By Marko Issever
Due diligence for an EB-5 project is about analyzing the ins and outs of the project chosen for green card qualification, focusing on the immigration, financial and business aspects.
When making their ultimate decision, investors should take an analytical approach and focus on certain important considerations in each category. This list could be augmented to arrive at an overall score for each project. Each category, besides being weighted, would have its own independent criteria. Investors can assign two numbers to each criterion within a category:
- The first number should be weight. Within the specific category, the more the criteria is of concern to the investor, the higher its corresponding weight.
- The second number should be rating. In comparison with other projects, the stronger the project is as it relates to this criterion within the category, the higher its corresponding rating.
The ultimate score for each category would be the summation of the product of the weight and rating across each criterion. Investors could use a 0-10 weighting and rating system respectively.
WHAT SHOULD EB-5 INVESTORS THINK ABOUT WHEN SELECTING PROJECTS?
There are four basic categories of concerns that investors should consider before proceeding with a deeper dive into the due diligence process. These are:
- JOB CREATION: Will the projects create enough jobs so the investors will not only get the conditional green card but the conditions on their green card will be removed.
- RETURN OF INVESTMENT: Will EB-5 investors get their capital investment back? To ensure this is the case, the investors have to perform some basic and some rigorous analysis of the regional centers and the developers.
- TIMING OF REPAYMENT: What will the timing of payment of the capital investment be? Investors have to study the capital return policies of the regional centers and read the private placement memorandum conditions of capital payback carefully. If there are retrogression and/or redeployment considerations, they need to make sure that what they read is realities they can handle.
- AMOUNT OF RETURN OF CAPITAL INVESTMENT: What will the return on the investment be? Now that the investment amounts have been increased substantially, and the adjudication periods have lengthened quite significantly, the return on the investment or at least on the redeployment of the initial investment can no longer be ignored.
WHAT TO CONSIDER BEFORE STARTING THE DUE DILIGENCE
Before elaborating on the above four categories, there are some basic questions that should be answered before the formal due diligence analysis starts.
- What is the administrative fee for the project that needs to be paid to the regional center?
- Is there any risk of being asked for additional capital payments in the form of capital calls?
- Is there any senior loan in the transaction? By whom? Is it committed? Is it already disbursed?
- Are all the permits to commence construction in place?
- Is there an economic report in place? Who has prepared the report?
- Is there a forward appraisal report for the property, reflecting its future expected value?
Now, let’s elaborate on the four basic categories mentioned above.
CATEGORY A: JOB CREATION
This is the most basic EB-5 project requirement. Every investor needs to create or get credit for 10 new full-time positions that his investments will create. The jobs do not need to be created after the investment is made. In fact, in many projects these jobs start to be created way before the investor wires his funds to the escrow agent for the project.
Before the EB-5 investors are solicited, typically, the developer secures a “bridge loan” that stands in between the senior loan and the equity. Once the senior loan, the bridge loan and the equity are secured, the developer becomes confident that he will be able to complete the project even if no EB-5 funds are raised. In most cases, as long as an application to U.S. Citizenship and Immigration Services (USCIS) for EB-5 funding intent is made before the bridge loan funding is secured, the jobs that are created can still accrue towards the EB-5 investors’ obligation to create jobs. That said, if the project has essentially concluded, and EB-5 capital is simply going to replace debt in which the jobs are already created through non-EB-5 capital, and that does not make a compelling argument that jobs were created as a result of the investment. It is important to make sure that a reputable third party conducts an economic analysis. Some of the statistical methods used to estimate job creation include RIMS II and IMPLAN.
One criterion that is becoming increasingly popular in deciding whether a project will be successful from a job-creation standpoint is whether or not the project already has an I-924 exemplar approval. It is important to note, however, that the fact that a project has I-924 exemplar approval does not provide any absolute assurance to the investors that the jobs will be created. All the I-924 exemplar approval means is that if the project ends up spending funds equal to or greater than the one indicated in the budget in their business plan, and they are successful in completing the project, then the construction jobs that were estimated to be created in the economic report will be deemed to have been created.
CATEGORY B: RETURN OF CAPITAL INVESTMENT / CAPITAL PRESERVATION
This part of the due diligence process has to do with looking at the financials, track record, and a whole host of other factors concerning the developer, regional center, and the actual project. The best indicator of whether the capital will be paid back would be statistics on the experience of the developer and the regional center for paying back previous investors in previous projects.
A developer who has paid back other investors can demonstrate that they not only finish their projects but at the same time can either sell or refinance them to execute an exit strategy and pay off their creditors. From the developer standpoint, they could have a tremendous track record of paying back their creditors, but this might not trickle down to the EB-5 investors in their projects. This will happen primarily if their typical investors come from countries that experience retrogression, and are therefore more subject to redeployment risk than investors from other countries. As such, a lack of robust repayment history should not necessarily be used against a developer. The same could be true for the regional center. Unless they too have marketed to investors from other countries, they will have the same issue. There are a handful of regional centers who have been around for quite a long time and therefore can demonstrate a robust “payback” history. While this certainly is one of the desirable characteristics, other aspects should also be considered.
All of these are criteria that make projects, developers and/or regional centers safer than others thereby increasing the chances of return of capital investment. One word of caution: Naturally, these categories are not necessarily mutually exclusive. Therefore, there will be intrinsic double counting of certain important features. While it is very difficult to correct for this with our rather simplistic scoring system, it could perhaps be dealt with by subjectively adjusting the assigned weights given to each feature within each category. The same kind of subjective adjustment could be performed to each category if the categories themselves are found to be overlapping.
