Webinar: EB-5 Diligence and Real Estate Investment Fundamentals With Investment Banker Siddharth Agarwal

 
Sam:
Hi everyone. This is Sam Silverman, managing partner of EB5AN. Thank you for taking time to join us for today’s webinar presentation. Today we’re going to be discussing EB-5 project due diligence and real estate investment fundamentals. We’re going to be discussing this important topic with Siddharth Agarwal, an EB-5 investor in our Twin Lakes rural EB-5 project who is from India. We’ll introduce him in just a few minutes. This is a quick overview of the topics we’re going to cover today. A little bit about EB5AN. We’ll talk about different types of real estate, supply-demand, capital stack basics for projects, the importance of developer reputation and track record, and access to capital in the current financial markets. A focus on growing markets in the US for investment. We’ll also cover a detailed investment framework that EB-5 investors can use as they evaluate potential projects. And then we’ll chat a little bit about Kolter and the Twin Lakes rural EB-5 project at the end. First, a little bit about EB5AN. We’re a national regional center and investment company. We’ve worked with thousands of investors from around the world.

This is a map showing where many of our investors have come from over the years. Most important here is that people from many nationalities and backgrounds all over the world have consistently found value in our investment approach to the EB-5 visa program. This is a map showing the coverage of many of our EB-5 regional centers. We operate one of the largest regional center networks in the US. This slide shows the two managing partners. As I mentioned earlier, I’m Sam Silverman, one of the two founding partners. My bio background is here on the left hand side, and as I mentioned at the beginning today, we have the pleasure of having Siddharth Agarwal, one of the EB-5 investors in our Twin Lakes rural EB-5 project. Sid is a finance guru and has graciously offered to share a little bit of his weekend with us to share some of his insights, having just gone through the EB-5 investment process recently. So with that, Sidd, I’ll let you take over, introduce yourself and then we can get started on the core of the presentation.

Sidd:
Thank you, Sam. Great to be here. Before I start, I think I’ll just give a brief introduction of what I’ve done so far in life and what makes me want to volunteer for this. Before that also, there’s a disclaimer. The disclaimer is that what I’m doing here today is strictly voluntary. A number of folks have approached me in the past after my first interview was posted, after I filed my EB-5 application, to get advice on the projects that they were looking to invest in. And it turns out that some people have the suspicion that for some reason I’m getting paid by EB-5AN or any other agency to advise people. I just want to make sure that I’m very clear about this. I am not getting paid to do any of this. This is purely in a volunteer capacity.

Now, the reason why I’m motivated to volunteer is because, when I started diligencing EB-5 projects, (given the fact that I have an above average understanding of how finance works and how real estate works), I realized that, unfortunately, the EB-5 industry is a bit of a suspect, for lack of a better word, when it comes to the kind of projects that are often in the market for EB-5 investors. They are often unsuspecting and not very financially sophisticated individuals, but for family reasons or from a career standpoint want to make the US their permanent home. And I realized that, even though this exercise of filing my EB-5 was a big financial constraint on me and my family as well, if I can extend a hand to folks who are also looking to pull themselves out of the quagmire of the H-1B cycle, it’ll probably be helpful to a few people if I take some time out and advise them on what my experience has been.

So, that’s the motivation for me doing this. In terms of my background, as you can see on this slide, I am currently a vice president in technology mergers and acquisitions at a large investment bank. Prior to that, I have a spent several years doing IT consulting back in India. I’m an engineer, much like most of the Indian EB-5 applicants, and then spent two years in business school in North Carolina, after which I started my banking career back in 2017. So, almost six years of investment banking experience, just drowning in financials and spreadsheets day in and day out. A lot of things that are probably not very obvious to other EB-5 investors jump out to me at times when I’m looking at the documentation that a lot of these projects are offering.

Real Estate Asset Classes in EB-5 Projects

That being said, Sam, we can probably move to the next slide. I think one important slide that we have here is the one that talks about what kind of real estate exists in the US, what is the categorization of that real estate, and how to think about the cashflow characteristics of these different types of real estate projects. And I think for an EB-5 investor, the most important thing besides your Green Card is a lot of people ask me, “Okay, do you think this is a safe project? Or do you think that Twin Lakes project is a safe project?” Now, there is no straight answer to a question about whether a project is a safe project. Number one, there is no such thing as a safe project. Every business proposition carries some sort of risk with it, whether quantifiable in terms of financial risk or qualitative, but there is always a certain amount of risk.

Now, what is very important in the case of real estate, or even in the case of buying shares in a company in the stock market for investment purposes, is the cashflow generation ability of that project. And it is also important to understand that, if you are putting $800,000 in today, what the return profile or the cashflow profile look in the future once the project is ready and it starts getting customers. In that, I think where the real juice, for lack of a better word, is in terms of how you can assess the success probability of a project. Look, there are no perfect answers here.

My views might differ from someone else’s views on a particular project, but these are just purely mine. That being said, there is obviously two broad categorizations of real estate projects. There is residential real estate and there’s commercial real estate. I’d like to talk about commercial first. Commercial projects, they are more like few and far in between when it comes to EB-5 investments; most of these projects are residential or hospitality, which here is classified within the commercial space. So commercial includes multifamily, retail, office buildings, hotels, industrial, sales, storage, and manufacturing. Now let’s tackle each one by one. Manufacturing is anything that is like a factory. So, without taking any names, there are EB-5 projects in the US right now that are building a steel plant. For example, that’s a manufacturing project.

Self-storage or industrial are very often warehousing projects; you have 50,000 square feet or 200,000 square feet of warehousing, which is built in a certain location. And the hope is that the warehouse will either find a permanent tenant, which will be there for at least a minimum period of five years and then renew the lease thereafter, or you just sell the warehouse. Now, leasing in the case of warehouses is more prevalent than outright sale with manufacturing. Just to touch upon that, again, you’re basically building; it’s typically a management team that is looking to build a factory and wants project-based financing for that particular factory. And the returns to an EB-5 investor or any investor in the capital stack will depend on the cashflow characteristics of that project, once the factory is up and running now, then you have hotels—easy to understand hotels or resorts.

There are projects in the US right now which are related to luxury hotels, probably franchise hotels like Hyatts or Hiltons or Ritz Carltons. And then there are luxury resorts which are like a golf resort or a ski resort or something like that. And then you have retails, which is basically malls and office buildings. I have not come across office building or retail projects in my research. Most of the projects that I came across were hotels, warehouses, and manufacturing. Besides the residential ones. Now talking about the risk characteristics briefly with manufacturing, I find that, and we’ll get to this later on in the presentation, I think it’s very project-specific in terms of the factory is going to manufacture. Is the factory going to manufacture a product that is a part of a very cyclical industry? For example, steel? With cyclical industries the problem is that you have to time the market.

You should be entering the market at a time when you expect the factory to get ready in the next two, three years. And then you expect that, in steel, cyclicality will take you to the top of the curve. Unfortunately, if you catch this wave at the time when the cyclicality is going downwards or the industry is kind of going through a glut of supply… A glut of supply means that there is too much steel available or too much copper available, and it means that prices are low, which means these factories, which usually have long-term contracts on their production, are not able to find willing customers to offer them good pricing. And in a situation like that where your customers are squeezing you on a product, which usually is a commodity, you will not be making a lot of money, or the factory in itself is not going to make a lot of money and servicing debt. This is usually the way these investments are structured or servicing convertible debt, and it is going to get very difficult.

Talking about warehouses. Now, this is where I found a very weird (maybe weird is not the right word) or a very clear dichotomy in terms of how these projects work. Look, the problem with warehouses is it’s a binary outcome. Either a big retailer like Amazon or Walmart is going to take your warehouse on a lease and you are good to go for the next five, six years—or they will not. Now, the time when I started looking around, I came across some warehouse projects. And at the same time, luckily reading the newspaper, I found that Amazon was looking to reduce its warehouse footprint. Now, Amazon as a company has a lot of market power. If Amazon wants to reduce its warehouse footprint, there is very little that existing warehouses can do about it. And I do not want to invest my money in a market where there are clear signs of the eventual customer reducing his footprint. This means that there is a high possibility that, even though the warehouse gets completed, it just sits waiting for someone to come and lease it.

Now, the bright side is that somebody will lease the warehouse and you don’t have to worry about cash flows for the next five, six years and your money will come back. But then when you think about investing and forget about your Green Card situation for a while… when you think about investing, always think about the downside. If you take care of the downside, the upside will take care of itself. So, I didn’t want to rest my fortune, for lack of a better word, on a binary outcome—which is as good as a coin plug. Now, from that, let’s move to hotels.

Hotels and resorts are projects which are numerous across the US for EB-5 investors. They are in different locations. They are in California, Texas, probably the northeast, a lot of places. Now, the problem that I find with hospitality in general is twofold. One is a long-term structural macro problem, and the other is just a very industry specific issue. Now, the macro problem is that in a world where Airbnb has democratized access to leisure travel, housing for leisure travel, or even for business purposes. I don’t see hotels growing as quickly or making that much of a profitable business endeavor as they were in the past. So that’s one thing. If I’m traveling with my family, I’m not usually looking for a hotel. I am personally looking for an Airbnb.

And if you think about the industry-specific issue, the industry-specific issue is where is your hotel located or where is your resort located? As the joke goes about real estate, it’s all about location, location, location. In some sense that’s very true for hotels and resorts. You do not want to be in a town of, let’s say, 100,000 people, you do not want to be the 15th Hyatt Hotel. Or in a town of 6,000 people, you don’t want to be a ski resort which has 500 rooms in it, okay? Because you have to make a guess, or rather a guesstimate in terms of what is the footfall that a hotel or a resort is expected to receive in any given year, given the location of the resort or the hotel.

What are the businesses located around this hotel or resort, or what is the real attraction for tourists or business travelers to come to this town? Now that being said, it’s not that every hotel or resort project is a dud, absolutely not. There have been some runaway successes in the past that I’ve heard about, but with most hotels and resorts, the way I would caution an investor is always think about the area where the hotel or the resort is located. Now, marketing materials for EB-5 projects: this is where I think another pain point has emerged with a lot of EB-5 investors that I’ve spoken to. They just tend to believe everything that the EB-5 prospectors are saying on face value when they just decide to invest based on that. The one thing that they don’t realize is any EB-5 agency is at any point of time trying to market a project.

Of course, there is a view that, and there are several agencies, and I would say EB-5 is in that category of investors where they’re trying to find good projects for its investors. But at the same time, it is also a function of supply in the market. And if I am trying to sell a product to a potential customer, whether I’m selling soap or I’m selling a car, or I’m selling a condo building, I’m going to want to show it in the best light. So, it is important for the investor to assess the risk of where this project is located. And you have to look for some very clear signs. Like for example, if a project is being located in an area where you know for a fact that there are not more than 10 or 12 hotels in town—the area is going to see a large defense contractor build a factory that will manufacture jet engines or something like that—that could be that tailwind for a project to succeed, okay?

Because it’s not going to be a small factory, it’ll produce thousands of engines a year. It’ll provide employment to a lot of people. It’ll require a lot of executives and customers of these jet engines to fly into the town, to other factory and things like that. So, you can have a good approximation of how the project is going to perform based on the influx of tourists or travelers into that particular town. So, that’s the key thing that a person needs to assess. And the one thing that I’d like to point out here is that a lot of this data is actually available online. One of the good things about investing in the US, whether you’re investing in stocks or whether you’re investing in real estate, is a phenomenal amount of data available. You can simply just go online and try to look for a hotel to book a room for a few days in that particular town and see the occupancy level of every hotel.

