By Brian Ostar / Issue 2
For EB-5 projects, the rules of prudent investing still apply. The greatest risks in any project can be tracked to a disregard for this principal. EB-5 projects need to be safe investments and follow the market rules of investing. Once a project has been evaluated with normal standards for investment, it can then be evaluated for EB-5 specific risks. Any departure from market standards of risk will lead to an increased risk of capital repayment for the investor.
At EB5 Capital, we like to caution investors to first look at whether the investment would be of interest if not for their interest in EB-5 (aside, of course, from the lower rate of return, which is standard for all EB-5 projects). Investors should look at the same criteria we look at when we underwrite a project. One must first look at the investment components for financial risk, and then look at the components for immigration risk. Financial risk is associated with location & timing, developer experience, market characteristics & competition, transaction structure & financing, and regional center experience. All of these factors interact and any one of them can override the safety of another factor. A project can be in a great location, but if the rest of these factors are weak, then the project may be unsafe for the investor. It’s the job of independent regional center operators to perform due diligence and stress-test all of the factors related to a project.
The quickest way for an investor to limit their investment risk is to research regional center operators. A regional center operator with many successful projects, multiple projects receiving I-829 approvals, and a record of a return of capital is more likely to have a disciplined underwriting process that continues this record of success. The bottom line is to look for experience in every choice.
The old adage of “location, location, location,” is true. Location matters when reducing the risk of real estate investment. But it can also lead to overpaying for an asset and reducing your upside if you buy into a high-demand market. You see inflated pricing for assets in many top world markets like London, Dubai, New York and Shanghai. So as much as location is a factor for safety, timing is a factor for success. If you invest in the right location at the wrong time, you may have limited profit if you build at the top of the market. It is sometimes safer to invest in a secondary market that has more growth potential. Although we focus our investments on gateway cities like Washington, D.C., New York, and Los Angeles, we have always invested in secondary cities such as Portland, Nashville, and Baltimore.
Location is really shorthand for knowing what is happening around the proposed project. The best way to know what is happening is to choose an experienced developer with a track record in similar environments. Such a developer will know what to look for when assessing the risk of the location. The developer can be new to a city but should have experience with similar cities. For example, you might not want to choose a suburban developer of estate homes to develop a high-rise in downtown Manhattan. The developer may have difficulty in the new environment. One must analyze the market characteristics of the particular location, as well as the competition – both current and future supply.
You can have the best project, in the best location, with the best developer, but the transaction structure or project financing can be unfavorable to the EB-5 investor. This is the most common place where risk to the EB-5 investor surfaces in EB-5 projects. There is a saying that applies here – “the devil is in the details.” The structure of the capital stack, events of default, major decision rights, and other protective features need to be in place to protect the EB-5 investor in their passive investment role.
Above all else, the only way to protect an investor is to choose a strong, independent regional center with a long and consistent track record of protecting investors. The experienced regional center will have significant reputational risk with each new transaction and every decision will be made to protect the investor. While project location is important for success, it is just one of many factors that must be considered when evaluating a project.