Private equity real estate funds have recently emerged as a promising avenue for investors already in the process of achieving permanent residence in the United States under the EB-5 Program. The potential for changes in the program have encouraged EB-5 practitioners to diversify their business models, and investors may also seek multiple investment avenues in an effort to provide maximum financial security for themselves and their families.
Although Congress has renewed the EB-5 Program until September 2016 and will likely continue to do so, lawmakers face pressure to review targeted employment area designations in light of the fact that investors are generally more attracted to large cities such as New York and Los Angeles, leaving rural areas lacking. As job creation is one of the pillars of the EB-5 Program and such areas typically suffer from higher unemployment, Congress may consider redrawing the map concerning targeted investment areas.
Such a change would present not only a shift in the program but also an opportunity for foreign investors seeking additional investment opportunities in the United States. Real estate is a relatively stable asset which can offer consistent growth, and regional center managers have thus begun to investigate facilitating investments in private equity real estate (PERE) funds as well as EB-5 projects. The United States offers one of the most promising commercial real estate investment environments for foreign investors, and PERE funds are considered worldwide to be among the safest investment methods because they are not affected by volatility in public markets.
This article discusses how PERE funds are a reliable recommendation for EB-5 investors seeking to explore avenues of investment aside from their initial EB-5 commitment. Regional centers and other EB-5 practitioners can therefore harness the opportunities offered by PERE funds to create sustainable investment models for their clients.
The Benefits of PERE Funds
PERE funds make up a significant amount of assets under management worldwide, with a share of $742,000,000,000 in 2014. Each fund is overseen by an experienced manager with knowledge of the unique nuances of the regional market, and most funds are diversified to further lessen the risk to investors, as underperformance in one market is balanced by overperformance in another. PERE funds have an additional advantage in that they allow investors to avoid trade and business income tax by investing through a blocker corporation rather than directly in the private equity fund. In this model, the investor is not considered a partner in the fund, allowing for a reduction in his or her taxable income basis.
For Chinese investors, who comprise nearly 80% of EB-5 visa applicants, U.S. PERE funds can provide additional security. The government devaluation of the renminbi in 2015 has encouraged Chinese investors to adopt more caution when building their portfolios. Nonetheless, the growth of the middle class in China has led to an abundance of capital and a strong desire to safeguard funds against further volatility in the domestic market. It is for this reason that PERE funds using foreign currencies have consistently raised more capital among Chinese investors than those using the renminbi. In 2013, according to a report by Chinese commercial bank Ping An Bank, foreign currency PERE funds making up only 3% of the total number of funds in China accounted for nearly a quarter of the entire amount of funds invested.
These figures highlight the desire among Chinese investors to safely commit their capital in foreign markets. As such, for regional center managers and other EB-5 practitioners in the United States who are frequently approached by those seeking additional opportunities to invest, PERE funds are an excellent recommendation, providing significantly less risk than other investment options as well as proven returns. Practitioners seeking to expand their client bases and diversify their business models can additionally benefit from working with PERE funds, which can facilitate relationships with networks of investors both nationally and internationally.
Partnering with PERE Funds
EB-5 practitioners seeking to branch out into the PERE fund market face the challenge of finding suitable partners in this endeavor. While most practitioners have established a network of experienced consultants over the years with the necessary credentials and knowledge for their particular areas of expertise, professionals such as residential real estate brokers and property managers may lack experience in managing complex portfolios for foreign investors. As such, these consultants may outsource the work of building and maintaining the investment assets to colleagues specializing in those areas.
This model introduces increased risks for investors, as the original EB-5 practitioner will not have the ability to vet each party, whose ability and commitment to managing the investment may vary. The involvement of multiple parties also increases the risk of misappropriation or fraud, which practitioners should be careful to guard against. As such, while existing connections may continue to offer support in other areas, they are likely not the best candidates to facilitate the acquisition and management of a diverse portfolio of real estate holdings for foreign investors.
Partnering with a local PERE fund provides practitioners with the assurance that the asset will be managed by a devoted professional experienced in the unique requirements of PERE investors. Unlike consultants who focus narrowly on their own roles, fund managers are able to view the portfolio of real estate assets as a whole and thereby assure investors of balanced performance over time. PERE fund managers generally have a proven ability to navigate the U.S. real estate market and create profitable assets, and because they have a vested interest in the success of the investment, they are better able to work in investors’ best interests.
Additionally, because PERE fund managers are experienced in the acquisition of real estate assets, they are typically able to leverage existing business relationships and negotiate proprietary deals, thereby eliminating the need for a real estate broker, allowing for more efficient acquisition of new properties, and ensuring those properties are purchased at the best price. The fund manager will typically also consolidate the acquisition and maintenance process, including asset sourcing, payment via escrow, and property management, among other services, to minimize risks for investors.
Foreign investors coming from the EB-5 context, in which fraud and misappropriation of funds have become increasing concerns in recent years, will be assured by the fact that PERE funds are overseen by the Securities and Exchange Commission as well as the Financial Industry Regulatory Authority, a private corporation which regulates brokers in the United States. PERE funds are subject to strict reporting and auditing requirements, resulting in a transparent environment for investors. An additional level of assurance exists in that fund managers are only compensated once investors have received their shares of the profit plus interest.
Foreign investors, especially those facing an increasingly volatile market in China, can benefit from diversifying their investments in the United States in addition to their primary investments in EB-5 projects. Regional center managers and other EB-5 practitioners can play a key role in facilitating stateside relationships for such investors. In expanding their client bases and business models to take advantage of the promise of PERE funds, practitioners can allow investors to achieve higher returns and additional security in their lives post EB-5.