The evolution of EB-5 hotel financing
13 JULY 2015 6:33 AM
EB-5 financing, a vehicle that provides visas to foreign investors, is not right for every hotel project but can be an effective part of a development’s capital stack.
REPORT FROM THE U.S.—For nearly 25 years, EB-5 financing has been a vehicle to link foreign investors with real estate projects, including many hotels, in the United States. As EB-5 moves from a financial oddity to a mainstream product, the platform is evolving in a number of ways and faces several challenges, sources said.
“The market has become ever more sophisticated over the past several years, meaning investors are looking for better projects and developers with solid track records that will more likely protect those investments,” said Jim Butler, partner at Los Angeles-based law firm Jeffer Mangels Butler & Mitchell and chairman of the firm’s Global Hospitality Group. “It has become a steady and reliable source of additional capital for U.S. developers, although it is increasingly harder to access.”
Congress created EB-5 in 1990 to stimulate the economy by creating jobs and attracting additional capital for U.S. businesses. The mechanics of EB-5 are straightforward: In exchange for a U.S. visa, a foreign investor makes a minimum capital investment in a U.S. business that creates an additional 10 full-time jobs for U.S. workers.
The required investment is $500,000 for companies in defined zones with high unemployment or in rural areas. In other locations, the minimum investment to receive a visa is $1 million. In 2014, 10,692 EB-5 visas were issued, with 85% of them going to investors from Mainland China.
Hotel developers have deployed EB-5 financing for part of the capital stack for a variety of projects. Williams & Dame Development and sister company EB5 Global have in the past 13 months opened four hotels using EB-5 financing, said Devin Williams, president.
The EB-5-financed projects include a combined 393-room Courtyard by Marriott/Residence Inn dual-branded property at L.A. Live in downtown Los Angeles; a 223-room Residence Inn in Portland, Oregon; and a 203-room Hyatt House in Portland. Another project, the 135-room Proper San Francisco, is under construction and scheduled to open in 2016.
Williams said the EB-5 money constituted from between 60% and 90% of the projects’ total equity. Low leverage construction financing provided the balance of the capital stack for most of the properties. For the San Francisco Proper project, Williams and Dame also accessed New Market Tax Credits and Historic Tax Credits.
“The criteria for a successful EB-5 project is essentially the same as the criteria for a conventionally financed project,” Williams said. “It must be a high-quality project in a strong market with an experienced developer possessing a great track record.”
Is it always a good idea?
Not all hoteliers agree EB-5 is a proper financing vehicle for hotel development.
“Generally speaking, EB-5 is what I call stupid money,” said Bashar Wali, president of Portland, Oregon-based Provenance Hotels. “It’s so easily available and cheap that it makes projects happen that shouldn’t probably happen.”
He said some projects done with EB-5 make sense, such as the two Portland hotels by Williams & Dame, because “they did it right and well and they put (EB-5) to use for the proper reason.”
“But some people misunderstand EB-5. They think it is an ATM; you stick in a card and money comes out,” Wali said, adding he’s considered EB-5 financing but found traditional sources of money a better fit for his projects.
“In reality, it is very complicated and takes a long time to execute,” he said. “And it is getting more complicated because the investors are getting more savvy, and since they’re seeing thousands of projects they’re more selective.”
Butler of Jeffer Mangels Butler & Mitchell said the increased competitiveness of the EB-5 market is good for all parties involved.
“Everyone is looking at these deals very hard, and developers have real skin in the game,” he said. “Generally speaking, EB-5 is 30% to 40% of the (project cost). It’s typically mezzanine and not generally senior debt or equity. It could be, but that’s not where it is going.”
EB-5 financing has been somewhat controversial over its history. Some critics believe it doesn’t create the economic benefits the law’s sponsors promised and it is merely a way for wealthy foreigners to buy U.S. citizenship. Charges of fraud also occasionally surface, as did a recent case brought by the Securities and Exchange Commission against a Florida company that brokered more than $79 million in EB-5 financing but wasn’t properly registered.
Congress is discussing legislation to reauthorize the EB-5 program and to tighten security measures around EB-5 investments. The American Job Creation and Investment Promotion Reform Act in the Senate and a sister bill in the House of Representatives would give the Department of Homeland Security and the SEC additional oversight authority.
If passed as is, the law also would increase investment thresholds for qualified EB-5 investments: to $800,000 for projects in rural and targeted unemployment areas and $1.2 million for other projects.
“We’ll get the reauthorization, but there are some issues with the new legislation,” Butler said. “However, if the minimum investment levels go from $500,000 and $1 million to $800,000 and $1.2 million there won’t be any significant impact.”
Another change is a widening of the pool of foreign investors interested in EB-5, although in 2014, South Korea and Taiwan trailed China by a wide margin as EB-5 source markets.
“That’s changing, and it will continue to change,” Butler said. “There is a lot of talk and interest in India, Korea and Latin America, but it’s going to take awhile. In China, the population knows the program and has been using it for years. While all of this is established in China, it is dead zero in these other countries.
“How do you get people to come to an investment seminar if they don’t even know what EB-5 is?”