How should hotel developers go after EB-5 financing?
Although the EB-5 immigrant visa program has been around since 1990, the current trend of using this as a source of financing for hotel development began only three years ago. We worked on one of the first hotel EB-5 financings for the W Hotel and Residences in Hollywood, and have since worked on more than 60 EB-5 projects all over the country. Now, use of the EB-5 financing program has gone mainstream. Headline grabbers include the $400 million financing of the SLS Hotel in Las Vegas, the $100 million Ritz Carlton & JW Marriott in downtown Los Angeles and now the $1 billion Silverstein project to be built in New York City with a Four Seasons Hotel.
As a growing number of savvy hotel developers hurry to assess the EB-5 financing opportunity, they frequently receive conflicting advice as to the best way to pursue EB-5 financing. Many immigration lawyers and advisors tout the advantages of the developer forming its own regional center — basically to shave a few points off the all-in cost of EB-5 financing.
Although this advice may work well for the EB-5 advisors (in that they get $100,000 or more of fees), for most of the hotel developers we know, forming a captive regional center is a bad idea. This article should provide a note of caution for developers considering this course.
Based on our extensive experience with financing hotel development from EB-5 funding sources, we believe that the answer for most hotel developers will be to obtain “preferred” status for themselves and their projects — if they can do so — and to tap into the very best established EB-5 funding sources. For more on this approach, see “Hotel development financing: How to win the race for EB-5 capital.“
Restricted capacity in channels for accessing EB-5 capital
As hotel developers compete in a very crowded field seeking EB-5 funding, there is something of a race to gain access to limited channels for tapping EB-5 capital. The restricted capacity is the limited bandwidth of the channels for accessing the pipeline of foreign investors. There is no shortage of EB-5 investors or developers seeking the capital. The channels for bringing the EB-5 investor money to developers have simply not been able to keep pace with the explosive growth.
The problem is the limited capacity of the pipeline or channel for connecting EB-5 investor money with all the would-be consumers of EB-5 capital. As some indication of the explosive growth straining the existing capacity of the system, 126 visas were issued under EB-5 in 2004 and that number is expected to approach the maximum statutory limit of 10,000 visas in 2014. Most of that growth has occurred in the last three years.
Explosion of new regional centers — most of which have no fund-raising experience
Along with EB-5 visa issuance, the number of regional centers approved by the USCIS has exploded over the past ten years from 10 to more than 532 as of July 1, 2014 according to official USCIS listings. And more than 300 of those regional center approvals were issued in the last two years. We believe that less than 10% of the approved regional centers have successfully closed financings totalling more than $5 million. But all of these regional centers are potentially offering their services to investors hungry for EB-5 capital.
A regional center approval from the USCIS is akin to a license to participate in the EB-5 chain of capital raising. It is only the first step in a long and difficult process of establishing a successful capital-raising machine. While status as an approved regional center enables increased job count for projects handled by the center (by counting direct, indirect, and induced jobs), it does not confirm any ability or experience in raising funds. And the strongest regional centers that have successfully closed EB-5 deals, have been committed to the business for years. These veteran organizations have established and maintain a regular operating presence in China, built a strong and permanent marketing organization in China, grown investor demand for their offerings based on their track record of getting visas for investors, and have regularly delivered funding on their promises.
Daunting hurdles for new regional centers
Newcomers to EB-5 funding find competition with the established regional centers to be daunting. The EB-5 investors want to know the track record of the regional center marketing a project. What percentage of their investors have gotten their green card? How many have failed? How many have been deported after moving to the US?
The best marketing agents to present projects to investors want to work for the best and most established regional centers. Why should they try to compete with established track records, duplicate organizational structure, and teach someone about the business?
It is difficult to recruit, train and oversee talented marketing agents, particularly in an increasingly regulated environment where the US securities and exchange commission continues to impose new requirements on top of all the complexities of immigration laws.
In short, there are too many regional centers already, and most of them have no organization or proven ability to raise EB-5 financing, much less to do so in a timely, cost-effective or reliable way.
Warning! Forming a regional center means getting into the immigration business
Many developers are being led to form a regional center because of bad advice. This approach should be selected only by those developers who cannot qualify for the “preferred” status or those who genuinely want to get into the immigration business for other reasons. This path should not be chosen to save a few percentage points in the cost of funds or in the mistaken belief that it is an easy path to follow.
Perhaps an example will help. In the heyday of real estate syndications (selling limited partnership interests to raise capital to buy commercial real estate), syndicators often started raising capital among their family, friends and business associates. But as more deals came, and as the capital recruit acquired grew larger, the syndicators usually ended up going to regional brokerage firms to raise their capital. In one sense, the capital was “expensive.” The cost of using such brokerage firms often ranged up to 8% of the offering proceeds. But the use of professional securities salesmen permitted the syndicators to focus on their core business of identifying great real estate investments, adding them under contract, repositioning them, and managing them profitably.
Perhaps one syndicator in 100 – or maybe one in 1000 – decided to take over the capital raising function by forming a captive brokerage firm. This was really an entirely different business from the core real estate business of the syndicator. It has unique capital requirements, licensing issues, regulatory compliance, liabilities and costs. Most real estate investors were well advised to stay out of the investment banking/capital raising business.
The same considerations apply to a developer looking at EB-5 financing. If the developer cannot qualify for “preferred” status, to a greater or lesser extent the developer may find itself getting into the immigration business. The developer may form a regional center, or will seek to identify regional centers to rent or otherwise cobble together with marketing agents and other compliments of the EB-5 capital raising chain. This is a difficult, time-consuming and somewhat risky course to set unless the developer fully understands the nature of the commitment, effort and capital likely to be required. This is not for the faint of heart.
The developer will be competing with a handful of dominant players who have been established for years. They have spent a vast amount of time and money to build their presence in China, along with their marketing organization, infrastructure, systems, forms and reputation amongst the EB-5 investor community.
A few final words on developers forming their own regional centers
An extraordinarily high percentage of developers who initially believe they want to build their own EB-5 infrastructure will ultimately abandon their path. Although we can help clients pursue this path with any or all of the steps it takes, developers need to understand this alternative involves setting up an entirely new business – the immigration business. It takes a long time to get regional center and project approvals, and even longer to push projects all the way through the EB-5 pipeline so that you can show new investors that all your prior investors got their green cards.
Most of our clients find that it is far better to connect with and rely upon well-established major players in the EB-5 financing chain.