Q&A: EB-5 Stakeholders Bank on Future Changes
A program that became a vital source of capital following the last downturn is getting a makeover. We asked Mark Edelstein of Morrison & Foerster to explain the impact of the overhaul on U.S. sponsors.
New EB-5 rules went into effect last week and stakeholders are reacting. In order to sort out what these and proposed program modications mean for U.S. sponsors, Commercial Property Executive and Multi-Housing News interviewed Mark Edelstein, Morrison & Foerster’s global real estate group chair. Edelstein represents U.S. investors using EB-5 investment money to help fund projects and senior lenders with interests in capital stacks that include EB-5 capital.
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First, what role has the EB-5 investment program played in the commercial real estate industry historically?
Edelstein: EB-5 has, since the downturn, provided relatively inexpensive capital for purposes of real estate projects and real estate development. The program has been around since the early 1990s, but until around 2007 or 2008, it had been used primarily for investment in operating businesses and, at the time of the downturn when liquidity dried up in the market, hotel companies. Later, developers found that that was an available source of capital. It sort of took off around 2008 or 2009 until the present day.
Can you highlight some of the criticisms that brought about these changes?
Edlestein: Some of the criticisms of EB-5 included the lack of supervision by the USCIS (U.S. Citizenship and Immigration Service) in terms who could be EB-5 Regional Center capital providers. There wasn’t a lot of oversight. So, for example, you could be a felon. You could have spent time in prison. You could have filed for bankruptcy five times, sued the government, sued your lenders and still gotten a license to provide EB-5 Capital.
The bigger criticisms, or the most notable in the media, have been the large number of fraud cases where money was raised for purported projects that didn’t really exist. Foreign investors’ money was stolen.
A third set of criticisms was some people in the EB-5 industry didn’t comply with all the securities laws and, as a result of that, the Securities & Exchange Commission and the Financial Industry and Regulatory Authority had investigations into both individual projects and the way Regional Centers ran. The net of all that is that there are a lot of proposed changes to improve the EB-5 program.
One other criticism that did go into the revisions is that there are two sizes of investments for EB-5: a regular investment until last week was a $1 million and an investment in a high unemployment area, known as a Targeted Employment Area, was $500,000. And the way they were calculated was determined by each of the states, and they permitted developers to aggregate census tracts–commonly known by those outside the industry as gerrymandering.
So, a lot of criticism. Also lots of successful projects at the same time. But there’s been a cry for years to try to improve the program in a logical way.
What are the key changes?
Edelstein: Last Thursday, the USCIS, the agency that runs the EB-5 program, which is a subset of Homeland Security implemented self-regulation. Six months ago, they published changes to the program in an effort to fix a couple of things in EB-5 because they saw that Congress, after years, couldn’t seem to be able to get it done.
There are four or five changes, but two or three really key changes. The investment amounts hadn’t been changed since the inception of the program in 1990 and, as a result, they were indexed for inflation. The new investment amounts went up pretty dramatically from $1 million to $1.8 million for a regular project. And the amounts for the high unemployment TEA locations went up from $500,000 to $900,000. The cost of a non-TEA is (still) twice the cost of a TEA.
The second change that people may not appreciate yet is one I mentioned earlier. The party that decides whether it’s a TEA is now the federal government. They are no longer going to refer to the state. And so there’s some concern that that might create backlogs and some related issues. And they changed the definitions of a TEA to prohibit the sort of gerrymandering of 10 or 12 census tracts to hit the target. Under the new rules you can really only blend with the adjacent census tract if your project happens to be on the border. You can’t take 10 or 14 census tracts and average them out and say you are in a high unemployment area. In urban centers–like L.A., San Francisco and New York–it will make the lower threshold investments much harder to come by.
Then there’s a couple of changes about investors staying in line and helping families. But for the purposes of the users of the capital, those were the really big changes.
What have stakeholder reactions been to the changes, which were actually announced six months ago?
Edelstein: There was a pretty wide reaction. Most of the stakeholders in the industry don’t like the new investment amounts. There was talk for quite a while about lawsuits being filed against the government to either slow down or challenge the rule changes, which you see did not happen. There was concern that the increased amounts will make it harder to raise EB-5 capital because they now have to go to much wealthier people and the number of potential investors will decline. The flip side, of course, is each investor will be putting in more money. But the feeling is it’s going to make it harder to raise the money for purposes of new EB-5 investments.
One of the other reactions is a lot of those same stakeholders hope that a key bill (S. 2778) circulating in Congress—there are actually a couple of bills–would actually overhaul EB-5 in a much more significant way. And one of the changes in that bill was to change the investment amounts in a less Draconian way. Under S. 2778 investments amounts wouldn’t be $900,000 and $1.8 million. They would be $1 million and $1.1 million. The difference between a high employment TEA and a non-high unemployment area was really only a $100,000 difference and the high end of the investment is no longer $1.8–it is $1.1 million. More people would be eligible to invest in the program.