And you will be able to understand very well in terms of what’s really going on in that market, and whether this project is actually going to succeed. And then we come to the next category. So ,taking a step back, I think my view on hotels is I personally deem them to be a very, very risky investment. Most hotels and resorts—in fact, when it comes to resorts, I am even more skeptical, because when the economy declines or when there is a recession or there’s a slowdown, the first thing that people stop doing is discretionary spending. So, projects like resorts fall in the category of discretionary spending.

And I don’t want to trap my capital in an area where the cash flows will be extremely unpredictable, because it completely depends on how consumers are going to behave a few years down the line—which is dictated by how the economy is doing. And that brings me to residential real estate. Now, residential as a category is my favorite category to invest in. Now, it doesn’t mean that every residential real estate project is profitable or will succeed. There are some very clear indicators of demand and supply in the US housing market for different categories of residential real estate, which are published widely. So, it’s very easy for investors to actually go online and find credible data on how different residential real estate markets in different parts of the US are doing at any given point in time.

And just a case in point, for example, the condo/apartment market in the US is significantly overheated right now because there is a lot of supply in the market. And when I say overheated, I don’t mean overheated in terms of prices. I mean there is a glut of apartments in the US now. Now that’s the macro view of how the overall market is doing, but then the investors also need to drill down several layers into the situation at the micro level. What I mean to say is, if I am claiming that the condo market in the US has an oversupply of apartments right now, is that how the Florida market is also behaving, or is that how the California market is also behaving? That’s the question I need to ask based on where the potential EB-5 investment is located. Okay. Now, for example, for EB-5 investors, Kolter has a condo project in Florida in a very good location.

I think that project is almost complete or will be completed in the next six months. That’s the Saltaire Project in St. Petersburg. The Florida market is probably the best performing condo market in the US right now. If you have a product that caters to a premium quality or a premium customer set, which is willing to pay top dollar for luxury real estate, you are most likely going to be very successful selling that project, provided everything else goes well. And that’s simply because… Which brings me to another point that I want to bring out to potential investors: always look at who the eventual customer is. The reason I say that is because when it comes to residential real estate, there are different products available for different categories of buyers. There is luxury real estate, obviously, which is in the form of single-family homes or condos or townhouses for people who are high net worth individuals.

Multi-millionaires, billionaires. If you go to Florida: I was reading the other day about the Porsche Design Tower in Miami and the Armani Casa Tower in Miami. These are apartments that cost north of $15 million or something like that. These apartments are pretty much recession-proof because they are in a state where there is a significant influx of people, which has very business friendly laws, very good tax related laws; you are seeing a lot of rich people moving to Florida. They’re looking for homes. They will want to invest in these apartments or condos or buy one for their own family. It’s a good tailwind that will carry the real estate market there for several years. Now, on the other hand, you have a residential real estate for middle-class people, for working professionals who are either looking to buy a condo if they are in a metropolitan city or are looking to buy a single-family home, if they prefer a more suburban lifestyle. These individuals are usually young professionals, 25, 30, 35 years old.

They are either starting a family or have just started one. They have some savings. They want to buy their first home and just make a permanent place for their families. Those individuals will be dependent on, in a significant way, on the mortgages that banks are offering at any given point of time—which is why you may be reading right now about how expensive mortgages have become. Housing is still expensive in the US despite the fact that the Federal Reserve is trying its best to somehow put the brakes on in terms of the housing market. These individuals depend a lot on mortgages, and there will be some impact to their ability to purchase a home based on where mortgage rates are. And then you come to the third category of home buyers, which is low-income households.

Now, low-income households will most likely buy homes which are either subsidized in some shape or form by the federal government. For example, I came across a low-income housing project in California, which was building some 500 or 600 single-family homes for low-income people. Now, I don’t quarrel with the idea behind why the government is subsidizing these homes. But at the same time, as an investor, you need to be cognizant of the fact that with low-income housing, you are selling homes to people who may not necessarily have a great credit history. They will be significantly dependent on mortgages. And the moment that the housing market has a problem in terms of high interest rates, they will be the first ones who will be most likely to either default on their payments or will start seeing significant delays in sending their mortgage checks to the bank. And that increases the riskiness of low-income housing projects to a significant level. So, as an EB-5 investor who’s basically looking to invest my capital in projects which are significantly safer, versus everything else that’s in the market, that’s probably not a good value proposition for me.

So, I think the key takeaway from this slide, if I have to summarize that in a nutshell, is that you have to assess not just what the marketing brochure about a project is telling you. You also have to take a few steps back and understand what the local market looks like in terms of that project, what the demographic looks like, in terms of who the customer set is eventually, and what are the long-term macro trends that you can see happening in this particular industry. Also juxtapose that with how the macro-economy is doing or is expected to do in the next few years. I want to remind potential investors that there is a lot of data available online for any type of real estate investment project that you’re looking at. I would also strongly recommend that investors do site visits and actually go to these sites in person, spend some time in the area, spend some time in the town or the surrounding areas of a resort where it’s located—to understand whether this is really a location where you will see a significant uptake in the rooms, hotel rooms, condos, or single-family homes that the builder is trying to sell. And that brings me to the right side of the slide, which basically talks about the four categories of real estate in the US: core, core-plus, value-add, and opportunistic. Now, I feel that for an EB-5 investor, it’s not necessary to understand what these definitions really mean, but because it’s on a slide, I’ll just kind of briefly summarize. Core is basically real estate, which is very safe. It’ll provide very stable income to the owners or the investors.

It’ll not require a lot of handholding by the owners. This is the kind of real estate which does not require a lot of active management by the owners of this real estate. They will generate stable and consistent cash flows. I’m basically thinking about a Walgreens drugstore, which has a 30 year lease. That’s a core property. So anything that provides you an income guarantee for the long term—and the long term means three to five years or more—is a core investment. Now, this kind of investment, obviously with the risk. There is a risk and return relationship wherever you go. Given that the riskiness is not very high here, the returns to the investor are not going to be very high. And when I say investor, I don’t mean the EB-5 investor. Later on in our presentation I will talk about why you should not be thinking about making a return in EB5; I have received calls from investors who are significantly interested in a project that is offering them a 5% rate of interest versus a project that’s offering them 0.25%.

But we’ll get to that. And then you come to core-plus real estate. Core-plus is basically an investment with a low to moderate risk profile. So core-plus property is usually… It’s both residential or commercial. They might require a little bit of property investment. There might be some management efficiency that can be extracted by the management of the real estate investment firm to kind of increase the value of that real estate. Now, if you have, let’s say an apartment building that is already existing and has been around for 15, 20 years, obviously there has been some wear and tear, the new management can take over that building. They can put some new fittings in, refurbish parts of the building, and it’s good to go as a new and improved version of the building that can hopefully generate good returns for the investors. And then you have value-add and opportunistic real estate. Value-add are basically investments where… Think about buildings in areas which are probably not doing well because there have been significant adverse economic impacts in that area due to a recession. There are buildings which have occupancy issues, there are management problems. This sounds very much like San Francisco, where I live, because a lot of buildings in both the commercial and the residential real estate verticals at this time in San Francisco are facing significant occupancy issues. And there are buildings that are being sold for literally pennies on the dollar right now because the existing owners just want to get out of those assets. And unfortunately, given the, I would say, political issues in San Francisco, or the crime related issues in San Francisco, there has been an outflow of businesses, as well as individuals from the city.

And then you come to opportunistic real estate. Think about opportunistic as grounds up development, which is basically acquiring land. You acquire four or five acres of land in a certain area where you feel this plot of land could be significantly valuable if you create a family of single-family homes around it—because there is a highway next to it, there is a nice healthcare system next to it, there is a nice school system around. That’s like something that you’re doing from the grounds up. Opportunistic real estate is where 99.9% of all EB-5 investments fall. The reason why I say 99.9% and not 100% is because, maybe there is that one project in the US somewhere and the existing investor just wants to raise capital to make some changes to the project, or make some improvements to the building, and then just sell it to someone. I don’t know.

But pretty much all your EB-5 investment projects are opportunistic real estate, which also leads us to the point about risk versus return. As I said, core real estate is the safest. Opportunistic real estate is on the other end of the spectrum. So, as an EB-5 investor, what you are investing in is the riskiest class of real estate investments in the US. You do not know what the future cash flows for this particular piece of land are going to look like, or this particular project are going to look like, because there is no demonstrated history in the past. The only history that you can have in terms of a demonstrated record is a track record of the developer who’s going to build on this land, which we will also get to at some point in this presentation. So, keep in mind that, as an EB-5 investor, you are looking at a very risky real estate investment. Can we move to the next slide, please?

Sam:
Sidd, I think before we move to the next slide, I think it would be helpful for our listeners maybe comment a little bit about how the Twin Lakes Georgia project specifically kind of fits within the framework of residential real estate and how the potential buyers fit kind of into that landscape for that project.

Sidd:
Again, the EB-5 Twin Lakes Georgia project is an opportunistic real estate project. Of course, at the time when I had invested in the project, construction had already started and some 300-odd homes had already been delivered to these customers, but I would still classify it as opportunistic because it’s still under construction. It’s not a completed project. Now, thinking about where this project falls in terms of the framework that I just provided, it’s single-family homes for senior citizens. Senior citizens means people who are 55 plus. Now, when I assessed the characteristics of this project, I was, as I said before, focused on the downside. And the downside was I could see that the market was undergoing a slowdown. There was a high probability of the economy going into a recession. The Federal Reserve had raised interest rates significantly in a very short span of time through several rate increases, and there was conversation of more interest rate increases in the future.

So keeping the macro backdrop in mind, I found that the best demographic in the US to sell to when it comes to real estate is high net worth individuals, who are mostly recession proof people. They will basically pay cash upfront. And barring that, because I just couldn’t find a project that would suit this requirement, the richest demographic in the US is senior citizens. And this is something that I found online. The reason why is very obvious. You are looking at an individual who is 55 to 60 years, or even more of age. They have spent 25 to 30 years of their adult life as a working professional. The expectation is that they have saved some money along the way. By the time they were 25 or 30 years old, which is going back 25 or 30 years, they probably purchased their first home.

After a lifetime of professional activities, they decide to wind down, retire, enjoy the fruits of their labor in a nice suburban area where people who are like-minded, of a similar age group, and probably also stay close to family who have moved around over the years. So, this demographic, when they are going to buy a home in Twin Lakes, are most likely going to sell their existing home in whichever location they were living earlier. Now, if they purchased this home 25 years ago, there is a significant amount of equity that has built up in their existing home. So, if they sell that home and move, they are going to buy something cheaper than where they were living for the past 25, 30 years. And they will end up spending a lot of that cash on just buying a home in Twin Lakes. That’s a good use of capital for them. Or let’s say they decide to put that house on rent, their first home on rent, and then move to Twin Lakes so that they can get some sort of stable income as well while they moved to a new place in Twin Lakes.

In both situations, the ability of the investor, or rather the ability of the customer to finance the purchase of a home is significantly higher than the ability of an investor who is either a first time home buyer, somebody like me, or is a low income household. That was one of the biggest factors which got me very interested in the Twin Lakes project. And I think that of course there is a certain amount of risk associated with this category as well. Because at the end of the day, it’s not guaranteed that every investor or every customer who’s going to buy a home in Twin Lakes or any other such project in the US is going to finance the home a hundred percent with cash.

They will often take mortgages, but their susceptibility to interest rate movement is not going to be as high as it is for a first time home buyer. Now that being said, I also wanted to point out one important thing, which I kind of missed out early on in terms of assessing EB-5 projects. I personally have a preference for projects where you sell and you get out, which means you build condos, you build single-family homes, you find customers to buy those homes, take them off your hands, and you exit the project. And the reason why I prefer those kind of projects over and above these lease or rental projects is simply because with properties where the builder has a plan to lease those apartments… That happens a lot in New York and San Francisco—builders would build an apartment complex, they’ll have 300, 400 apartments, and then they’ll just rent those apartments out.

