Until 2012-2013, many hotel developers sought EB-5 capital when other forms of capital were unavailable. Today, traditional capital is more accessible for well-conceived hotel projects, and EB-5 capital is no longer as accessible for projects that fail to meet traditional underwriting criteria. Hotel developers seek EB-5 capital today primarily for its pricing advantage.
There are other advantages to EB-5 capital besides low cost. EB-5 also has some important disadvantages that must be anticipated and managed for a successful EB-5 program. This article will discuss the advantages and disadvantages after a brief introduction to the EB-5 program.
What is the EB-5 Visa Program?
The EB-5 Visa Program for Immigrant Investors was established in 1990 and offers foreign nationals the opportunity to receive a permanent visa for themselves and their family members under age 21. By investing $1 million (reduced to $500,000 if the investment is in a targeted employment area, or TEA) in a U.S. business and demonstrating the creation of at least 10 jobs with their investment, the investors are granted green cards. Under current law, 10,000 EB-5 visas are available per year, representing $2-3 billion of capital per year. (The available capital is less than $10 billion because almost all larger programs are located in TEAs and use the lower investment threshold, and the investors’ family members are also counted against the 10,000 visa limit.)
What hotels are using EB-5 financing?
Hotels funded with EB-5 capital include the SLS Las Vegas, the Marriott/Residence Inn at LA Live, and the Homewood Suites in East Point, Ga. There are many other upscale and limited service hotels throughout the country currently in the market seeking EB-5 financing such as the NYLO South Side hotel in Dallas, Texas, and Silverstein Properties’ Four Seasons Hotel in New York.
Why are new hotel construction projects so popular in the EB-5 market?
New hotel construction is probably the most popular type of investment today in the EB-5 market. The reasons relate to the two primary goals for EB-5 investors:
- Obtaining a visa
- Return of principal
Hotel projects tend to create a high number of jobs per dollars invested. More jobs mean greater security in the visa process. Hotels create substantial direct jobs during the operational phase, and the EB-5 “regional center” program enables projects sponsored by a regional center to count in addition “indirect and induced” jobs determined through economic models. Hotels can take advantage of indirect and induced jobs deemed created during the construction phase and during the operational phase. Where, as is typical today, EB-5 capital represents a minority of the total capital stack, the total number of jobs created by the project are leveraged for the EB-5 investors. For example, if a $50 million hotel will create 500 jobs (including indirect and induced jobs), and $15 million (30 percent) is funded by EB-5 investors each contributing $500,000, the total of 30 investors will divide the 500 jobs among them, resulting in over 16 jobs per investor. This represents a “cushion” of more than 60 percent over the 10 jobs required for each investor, which enhances an investor’s chances of obtaining his or her visa.
Hotel projects are also perceived to be relatively safe in the marketplace for return of capital. Foreign investors believe they understand the revenue model of a hotel, and they are often comforted by a flag and location they recognize.
How much does EB-5 capital cost?
The investors in most larger EB-5 deals today are recruited by Chinese migration agents. For EB-5 deals marketed through these agents, developers can expect to pay a fixed rate of interest, or preferred return on capital raised, of 5-8 percent annually over the five-year expected life of the investment. Depending on the structure of this deal, there may be upfront points (usually not more than 1 percent) and substantial upfront transactional costs. The annual cost of capital may be lower for developers who have their own infrastructure to recruit and maintain relationships with migration agents. However, these relationships take a long time to build and there is significant effort involved in positioning and maintaining an EB-5 offering that will be presented by migration agents. Most developers will require the services of an intermediary to interface with the migration agents in order to ensure success of the offering.
The cost of EB-5 capital is usually more than the current variable rate offered by senior lenders, and may be more than the effective fixed rate available on a senior loan by purchasing a swap. For this reason, EB-5 capital most often makes up the part of the capital stack that is typically funded with mezzanine capital, traditional equity or preferred equity. Compared with typical costs of between 9-20 percent annually for mezzanine capital, traditional equity or preferred equity (plus potentially points upfront and equity participation), EB-5 capital has obvious appeal for hotel developers.
What are the benefits of EB-5 capital other than cost?
Other advantages to EB-5 capital that make it attractive for hotel developers are:
- EB-5 capital rarely requires personal guarantees from the principals of the developer, though related entity guarantees may be required for some projects and deal structures.
