Understanding EB-5 investments: key financial insights and risks

By Chris Foulger 

From the glitzy skyscrapers of New York City to single-family homes in San Diego, and everything in between, EB-5 investors face a dizzying amount of real estate projects in the marketplace vying for their trust and investment dollars. Although most individuals with $800,000 to allocate to a green card program are financially sophisticated, they may not have the U.S.-specific real estate experience to evaluate the risks and rewards of these complex investments fairly. This article hopes to guide investors as they navigate these waters and try to determine if a proposed project is appropriate for their situation. 

Though there are a great many variables to consider, all should agree that an investor’s two primary goals are: 1) to receive their green card, and 2) return on their $800,000 investment. With these goals in mind, below is a primer on some fundamental factors to consider when comparing EB-5 opportunities.  

JOB CREATION FOR EB-5 

Each EB-5 investor must create at least 10 jobs through their investment. The U.S. Citizenship and Immigration Services (USCIS) recognizes two types of job creation through regional center investments: direct and indirect. Direct jobs are those created from the EB-5 project itself. Examples of direct jobs include the construction jobs associated with building a project or the employees who work at a hotel once completed. Indirect jobs are those created from the economic activity generated by the project.  

Regional centers use an economic model such as Rims II to determine the number of direct and indirect jobs created. A project’s economic success (or failure) does not necessarily determine whether the job creation requirement has been fulfilled.  A project may be financially successful but fail to create the required jobs. Alternatively, a project could fail financially but still achieve the requisite job creation purely through project construction. Because USCIS allows for bridge financing, some projects have commenced construction and, therefore, created the requisite jobs even prior to receiving EB-5 funds. This unique scenario can completely remove the risk of job creation for an EB-5 investor. 

EB-5 IN THE CAPITAL STACK 

The capital stack is the term used to describe how the total cost of a project is divided among the various investor groups providing the necessary capital. Job creation can only materialize after the sponsor has the capital stack committed and the project gets built. A prudent capital stack is important for job creation and capital return. In this case, a prudent capital stack avoids excessively high leverage. For instance, 90% leverage is commonly recognized as extremely risky. As an example, a typical capital stack on a $100 million apartment project might be $60 million (or, 60%) of first position “senior” mortgage debt, with $40 million (or, 40%) of equity advanced by the owner of the project. A common variant of this structure is when a developer includes an additional level of riskier second-position debt called mezzanine or “mezz” debt between the senior loan and the equity. In this example, the $100 million apartment project above would still have the $60 million of first position senior debt. Still, it would layer in another layer of subordinate or mezz debt (let’s use $25 million in this example), reducing the owner equity investment in this example to $15 million.  

In the United States, pricing, or the return required by investors in each of these various portions of the capital stack, would be approximately as follows: Senior Loan; 7%, Mezzanine Loan; 13%, Expected Equity Return; 18%. This pricing is relevant because it shows the relative risk each party is taking; as the risk goes up, the expected return goes up. EB-5 opportunities are offered in every layer of the capital stack.  

Although there is nothing wrong with an equity or mezzanine EB-5 investment, an investor should be aware that they are taking on more risk in that position and should be adequately paid for absorbing that risk. All else being equal, if two projects are offering EB-5 investors the chance to invest, one in a senior loan structure at 0.5%, versus a competing project offering an equity investment structure at 5%, the senior loan provides the better risk-adjusted value based on how experts in the United States price real estate risk.  

The bottom line is: the capital stack matters, and EB-5 investors must have confidence that the capital stack is solid to ensure the project will be built, enabling the job creation required for the green card. The relative position within the capital stack also matters, as each layer represents a different level of risk. Just because a well-known bank supplies the senior loan of a capital stack, it should not be assumed the bank is endorsing the EB-5 investment. Remember, the bank is underwriting their risk, and they will have no problem foreclosing out EB-5 investors to protect the bank’s interest. If EB-5 investors aren’t paid significantly more to take junior positions in the capital stack, they might want to consider a senior loan project.  

PRODUCT TYPE FOR EB-5 PROJECTS 

EB-5 projects have come in all asset classes. Hotels, office, industrial, manufacturing, retail and residential have all benefitted from EB-5 financing. Each asset class has advantages and disadvantages that investors must consider when evaluating the investment.  