The problem with these apartments is that a lot of times, the influx of tenants is totally dependent on, number one, how the economy is doing at the time in that area. And number two, what kind of competing projects or apartment complexes exist in surrounding areas. That means there is not a guarantee of 100% occupancy at all points of time in the future if it’s a leased real estate project. And a lot of times people tend to get flustered by the level of financial modeling, so to speak, that you will have to do to understand what’s really going on in a real estate project. But I think it’s easy enough to do a back-of-the-envelope calculation in terms of “Okay, if this project requires $200 million of investment. They’re building 200 apartments. What is the going rate for a one-bedroom apartment in the surrounding areas?”

If it’s like, $3,000 or something, then $3,000 multiplied by the 200 apartments, you are looking at something like $600,000 a year in rental income. So if that’s the rental income, then you have to take out a lot of costs associated with this project. And these costs, which are spent upfront to build a project, are going to be allocated over several years. And that will not look very good from a cashflow standpoint, because not only does the builder want to turn a bit of a profit or at least recover its costs on the project, but at the same time, the builder also wants to service the debt that the builder has taken to build the project. Now, all that sounds well and good in a location which is projected to see a very high influx of migrants, whether working professionals or other people, because that area is economically booming, there’s a lot of jobs being created, there’s a good school system around, there’s a good healthcare system around. All that is well and good.

But in an area where there is either a predicted decline or there is a demonstrated decline in the economy (in the local economy of the area), residential real estate projects with lease or rental characteristics become unpredictable, and they become much more risky. Case in point being, I came across projects in Oakland, in the Bay Area. And I live in San Francisco, so Oakland is close by. The problem with Oakland is that Oakland has been a troubled area for several years. And this is widely known. There has been a lot of crime in the area. The government has made several attempts to gentrify the area, make it more amenable to industries, or rather companies setting up their offices and young professionals moving into the area and setting up their residences in the area. But gentrification of any such area takes 30 to 40 years.

Places like Oakland are still in the early stages of that transition. Now, there are parts of Oakland which are really good, and the rentals kind of reflect the high demand of the area. But there are several other parts of Oakland that are not that great. And the problem I found with even those projects that were located in good areas of Oakland is the Bay Area in general: post-COVID it has seen a significant decline in the influx of migrants. There is a net decline of around 6% or something from San Francisco itself, where people have either left San Francisco for good and they’ve just completely moved out of California, or they have just left San Francisco and gone elsewhere 40, 50 miles out because a lot of tech companies are now either fully remote or partly remote. So, keeping that long-term demographic trend in mind… That gets reflected in how local businesses are going to behave.

And when I say local businesses, I mean small businesses like restaurants, retail stores, grocery stores. A lot of these businesses are facing the headwind of people moving out of San Francisco. And at the same time, a lot of commercial real estate in the area is also sitting empty, case in point being the Salesforce Tower, which is arguably the tallest building in the western side of the US. The majority of that building is vacant for the simple reason that a lot of businesses have just moved out of San Francisco. And that’s not a good thing for a proposed EB-5 investment project. The riskiness of that project is extremely high. So, that’s something I would caution potential investors against—in terms of making sure that you are looking at an area where there is a net influx of migrants. Can we move to the next slide now?

I think Sam has already done a pretty good job here of laying out what the four different types of real estate categories are, which I described earlier: your core, core-plus, value-add, and opportunistic. And as he rightly pointed out, most EB-5 projects are basically a part of the opportunistic category for the simple reason that a lot of it is structurally based on the laws and the rules laid down by USCIS: it has to be a new project. Because a clear aim of the EB-5 Green card category is to generate more employment in the US. So keeping that in mind, if you think about how an existing real estate project works versus how a completely new real estate project would work, the job creation requirement is just significantly higher in a new construction versus an existing one.

That being said, we moved to talk about some macro factors in the real estate area, which is in terms of supply and demand. I think this lays out some key points which I feel are important to look at and assess whenever you’re thinking about investing in a real estate project. I think the first point is— the basis of any business in the world, wherever you are, is supply and demand for the project, or supply and demand for the product. So, if you think about supply and demand in the US real estate market, when it comes to the kind of drivers that you see in the market today, I think the biggest driver of all is interest rates. That’s the big elephant in the room where the hope that the government has to raise the interest rates high enough starts impacting the housing market.

Now, for people who pay a lot of attention to the CPI numbers every month: while CPI has significantly declined, I think it’s almost 3% now, or close to that, core CPI, or core inflation, is not moving a lot for the simple reason that a big component of core inflation is housing. And the reason why that is happening is because there is still an undersupply of housing in the US at an aggregate level. Now, you would want to contrast this with a statement I made earlier in the presentation. I said the condo market in the US has a glut. So, how do these two very conflicting statements make sense? And they’re both correct, by the way. The reason why those statements make sense is because the US market in general, in terms of residential real estate, is primarily a single-family home driven market.

It is not primarily a condo driven market. You don’t find condos in majority of the areas in the us. But if you go to New York City, then it’s pretty much all condos. Or if you go to Miami, it’s pretty much all condos. So, those markets are driven by condo-related dynamics. But overall, there is still an undersupply of single-family homes in the US. Now, as I said before, you cannot take the statement on face value and just say, “Okay, as long as I see a single-family home project, it should be good to go because there’s an undersupply.” No. You have to drill down and see what the housing market in that particular state of the US and that particular city is doing when it comes to supply and demand. If you are building a condo project in downtown San Francisco right now, I’ll say good luck.

I would probably try to caution you against building it in the first place. But if you still want to go ahead with it… yeah, good luck, probably not going to succeed. But if you are building a condo project in, let’s say, downtown Miami or South Beach, I’m happy to write you a check. It’s that sort of a dichotomy in the market right now. So, I think it’s interest rates that will significantly determine of how the single-family market is going to behave. At the same time, the other driver that you also have to look at is employment. Now, employment is directly impacted by this increase in interest rates. As you can see, there are not a lot of layoffs happening in the US market right now. The expectation was, last year when rates started increasing, that by 2023, or mid-2023, you would start seeing a lot of layoffs happening across different sectors of the economy.

That has not really happened. There have been significant layoffs in technology, but technology is a very small part of the US economy overall. The most significant parts of the US economy are other things like healthcare, retail, manufacturing; a lot of other areas. And those things have not really seen a significant layoff situation or any significant bankruptcies happening. Now as a banker, I can tell you that given that rates are very high right now, there are a lot of companies in the US which, in the past few years, before rates were not so high, raised significant amounts of debt because it was cheap. And a lot of that debt is floating rate debt, which means the rate that you pay every month or every quarter depends on what the existing rate is in the market. And a bunch of those companies will start seeing significant pressures on their profitability and their performance because of this high interest rate.

But a lot of those companies are owned by private equity or other such investors who are kind of used to dealing with these kind of situations. At the same time, I still don’t see a lot of layoffs happening in the next six months to 12 months. Now, the question is, what happens in a market where there is an oversupply and limited demand? Now, I think I answered that question indirectly by describing what is happening in the San Francisco real estate market right now. There is a lot of supply, but there is not a lot of demand. And what does that mean? It means that if I go and try to rent an apartment right now, I will be able to dictate my terms to the real estate management company. And when I say dictate terms, it doesn’t mean that they’ll give me a 50% discount on rent. But if the apartment is $3,500 a month, I can probably negotiate that down to $3,100 a month.

And if it’s on a 12-month lease, I can negotiate it to a 15 month lease, or I can tell them, “Okay, I’ll do a 15 month lease and you give me two months free out of these 15 months, so I’ll only give you rent for 13 months. And by the way, I’m not going to give you $3,500. I’m going to give you $3,100.” So, that level of negotiation can happen in the San Francisco residential real estate market right now, which means that the market is not doing well. And you will probably not be able to negotiate similarly or as aggressively in probably the Miami market right now, given the demand that exists. And then we come to stable prices. Stable prices, and I’ll also club the shifting curves with that. Now, stability of prices in any area is extremely important because almost all real estate projects are highly leveled.

Now, what does the statement mean, highly leveled? Highly leveled means that all real estate projects take a significant amount of debt when the projects are being built. Now, the reason why certain projects or certain businesses take a lot of debt versus other businesses that don’t take almost any debt is dependent on the characteristics of that business. For example, if you look at technology companies, you will not hear about Facebook or Microsoft issuing a lot of debt. Sure, there is some debt on the Microsoft balance sheet, and I think even Facebook has some. But most of these tech companies don’t issue any debt because these businesses are inherently perceived to be very risky, especially when they’re starting out. And investors want to be a participant in the equity upside of these businesses, assuming they do very well in the future. And while these businesses are trying to find product market fit, you don’t really have any cash flow. So, how are you going to service your debt anyway? Now, contrast this with something much more stable and predictable.

Contrast this with something like a utility, a power generation facility, or a toll road or a residential real estate or condo project somewhere. There is a lot of predictability there because you can say with a certain amount of certainty that, given the number of migrants coming to this town, these are the number of people who will need new housing. This is what their income level is going to look like because their employers in the city are going to pay them X, Y, Z. Given the age demographic and the proximity to entertainment venues, to restaurants, to shopping areas—this probably pegs us at a range of X, Y, Z dollars per month in terms of what we can charge our potential tenants. Okay, which means that you have, with a certain level of probability, arrived at a model of what your cash flows might look like in the future. Based on that, you can say that, okay, if we take in a project that requires $100 million of investment, we can take, let’s say, $40 million or $50 million or even more of debt to finance—because if we get 10 years’ worth of debt, it’ll take us X number of years to service the debt based on the projected cash flows that we can generate from this project.

Now, again, it’s a projection. A projection will most likely not pan out in the future, and no financial models ever pan out 100%. But keeping the factors prevalent at the market at the time, there is a certain level of probability that you can attach to whether these projections will pan out or not.

Supply, Demand, and Cap Rates in Real Estate

Okay. The question of how increasing supply and decreasing demand will affect is exactly what I just stated earlier, that it is going to drive down prices for the end customer. If you are trying to buy…

This is where I’d like to quote an example that I came across yesterday. A lot of people are probably familiar with the Hudson Yards real estate project in New York. Now, Hudson Yards is a massive development spanning, I think, 28 acres and it has, I think, seen capital investments of at least $20 billion over the years. There are several office buildings. There are several apartment complexes. There are amazing shopping areas. There are great restaurants. I think there are schools in the area as well. The hope is that that is going to be the next big area of growth in New York, which already is overcrowded with people.

The surprising thing is, it’s a project that has not done very well financially. The reasons for that are there has been a lot of cost overruns. Projects have been over budget. There have been a lot of delays, which have actually caused losses to a lot of EB-5 investors. I was reading about a couple of condo buildings in the area, which are ultra luxury real estate projects. Apartments are selling for a 40% to 50% discount at this point of time. In fact, I read this in Wall Street Journal: apartments that were quoted at $15 million are selling for $7.5 million or $8 million. So, I think the reason for that is simply the fact that there is an oversupply of real estate in those areas.

Now, I made a statement earlier in my presentation where I said, “Well, if you’re selling to ultra-high net worth individuals, you don’t have to worry because they will buy.” Yes, you don’t have to worry in terms of their ability to finance the purchase, but you still have to worry about the location of the project and other market factors that will propel a customer to make a purchase. Because even in terms of luxury real estate, New York as a city does not have a dearth of luxury housing available.