- When not in a first lien position, EB-5 capital will often be unsecured and/or have deep subordination.
- In the form of preferred equity or as an unsecured loan, EB-5 capital may be permitted by senior lenders that would not permit other mezzanine-type structures.
- Covenants are typically light and financial covenants are not common.
- EB-5 capital can be used to replace sponsor equity or other more expensive bridge capital, and can therefore allow a developer to redeploy a portion of its sponsor equity to other projects.
- Where EB-5 capital reduces the amount necessary or outstanding on senior loans, it may enable better senior loan terms and/or easier covenant compliance.
What are the disadvantages of EB-5 capital?
EB-5 capital also has some important limitations and disadvantages that a developer should consider carefully.
Timing. Structuring and raising EB-5 capital takes substantial time and then funds often are not available to the project until visa milestones are met. Time horizons of nine months to two years (and sometimes even longer) are common, depending on the type of program and funding model. Aligning the EB-5 timeline with the project’s construction timeline is challenging and critical to success. Bridge financing may be required and is frequently used for EB-5 hotel projects.
Up-front costs. Because EB-5 capital involves a syndicated offering of securities to individual foreign investors who are not professional hotel financiers, comprehensive offering documentation directed to retail investors is required. These documents, and the complexity of EB-5 program requirements, cause higher transaction costs than for most other forms of capital for hotel development. Moreover, many of these costs must be paid well in advance of receipt of capital to offset those costs and many of them cannot be paid directly with EB-5 funds. Because many of these costs are fixed and unaffected by project size, up-front costs are a larger concern for smaller project.
Management diversion. EB-5 financing is complex and typically requires significant management attention for many months of fundraising. Various models outsource some or most of this work to others, but outsourcing typically leads to greater cost of capital.
Constraints on exit. EB-5 program requirements and current uncertainty in USCIS visa adjudication policy may cause limitations on the ability to sell or refinance the hotel when desired. Most EB-5 programs are structured for a five-year investment horizon which is optimized for these concerns, but problems may arise for a developer that wishes to sell or refinance before the end of five years.
Securities law liability. Securities laws in the United States and elsewhere create significant administrative and litigation liability exposure to developers. Persons who participate in a flawed offering of securities can be found personally liable for investor losses. Securities lawyers must consider the effect of other securities laws, including broker-dealer laws and laws governing investment advisers and investment companies.
How do I decide if EB-5 is right for my hotel project?
Hotel developers inexperienced in EB-5 will require help from experienced EB-5 professionals. Some professionals, including broker-dealers and project finance attorneys, will assist by developing EB-5 feasibility studies. While some may perform this type of analysis without charge in hopes of securing a paid engagement, a reliable read on feasibility will likely require a developer to pay for the work involved (one way or another). Unfortunately, many EB-5 programs commence without any real feasibility planning and then fail in the marketplace after incurring substantial cost for execution that was devoid of design for success.
How should I choose EB-5 professionals?
Developers should choose professionals the way they do outside EB-5 — based on professional qualifications, industry experience, successful track records, skill, personal compatibility, and budget compatibility. In choosing professionals, developers should consider that the market has evolved rapidly to reflect changing adjudication policies at USCIS, attention from securities regulators, increasing sophistication, underwriting scrutiny of marketing agents, and enhanced competition in the marketplace. What worked in 2012 or even 2013 very likely will not work today, and developers should assess a professional’s recent EB-5 experience and experience outside EB-5 to assess a professional’s versatility in the changing legal and market environment.
Ali Jahangiri is the founder of EB5 Investors Magazine and EB5Investors.com, a unique online platform allowing investors to communicate directly with attorneys, and developers to connect with EB-5 regional centers and funding sources. In 2014, he published The EB-5 Handbook: A Guide for Investors and Developers, an essential resource both for foreign investors who wish to pursue their U.S. green cards, and for American developers seeking to learn more about EB-5 capital as a funding option. His articles and Op-Eds have been published across many platforms, including local newspapers and the Huffington Post.
John Tishler is an EB-5 corporate and securities attorney with Sheppard Mullin Richter & Hampton, LLP. His EB-5 experience includes securities compliance and representing clients that wish to acquire EB-5 financing. He publishes on several blogs, including the Financial Institutions Law Blog and the Corporate & Securities Law Blog, and he has authored multiple articles published by the San Diego Daily Transcript and the California Business Law Practitioner.