What other criteria can give EB-5 investors an idea of what to look for when picking a project from a return of capital investment standpoint?
- Does the developer have a standalone rating from a reputable international credit rating agency? If so, how strong is the rating?
- Is the developer known in the marketplace? How long have they been in the real estate development business? What is the total square footage developed? Any known insolvencies, bankruptcies?
- Does the developer have a well-known CEO or founder who could be relied on in times of crisis? If so, would his future departure be a significant concern? In other words, is there a strong key man risk with the developer?
- Is there a senior lender in the project? If so, how reputable is the lender?
- Is there an I-526 denial guarantee? If so, is that only triggered due to project-related denial or does the guarantee extend to cover denials due to source of funds related issues that do not involve any fraud or misrepresentation?
- How crucial is the EB-5 raise for the project? If all of the contemplated EB-5 is not raised, does the project still have enough funding to complete the construction?
- Is there a building completion guarantee? If so, who is the provider of such a guarantee?
- Is there a corporate guarantee that the loan, if any, extended by the new commercial enterprise (NCE) to the job-creating enterprise (JCE) is guaranteed by a deep pocket? If so, who is the guarantor? Is it a shell company, the developer or a third party?
- Has the project started? When is it expected to be completed? How realistic are the exit strategies given the type, location, and size of the project?
- Are there any conflict of interest issues? Is the regional center an affiliate of the developer or a separate independent entity? Once the NCE is paid off by the JCE, will the investor get their capital back assuming that all the immigration-related requirements are met?
- Another criteria investors should be very careful about is “dilution risk.” Typically, while the senior loan is in place, no dilution through additional borrowing would be allowed. However, the documents could be written in such a way that once the senior loan is repaid, before the EB-5 investors are repaid, the developer could borrow additional funds ahead of the EB-5 investors. That could worsen the original LTV applicable to the EB-5.
- Is the equity invested by the developer above or below the EB-5 in the waterfall?
- What sort of redeployment strategy is in place: a diversified portfolio or another single project investment? Once the required jobs are created by the time of redeployment, investors might prefer a diversified portfolio as the redeployment option as opposed to another single project.
- Other than the basic LTV ratios, investors should look at the following ratios:
- Committed equity as a percentage of total project cost: The higher this number, the more committed the developer.
- Senior loans ahead of EB-5 plus EB-5 as a percentage of forward appraisal of the completed project: The lower this number is, the better, as it is an indication that there will be plenty of collateral leftover after repayment of non-equity obligations including the EB-5.
- EB-5 as a percentage of forward appraisal of the completed project after repayment of the senior loans ahead of EB-5: A lower ratio is better as it is an indication that there will be plenty of collateral left over to pay off the EB-5 loan after repayment of non-equity obligations.
- The number of EB-5 projects the regional center has been previously involved in is also an important number. This statistic underlines the experience of the regional center in managing EB-5 projects.
- Statistics on previous number of I-526 approvals, conditional green cards issued, I-829’s filed, I-829’s approved and number of investors who are actually paid back their capital are all very helpful. However, the composition of the investor base of the specific regional center is vital information not to unjustly penalize them for having a huge number of approved I-526 applications with comparatively few conditional green cards obtained, I-829’s filed and approved. This could be due to their investor base being heavily skewed towards mainland China-born investors who are currently experiencing unprecedented retrogression periods.
CATEGORY C: TIMING OF THE CAPITAL REPAYMENT
This topic has gained enormous attention in recent years. Up until a few years ago, when the project was completed and the JCE had returned the funds to the NCE, the funds would either be disbursed to the investor or would be kept in an account such as an escrow account of the regional center waiting to be disbursed to the investor. In recent years, USCIS has been very vocal of interpreting the law such that the EB-5 investors’ funds have to be “at-risk” at least until I-829 filing.
Even without any retrogression considerations, I-526 approvals, as well as subsequent immigration steps, are taking longer than previously. Thus, even if the initial project is successfully completed, sold or refinanced, if the investor is not able to receive back his capital, the capital will need to be redeployed.
One key criterion in this category is whether the regional center has updated its policy to payback eligible investors at the I-829 filing stage, as opposed to the I-829 approval stage. This could have dramatic implications. While we expect most I-829’s filed to be adjudicated within a year, the USCIS website is currently showing otherwise. They are posting 23.5 to 54 months. Therefore, regional centers who have adopted the new USCIS policy of paying back soon after the I-829 filing as opposed to after the I-829 adjudication, should be preferred.
CATEGORY D: RETURN ON THE CAPITAL INVESTMENT
This used to be the least important criteria. Investors were told to focus on the return of their investment rather than return on their investment. Most EB-5 investors have been primarily concerned about getting their conditional green card and keeping it by making sure that the conditions are removed following I-829 filing. The second criteria that investors cared about was to be able to get their capital back. The timing of the capital return and the return on the capital investment has for the most part been ignored. Most projects that offered “above-market” returns were projects that the savvy investors preferred to stay away from due to their undue risk. Today, with the increased required investment amounts for both TEA and non-TEA projects, return on the investment can no longer be ignored.
In a typical EB-5 financed project, the cost of funds for the alternative financing method of EB-5 is between 8 to 12% per annum. Therefore, developers could afford to pay a reasonable rate for the use of these funds and still save a significant amount on the cost of their funding. The sharing of the investment returns with the EB-5 investors has already begun in certain projects at the redeployment stage.
Going forward in the new environment, EB-5 investors need to get a clear explanation of the redeployment strategy. They will also need an explanation of the revenue sharing arrangement with the regional center who will most likely be redeploying their funds. The return that is offered to the EB-5 investors will need to better reflect the opportunity cost of tying their money for so many years.