There’s this street in New York, I think it’s called the Billionaires’ Row or something like that, which has a lot of these very ultra-expensive condo buildings and are known to have home purchases made by billionaires from the Middle East or hedge fund guys or tech entrepreneurs. Even in that area, there are several apartments that are sitting vacant right now because they just can’t find the right buyer.

So, in a market where there is a lot of demand for any type of real estate product, if builders build indiscriminately, they will eventually get to a point where the number of buyers will not be as many as the choice available to the investors. That’s exactly what is happening in a lot of real estate markets in the US right now.

As you can see from slide 15, it is a classic Economics 101 slide that I think pretty much everybody has seen: a demand and supply curve. What is happening right now is that this new supply is basically driving down the pricing of existing supply. That does not bode well for real estate projects because the inflow that you will get in terms of either people buying those apartments or condos outright or paying you a rental fee every month is lower than what you had projected. But at the same time, the debt that you had financed the project with could most likely be a fixed rate. Either it will be a fixed rate debt or it’ll be floating rate. In case of a floating rate debt, you are being hit on the other end by high interest rates, which means, if your debt service cost was 5% last year, it has probably gone up to 10% to 15% this year. A lot of projects in the US are in that situation right now where they just somehow have to find enough cash to make good on their monthly interest payments to the bank.

So, you’re basically being hit in both directions. That is on the one end, you have overbuilt, so customers are not willing to pay you what you thought you would get. At the other end, you also have to service the debt that you raised to build the project, which is one of the biggest reasons why a lot of projects actually go underwater.

Now, we come to a couple of interesting ideas, which are very specific to real estate projects. Probably the most interesting idea here is that of a cap rate. So, the question is, what does a cap rate really mean? A cap rate is simply… It’s a basic formula. It’s a ratio. It’s basically the net income that you generate from a project versus the property value. So net income divided by property value.

Now, after you subtract the operating expenses… Let’s say I pay $3,000 a month for my apartment; the building management will subtract its operating costs. When you think about operating costs, it’s not just changing the fittings in your apartment if something breaks down. It’salso the salaries that are paid to the security, the salaries that are paid to the building management or the maintenance people to be available 24/7 to help you out in case of an issue. When you allocate those operating costs on a single apartment basis, you will arrive at the net income that you will generate from a particular apartment. Then you can simply extrapolate that to an entire building or an entire project.

So, if you’re generating a certain amount of money every month, or certain net income every month from an apartment or a building where the market value of that building is X, or whatever the market is appraising the value at, what you get is a cap rate.

There are no scientific rules around what the most optimum cap rate is, but anything above a 2% to 3% cap rate is a good cap rate to have, which basically means that it’ll take you… Let’s say if you have a cap rate of 3%, then it will basically take you 33 years to recover the market value of that building based on the rent that you are getting right now. Okay. Anything higher than that just reduces the number of years it takes you to recover the market value of that building, which means the higher, the better.

This cap rate is dictated… Both in the numerator as well as the denominator, it’s dictated by the location where the project is located and the quality of the building. You will see that in a place like New York or Miami, where there are several apartment complexes being built next to each other: you will often find that the newer apartments have a much higher rent versus older ones. That’s simply because the newer apartments have fittings that are newer. Okay. They’ve just been opened. Everything is completely unused. You are probably the first tenant to use the apartment. You are getting the benefit of everything being completely fit and fine, versus 10 to 15 years down the line when the apartment will go through some wear and tear, the building will get a little older, and there will be increased competition in the surrounding areas as well, because newer apartment complexes will come up. That will lead to a reduction in the rents that the builder will be able to charge. At the same time, the builder will also recover a significant part of its cost of building the project early on itself.

Okay. So later on, after 15, 20 years, what you are generating in terms of rental income from the project is basically just pure profit after taking out the operating costs.

Okay. The second question is, how do interest rates affect the cap rates? Basically when interest rates rise, as we’ve seen earlier, it just makes it difficult to own a property. As you can see how rising interest rates are making it difficult for people to get mortgages. Because it’s making difficult for people to get mortgages, it’s reducing the demand in the market. If it’s reducing the demand in the market, then supply has to respond by reducing prices. So, it’s all a chain.

Another interesting way in which you can think about real estate is think of a bond. What does a bond do? You buy a bond for $100 or $1,000, and it has a fixed stream of coupon payments to you for the number of years that the bond is being issued for. So if the bond has a maturity of 10 years and you buy a bond for $1,000 today and there is a 5% coupon on the bond, you’re getting paid $50 a year by the issuer of the bond to hold the bond for that. At the end of those 10 years, you’ll get your $100 back and it’s all done.

Now, what happens if the interest rates in the market increase from 5% to 7%? This is where you come to a term in economics which is called yield, Y-I-E-L-D. Yields decide what the value of existing assets in the market is. These assets could be anything. They could be bonds, they could be stocks, they could be real estate. If you think about interest rates rising from 5% to 6%, let’s say, it implies that—if the investors deem or the investors think that this particular company or this particular bond should be more expensive in terms of the return demanded by investors—the riskiness of this company or this project is higher than it was before. What this means is, if the interest rates move from 5% to 6% or 7%, that bond you purchased for $1,000 is now going to sell for less than $1,000. So if you go and try to sell that bond to someone else tomorrow, they’re not going to give you $1,000 for it. They’re going to give you something less than that, for the simple reason that they think what you’re selling them is riskier than what it was before, and hence, they demand a discount.

Real estate works in a similar manner. If you own a piece of property that is expected to give you a certain amount of return every year in terms of the cap rate through rental income… if interest rates are higher, the value of that property will go down because people may not want to rent your property out. Or if you are selling that property, then people may not want to buy that property from you because the monthly payments that they will have to make on their mortgages have gone higher, which means that the bank thinks they are a risky borrower. If the banks think they are a risky borrower, then the borrower itself wants a discount on buying the property.

I understand this is a bit of a convoluted and a slightly difficult concept to understand, but I think the next slide can probably make this a little more clear. I think this slide does a pretty good job of showing how the financial dynamics of real estate projects have changed in the past few years just because of the ongoing interest rates issue.

If you look at the left side, it shows you: in 2019, if a real estate project was started in 2019 versus 2023, what are the changes that have taken place? Those are, unfortunately, adverse changes. If your estimated development cost in 2019 was $60 million, unfortunately because of inflation over the years, that development cost has increased to $70 million. But at the same time, because rates are higher, property values have declined, people are willing to pay less, whether it’s for rents or whether for properties outright; your rental income has also declined. But at the same time, your costs remain the same, which means that the cash flow that is available to a builder to service the debt after subtracting their costs to operate the property—and keeping in mind the lower than projected rental income that the builder is generating—there is less cash available to service the debt. But at the same time, the interest rate costs have also increased. This is where there is a high probability of the builder generating a loss. That’s the thing that investors need to be very careful about when they are thinking about the front end of real estate projects.

Can we move to the next slide?

Sam:
Sidd, I think one interesting point to talk about here is the change in cap rate combined with the decrease in net income. For example, for an apartment complex, let’s say, that was started under construction in 2019 or 2020: talk a little bit about the compare-contrast between what the value is of that building, what it’s actually going to turn out to be given these interest rate changes, and what that means for investors who are either debt or equity in that building.

Sidd:
Now, cap rates, as I stated earlier, the higher they are, the better. Now, the higher they are, the better in a good market. In a market where trends are rising, which means your numerator is increasing, but the denominator stays the same or increases further. This is the market value of that property, which either stays the same or increases.

But the problem comes in situations where there is an oversupply in the market and there are macroeconomic factors that determine that the project is probably not going to be as successful as possible. What happens is this: what investors are looking at from an EB-5 perspective, they’re looking at sitting in probably the lower end of the capital stack. The lower end of the capital stack is the riskiest part of that capital stack, which means debt is the cheapest and it is also the safest because bank debt is often backed by the collateral of the project. But for EB-5 investors, they are not really sitting in the mezzanine area of the capital stack. Mezzanine means that the capital has certain characteristics of debt, and it also has certain characteristics of equity, which makes it even more risky.

In a situation where the operating costs and the debt service costs are eating into the income that the real estate builder is able to generate, there is a high risk of the builder not being able to return the capital that it has taken from its investors because there is not sufficient cash flow to go around. That is a big concern in a macro environment like this; that if you have lower income or if you are making a loss because the bank loans need to be repaid, the interest needs to be paid to the bank upfront. People who are sitting below in the capital stack are not able to get a return on their capital, or rather are seeing a loss of capital for the simple reason that the people who sit above in the capital stack have to be taken care of by the builder first. Does that answer the question?

Sam:
Yes. One other thing I want to point out is that, just because you decided to build, in this case, an apartment building, let’s say, that started in 2019… Your original plan was, “I’m going to build this on the left side for $60 million,” and at the end when it’s built, you thought it was going to be worth $70 million. 5% cap rate was the projection. You build it for $60 million. It’s finished. It’s worth $70 million. You sell it, you make a $10 million profit.

But what’s actually happened is that building you thought was going to cost $60 million to build, due to inflation, delays, labor, COVID, all of that, the building actually costs $70 million. When it’s done, because cap rates have gone up and interest rates have gone up, now the building’s actually only worth maybe $25 million or $30 million. Now, that seems crazy, but the reality is just because you spent that money on the building, the value of the building is going to be primarily based on the income that it generates taking into account interest rates. So, even if you spent that amount of money building it, what it’s worth is really only going to depend on what the income is when it’s done. So, anyone who invested part of that $70 million of what it actually cost, really only the first $25 million, the safest, most likely the bank, was part of that first $25 million.

Sidd:
Correct.

Sam:
Any investors who are in the second $45 million behind the bank, if that building sells, they’re going to lose all or the majority of their money.

Sidd:
Exactly.

Sam:
It’s critical to really understand when was this thing originally built, what are the interest costs, and what is it actually going to rent for. Because a building like this could look great. It could look like a big tower six months away from being completed, but when you actually look at the assumptions, what it actually cost, the debt service, the revenue is it actually going to rent for— it can be very clear that you would be part of that $45 million immediate loss essentially by joining the project. So, that’s why it’s really important to not only look at the marketing materials, but dig into the capital stack, as Sidd mentioned. Really look at the income and the potential debt service associated. That’s really critical, especially for projects dependent on rentals or apartments, or hotels that were started a few years ago.

Capital Structures in EB-5 Projects

Sidd:
Correct, correct. With that being said, maybe we can go to slide 20 directly, because I think that’s where the real. That’s where I really want to talk about something, which I find a lot of EB-5 investors have a lot of confusion about or just do not understand at all—and end up falling into traps they shouldn’t fall into.

I think the most important concept that a lot of EB-5 investors do not understand here is how does cost of capital work and what does a capital stack look like?

Sidd
One thing that I really wanted to talk about in the seminar—and one of the key reasons why I wanted to do this—is because I think there is a very poor understanding of how a capital stack works and how financing really works for a real estate project. This is Basic Corporate Finance 101. It’s applicable to companies in general also. But I think people need to understand where they sit in the capital structure overall whenever a project is built, and what are the different returns and risk profiles that different levels of the capital stack offer?

A lot of EB-5 investors seem to fall into the trap where they are attracted more to the rate of return that the project is offering them, versus the safety of capital that the other characteristics of the project, which we know we have discussed early on in our presentation, offer compared to the return profile of the project.

Moving on to the next slide, there’s a really nice chart which breaks out what the capital stack looks like. What you are looking at in front of you is a stacked bar chart that shows you what the liability side of a balance sheet typically looks like. So, if you’ve ever seen a balance sheet in your life, you’ll see there are three sections. There is assets on the left side, and there is liabilities and equity on the right side. This is only the right side of the balance sheet because any project or any business in general is financed with either debt or equity or a combination of the two.

