates the permissibility of fixed/absolute returns. Having any type of return that may appear guaranteed, could be violative of the “at risk” requirement.
WORKING WITH INTERMEDIARIES
While redeployment is a relatively new concept, there has been the emergence of a few EB-5 redeployment intermediaries. The key value of intermediaries in the redeployment context is providing a level of oversight and management wherein such groups can help source, pre-qualify and aggregate investment opportunities. Intermediaries can be an important link to investments that can meet an NCE’s needs in terms of the amount of capital to be redeployed, risk and reward profiles and most importantly, investment timelines.
PLAN AHEAD FOR GREATEST SUCCESS
Ultimately, the key to success in turning redeployment into an opportunity is being prepared and working within the parameters of compliant securities and EB-5 policy guidelines. Regional centers and NCEs should be in constant contact with their investors, JCEs and importantly, with their securities counsels. If the NCE needs to redeploy capital outside of its own holdings, it would be wise to begin discussing alternatives sooner rather than later.
Some best practices for NCEs to consider include legal and investment guidance from experienced counsel and professionals, institutional level due diligence, securitized investments where possible, reasonable risk and return investments, strong business teams, reasonable length of investments and ensuring an alignment of interests with all the pertinent stakeholders.
TO SUCCEED IN REDEPLOYING FUNDS
Having access to a pool of capital that needs to be invested should not be viewed as a liability. Certainly, there are new legal, management, administrative and fiduciary concerns outside of the normal operations of a regional center or a NCE that must be taken into account.
Given the unique requirements and timing concerns reflected in EB-5 capital redeployments, working with experienced legal counsel and intermediaries can help NCEs and investors navigate the waters, potentially lowering risk and finding options that match specific needs.
As with all investments, redeployment is as much an art as it is a science. Therefore, plan accordingly by getting to know the products and players as well as mapping out internal needs. With proper planning, consideration and communication, the expectations of the stakeholders could be met and the opportunities to generate additional revenue in a risk-minimized fashion could similarly be developed.