The EB-5 Visa Program: The Outlook for 2017
By Lynn K. Cadwalader, Partner, DLA Piper
Impact of the Election on EB-5
On September 29, 2016, President Barack Obama signed the Continuing Resolution, passed by Congress to avoid shutting down the Federal government by continuing to fund government operations and most of its agencies. The Continuing Resolution is a temporary solution, and continues funding at 2016 levels only through December 9, 2016. A number of programs are included in the Continuing Resolution, among them, the EB-5 Regional Center program. The Continuing Resolution keeps the EB-5 Regional Center program running until Congress can reconvene and devote itself to sorting through all the budget issues, as it did last year at this time. However, this year, the surprises created by the Presidential election have led to some uncertainty on the EB-5 front. While there continues to be wide-spread support for EB-5 in Congress, a few senators and congressman would like to greatly restrict the program, or eliminate it altogether.
The good news is that Congress will probably extend the Continuing Resolution and thus extend the operations of the federal government at the current funding rate through March 31, 2017, and it is likely that this will be the vehicle for a short-term EB-5 program extension. However, a longer-term extension of the EB-5 program, as well as the terms of any such extension, will have to await the new Congress, which convenes on January 3, 2017.
As to the direct impact of the Presidential election, here are some thoughts: At one level, everything remains the same - the Republicans controlled the Senate and House before the election, and they still do. What has changed is that President Obama is being replaced by President-elect Trump. Although the Obama Administration has not been particularly pro-EB-5, it has always been assumed that President Obama would sign any EB-5 legislation that passes both Houses of Congress. While we all know Trump's views on many aspects of US immigration policy, these views do not generally affect EB-5. What we do know is that the Trump's Bay Street Project, a luxury residential rental complex in New Jersey built by Trump's son-in-law and advisor, Jared Kushner, has benefited from EB-5 capital. Still, it is not clear what role the White House or Kushner will play relative to EB-5. Here are a few possibilities:
Here are a few possibilities:
- It is possible that Congress will let the EB-5 Immigrant Visa Program lapse, but this is unlikely.
- We could see a replay of 2016, where the EB-5 Program is extended through September 30, 2017 without any substantive changes - this could happen for two reasons: first - the new Administration will have its plate full with other priorities during the first quarter of 2017, such as confirmation hearings for a Supreme Court Justice and other federal appointments, little leaving little time for a substantive debate on EB-5; and second - if Trump plans on making immigration reform a priority, he might prefer that substantive debate on any immigration issue wait until the President's team has a chance to formulate its overall immigration policy strategy.
- The most likely scenario is that in the first quarter of 2017, Congress will finally agree on comprehensive EB-5 legislation, which would include a long-term (probably 5 year) extension, and likely much-discussed changes to the EB-5 Program, including increased investment thresholds.
Notwithstanding these possibilities, the biggest impact of the Presidential election may be to lessen the chances of a legislative fix to the substantial EB-5 quota backlog for Chinese investors, or "retrogression". Before the election, the hope for addressing the retrogression problem was comprehensive immigration reform which could increase immigrant numbers beyond the current annual cap of 10,000; immigration reform was likely to be one of the early initiatives of a Clinton Administration, even though a Republican Congress may have slowed the process down and altered it significantly. However, it is unclear whether the Trump Administration will support an increase in immigrant numbers, and any executive action to alleviate the problem is certainly off the table.
What is Retrogression and Why is it Important?
The issue of retrogression backlog is simply this - demand for EB-5 visas far exceeds the annual supply of 10,000 that are available, which has resulted in an estimated 6 year + wait to be issued a conditional visa to live in the United States. The backdrop is that global citizenship and residence programs are gaining momentum around the world; if Congress does not act quickly to address this backlog, the fear is that Chinese and other immigrant investors will choose other countries where their investments are encouraged and the wait for a visa is shorter. This could result in significant loss of investment capital to the US.