Even when it comes to debt or equity, there are different types of flavors or different varieties of debt or equity that exist. The least risky form of debt is a senior loan. Okay, senior loan is basically bank debt. A well-known bank like, let’s say, Wells Fargo, is going to issue this loan to the builder. At the same time, the bank will demand collateral of commensurate value, which will usually be the value of the land on which the project is being built. Okay, that will be collateralized to the bank in the sense that: let’s say in future the project does not do well and it fails. The bank has to recover its money; then, the bank will be able to take control of the land. It will be able to sell that land and recover some of its capital or all of its capital.

Then you come to junior debt. Now, junior debt is a riskier form of debt. Junior debt is also called mezzanine. It is unsecured debt. Unsecured means that, as a debt holder, the investor will be guaranteed a certain coupon or a rate of interest periodically on the debt, but in case the company goes bankrupt or the project fails tomorrow, the investor in this part of the capital stack does not have any recourse to the assets of the company. Or the only recourse that it has to the assets of the company are assets that are left after the senior loan holder has recovered, fully recovered its capital. Then, you have preferred equity. So, preferred equity is basically a hybrid between debt and equity. A preferred equity is like preferred stock, if you have heard about it. So, for people who work in technology companies, then startups raise capital through several stages of financing. They are raising equity not through common equity. Common equity is mostly held by the founders of the company. They are raising equity through preferred equity. Preferred equity has features of both debt and equity associated with it. So, in a preferred equity scenario, while you hold equity in a project or a company, you are entitled to a certain fixed rate of interest/dividend by that project or company on an annual basis, along with the fact that this equity can give you high returns in future if the project succeeds.

Now in preferred equity, there’s also convertible equity or convertible debt, which is basically debt that is issued by the company or the project—wherein, based on certain factors, the debt can be converted into equity for the investor or the holder of that. But in this scenario, I think convertible debt is a little too complicated and not relevant for EB-5 investors, so we’ll not talk about that.

The two typical positions where EB-5 investors are normally set or are offered investment opportunities are the mezzanine and the preferred equity parts of the capital stack. This basically goes to show that EB-5 investors are usually sitting in one of the riskiest parts of the balance sheet. Now, developer equity is ideally the riskiest, but that’s only because a developer is required to commit some of his or her own capital in a project before the project kicks off.

So, the initial capital provider, being the owner and the manager of the project, will obviously have the highest level of, or the highest allocation of the profitability of the project. Now, the most important thing, which I find investors do not understand in the case of EB-5 is, whenever you are being offered a certain rate of return on a project, always think about the cost of capital that the builder of the project or the developer of the project is incurring. There is a wide gap between the return that the EB-5 investor is going to see on a project versus the cost of capital that the developer of that project is going to incur. Why do I say that? I say that because, for example, there’s an EB-5 project somewhere in California, in a university town where there is student housing being built, and the builder is offering a 4% rate of interest annually to EB-5 investors.

Now, the industry standard for high-quality projects in EB-5 is usually a 0.25% or 0.5% rate of interest. Now, if that 4% rate of interest is being offered to the EB-5 investor, investors need to keep in mind that the EB-5 agency or the facilitator, the regional center, is also making a significant return on the capital that is being invested. That return on capital being invested is going straight to the regional center, after which another 4% is going to the EB-5 investor. Which means, let’s say the industry standard, and then investors should read all the documentation that is provided by the regional center. I think it’s extremely important to read the memorandum. They should read the debt agreement, the senior loan agreement that any project has. I have come across projects where investors have not been provided the loan documents associated with the loan that the senior lender has made to a particular project.

I have, by God’s grace, been able to help those investors stay away from such projects, because I want to make sure that I know how my capital is going to be treated based on not only the agreement that I have with the builder or the developer. I also want to know how the person above me in the capital stack is going to get treated in the case of a default or a project failure, because that is going to determine to a significant extent as to how I’m going to get treated eventually in a court of law. Without getting too much into the legal ramifications of how these things work, because that’s a completely different topic on its own: the key thing that people need to understand is the developer is taking this pool of money raised through EB-5 through the regional center.

The regional center is the GP here because it is facilitating this investment into a project is going to earn a certain rate of return. If you read the memorandum, that rate of return or that rate of interest will be mentioned, around 5%, let’s say. On top of that, a builder or developer is offering an additional 4% to the EB-5 investor. What does that mean? It means that the total cost of capital for the developer in a project taking money from EB-5 investors is 9% just for that capital part of the capital stack—which should tell you how risky that project is. The more risk a project has, the higher the rate of return. And you should also contrast this with the fact that EB-5 investors are probably the most powerless class of investors in the U.S.

EB-5 investors are not citizens in the U.S., they are immigrants. They have very little knowledge of how the legal system works. They put their capital into a project, which is highly risky because it’s opportunistic real estate, where they will set very low in the capital stack and one of the riskiest parts of the capital stack. They are usually not guaranteed any rate of return, and there is also a risk of capital loss. If these are the ground realities of how EB-5 investors are treated, then how is it possible that, even the easiest set of investors to deal with in the case of an adverse scenario, is being offered such a high rate of it return? If you just think about this in a Machiavellian sense, that you as a developer or as the owner of a particular project, you have to decide how you are going to treat your customers, your investors, in an adverse scenario.

You are obviously going to want investors who do not have a lot of power when it comes to extracting concessions out of you in an adverse scenario. The reason why a bank loan/a senior loan carries a lower rate of interest is because the bank ensures that contracts are enforced. The bank ensures that there is a high value collateral associated with the project in exchange for the money that they’re attending to the developer. And in an adverse scenario, a bank will not hesitate in going to a court of law and getting the matter resolved. So, an EB-5 investor does not have those protections, or even if they exist, most EB-5 investors do not have the financial capability or the time or the resources to actually go and take the action. So, EB-5 investors need to understand the person or the developer of the project; what is their cost of capital in this project?

Cost of capital varies across different levels of the capital stack. So, a senior loan will be 4 or 5%, but if the mezzanine or the preferred equity investment (which is being taken from class of investors that does not have a lot of financial or legal sophistication) promises you 10 to 15% rate of interest or a total 10 to 15% cost of capital, it should ring alarm bells. That project is extremely risky.

Now, if this mezzanine debt or preferred equity was held by a hedge fund or a mezzanine debt investment fund, which are highly sophisticated pools of capital, which are run by very experienced professionals in the U.S., they would not accept a 5% rate of interest. They would want a 10 to 15% rate of interest, but that’s also because they understand what the real cost of capital for this project should be. They are willing to price the riskiness of that project into their estimate of what they’re going to charge the developer of the project, and in an adverse scenario, they will also have the resources to take the developer to court and get the matter resolved. EB-5 investors don’t have any of this. So, you have to be very careful about thinking about what the incentive or what is the cost that the other side is going to incur in taking this capital. I think this is the one key point that I really wanted to bring up because, I am sorry to say, a lot of EB-5 investors just don’t have that understanding.

The Importance of Reviewing Senior Loan Documents

Sam:
Thanks, Sidd. I think that was really comprehensive. One thing I want to expound on that you mentioned is the importance of seeing the senior loan documents. Could you talk a little bit more about that? Why is that so important? And in addition to senior loan documents, how critical is it to also see the balance sheet, the financials of the company, and any guarantor company that’s securing the repayment of investors funds?

Sidd:
Yes, that’s extremely important. Let’s hit upon the bank loan documents first. You want to make sure that the bank loan documents do not have any governance in the loan documents, which directly adversely impacts people who sit below in the capital stack; people who sit below the bank loan in the capital stack. Now, most banks will not have anything like that. I have personally not seen a loan document which says, “We are going to take away money from the lower part of the capital stack or whatever.” Most governance will focus on, in case of an adverse scenario, we expect to be repaid in full of whatever our initial investment was. The problem, however, is if that adverse scenario does happen, then the bank has the means to actually go and recover as much of its capital as possible, but other people don’t, or EB-5 investors don’t.

Now, let’s say the bank loan was $100 million. The project fails. The bank is able to recover $105 million. Now out of that $105 million, the bank is going to take out $100 million. It is probably going to also take out the additional interest that has been accumulating over time. It might also want to take out its legal costs, and then whatever $1 or $2 million remain will go to the investors who sit below in the capital stack. That $1 to $2 million versus a $50 to a $70 million pool of EB-5 investments is nothing. You’re basically getting almost nothing from the recovery.

So that being said, I think it makes it extremely important for investors to demand that the regional center that is marketing a particular EB-5 project to provide the financial statements—or to provide enough information that makes you comfortable with the financial position of the company or the developer’s business.

Now, in the case of Kolter, for example, I was looking at the Saltaire project initially. I changed my mind and decided to invest in Twin Lakes. The one thing that I liked in both these projects is that the builder had been very clear about what the financial position of the project looked like. Now, keep in mind I said the word project. I said the word project because everything in the U.S.—all of these projects are basically private entities. The developers are also private entities or private builders. With private entities there is something called as an LLC, which is a limited liability company. A limited liability company, or a limited liability corporation is a corporation, where the owners of the corporation… Let’s say the business venture that is undertaken through that LLC fails, then they are only liable for the investment that they have made in the business venture.

They are not liable for all of their assets. Besides LLCs, there are corporations that people are familiar with, and there are proprietorships. If you’re a proprietor in a business or if you are a non-limited partner in a business, then if the project fails or if the business fails, the creditors can come for your personal assets. But the way business is done in the U.S., and increasingly being done in other parts of the world now, is limited liability. That is, I’m only liable for the amount of capital I put up, not for all my assets. You can structure anything as an LLC. An apartment can be an LLC. A building can be an LLC. A plot of land can be an LLC. And in the case of these two projects, I found that the EB-5 investors were being offered… EB-5 investors were basically participating in mezzanine debt.

We’re being offered a guarantee by a parent entity being set up by the developer with enough assets to guarantee the repayment of the loan. What does that mean? What it means is, let’s say Sam and I do a business transaction. I lend Sam a hundred dollars, and Sam’s partner, Mike says to me that if Sam can’t give you this a hundred dollars back in 10 days, then I’m going to give you the hundred. That’s a very simple explanation, and the way it applies to the Kolter situation or the situations I came across was: all loans, whenever they have a collateral associated with them, have something called as an LTV ratio. This is loan to value, which means that if the loan is a hundred dollars, then there has to be a collateral worth $120 backing that loan. What Kolter did for EB-5 investors in the mezzanine debt category was create an LLC.

The LLC was given a certain market value of assets. Those assets could be anything. They could be plots of land, they could be apartments, they could be single-family homes, anything. They were at least 120% in value compared to the amount of money being borrowed by Kolter through the mezzanine debt fund from EB-5 investors. So, while the money being raised is going towards developing the project, let’s say the project fails tomorrow. Then, this LLC that is guaranteeing the debt will sell its assets and repay the EB-5 investors their capital. That’s what it means.

Vetting EB-5 Project Developers

Sam:
We talked a little bit about the financial capital stack and some basics to be aware of. Now we’ll shift gears and chat about the importance of developer reputation and track records. I guess from your experience—other than how the project’s financed, the builder, their track record, their experience with this specific asset class that the EB-5 project is under—tell us a little bit about that and how that factors into an investor’s diligence process.

Sidd:
Whether you are investing in stocks or whether you’re investing in real estate, developer track record, or the management track record, is extremely important. Now, the way you assess a person’s track record is looking at the demonstrated history of that person’s or that business’s professional accomplishments. Now, when you think about it this way, if you hire a person for a job, there is something called as a background check that takes place. If you’ve applied for a job somewhere and you’ve been offered a position and you signed the offer, you’ll also have to go through a background check. What does that background check do? That background check basically ascertains that you are the alleged person, you don’t have any criminal records against you, and things like that. At the same time, they will look at your resume and will often make calls to the people you have worked with in the past (without telling you, of course) about your performance at work, and whether you’re somebody who should be hired for this position.

