By Jim Butler and the Global Hospitality Group® 27 March 2017
Unless Congress acts in time, a critical part of EB-5 financing will lapse on April 28, 2017
The Regional Center program was enacted in 1992 as a “pilot project.” Since then, it has been renewed or extended many times by Congress, with the current extension due to sunset April 28, 2017. Combined with some negative comments by a few foes of the program, some have begun to wonder out loud if the end of EB-5 financing is near. And, if Congress does not act soon, it would have a serious impact on the program.
Important people, is an important part.
What will likely happen if Congress lets the EB-5 program sunset on April 28
Most people involved with the EB-5 industry believe there is little chance the program will not be extended or made permanent. This “pilot program” has been renewed for more than 20 years, and in the last five years has provided hundreds of thousands of jobs for US citizens, and billions of dollars of vitally needed capital for both public and private facilities that would not otherwise have been feasible.
The breakthrough on resolution could come next week (the week of March 27)
Since President Trump’s inauguration, the Administration and Congress have been focused on transition matters, appointments and confirmations, and related issues. However, insiders now believe that by the last week of March, EB-5 industry groups will be able to meet with members of Congress and work through some reasonable resolution of all concerns. A new bill is likely to be introduced shortly thereafter.
After some internal disagreements, it finally looks like the EB-5 industry is coalescing on its priorities and recommendations. Some top experts have said that right now circumstances appear more favorable for agreement and resolution than any time for several years.
Benefits to developers from EB-5 capital
While EB-5 capital can be structured in any form capital (such as equity, senior debt, mezzanine debt or preferred equity), it seems to have created a particular niche as relatively low-cost mezzanine debt. This has been particularly helpful to hotel developers because hotel projects struggle more than other developments to get adequate capital for construction. For example, most senior lenders will not provide more than 50-60% loan to cost, and where it is available, traditional mezzanine debt costs something in the low to high teens. For qualified developers and projects, the EB-5 capital helps bridge gaps in the capital stack, bring down project finance costs significantly and release equity.
If not extended by Congress, loss of the EB-5 program would hurt hotel development
Elimination of the EB-5 program (or major changes that affect its viability) would have a significant adverse impact on new hotel construction and job creation — particularly on larger hotel and hotel mixed-use projects that cost $50 million and up.
If you have a hotel that can be financed with an SBA loan, or a small select service property that a local bank will fund, you may not need EB-5. But construction financing for major projects has never returned to pre-recession levels and EB-5 is a critical part of the capital stack for many of them.
Concerns about EB-5 program fraud and gerrymandering have an easy “fix”
There have been some relatively minor issues with EB-5, but they have been highly publicized and their importance has been blown out of proportion.
Gerrymandering. Fortunately, all these issues can be fixed quickly and easily. For example, one of the biggest complaints is that some projects qualify for the minimum $500,000 investment by “gerrymandering” disparate census tracts to create an area of high unemployment designated as a TEA.
Until now, TEA designation has been left up to each local jurisdiction. Critics say that some states, like New York, were willing to aggregate almost any series of census tracts necessary to get the unemployment rate required to designate a TEA. Other states, such as California, would not permit such gerrymandering, limiting the number of census tracts and requiring them to be contiguous. This meant that many projects in California could not qualify for the all-important minimum investment level.
The gerrymandering issue has very simple solution. All we need is a single national standard as to what qualifies as a TEA. For example, you could limit the total number of census tracts aggregated to ten
Fraud and abuse. The other major bogeyman thrown up in opposition to EB-5 is fraudulent schemes used by criminal hucksters to defraud innocent foreign investors. Everyone in the EB-5 industry is opposed to fraud and abuse. Confidence in the program and highest levels of integrity are vital to the future. But is the fraud and abuse in EB-5 any greater than in other investment areas such as securities markets and real estate investments? (Remember Bernie Madoff?) There does not seem to be any evidence supporting such a contention.
Many experts believe that current securities laws and anti-fraud laws are adequate, if enforced. If anything, laws only need clarification as to jurisdiction and applicability of existing provisions. It is already illegal to defraud someone or sell them interests in a non-existent project.
And in all events, the EB-5 industry is supportive of reforms to improve the industry, protect investors and eliminate bad players. The EB-5 industry has come from obscurity in 1991 to main stream in the past 5 or 6 years. The major stakeholders in EB-5 are institutional, long-term players, and they are taking the lead in working out necessary refinements and reforms.
The impact on developers of the uncertainty on the future of EB-5
The uncertainties surrounding EB-5 has been a Tale of Two Cities for hotel developers. Instead of pursuing EB-5 financing, many developers decided to “wait and see” what happens. Most of them have lost out on financing opportunities and are still waiting.
Others evaluated all the circumstances of their project, found reliable and consistent EB-5 lenders with unblemished track records of success, and proceeded cautiously to take advantage of the opportunity. This is an incremental process, so the effort and expense can be evaluated every step of the way. I don’t know about others, but our developers who pursued this approach have had a 100% success rate, and are continuing to do so even now.
What you should do now if you have a project that might include EB-5
Based on our experience in closing more than $2.1 billion of EB-5 financing for our clients, and 100% track record in securing funding for clients we accept, we believe that Congress will do the right thing and extend EB-5 as a viable program. You should monitor developments on EB-5 closely if you think it might benefit you. Don’t start anything without getting the right advisors and team to avoid costly missteps. Look for experience, experience and experience!
This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. Why don’t you give us a call (or send an email) and let us know what you’re working on? We would like to see if our experience might help you create value or avoid unnecessary pitfalls. Who’s your hotel lawyer?