EB-5 projects that are not fully financed pose a high risk for EB-5 visa applicants.
Financial markets worldwide, and particularly in the United States, are facing a pronounced downturn in 2023. Surging interest rates needed to stave off inflation will slow economic growth in the United States and have already proven detrimental to the financial markets.
This trend, which is expected to continue throughout this year, has important ramifications for the real estate development industry and, in turn, for the EB-5 investment space.
To qualify for U.S. Green Cards, EB-5 investors are required to create 10 jobs as a result of their capital, which is usually invested in real estate development projects. Moreover, EB-5 program regulations do not allow EB-5 visa applicants to receive any contractual guarantees of repayment.
These two policies create a degree of immigration and financial risk for EB-5 investors.
Due to the economy’s exceptionally volatile state, it is now more important than before for EB-5 visa applicants to invest in projects that are already fully funded. EB-5 investors’ chances of immigrating to the United States and receiving a timely return on their capital depend on investing in a project with a solid capital structure.
Rising Interest Rates Create a Grim Outlook for U.S. Financial Markets
On February 1, the Federal Reserve announced yet another interest rate hike, raising it to 4.50%–4.75%. This is one of the highest U.S. interest rates since the 2007-2008 housing market crash, a necessary measure in view of growing inflation.
At the same time, higher interest rates make borrowing capital more expensive, which in turn hampers economic growth and demand. Federal Reserve Chairman Jerome Powell has noted that the Fed will “take into account the cumulative tightening of monetary policy” and “the lags with which monetary policy affects economic activity.”
Higher interest rates already had a noticeable effect on U.S. financial markets in 2022: according to the FT Wilshire all-cap index, stocks lost $12 trillion of market capitalization from January to October 2022. Similarly, the S&P 500 fell approximately 12% year-on-year in October 2022.
Morgan Stanley’s chief U.S. equity strategist, Michael Wilson, predicts that the S&P 500 could fall a further 20% in 2023. Backing his projections, fourth-quarter earnings reports released in January 2023 reveal a 5% year-on-year decline in earnings per share for S&P 500 companies.
On February 6, 2023, Bank of America Vice Chairman Keith Banks gave his outlook on where the U.S. economy is headed this year: “We think as the economy slows, revenue is going to slow, and as a result, you’re going to start to have some margin pressure and also negative operating leverage, none of which is good for earnings.”
In addition, the Economist observes that, in view of these massive losses, “it is hard not to feel a sense of foreboding” about what is in store for the markets in the coming months.
Interest rate hikes will apparently continue for the time being, as Powell recently stated that “it is very premature to be thinking about pausing.”
Impact on the Real Estate Development Sector
With the rising cost of credit, it will become increasingly difficult for the real estate development industry to secure new loans to finance its projects, even from major banks.
Morgan Stanley managing director Betsy Graseck acknowledges that securing a loan is significantly less likely given the interest rate hikes: “In the most recent senior-loan-officers survey every single question they asked bankers about financial conditions flipped to tightening, all at once. I have never seen that before.”
Financing a real estate development has simply become too expensive in most cases, and a dearth of lenders with capital to risk will surely make the following months difficult for the real estate sector. A number of major banks, including Wells Fargo, have already exceeded their loan ceiling, and other leading financial institutions, such as JP Morgan and Bank of America, have paused financing for commercial real estate ventures.
This trend, which began in mid-2022 and has continued into 2023, follows a particularly active first semester in 2022, during which U.S. banks financed $316 billion in loans for real estate developments. Real estate investment banker Michael Van Konynenburg states that “there is now more caution due to economic uncertainty as the Fed tightens.”
Impact on EB-5 Real Estate Development Projects
Most EB-5 visa applicants invest in real estate developments to qualify for U.S. Green Cards. The EB-5 program requires EB-5 applicants to invest at least $800,000.
In light of the significant financial commitment involved, EB-5 applicants look for the projects that are most likely to fulfill the EB-5 program’s requirements for immigration and succeed financially.
However, the current economic outlook makes EB-5 projects that have not yet secured financing extremely risky for investors. With the high cost of credit and with major banks unavailable for loans, such projects are highly unlikely to reach completion, create 10 jobs per EB-5 investor, and ultimately help their investors immigrate to the United States and receive a return on their funds.
The most important takeaway for EB-5 investors is that projects that have not yet secured a senior loan from a major, third-party bank pose an extremely high risk.
Projects that rely heavily on EB-5 funding are even riskier: should these projects fail to raise all of their projected EB-5 capital, they are likely to fail early on.
Certain real estate industries also constitute a higher risk for EB-5 investors. This is particularly true for hospitality and luxury real estate developments, both of which require significant upfront costs before generating revenue. Moreover, these real estate asset types rely on demand projections that may be significantly lower than expected, as the upcoming economic downturn will likely have a negative impact on tourism and luxury real estate.
The upshot of these trends is that hospitality and luxury real estate projects are especially unlikely to get new financing.
How EB-5 Investors Can Identify Safe Projects
The uncertainty in the commercial real estate sector makes it crucial for EB-5 investors to select projects that are already fully funded.
Projects that are already fully financed also have a distinct advantage regarding job creation. Most EB-5 projects calculate job creation through econometric modeling that estimates job creation based on construction expenses. These economic input-output models typically estimate the creation of approximately 10 jobs for every $1 million spent on construction.
Therefore, if an EB-5 visa applicant invests in a project that is already fully financed and has already started construction, some or all of the necessary jobs may already be created. Projects like this effectively reduce investors’ immigration risk. In addition, if the project is already fully financed regardless of how much EB-5 capital is raised, it is very likely to reach completion and repay investors’ funds promptly.
If a project complies with the above criteria, has already started construction, and relies mostly on senior loan financing and developer equity, it is likely a low-risk option for EB-5 investors.
Sid says that you need to analyze the capital stack when choosing an EB-5 project to invest in. Here’s why.
Not sure if an EB-5 project you are considering is fully financed? Simple, just ask.
Send an email in writing to the EB-5 project sponsor (usually the General Partner) of the EB-5 investment fund and ask the following:
“Can you confirm that this EB-5 project has (i) an executed senior construction loan, (ii) that the loan has already been funded, and (iii) is currently in good standing?”
If the project sponsor refuses to put anything in writing, you should avoid the project completely, and if you do get an answer in writing that is anything other than “Yes, Yes, and Yes.” then you should eliminate the project from your consideration unless you are willing to assume significantly higher immigration and financial risk on your EB-5 investment.
Find a Reliable EB-5 Project with EB5AN
As one of the leading fund managers and regional center operators in the EB-5 investment space, EB5AN has helped more than 2,000 investors find low-risk projects that maximize their chances of immigration and financial success. We only work with best-in-class projects that are financially viable in the long term, can fulfill all of the EB-5 program’s criteria for immigrant investors, and have a solid capital structure that avoids reliance on EB-5 financing.
For more information on how to find the safest EB-5 investment opportunities, schedule a free consultation with EB5AN.