That is basically a way of assessing a person’s track record. You apply the same logic to assessing a track record of a developer. The way you do that is look at the demonstrated projects that they have built so far. Look at the projects that they have executed on. If you have the resources and have the time or those projects are nearby, maybe drive down to a particular project that the builder has executed in the past and look at how good that project was or how bad that project is. What is the quality of their execution? Try and have conversations with people who live in those areas or who have a condo in that building or who have a home in that single-family complex to understand what their experience has been with the developer.

That is going to give you a very good view of the perceived reputation of this developer in the market by customers. You can also do a simple Google query to see Kolter’s reputation. Are there any significant issues that Kolter has encountered in the past? Have there been issues with their ability to repay their lenders in the past? What does the market generally say about them? So, I did not find even a single instance where Kolter has not repaid their investors in the past. In fact, I found evidence to the contrary, where (apparently during the global financial crisis when the real estate industry was significantly adversely impacted in the U.S)., some of Kolter’s projects were also underwater at the time. And instead of declaring bankruptcy and basically depriving the investors of their investment or customers of their deposits, Kolter decided to repay its investors or return their deposits and then ride the project out until the financial crisis was over. You bring it back into the light.

So, I think that gave me a lot of confidence in Kolter’s ability to execute and just in general, do a good job or do the right thing by its investors. At the same time, given that I was investing in a project that is pretty big (it’s 1,300 homes), I wanted to get some comfort on whether Kolter had the ability to deliver such projects. I looked at the properties that they have executed in the past. One comforting factor, or one of the biggest comforting factors, was that the Cresswind Twin Lakes project is not the first Cresswind-branded project that Kolter has executed on. They have already executed several such projects in the past, not just in the Atlanta area, but also in the North Carolina region. In fact, in Atlanta, Twin Lakes is the third Cresswind-branded project that Kolter has done.

The fact that the first two were runaway successes and sold out in the projected time gave me confidence that, as a builder or as a growing business, you want to take on bigger and bigger challenges as time passes, but at the same time, the fact that you have been able to execute on the existing challenges—or the ones that you took upon yourself in the past—gives me confidence that you will be able to handle a bigger challenge in future. So, from its success in delivering and completing a 600-home project in downtown Atlanta, which was branded under Cresswind, (I think it was 400 homes, I don’t exactly remember)… The fact that those homes were much more expensive than the homes that are being built for Twin Lakes gives me a lot of confidence that this builder has the ability to complete such projects.

At the same time, look, I think the VDR is also very important here. The investors should look at guarantees in the form of a completion guarantee, a delivery guarantee, which is basically a legal agreement signed between the contractor and the developer to be a part of the information package provided to EB-5 investors. I find that a lot of EB-5 investors don’t even know that such things exist or don’t even pay attention to this part of the equation. But I think they really should, because even if your capital stack is fully financed, if there are issues between the contractor for the project and the developer—that could significantly delay the project and increase the costs associated with the project. This will impact the delivery timeline and could very adversely impact your return of capital.

Sam:
What would be an example in your mind of a project that something went wrong because of inexperience? What would something like that look like?

Sidd:
In fact, I think there’s one project here in California in the Bay Area, I think it’s in Oakland as well, which is being sold by a competing regional center. When I look at the track record of the developer, I don’t see a significant history behind the developer. Look, I’m not saying that the developer is definitely going to fail, or I’m not making a final judgment on the developer. There is a possibility that I’m wrong and they deliver to the timeline exactly as they said they were. But given the information I have, I was not comfortable with the prospects of the project, given the lack of history that the developer has. A very clear cut example of this is… think about this in terms of how Warren Buffett thinks about investments. He will never invest in a startup. They look for companies with several decades of demonstrated history of delivering to their customers. You have to think about it in a similar manner if you are going to put your capital behind something, which is already is a risk. That’s my take.

Sam:
To quickly summarize that, to really reduce developer and execution risk, it’s better to go with a project where the developer, let’s say over the last 20 years has executed successfully, profitably on nearly identical projects—and this is just project number 10, 15 that follows a long track record of successful projects that are essentially identical. In other words, go with what’s proven. If the developer has been building hotels for a long time and then all of a sudden this is their first condo project or their first single-family home project, then that’s where you need to be very careful.

Sidd:
Agreed. That’s exactly what I wanted to say.

Real Estate Project Risk in the California Bay Area

Sam:
Sidd, I know we touched upon this a little bit earlier with the example of a project that started in 2019 and is now coming onto market, but I think the Bay Area is a great illustration of what can happen over a four- to five- year time horizon. Why don’t you walk us through this visual and how you’ve seen this play out in your backyard?

Sidd

In fact, I was looking at this tunnel thing that you’ve shown on the page, and I was just thinking about this tunnel that connects the San Francisco area to Bell Valley, which is, by the way, a really nice area. But switching gears and talking about how things have panned out in the Bay Area, especially a place like Oakland: look, the Bay Area is already struggling with a very high cost of living. San Francisco, surrounding areas, even South Bay, especially areas like Palo Alto, Menlo Park—these are not areas that are meant for people with moderate income levels. These are high income, luxury areas. The quality of homes that you may get in these areas may not be very high, but just the fact that the location is so prime, people end up paying top dollar for housing.

Now, unfortunately, given COVID and given the rising interest rates, a lot of businesses (and at the same time, because the government in San Francisco has failed miserably in controlling crime in the city, which at this time has impacted the city in such an adverse way) have started shutting down. Every other day we read about some retail store closing in a mall.

Then we just read that the Westfield Mall in San Francisco is also probably getting foreclosed because they were not able to repay the debt that they have raised, or rather not even able to service the debt that they had raised to finance that development. At the same time, to add fuel to fire, the tech industry in general has seen majority of layoffs in the current macro environment.

That’s the worst-hit area of the economy. Even though it’s small in the overall scheme of things, there are thousands of layoffs that have happened in the Bay Area. Now all of these factors together have not only prolonged the timelines for real estate development projects in the Bay Area; they have also made it extremely uncertain as to whether these projects will even succeed. You do not want to be in an area where people are looking to leave; you want to be in an area where people are eager to come. Okay. I don’t know what the government is going to do to turn this tide in the favor of the area in general or in the favor of businesses here, but this is something that rings alarm bells for me all the time.

I cannot advise anybody in good conscience to invest in anything that has been developed in the Bay Area. Even if the developer has a really good track record, I would probably stay away from investing in this area just because of the macro factors that are not in the favor. As Warren Buffett said, “Whenever an industry with a reputation for bad economics meets a management with a reputation for good management, it’s usually the reputation of the business or the industry that remains intact.” So, in this case, I think that’s what’s going to happen as well. That’s my take.

Sam:
Obviously, the bigger the developer, the more financially established they are. These factors, not all of them, but some of them rising rates, for example, and COVID—those two of these six factors have impacted every real estate market in the United States over the last couple of years. So, having a developer who has the experience, like you mentioned earlier, of making it through similar type negative economic periods—the ’08 recession, etc.— successfully in the past without any bankruptcies, foreclosures, things like that… That’s always a good sign because you never know when the next negative economic event is going to happen. If it does happen during the period when an investor’s EB-5 funds are at risk, that’s when you really want to make sure that the developer that has your funds is responsible and knows what to do when the economy slows down and doesn’t immediately give up and let the bank foreclose and take the project.

Sidd:
Unfortunately, I don’t know what exactly transpired with the Hudson Yards project, but one of our mutual contacts who recently invested in Twin Lakes: he has a friend who lost his entire $500,000 investment in the Hudson Yards project, despite the fact that the developer who’s building the project is still a very, very successful developer and is also planning to build projects in Florida now. Unfortunately, some developers are just (and this is another factor in terms of assessing not just the reputation of the developer) at the same time, assessing… I’m not sure if ethical is the right word to use here. I think it’s more about assessing the willingness of the developer to conduct itself professionally and make good on its promises to all the stakeholders in the project. I think that is a much harder thing to assess than just looking at the financials of a business and assessing the position or assessing the situation. I think the reputational aspect or the conduct, professional conduct aspect is much harder to determine.

Sam:
We’ll chat a little bit later about conflict of interest and how it’s important to have that independence, because I know, in a lot of those Hudson Yards related projects, there was not independence. That, in my opinion, was one of the driving factors for why investors had issues there. All right. Continuing along the thread of developer track record and reputation, let’s chat for a minute or two about access to capital. Obviously, you’re knee-deep in the financial markets on a daily basis, so when access to capital dries up, it doesn’t usually dry up to zero. What happens, who still has access and why, and what does that typically look like?

Access to Capital in EB-5 Projects

Sidd:
I think developer access to capital is probably one of the first things that will determine whether the project even has a chance of succeeding or not. I say this from the perspective of somebody who grew up in a family in India where my relatives (my father also to a certain extent) were involved in the real estate business. We have been significant purchasers of real estate in the past, at various points in time, and having observed how a lot of real estate projects—and this is the thing that actually shocked me when I came to the U.S.—that a lot of developers even here, are willing to start projects without putting a complete financing package or a financial plan in place when it comes to how they will build the project.

A lot of projects are started with the mindset that, “Okay, we will launch the marketing phase of the project. We will get the first 10% or 20% of the customers to provide us the capital that we will use to build the project, and then we will wait for other customers to come and give us capital to complete the project.” I think that is a very, very dangerous strategy and one that every EB-5 investor should stay away from. A few pointers. If your capital, if EB-5 capital is the first dollar to go into building a project, then stay away from that project. There is a scrap iron steel plant that is being built in the U.S. somewhere (I think in the Southwest or some part of the U.S.), just by looking at the documents, I think the terms that were being imposed on EB-5 investors were extremely onerous. But at the same time, without having committed capital from the senior lenders in the project, the first dollar to go in was from EB-5 investors.

I just did not see myself ever recommending anybody in good faith to put that money in that project. Look, we can get to different classes of investors later, but I think a very good sign of the developer being reliable and smart and successful is this: if a large bank like Wells Fargo or Bank of America or J.P. Morgan, or any of these publicly-listed banks, are willing to give a senior construction loan to the developer for a project. It may not necessarily have to be just the project where you are investing in, but if there is an established record of the developer is raising money from the top banks in the country to finance its projects, that gives you a lot of confidence in the ability of the developer to deliver. Because see, and this is something I pointed out in my interview earlier, we are operating in a market where there is a huge information asymmetry. The reason why EB-5s, as I said, are such a suspect of faulty projects is because there is a lot of information asymmetry in the industry.

It’s highly fragmented, and that is what some unscrupulous operators take advantage of. I think the important thing is if you do not have the sophistication to assess, or if you do not have perfect information to assess the quality of project or developer, then you should try to piggyback on the coattails of a more sophisticated institution that does have the ability to do this. If a big bank like Wells Fargo or J.P. Morgan or any of these very well-known banks like, MNB Bank, for example, that has given a loan to a builder for a project in the past or has given several loans in large denominations to a builder in the past or a developer in the past. Then, it means that there is a confidence that this institution has and the ability of this developer to deliver. Institutions like Wells have been doing this for generations. They’ve been around for so long, they are the biggest lenders to real estate.

They know how to assess projects better than we do, and the cost of capital for them—this means the rate that they will offer to these developers is also going to be lower than the rate that will be offered by a hedge fund or a private equity fund or a private credit investment fund. Which brings me to my next point, which I was going to mention: the different classes of investors that exist even at the top of the capital stack. You have different investors, who are not just your larger retail banks, which obviously have a much lower cost of capital in terms of raising money from depositors. If you and I put our money in a bank like J.P. Morgan, today, we open a bank account and we create a savings account, we will get a very low rate of interest. That’s because those banks are extremely stable. They’re very reliable. They don’t need the incremental one depositor to put its money into their bank.