When the EB-5 Visa Program was initially enacted by Congress as part of the Immigration Act of 1990, it established an arbitrary cap on the number of immigrant visas available through the EB-5 program at 10,000. Due to the attractiveness of the United States to foreign nationals as a place to live and invest, there currently is an estimated backlog of EB-5 petitions of around 20,000-25,000. One of the easiest ways to address the backlog is to change the way the cap is calculated. Currently, both investors and each of their family members (spouses and dependent children under the age of 21) are counted when calculating the cap. Each petition averages about three visas per petition. Many believe that the cap, which was set in 1990, was intended to limit the program to 10,000 investors annually, with family members allowed in addition to the 10,000. Further, no one country is allowed to exceed more than 7% of a visa category. At present, the EB-5 visa category is current for all countries except China. EB-5 has retrogressed to those cases filed in 2014 and earlier, and is expected to retrogress further because of overall demand for visas from China. Here are a few ways Congress could address the backlog:
- Recapture unused immigrant visas
- Increase the number of immigrant visa numbers for employment-based visa categories outside of EB-5.
- Adopt a deficit reduction component of the program which imposes a one-time mandatory fee on any petitioner who obtains a new, borrowed or recaptured visa, and commit those revenues to reduction of the deficit.
- Do not count family members of principal EB-5 investors as part of the visa cap.
- Eliminate or modify per country quotas for immigrant visas.
Another impact of retrogression is seen with children of EB-5 investors. With such a long wait for families, it may be that the investor's children will not be young enough to be considered derivative of the EB-5 investor by the time the visa is finally issued. A further risk is that between the time the investor files an I-526 and the time he or she becomes a conditional resident, a material change in the business plan of the project may have occurred due to change in market conditions during the extended waiting period, which is grounds for denial or revocation of the I-529 petition.
The hope is that a comprehensive overarching immigration policy may be adopted by Congress in 2017, backed by a pro-business President and Administration, which would treat EB-5 immigrant visas as a category separate and distinct from the Administration's very different concerns on other immigration issues.
Some Stats on EB-5 - Why Hotel Projects Top the List of EB-5 Projects
Job Creation - Hotels are one of the most prevalent project sectors currently being funded with EB-5 capital. What hotels provide is the creation of significant ongoing operations, which means the creation of direct operating jobs. This is not always the case with other businesses. Here's how it works relative to job creation: Hotels create substantial jobs "direct" during the operational phase of the project, 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. Typically, EB-5 capital represents only a portion of the total capital stack; however, the total number of jobs created by the project can be leveraged for the EB-5 investors based on the total project financing. For example, take a project for construction of a $50 million hotel, which will create 500 jobs (including indirect and induced jobs). If only $15 million is funded by EB-5 investors (each contributing $500,000), then the 500 jobs can be allocated among the 30 investors, resulting in over 16 jobs per investor; this provides 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.
Stability and Value - Another reason EB-5 investors favor hotel projects is that hotels involve real estate investment, which tend to be more stable in value than other forms of investment which may qualify for EB-5 financing. Further, hotels present a business model that is easy for investors to understand, and are often operated under franchise or management agreements by well-known hotel brands, which gives comfort to EB-5 investors.
Lower Cost of Capital - As to the availability of capital for construction of new hotel projects, until around 2012-2013, typical capital sources were not generally funding hotel construction. However, the market has changed and traditional capital is now more readily accessible for well-planned hotel projects. While EB-5 financing was once considered less structured and somewhat lax from an underwriting perspective, this is no longer the case and traditional underwriting requirements are now generally applied to EB-5 financings. The main reason hotel developers look to EB-5 capital today is primarily due to its lower cost of capital.
What is the current cost of capital for EB-5 projects? For most of the larger EB-5 deals today, investors are recruited by migration agents in China. There are marketing cost associated with EB-5 deals marketed through these agents, as well as other transaction costs, and developers can expect to pay an aggregate rate on capital raised (including interest) of 5-8 percent annually over the five-year expected term of the investment. Some of these costs may be structured as upfront points, and there are substantial upfront transactional costs which must be paid before a penny of EB-5 money becomes available. In addition, there are limitations on the use of EB-5 funds to pay for deal costs.
