With the surge of interest and participation in the EB-5 Immigrant Investor Program, there has been a similar explosion of regional center investment offerings to keep pace with this growing demand. This offers the immigrant investor more EB-5 investments from which to choose. Since there are many variations in the structure of regional center investments, the possible outcomes and risk exposure differs widely. It is up to the investor to perform their own due diligence to ascertain the worthiness of each investment.
A standard due diligence evaluation of an investment attempts to calculate a realistic rate of return while gauging safety of principal; for regional center investments, the ability of the regional center to create the 10 required jobs needed for each investor is equally important. If a regional center preserves the investor’s capital and delivers an acceptable rate of return but fails in meeting the required job quota, the investment is a failure.
Components of Regional Center Investment Offerings
Like other investment pools, regional centers combine general partners, who bring their experience to the table, with limited partners, who provide financing. Often, in addition to the funds provided by the limited partners, the general partners seek additional financing in the form of conventional loans. The general partners also structure the profit sharing arrangement of the regional center investment.
A seasoned investor will learn to look at these two components in the first stage of analysis. By understanding the debt burden as a ratio of invested funds, the investor can better judge the risk of their investment capital. By fully comprehending the backend profit sharing plan, the investor can better assess the probable return on their capital commitment.
Judging Capital Risks
While judicious use of debt can increase returns on investment through effective leveraging, regional centers that rely too heavily upon debt capital can find themselves at risk of foreclosure or restructuring debts at higher costs. Therefore, a careful study of the debt to capital ratio should be the first step in examining a regional center offering. While some regional center operators will seek to obtain 80% financing, this leaves a thin layer of protection for the investors who represent the remaining 20% of capital.
Since debt financing must be paid back before sharing profits, a small decrease in the value of a heavily leveraged investment will directly and negatively impact the investors while the lenders remain whole. The only way lenders risk a loss is if the investors are completely wiped out and there is still insufficient equity to pay back the loans. Most lenders are careful to ensure there is enough cushion to avoid that financial calamity; however, lenders cannot be concerned about the welfare of the investors.
Therefore, investors are advised to only consider regional centers which limit their debt to 60% or less of the total investment. Unless a complete catastrophe occurs, the chances of the investor losing their principal is greatly reduced. Such a low percentage of debt also serves as a buffer during difficult economic periods when revenues and reserves may temporarily decrease.
Assessing Probable Returns
Although determining debt structure is straightforward, assessing the potential returns entails more guesswork and estimates. There are many variables that can impact the final return for an investor; some variables are better anticipated than others. In all cases, the general partners should provide historical data to support their forecast and clearly explain any discrepancies or unusual projections that deviate from the supporting information.
While general partners cannot control such elements as the state of the economy, current interest rates, or overall appreciation on invested assets, the managers of the fund can structure the profit sharing to ensure that their interests remain subordinate to the priorities of the investors. There are many creative approaches that the general partner can offer, but the investor should expect a preferred return on their investment before the general partner can share in the profits.
Because general partners want to paint a positive picture, they often use favorable assumptions when estimating the use of funds, expected cash flow, and anticipated final sale. It benefits the diligent analyst to counter these glowing predictions by employing a conservative approach and crunching the same numbers. This allows an investor to get a realistic picture of probable returns that may be expected under a worst-case scenario.
Minimizing General Partner Conflicts of Interest
Regional center general partners should properly align their interests with the expectations and needs of the investing partners. Because general partners earn fees for managing the investment fund, they are motivated to operate a long-term project. On the other hand, since investors are seeking the quickest return of their investment, they prefer a shorter holding period for the investment. This creates an immediate conflict of interest that must be satisfactorily addressed by the general partner.
While most investors desire a quick turnaround, sometimes as short as five years, this is not a realistic assumption. Raising funds can sometimes take several years before an EB-5 project can begin in earnest. Also, the managing partners have no control over many factors, including the general economic picture. Investors should anticipate a holding period of at least seven years; ten years is more realistic. Of course, if the regional center investment should be fortunate enough to complete and sell its project in five years, this is a bonus for the sensible investor.
If a regional center is projecting strong results based upon aggressive assumptions and variables, the managing partners should be willing to back those numbers with performance guarantees. For instance, if they are promising a five-year return of principal and will allocate 30% of the profit for themselves (leaving the investors 70%), then they should scale back their profit sharing percentage in the event they do not reach their goal. By reducing their portion of the profits by 5% per year, they are motivated to meet their goal or pay the price for not keeping their word.
Meeting the New Jobs Requirement
EB-5 investors must also factor in the goal of meeting the requirement of generating at least 10 new jobs within the first two years of operation. This element depends upon the performance of the general partner.
An investor should not assume that if their I-526 petition is accepted by the USCIS based upon the anticipated number of jobs to be created, this guarantees that the regional center has met the predicted goal. It is only after form I-829 (which documents the actual number of jobs created) is successfully accepted with documented proof of new employment that permanent residency is granted to the investor and immediate family.
This means that careful attention should be paid to the assumptions and projections used for the job creation component of the EB-5 investment. Due diligence should reveal whether there is valid data backing up the job generation predictions. One should also look to see if conservative projections easily exceed the 10-job minimum each investor needs to achieve for an extra cushion of safety.
Past Performance Results
If the above due diligence steps pass muster, the final investigation should focus on the managers of the regional center. While past performances never guarantee future results, a smart investor will judge the experience and success of the general partners in previous and currently operating projects.
Many investors will once more look to their EB-5 advisors for their endorsement of a regional center investment. Because these professionals have had more exposure and experience working with regional center principals, they are an excellent resource to seek out in this final and crucial stage of the due diligence process.
As any veteran investor understands, due diligence cannot guarantee success, but it goes far in eliminating projects that are riskier than the investor is comfortable with. It also reduces unpleasant surprises that could arise in the future and soften the financial blow of any temporary downturns.