Because the cost of capital is so low, the money that people like you and me deposit in these banks is then recycled by these banks and repackaged in the form of construction loans or other types of loans to customers and businesses. The fact that Wells or these other big banks are going to take collateral in exchange for providing this capital—look, banks are not in the business of foreclosing properties and selling them to recover their capital. No bank or no financial institution wants there to be a situation where they will have to take control of the property. It’s not their job. The only reason that they take this collateral is because just in case this project goes south, we have a recourse. But they do apply their collective knowledge over several decades to assess the ability of the developer to deliver. This is where I think Kolter stands out, because they have multiple projects which have been funded by Wells. In fact, this project was also funded by Wells until they decided to refinance and source funds from somewhere else, but the South Bay project was financed by Wells.

I think there’s another couple of projects where they’ve raised money recently in Florida and elsewhere, which are also financed by Wells. So when I see that, it gives me a lot of comfort. The other thing that you have to also be careful of is credit funds or other institution investors. Now there are projects which (and this includes hotel projects or resorts, and it also includes a steel plant project) where very sophisticated hedge funds or private credit funds are going to be the senior lenders to these projects. Despite the fact that I work as an investment banker—and I have a lot of respect for these institutions and the value that they provide in the market—if I’m looking at the safety of my capital or the risk profile of the project I’m investing in, I will most likely not invest my money in a capital stack where I am sitting below sophisticated hedge funds or private equity funds; for the simple reason that their cost of capital is significantly higher when they raise money.

They’re raising this money not from people like you and me; they’re raising this money from high net worth individuals or institutional investors who are investing in alternative assets. The investments that these credit funds make are classified as alternative investments. Alternative investments, just by the very definition, are a very risky class of investments. Given that they are raising money from a group of capital providers who are demanding a high rate of return, they in turn, have to loan that capital to projects at a higher rate of return. Now, they also offer a lot of advantages to builders, developers, or operators of manufacturing plants in the sense that, a lot of times, the retail banks or the commercial banks that exist (the conventional banks) don’t offer the kind of tailor-made bespoke solutions in terms of financing requirements, which a lot of these projects have.

In that case, the alternative investment funds, credit funds, hedge funds; they are probably the best suited investors for those kind of projects. They understand the risk and return profile, and they’re able to orchestrate a very smooth process for these developers or builders. But I don’t want to be associated with that level of risk. The inherent return embedded, the return profiles that these sophisticated investors are looking for inherently makes the projects they look for risky as well. If I am sitting in the capital stack below 10, then I’m probably not going to be very, very comfortable in terms of safety of capital over the long term.

Sam:
Just to quickly summarize that, because we have seen a number of large steel manufacturing projects in the market that fit that capital stack profile. Said differently to summarize, a project like that is typically not going to be able to get a traditional senior loan from a major bank that would be lower cost. The reason the senior bank like Wells Fargo is not going to make a loan to that project is because it’s higher risk and Wells doesn’t want to take that risk. So, the only type of loan typically available for a business like that is a senior credit fund or a private equity fund. So, that type of a business would make the loan, but it’s going to be at a much higher cost because they acknowledge that that’s a much riskier business to begin with.

Then as an EB-5 investor, do you want to be behind a company like Wells that is really picking out the very low risk projects or behind a senior credit fund or a private equity fund that is seeking higher risk deals? Now by going behind someone like them that you’re in a higher risk deal, and you’re also behind a very smart, sophisticated investor that is going to be ahead of you. If something goes wrong, then you can rest assured that they’re going to be focused on protecting themselves and not helping anyone else who’s invested in the project behind them.

Sidd:
Exactly. So, I think that summarizes this really well. I want to make sure that EB-5 investors understand this level of risk. I find that a lot of people get very impressed with a lot of very famous institutions or well-known institutions that willing to make those kind of riskier investments. As I said, these are extremely sophisticated investors, very, very knowledgeable, and they do really, really well when it comes to generating returns for their LPs. But the kind of profile, the risk return profile that they seek is inherently very different from the kind of risk return profile that an EB-5 investor looks for or should look for, in my view. So, that mismatch needs to be corrected. People need to look at safety here versus brand names.

Geographic Considerations in Real Estate Projects

Sam:
Got it. That makes a lot of sense. I know we touched on this earlier a little bit in terms of outmigration and the importance of focusing on particular areas, but just to spend another quick minute or two here, talk to us about what you’re looking for in terms of general geographic characteristics.

Sidd:
I’m looking for an area where— and all this data is by the way, available through government websites, that basically tells you about the increase in housing in a particular area. What is the increase in the population of a certain area over time? What do you see in terms of the delivery of services to people in the area? Are you seeing a lot of businesses opening up in these areas? Are there new companies getting started or are there new shopping complexes opening up, new restaurants getting started? This gives you an indication that the area is being developed as a potential attraction to future residence. So there is expected to be a lot of demand for a lot of these services by the residents in the areas.

Then, just in general, I think, in the U.S. it’s very dependent on the government in the particular state. There are state-specific laws that create different tax states in various states. I think that also plays a significant role in terms of how people are motivated to move from one state to another. I think one of the reasons why Florida sees a lot of influx of migrants is because it’s called zero state tax or something, versus California, which probably has the highest state tax in the country. So, these things are some easy to find indicators that I look for when I’m trying to determine whether it’s even worth looking at a project in this area or not.

Sam:
One of those easy-to-find public resources is population gain, right?

Sidd:
Yes.

Sam:
So, when we look at this chart here that shows the United States in 2022 by state, we can very easily see that the Southeast—Florida, Georgia, where the Twin Lakes project is located— has one of the highest migration population gains, contrasting with some of the West Coast here, California where people are leaving, right?

Sidd:
Yes.

Sam:
There’s just population loss. When people leave, generally, they’re not leaving to another country, they’re usually leaving to another state. So the red states is where on this map, people are leaving. Blue is where they’re going.

Sidd:
Right.

Sam:
You see a lot of that blue concentrated here in the Southeast. This particular region here is essentially where all of Kolter’s projects are located. Right?

Sidd:
Exactly.

Sam:
That’s not a coincidence. Then when we translate that over, we talked previously about supply-demand—what does that mean? Well, if supply continues to increase or even stay steady, but the demand for housing drops (because people are leaving and they don’t want to be a homeowner or a renter in a given geographic area), you see that same thing playing out in the price of real estate. You see a sharp decrease, particularly in California, the darkest being here in the Bay Area right here, but then in Florida you see the opposite. You look in Miami and prices are stable or they’re still increasing, right?

Sidd:
Yes.

Sam:
The previous slide where we see that migration happening then plays out here in terms of real estate, with more people in the market for homes, whether they’re renting or buying—which is really important to conceptually understand. Then, when we look at the actual price growth year-over-year for these different markets, we see the same thing happening here in one of the most recent quarters, South Atlantic. That’s the Southeast, Florida, Georgia, South Carolina— that has the highest price growth, which means that more people are moving and supply is having trouble keeping up with demand. So, that’s pushing prices higher. Then, when we look at the bottom of the same chart here, the Pacific Division, we see a negative, right?

Sidd
Right.

Sam:
And over the last year, basically the lowest in comparison. And so that gives you an idea of what the real estate fundamentals look like for new projects coming online in those areas. You want to go where prices are increasing because, if you can sell the house for more than you expected originally, then you’re going to make more profit versus less than what you were planning.

Sidd:
In fact, one of the things that I used for my research was Twitter, surprisingly. I think Twitter has some really good accounts related to real estate which I think people can follow and go through older tweets to see what these accounts are talking about in terms of what’s happening in housing in the US or real estate in general.

I think there’s a gentleman called Eric Basmajian who is the founder of a research agency called EPB Research, which is E for elephant, P for potato, B for beautiful research.com. He posts very in-depth threads on the recent activity in the real estate markets of various parts of US. Not just macro US data, but data pertaining to specific regions in the US. And then I think there’s another person called Lyn Alden who is a very well-informed person about general macroeconomic dynamics in the US economy, which I also follow.

So, I think these are free resources available for people to go through, and they can learn so much about the situation on the ground that I think it fills a lot of those gaps that I mentioned in terms of information asymmetry.

A Framework for Evaluating EB-5 Project Risk

Sam:
Great, that’s super helpful. Now, we’re going to chat a little bit about an investment framework that EB-5 investors can apply to any potential EB-5 project they’re looking at. And before we get into the questions here, one thing I want to emphasize in general is that this is going to take some time. You’re not going to be able to just go to Google in 30 minutes, download five different EB-5 projects, skim the materials in another hour, and then apply this framework and then come out to the right answer. This is not a 3, 4, 5-hour exercise. This is a 30, 40, 50-hour exercise. You’re going to have to have multiple conversations. You’re going to read hundreds of pages of documents. You’re going to ask for more documents. You’re going to ask for questions. You’re going to ask for questions, review the answers. It’s not going to be a one-weekend process if you want to get the best result and really maximize the safety of your capital and the odds of getting the Green Card.

Before we get into these specific questions, give us an idea of what that process looked like for you. Even someone like you with extensive finance experience, how many hours? How long did that process take when you went through it?

Sidd:
Yeah, it took me approximately two months of diligence work. This is something that I would devote three to four hours daily to just get myself comfortable with the projects that I was looking at. The first project that I said, I was looking at the Saltaire I, and then I decided to go for the Twin Lakes project. I had to do the same level of diligence in both the cases.

And even if I was only doing diligence on one of the projects from the very beginning, the fact that I spent some time on other projects offered by other regional centers… I think in my mind, in a way it works pretty quickly for me. I think I was able to say no to projects I found very risky in a very short span of time. Without even reading documents, there were a bunch of projects where it took me 10 minutes to decide that this was not for me. But the projects that I did find interesting, and both of which were Kolter projects— it took me a good two months due diligence every day to get comfortable with what was going on.

Sam:
Yes, it’s not quick and there are a lot of details and we haven’t even really talked about: the immigration aspects of the investment. That’s a completely separate topic, and we’ve got a number of webinars and resources on the Green Card and job creation and all of that, which we’re not going to cover in this financial-oriented webinar. But that’s another layer of diligence that investors need to really consider as well. With that, walk us through this framework. We’ve got this slide and one more, and then we’ll spend a few minutes talking about the Twin Lakes project.

Sidd:
I think the framework would have, I think, three things that you focus on broadly. Number one, the target area, the region, the state. We’ve already seen a page where we saw how migration patterns are affecting different states in the US. That’s what you start with from a project standpoint. If you imagine a triangle, this is one word to see of the triangle.

What’s the second word to see? The second word to see of the triangle is basically the developer, or rather the financing that is already in place with the developer for this particular project. That is extremely important. If your money is the first dollar going in, please do not invest.

The third part of the triangle is the type of real estate project. I have already spoken very extensively about this in the beginning of the presentation where I described the different types of real estate projects that exist in the US; the cashflow predictability, cashflow profiles of these different types of projects in my personal preference for things where you can just sell outright and walk away. Those are the three key things to think about. If either of these three things do not make sense or move more towards the risky end of the spectrum, then my suggestion is for you to walk away and look for another project.

And then moving on to the next slide where we have a layout of the development framework, of the investment framework: you have to make sure that the developer has a good track record. This is something that should literally take you five minutes. If they say they’re building condos, go to the developer’s website and see how many condo projects a developer has developed in the past. Do a quick Google search to understand if there are any news articles about a particular developer seeing delays in certain projects, about investors having issues recovering their capital, about stalled projects, about bankruptcies, any of those things. This should literally take you five minutes.