In comparison to current market rates for hotel construction, the cost of EB-5 capital can be greater than the current rates offered by senior lenders. For this reason, EB-5 capital in recent times often makes up the part of the capital stack that is typically funded with mezzanine capital, traditional equity or preferred equity. Compared with typical annual costs of between 9-20 percent for mezzanine capital or traditional/preferred equity (in addition to possible upfront points), EB-5 capital can be appealing to hotel developers to fund these pieces of the capital stack.
Some other benefits of EB-5 capital that make it attractive for hotel developers include:
- EB-5 capital can be used to replace sponsor equity or other more expensive bridge capital.
- Where EB-5 capital reduces the amount necessary on senior loans, it may enable the developer to obtain better senior loan terms.
- EB-5 capital may not require 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.
- Senior lenders may allow EB-5 capital in the form of preferred equity or as an unsecured loan, whereas they may not permit other mezzanine-type structures.
- Financial covenants are typically light.
It's Not All Roses - EB-5 Financing Has its Limitations
Notwithstanding all of the benefits of EB-5 financing, it is not without limitations, which should be carefully considered:
Timing - Structuring and raising EB-5 capital takes substantial time, and funds are not available until certain visa-related milestones are met. Time horizons of 18 months - two years (and longer) are common, depending on the type of program and funding model. It is important to align the EB-5 timeline with the project's construction timeline, which can be challenging. Typically, bridge financing is required to span the gap between EB-5 fund raising and availability of EB-5 capital.
Complexity; time and effort - EB-5 financing is complex and requires significant time and effort, including months of fundraising. While some of this work can be outsourced to others, the developer must be present to manage the process.
Significant Up-Front Costs - There are significant upfront costs that must be funded by the project developer in addition to cost of capital (discussed above), due to the involvement of a number of project professionals early in the transaction. These costs include retaining professionals to 1) prepare comprehensive securities offering documents directed to the EB-5 investors which meet EB-5 program requirements, 2) prepare loan documentation, and 3) prepare economic and job creation studies, among others. All of these costs must be paid in advance of the capital raise which would typically offset those costs, and there are limitations on use of EB-5 funds to pay for these costs. Further, EB-5 program costs are fixed and apply equally regardless of the project size, which can make up-front costs a concern for smaller projects.
Limits on Ability to Exit the Investment - Most EB-5 programs are structured for a five-year investment horizon, which limits the ability of the developer to sell or refinance before the end of five years.
Potential Securities Law Liability - EB-5 projects are structured as securities offerings under the laws in the US, and unless structured properly with full disclosure of all material issues, can create potential liability and exposure to developers. In addition to the securities offering exposure, developers should consider the effect of other securities laws, including broker-dealer laws and laws governing investment advisers and investment companies.
How Does it All Add up?
EB-5 investor financing can be a great alternative to traditional construction financing for some hotel projects. However, careful thought should be given to the project size and capital needs, appropriate economic modeling, as well as comparing EB-5 and traditional financing options. Further, before putting substantial time and effort into structuring an EB-5 financing arrangement for an upcoming project, it might be prudent to take a "wait-and-see" approach pending the new Administration's stance on EB-5 and upcoming EB-5 Investor Visa Program changes.
Lynn K. Cadwalader represents clients acquiring, developing and operating hotels and mixed-use projects in the United States, Latin America and the Caribbean. Her practice includes providing legal and business advice to foreign investors seeking to invest in hospitality and real estate assets in the US. She also represents clients in the EB-5 immigrant visa program. Ms. Cadwalader represents private equity firms, developers, owners and operators in all facets of hospitality and mixed-use real estate. She understands the legal aspects of negotiating key transactions in this area. Ms. Cadwalader crafts workable solutions for tough legal and business issues. She is also adept at creating flexible legal structures. Ms. Cadwalader can be contacted at 415-615-6050 or firstname.lastname@example.org Please visit http://www.dlapiper.com for more information. Extended Bio...
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