• Hotels are known for their ability to change their rate daily. This is a double-edged sword, as a hotel will outperform other asset classes in a hot market and underperform in a down market.  

• Office has been known for the stability of its long-term leases and stable cash flow. Because of this history, few foresaw the work-from-home trend that exploded during the COVID-19 pandemic, causing vacancies to spike and financial ruin for many owners.  

• Like office, retail relies on long-term leases. Still, it has been largely out of favor from investors and developers as it has struggled to retain its footing in response to online purchasing becoming ubiquitous. Industrial has perhaps the longest average leases, with 10-20 year leases common. This asset class has been enjoying a golden era as online retailers have had an insatiable appetite for warehouse space, fueled further by the pandemic.  

• Manufacturing is not glamorous and there is a long history of outsourcing to countries with lower labor costs, though certain industries have benefited from a concerted effort to try and bring manufacturing jobs back to the United States.  

• Residential has long been thought of as the safest asset class. After all, people will always need a place to live, and the credit crunches that afflict other areas of real estate are mitigated with Government Sponsored Entities (GSEs) like Fannie Mae and Freddie Mac which provide subsidized, consistent financing for the residential sector.  

So, when picking an EB-5 investment, does product type matter? In short, not as the sole determinant. However, the investor should consider whether the proposed project is appropriate for the location proposed and be sure there is sound reason and data to support the success of the new development. An office building built in a terrible location but fully leased to a longstanding credit tenant such as JP Morgan for 20 years could be a great investment, while a high-end residential project may be a terrible bet if built in a sub-par location. Any of these asset classes can provide a safe and appropriate EB-5 investment as long as the overall investment thesis makes sense.  

LARGE VS SMALL EB-5 PROJECTS 

A decade ago, the EB-5 market was dominated by $100 million mega-projects. The market today leans toward smaller bite-sized projects. Does project size matter? Maybe, but that isn’t the right question. More critical than project size is the project status and the questions surrounding it.   

Questions such as: Has construction started? Does the developer need the EB-5 money to start the project, or do they have a bridge lender or their own funds to cover any EB-5 shortfall to ensure project completion and job creation? Many EB-5 investors place their money in escrow and must wait years before it is drawn and utilized in the project because the developer cannot start the project until all the EB-5 funds are raised. This may be prudent for the developer, but it places the EB-5 investor in a very precarious position, not knowing when their jobs will be created or perhaps when they might recoup their investment. 

SPONSORSHIP EQUITY AND EXPERIENCE 

Nothing provides evidence of a sponsor’s belief in their project, such as investing a large amount of their own money as equity. The deal should be structured so that the developer is positioned to risk all their money before EB-5 investors risk losing even a dollar. It may be beneficial if the sponsor has previous EB-5 experience, but it is much more relevant that they have experience with the proposed business. If the project sponsor does not have successful experience with the proposed asset class, run, don’t walk to the next project.  

CHOOSING THE RIGHT EB-5 PROJECT IS PART OF A SUCCESSFUL APPLICATION 

EB-5 Investors certainly face a steep learning curve. They must learn about the intricacies of U.S. immigration law, related to the EB-5 program, and evaluate a complicated real estate transaction on the other side of the world.  

An investor’s first defense against making a misstep should be picking a reputable immigration agent and lawyer who has deep experience with EB-5. However, investors must carefully evaluate the projects the agents recommend. It is helpful to use professionals to do proper due diligence. 

By selecting a reputable agent and immigration attorney, committing time to review the project’s business plan and accompanying documents, and studying the developer’s reputation, EB-5 investors can position themselves for success. 

DISCLAIMER: The views expressed in this article are solely the views of the author and do not necessarily represent the views of the publisher, its employees. or its affiliates. The information found on this website is intended to be general information; it is not legal or financial advice. Specific legal or financial advice can only be given by a licensed professional with full knowledge of all the facts and circumstances of your particular situation. You should seek consultation with legal, immigration, and financial experts prior to participating in the EB-5 program Posting a question on this website does not create an attorney-client relationship. All questions you post will be available to the public; do not include confidential information in your question.