By Devin Williams / Issue 2
Understanding what separates a solid EB-5 project from a risky project will protect your investment and your Green Card. A few well-known benchmarks to assess include: a Regional Center (RC) with a 100% track record on I-526 and I-829 approvals, solid job creation estimates with a job buffer of over 150%, and an impeccable developer track record.
However, several key factors often go unnoticed despite contributing to the success or failure of your investment. We will outline these key factors, and demonstrate how to choose a strong and safe investment.
Capital Stack and Low Debt Burden – Investors must evaluate the entire capital stack, not just the EB-5 piece. It is not enough to say that EB-5 is “only a 30% loan” if the EB-5 is behind (in second position) a 50% senior loan, because this means the project is actually 80% total debt. Look for projects with low total debt (ideally below 55%) which provides flexibility for weathering unexpected economic downturns. An EB-5 investment is for 5-7 years, you need to know that your capital is safe over the entire life of the investment.
Alignment of Interests – Ask how your RC is being paid. It is important for the RC and the investors to be in alignment. This means that what is in the investor’s best financial interest is also in the RC’s best financial interest. Alignment of interests means that the financial structure of the project should motivate the developer and RC to make decisions that benefit the investor, and the project documents should detail this alignment of interests.
In most EB-5 loan projects, the developer and RC are not aligned with the investor. In fact, they have a financial incentive to keep the loan outstanding as long as possible, even if investors are eligible to receive their capital back. This is a problem. If a RC makes all their profit from interest on the loan, then the longer the loan is outstanding, the more money the RC makes. This creates a conflict between the desire of the investor – to receive their capital back, and the desire of the RC – to keep the loan outstanding.
Additionally, with loan projects, RCs earn all of their profits over the life of the loan (through interest payments), and therefore repayment performance is not factored into their compensation. Fundamentally, this is a huge misalignment of interests. It means that the RC will make the same amount of money if the EB-5 investor receives 100% of their capital back, or if the EB-5 investor receives none of their capital back.
At EB5 Global, we build financial penalties for the developer and the RC into the structure of our deals. If there is a delay returning the investor capital, the developer and the RC are both subject to financial penalties (and our investors earn increased returns). These penalties create motivation for both the RC and the developer to return capital as quickly as possible.
Most importantly, at EB5 Global, our primary source of profit is not earned until after our investors are fully repaid. The developer and EB5 Global do not participate in the profits of the sale until our investors receive 100% of their capital back.
There should always be a financial penalty to the developer and the RC if the EB-5 investment is not repaid in full.
Project Location and Market Demand – Many investors select projects based solely on a big city location, but real estate is cyclical and you want to invest in a market at the right time. For example, in 2017, New York City condominium prices declined due to an increase in inventory, with tens of thousands of new units coming into the market over the next two years, signaling a softening of the market (Source: CNBC).
Similarly, the Manhattan hotel market has seen a huge increase in new room supply for five years, resulting in an oversupply of rooms, which led to a decline in the Revenue per Available Room (“RevPAR”) measure since 2014 – a key indicator of the financial health of the market (Source: Forbes).
Look deeper, do not assume a premier city will automatically lead to success. Ask how the local market has been performing and how much new supply is projected. For example, San Francisco is a premier city, but its hotel market is extremely healthy due to the limited supply of new rooms over the last five years, and limited supply of new rooms forecasted over the next several years. This has led to occupancy rates over 87%, and double-digit year over year growth in Average Daily Rates (ADR) and RevPAR since 2010 (Source: HVS Market Pulse).
The bottom line: Dive deeper rather than assuming that a well-known city will deliver financial success.
Financial Projections –Be sure to ask the RC who developed the projections. For instance, on a hotel, the hotel management company (e.g., Marriott, Hyatt, Proper, etc.) should generate and approve the projections, not the developer. Avoid projects that require above market occupancy or absorption and aggressive rents or rates.
At EB5 Global we protect our investors’ money by starting with conservative projections and then exceeding them. As a result, we have an exceptional track record. Every one of our hotels has outperformed our original projections. By using conservative projections and a strong capital stack, we keep our investors’ capital safe over the life of their investment, regardless of market conditions.
Marriott Residence Inn, Portland, Oregon: An EB-5 Real Estate Success Story
The 223-room Marriott Residence Inn was Oregon’s first EB-5 project. Developed by Williams & Dame Development, EB5 Global’s sister company, the hotel opened in Portland’s Pearl District in April 2014 – on budget and a month ahead of schedule. The hotel has a great location, experienced development team, strong market fundamentals, a safe capital stack, and conservative financial projections. As a result, the hotel has doubled our initial Net Operating Income estimates.
The $51,000,000 hotel was built using $44,000,000 in EB-5 equity and a $7,000,000 construction loan. With only 13.7% debt, the hotel has been an extremely safe investment. Due to the exceptional performance of the hotel, investors received their full 15% ($75,000) profit eighteen months after opening.
The strong performance of the hotel has led to purchase offers of over $85,000,000 in 2016, allowing us to repay investor capital in full as soon as we are permitted by USCIS.