The EB-5 Program was established to facilitate job creation in the United States. While real estate developments have historically been limited in their ability to create the requisite number of jobs per investor as a result of regulatory limitations, these developments currently comprise a large number of EB-5 investment projects. This article examines trends in EB-5 real estate projects and breaks down some of the benefits and drawbacks of these projects for investors and developers.
How EB-5 Financing Suits Real Estate Projects
The financial crisis of 2008 was devastating for real estate development, with the result that projects were unable to obtain conventional financing, particularly construction loans. Prior to this time, EB-5 job creation regulations had been unclear on the potential for construction jobs to fulfill the required job creation quota per investor, and EB-5 investors avoided real estate projects because of this uncertainty.
During the crisis, however, the EB-5 Program relaxed these regulations in an effort to encourage real estate investment. In late 2008, Senator John Cornyn requested that United States Citizenship and Immigration Services (USCIS) revisit the job creation regulations as they related to regional centers and the construction industry, and USCIS replied with a memo the following year to clarify that induced or indirect construction jobs could count toward the EB-5 job creation requirements.
This clarification brought about a change in the real estate landscape, as regional centers could now recruit investors for large developments. These foreign investors brought with them an influx of financing as well as a number of new mechanisms for project developers, among them unsecured short-term low-interest loans, which allow developers to save millions over conventional financing. Additionally, recent 2013 guidelines have specified that EB-5 investments can be used as bridge financing and that projects can be credited for jobs even after construction has commenced.
For EB-5 investors, real estate projects offer real collateral as well as the promise of a return on investment, as opposed to manufacturing projects, for example, where returns may not follow within an acceptable timeframe. Some EB-5 investors also prefer real estate as a tangible investment which they can physically inspect, unlike intangible investments such as stocks and bonds. Real estate investments have traditionally proven a good inflation hedge to protect against a loss in the U.S. dollar, as well. Additionally, investors appreciate the opportunity to conduct their due diligence on a project using background checks and appraisals.
The new flexible regulations and real need for investment among real estate developers has created an excellent conduit for EB-5 investors.
Considerations for Developers and Investors
Recent events surrounding the Chicago Convention Center (CCC) project and the fallout from that scandal have encouraged caution on the part of both investors and developers. In that case, the Securities and Exchange Commission (SEC) pursued securities fraud charges against the CCC developers for misrepresenting the legitimacy of the real estate project to hundreds of EB-5 applicants. For example, the developers falsely claimed that all necessary permits for the projects had already been obtained. Additionally, Illinois Governor Patrick Quinn, who was immune from liability in the resulting fraud trial, had spoken highly of the project, lending it credibility and encouraging investors to drop their guard.
The results of that case slowed the EB-5 market in China significantly, and investors and immigration agents have since adopted a more cautious outlook about real estate projects. Where the involvement of a politician or government official in a project would once have implied to investors that the project bore no risk of fraud, investors are now wary of such developments. Additionally, investors generally conduct extensive due diligence before committing to a project, as marketing material containing misinformation is still endemic in China today.
Investors should additionally keep in mind that local regime changes can affect the real estate climate in prime EB-5 investment targets such as New York, where the current mayor, Bill De Blasio, has adopted a stance favoring affordable housing. This means developers of hotels and other luxury real estate may face hurdles regarding construction permits and government financing. As always, investors and their representatives must take the time to thoroughly research potential investments and take into account such factors before committing any funds.
More positively, the SEC has recently made efforts to prevent misrepresentations by developers marketing projects to potential EB-5 investors. Developers are forbidden from intentional false statements, reckless material misrepresentation, and omission of material information, meaning any marketing materials must not be misleading to investors. Nonetheless, misinformation remains a problem, especially in the Chinese market.
Frequently Asked Questions about EB-5 Real Estate Projects
Can a developer use EB-5 investment funds to buy real estate?
While no USCIS guidelines prohibit a developer from using EB-5 funds to purchase real estate, those funds generally cannot be considered part of the economic impact of the development project. The Matter of Izummi ruling has clarified that any investment funds must be used by the business responsible for the job creation on which the EB-5 petition is based, meaning that a developer might legitimately use some funds to buy a parcel of land and some to create and operate a business on that land. While the real estate purchase itself cannot be considered to have created jobs, the resulting business operations would, therefore justifying the initial EB-5 investment. This and any other use of EB-5 funds must be detailed in the business plan for a project.
On the other hand, an EB-5 candidate cannot simply buy real estate in the United States to qualify for the program. USCIS requires that the investment capital be placed at risk, such as through the creation of an enterprise, and funds must result in the creation of ten fulltime jobs per investor.
Do tenant jobs count toward the job creation requirement?
Because the goal of the EB-5 Program is to create jobs, USCIS requires that any tenant jobs counting toward the job creation requirement meet certain criteria to prove that the tenant would not have been able to operate in the region prior to the development project. This means any tenant jobs must be newly created rather than transferred from another location of a business.
The following are examples of evidence that should be provided with an EB-5 application to justify the counting of tenant jobs:
- A marketing plan and description of the regional prospects of the business
- A breakdown of historical or industry trends and financial projections
- Proof of limited or no vacancy in existing commercial space in the region
- Proof of a lack of suitable space for the business in question
- Signed documents from a government official attesting to the lack of space
- A description of the services to be provided by the business
The creation of tenant jobs is difficult to prove. If a developer is unsure as to whether those jobs would meet USCIS criteria, the best option is to remove them from the job creation total to avoid the issue entirely and decrease the chances of being issued a Request for Evidence (RFE).
How do debt, equity, and preferred equity differ for EB-5 projects?
EB-5 real estate projects are generally financed by one or a combination of two loan models. The first is to use EB-5 funds as a short-term loan to be returned to an investor when his or her permanent residence has been approved (equity). The second is to use the EB-5 funds as an investment, meaning an investor will hold shares in the project and receive dividends based on the performance of the new enterprise (debt).
A third category is to categorize the EB-5 funds as preferred equity, meaning an investor will have a priority claim on the assets and earnings of the new enterprise, and as such he or she would earn dividends to be paid out before dividends to owners of common stock. However, investors holding preferred equity generally do not have voting rights in the new enterprise, as would common stock owners. Because this sort of agreement can be interpreted as a redemption agreement if not structured correctly, and redemption agreements are not allowed under EB-5 rules, investors and developers should proceed with caution when using this model for an EB-5 real estate project.
The number of EB-5 real estate projects has tripled over the past five years, and real estate projects are among the most successful for EB-5 investors and developers. Real estate developments are attractive investment opportunities for EB-5 investors because of their potential for returns and job creation and their security against inflation of the U.S. dollar. For developers, EB-5 funds provide alternative sources of financing as well as significant savings over conventional loans. Despite recent legal SEC investigations in this field, investors and developers willing to conduct their due diligence can benefit from the opportunities of EB-5 real estate projects.