EB-5, a Once Little Known Program, is Becoming a Mainstream Source of Hotel Financing
By Daniel B. Lundy Attorney, Klasko Rulon Stock & Seltzer, LLP | November 17, 2013
With the effects of the recession lingering, and traditional credit sources tight, hotel developers have been turning in increasing numbers to a once little-known immigration program as a source of funding for their development projects. The EB-5 visa program, administered by the U.S. Citizenship and Immigration Service (USCIS), which allows foreign investors willing to invest at least $500,000 or $1 million in a new commercial enterprise that creates at least 10 full-time, permanent jobs for U.S. workers, to qualify for a green card, was created by Congress in 1990 to promote domestic job creation through the facilitation of foreign investment into the U.S. The Program was further expanded in 1992 through the Immigrant Investor Pilot Program, which allows the pooling of foreign investments through an approved Regional Center. A Regional Center is an entity that may sponsor EB-5 investment opportunities under the EB-5 Program, and has non exclusive jurisdiction over a specified geographic territory. Through partnerships with Regional Centers, many developers across the county have been able to access relatively low cost foreign investment capital through the EB-5 program to fund a variety of hotel developments, ranging from small and mid-sized projects, to some of the largest hotel and casino projects under development today.
Funding through the Program is often available to developers at a relatively low cost, due to the relatively low rate of return expected by investors, who expect to obtain permanent resident status in the U.S. (a "green card") in exchange for making a qualifying investment. Investments under the program frequently offer rates of return to investors of between 0.5% and 1%, however, the cost to developers is generally higher due to the costs of having the project adopted by a Regional Center and by the costs of marketing the project to foreign investors. The total cost of capital to a developer under the program can vary, depending on a number of factors, but a developer can generally expect to see rates between 4% and 12%, with 5% to 6% being average. While this is not necessarily "cheap" money in comparison to a first lien loan from a commercial bank, EB-5 funding provides a number of benefits. First, funding can be in the form of debt or equity, and can occupy different portions of the capital stack. EB-5 funding frequently serves to bridge the gap between developer equity and the loan-to-cost requirements of many commercial lenders, and is often used as mezzanine financing. EB-5 funds can be secured by a first lien, second lien, mezzanine pledge, or other collateral, and it may be in the form of recourse or non-recourse debt. The typical term of an EB-5 loan to a developer is five years, although a one or two year extensions may be possible.
Almost all EB-5 investments being marketed abroad are at the $500,000 level. An investor must invest $1 million to qualify for an EB-5 visa, unless the project is located within a Targeted Employment Area (TEA), in which case the minimum investment amount is reduced to $500,000. A TEA is defined as either an area with 150% of the national unemployment level, or a "rural area," which is an area outside of any metropolitan statistical area or any city or town with a population of 20,000 or more. High unemployment TEAs are designated by officials in each state, and any grouping of contiguous geographic or political subdivisions can be designated as a TEA, provided that the area, as drawn, meets the 150% unemployment rate. TEAs are generally drawn through aggregating contiguous census tracts, although single census tracts, and sometimes whole counties,
may qualify on their own. A TEA may contain areas of both high and low unemployment, as long as the average unemployment for the area meets the threshold. This is due, in part, to the fact that the job creating effects of a project are usually spread over an area far broader than a single census tract. A project in a low unemployment area may well draw its labor force from surrounding areas of higher unemployment. The result is that while the project must be in a TEA, it does not have to fall in the portion of the TEA with the highest unemployment rate. This provides hotel developers with some degree of flexibility in locating development projects.
A primary side effect of the fact that most projects are being marketed at the $500,000 level instead of the $1 million level, is that a project must create more jobs with less foreign investor money, meaning that EB-5 funding can almost never constitute 100% of the capital stack. In order to create enough jobs to meet the ten-jobs-per-investor requirement, there must be additional sources of funding for a project. Investors also want to see that a developer has some of its own equity at risk in a project, and frequently also like to see some amount of bank debt, as a sign that a project has been underwritten. A typical hotel project funded with EB-5 money will have between 30% and 60% EB 5 funding, and a mix of developer equity and debt filling in the rest of the stack.
When an investment is sponsored by a Regional Center, investors are allowed to count jobs created both directly and indirectly by their investment. Outside of the Regional Center context, EB-5 investors can only count the direct, W-2 employees of the new commercial enterprise in which they have invested toward the required 10 jobs. For Regional Center projects, jobs are calculated on the basis of an economic model rather than by counting W-2 employees. The model is based on multiplier tables (including those developed by the U.S. Bureau of Economic Analysis), which predict a certain number of created jobs for a given unit of input. In the hotel context, the three most common inputs are construction expenditures, hotel revenues, and restaurant revenues. The numbers are put into an input/output model, which applies the regional multipliers, to predict how many jobs will be created. For example, if a project has $100 million of qualifying construction expenditures, and the regional multiplier for construction is 15 jobs per million, the project would generate 1500 jobs. This would be sufficient for 150 investors. At $500,000 per investor, the result would be a maximum possible EB-5 investment of $75 million. The multiplier effect for hotel and restaurant revenues works in a similar manner. Using construction expenditures is further complicated by a USCIS policy, which allows for the counting of "direct" construction jobs (i.e. the people employed directly on site) only if the construction lasts longer than two years. If the project lasts less than two years, only "indirect" and "induced" jobs may be counted. These are somewhat complicated economic terms, but explained simply, indirect jobs are defined as jobs created in the supply chain (such as sheetrock manufacturers), while induced jobs are created when the workers at the site spend their paychecks in the local community. The bottom line for developers thinking of using the EB-5 program as a funding source is that the multipliers for construction expenditures are roughly cut in half if the direct jobs are not counted. In the example above, that would mean that $100 million of qualifying expenditures would produce 7.5 jobs per million, or 750 jobs, which would support 75 investors, and an EB-5 capital raise of $34.5 million. Fortunately, jobs created by construction can be combined with jobs from operations (hotel and/or restaurant revenue) to allow additional EB-5 funds to be raised.