Then the second point about the reputation of the developer; that is also answered very quickly online. And then call up people who live in those areas. I’m sure everybody has friends around the US. You can very easily or just go to Reddit or any of these online forums and you can easily understand what is going on in a particular area. You can also get a sense of what the reputation of the developer is in that particular area just by visiting and talking.

And then third thing, which is the one thing which as I pointed out earlier: most EB-5 investors do not understand the cost of capital for the developer. Not the return you are getting, but the cost of capital to the developer. Then you also have to look at… this brings me to the next point, and in terms of the EB-5 investment in itself sitting very low in the capital stack. You have to make sure that you are sitting below in the capital stack from a very secure, very well-known, very old financial institution that directly points you to a bank. Because their cost of capital is going to be very low, and hence they will be able to provide a lower cost of capital to the developer of the project, versus a hedge fund or a credit fund where the cost of capital is extremely high on the backend. Hence the risk return profile that they are looking for in terms of their investment prospects is also on the higher end or on the risky end. That should immediately tell you whether it’s a risky project or not. Then another point that we just discussed five minutes ago was migration patterns.

I think that’s very important. Looking at the location of the project, whether it’s housing or whether it’s commercials such as hotels or resorts. Then that also directly takes you to the idea about price volatility. Price volatility: you usually want to go towards stability. As an EB-5 investor, you are looking for plain vanilla. You are not looking for exotic. You are looking for boring. For EB-5 investors, boring is good. So if you are in an area where or investing in an area which is well-known, very stable, very quiet, great prospects in terms of businesses being built around the area, lots of residences, entertainment venues, great schools, great healthcare system—you can have the assurance that the different dynamics of the area are pointing in the right direction, which is positive.

And the last point here is (of course this is something that we didn’t discuss earlier) what is the development timeline of the project? The developer should be clearly able to articulate what the delivery timeline is. Of course, I personally build a forward tolerance in every projection provided by a developer. If the developer says five years, I assume seven years. You should realize that real estate projects—most of them do not adhere to the timelines that are provided by the developer. Inevitably, delays happen. But you have to make sure that the developer is very clear about what the plan is from the beginning in terms of executing on the project and how is the developer going to return capital to various stakeholders in the project.

If there are investors in the project in Twin Lakes, I think, who get periodic payments from the developer in terms of return of profits… if they are in the equity stack, if they hold equity in the project, versus the loan provider (which is a bank that is going to basically get interest payments every quarter or every six months)…. I think this is the broad framework. And then, of course, there are other factors that I discussed earlier, about the overall reputation of the developer when it comes to the market perception that people have about the developer.

I strongly recommend site visits. They will tell you a lot more than just reading documents will. But you also have to make sure, and this is something which is not on this page—you have a right to ask questions as an investor to get certainty around your investment. So, I have received calls from investors where they said, ” I don’t know if I can ask this.” I said, “Well, you very well can because it’s your money on the line.” So, feel free to ask for more documentation from your regional center. If they cannot provide it to you, they have to tell you why.

And make sure that you read every document that is provided to you in the VDR. There are certain documents that are just non-negotiable when it comes to investing in EB-5. You have to look at the loan agreement, the senior loan agreement. You have to look at the completion guarantees that have been signed between the developer and the builder of the project or the contractor, and any other documents that are related to the execution of the project, the sourcing of any materials for the project, or any other agreements that the developer has with the service provider. And things such as the real estate appraisal reports, which are provided by agencies like CB Richard Ellis or Cushman & Wakefield, which assess the valuation of the project.

Sam:
On that last point there of documentation that’s non-negotiable, the financial statements. Unfortunately, a lot of the other EB-5 companies that we’ve seen, they either don’t have the financial statements or they’re not willing to share them, and that is a major red flag. You’ve got to be able to look at the financial statements because that will very quickly… It’s like an SDT score. It’s easily comparable across applicants, or in this case, projects. You can very quickly determine the financial health of a company by looking at their financial statements. They’re not required by law to be provided, but they are something that you can ask for. And the inability or unwillingness to provide them is a very big red flag. That’s something to absolutely keep in mind.

And then the other thing I want to emphasize that you mentioned, Sidd, is the ability to ask questions. You should be very excited about asking any question. There’s no question that’s off limits. Now, whether the regional center is going to be transparent and willing to provide an answer, that’s going to vary by regional center. But there’s absolutely nothing preventing an investor from asking questions in writing and asking for a response in writing. That’s definitely recommended.

And oftentimes, you can very quickly see, if you ask the same 10 questions to 10 different regional centers, 10 different projects—you’ll see that some of them are willing to quickly provide answers in writing. Now, maybe you won’t love every answer, but at least you’re going to get the answers. And some of those regional centers just won’t provide them or they’ll say something like, “Oh, let’s get on a call, talk about it.” But then you’ll have no record of what was actually told to you. So, you’ve got to really ask questions. And if the materials aren’t provided to you in that initial package of materials, definitely ask for something that you think should be available and review it.

Sidd:
Yes, definitely. There is no such thing as less information here. You have to be able to ask anything that you or your advisors deemed important here. And I think Sam is absolutely right when he says you may not like every answer. There were times when I asked questions during my research process where there were no clear answers to offer really, but I was at least happy that every answer that I was getting was an answer in writing—not over a phone call or something like that where there’s just no record of what was there.

EB5AN’s Twin Lakes Rural EB-5 Project

Sam:
Yes, exactly. We’ll switch gears now and chat a little bit about the Twin Lakes rural EB-5 loan project that we’ve mentioned a few times during the presentation. And then we’ll wrap it up. Twin Lakes rural EB-5 loan project: this is a real estate development project being developed by Kolter. It’s a single-family home community that’s located just outside Atlanta, Georgia. It is a rural TEA project, which means it qualifies for the reduced EB-5 investment amount of $800,000 and priority processing, which means the I-526E Green Card application will be processed by USCIS on a priority basis. And it also qualifies for the 20% visa set aside, which means that more visas are exclusively available to investors who choose rural EB-5 projects. That’s primarily applicable to Indian and Chinese-born investors. Since those countries, China and India, have historically had the most investors, there have been backlogs in the past. And so a rural project gives you the best shot at avoiding any potential future backlog given the priority processing and the largest 20% visa set aside.

This particular project is a single-family home community with amenities. It’s a retirement home community and part of the Cresswind family brand, which we’ll talk a little bit more about in a minute—meaning it’s 55-and-up in order to buy a home and live in the community. Construction’s well underway, as you can see on the left-hand side photo here. As of the end of June, over 520 homes have already been sold. Almost 400 homes have already been built, delivered, closed to buyers with residents having moved in. The clubhouse and the gym, the pools, all the primary amenities—including the largest pickleball facility in the state of Georgia—have all been completed and are operational.

EB-5 capital as a loan in this project is about 12% of the total project cost; a pretty small percentage of the total capital to develop the project. The total cost is almost $700 million. As Sidd mentioned earlier, the project was previously financed by Wells Fargo Bank until earlier in 2023, and was recently replaced with another loan from another institutional bank called Third Coast Bank. The project has created more than 1,800 EB-5 eligible jobs through March, and that means that all of the investors who joined the project, including Sidd, have already received more than the 10 jobs they need to successfully complete the EB-5 Green Card process and receive the permanent Green Card (which is conditioned on creating at least 10 new jobs in the US economy.)

The Twin Lakes project follows 14 prior Kolter EB5AN projects. EB5AN, we’ve been working with Kolter closely for approximately 10 years across many different projects ranging from condominiums, hotels. Artistry Sarasota that you see here is another similar large single-family home community in Florida that was also done as an EB-5 loan. Most importantly here is that all of these projects are either 100% completed and financially successful, or they’re still ongoing under construction. And all the EB-5 investments are in compliance or have been repaid.

As Sidd mentioned, Cresswind at Twin Lakes Georgia is one of 13 Cresswind communities across the Southeast. And this particular concept—55-and-up with extensive amenities targeting the 55-and-up new retirees who want a new home amenities, a well-run community—is a type of project that Kolter has successfully executed on over the last 10 years in many different geographic locations, including a few in the immediate vicinity around Atlanta, Georgia. So, this 55-and-up single-family home community concept is well-established and has been proven by Kolter over many years with significant home sales across their portfolio.

As I mentioned earlier, Twin Lakes Georgia is a rural project, so it does qualify as a rural TEA or targeted employment area. What does that mean, and why do I care about that? It means that the I-526E application, which is the application for the Green Card, will be processed on a priority basis, whereas all the other project types are standard processing. It also means that you can file concurrently, which is the same across the other types. This means you can apply at the same time you apply for the Green Card and get the work permit and the travel card in a matter of months—and stay on that flexible work permit until the Green Card gets issued. The minimum investment is the lower $800,000.

And most importantly, the visa set aside on the first row there is 20%, which is really critical for investors from China and India, where there have historically been very high volumes of investors in the past. A little bit about Kolter. They’re a very, very large real estate development firm in the Southeast. They’ve been developing real estate since 1997. Currently, they’ve got more than 70 active projects, hundreds of employees, multiple divisions across the company. The Kolter Homes Division, which is the division that the Twin Lakes rural EB-5 project falls under, is the largest and the oldest of their five divisions. As a company, they’re a financially strong developer with a significant amount of experience and an award-winning management team. Most importantly here on the left, they’ve never not repaid a single loan. They’ve borrowed billions of dollars over the last 30 years. Many of those loans are from some of the largest financial institutions in the US.

These are some of the major banks that Kolter has received loans from over the last 30 years. And as Sidd mentioned, there have been a lot of recent high-profile loans that they’ve obtained. As we can see here on the left, as of the end of 2022, they had secured loans from 5 of the 10 largest banks in the US with over 1 ½ billion dollars of loan commitments. And the reason that they’ve been able to do that is because they have a impeccable track record of borrowing and repaying funds, and so many of the major banks are comfortable in loaning them funds.

Sam:
This is a map showing historical Kolter development projects. As you can see, the majority of these projects are in the Southeast with the focus on Florida, Georgia, and the Carolinas. One of the most unique aspects of this project is the niche that it focuses on, which is the active adult 55-and-up retirement community segment. And this is a niche that Kolter has really outperformed in. And if we look at this chart, we can see that the active adult single-family market for Atlanta Metro area where the Twin Lakes Georgia project is located—they have been the most successful. They’ve sold the most number of homes with 17% market share, and they’ve outperformed some of the significantly larger home building companies in the US that are a lot bigger even than Kolter. But given Kolter’s execution ability and the quality of their product, they’ve still even managed to outperform some of these much larger home builders, which gives you an idea that this is a very attractive niche market (the 55-and-up single-family home market), and it’s one where Kolter is really leading the pack on.

One of the things that we’ve really tried to focus on as a company is transparency and helping investors benefit from different perspectives and from the experiences of others in similar situations. You can see here on the left, we’ve got a quote here from Sidd as well. These are a few video testimonials that are available on our website about the Twin Lakes Georgia rural EB-5 project. And you can watch each of these at your own leisure. There’s a link there at the bottom. They range from 45 minutes to about an hour long. And we also have all of the transcribed text as well. So if you want to scan the transcripts, you can also do that as well at your convenience.

That concludes today’s presentation, and I want to thank Sidd again for taking his time to join us today. If you do have questions about the EB-5 process or about the Twin Lakes rural EB-5 project specifically, please reach out. We’re happy to share more information. All the investment documents, everything that we have available on the project is all centrally located, and we’re happy to get you access so you can take a look. Thank you again for taking the time to join us on today’s presentation.