EB-5 investors are increasingly paying more attention to the “investment benefits” of the EB-5 program—as opposed to before, when investors primarily focused on the immigration benefits. This shift is largely due to increasing investor knowledge and many regional centers’ lack of transparency.
While immigration benefits (a U.S. Green Card) remain the primary goal of most EB-5 investors, these investors also want to recoup their capital and even profit from their investment where possible.
To ensure there’s a likelihood of EB-5 capital repayment, your EB-5 project due diligence must go beyond checking for regulatory compliance and its ability to create the required jobs. You must also scrutinize the project’s capital stack to understand its funding sources.
Understanding an EB-5 project’s financial structuring will enable you to predict the profitability of your investment. It’ll also help you make a more informed decision to protect your capital.
In this article, you’ll learn about the EB-5 capital stack and how to evaluate it when making an EB-5 investment.
What Is a Capital Stack?
Components of an EB-5 Capital Stack
Choosing the Financial Structuring for Your EB-5 Investment
EB5AN Can Help You Assess EB-5 Investment Risks
What Is a Capital Stack?
A capital stack refers to the different contributors of funds for financing a project. It comprises layers of capital used in developing a real estate project. A capital stack also outlines the order in which investors will receive profit and capital repayment from the project.
Most EB-5 rural targeted employment area projects are real estate developments, so understanding the capital stack is essential for evaluating these EB-5 projects’ financial risks and potential returns.
Components of an EB-5 Capital Stack
A capital stack typically comprises four financing sources: common equity, preferred equity, mezzanine debt, and senior debt. Common equity holds the lowest priority, while senior debt has the highest priority. This means senior debt lenders receive interest/dividends before other lenders. They’ll also be repaid first after the project is completed or if it fails, while common equity lenders are paid last.
EB-5 capital has traditionally been structured as mezzanine debt. However, more projects are beginning to offer EB-5 investments structured as senior debt, common/preferred equity, or a combination of both.
Each capital structure has its advantages and disadvantages. We’ll look at each of them in the following sections.
Senior Debt
Although positioned at the bottom of the stack, senior debt holds the highest priority in an EB-5 capital stack. This means EB-5 senior debt holders are the first to be paid interest/dividends and the first to receive capital repayment when the EB-5 project is sold or refinanced. It is the least risky position, as it enjoys first-lien rights on the project.
Senior debts typically comprise the largest percentage (50% to 60%) of a project’s total cost and earn significantly less than other capital forms. Their dividend is limited to a pre-agreed interest rate. This is because of senior debt’s comparatively minimal risks and priority repayment. Furthermore, senior debt is secured through a repayment guaranty or a first-lien mortgage on the property, which minimizes capital loss in the event of a default.
However, it’s important to note that even when an EB-5 senior debt is secured by real estate, the property is often worth less than the EB-5 capital unless fully developed. Additionally, a senior debt EB-5 capital structuring does not necessarily impact the viability of a project.
In evaluating an EB-5 senior debt offering, EB-5 investors should check the sunk financing costs. Projects with high sunk financing costs and poor structures usually fail first in an unfavorable economy.
Mezzanine Debt
Also known as junior or subordinated debt, mezzanine debt lies above senior debt in a capital stack. It holds lower priority than senior debt and higher priority than preferred or common equity. This means a mezzanine debt holder receives dividends/interests and capital repayment only after senior lenders are fully paid/repaid.
Mezzanine debt typically comprises the second largest percentage (25% to 40%) of a capital stack and has higher interest rates than senior debt because it is less secure. However, mezzanine debt is still secured by a pledge of ownership interests in the event of a default.
This means mezzanine lenders can take over the developer’s equity and ownership of the property if the note defaults. However, this is only possible if stated in the intercreditor agreement. Unfortunately, many EB-5 mezzanine offerings do not contain an intercreditor agreement.
Even when there’s an intercreditor agreement, enforcing ownership rights often involves a long legal battle. Most regional centers prefer to extend the loan term, giving the developer more time to stabilize the project. This way, they can avoid the burden of taking over and completing the project—in addition to earning more interest on the extended loan.
When evaluating an EB-5 mezzanine debt offering, EB-5 investors should ask the regional center how the increased interest rate will be shared in case of a loan extension.
Preferred Equity
EB-5 preferred equity lies above mezzanine debt and below common equity. It offers higher returns than senior and mezzanine debt and receives priority payments over common equity after all debts are settled. Preferred equity holders also have more rights over the project than common equity holders if the project fails.
Preferred equity returns are usually fixed and may or may not include profit sharing. The returns on preferred equity must be paid before common equity, and preferred capital must also be repaid first.
Most preferred equity investments only receive payouts when the project’s cash flow is positive. The returns are accrued until the project becomes viable, reducing the sunk financing costs of the project.
Common Equity
At the top of the capital stack is common equity. It offers the highest returns but receives the lowest payment priority. Common equity holders (usually the project partners) can only receive dividends or profit shares after all debts and preferred equity are settled.
Although common equity bears the highest risk in the project, it also gains the highest returns if it performs well. It’s a suitable investment structure for EB-5 investors with higher risk tolerance.
The profit-sharing and capital repayment terms of a project’s common equity vary depending on each partner’s class of equity. You should carefully review the offering documents to understand the dividend and capital repayment priority of common equity shares.
Choosing the Financial Structuring for Your EB-5 Investment
The financial structuring you choose for your EB-5 investment will depend on your risk tolerance, investment goals, and the available regional center offerings.
EB-5 loan offerings (senior and mezzanine debt) are more secure and typically offer quicker returns and capital repayment than equity offerings. However, they also turn in less profit than common and preferred equity. This largely means that EB-5 loans are suitable for investors who have a lower risk tolerance.
On the other hand, EB-5 equity offerings are suitable for less risk-averse investors seeking higher returns. While you will likely have to wait longer to receive any return, you may make higher returns than other lenders if the project succeeds.
EB5AN Can Help You Assess EB-5 Investment Risks
EB-5 investments are broadly structured as loans and equities. The financial structuring you choose for your investment will determine how much profit you’ll make and how fast you’ll receive capital repayment. This is why conducting financial due diligence is essential before choosing an investment structure.
EB5AN offers loan- and equity-structured projects that satisfy the varying financial goals and risk appetites of EB-5 investors. In over a decade of practice, we’ve assisted over 2,300 families in successfully relocating to the U.S. as permanent residents. If you’re considering an EB-5 offering, our experienced EB-5 professionals can help you assess projects’ financial risks.
For more information about EB-5 financial structuring and help in choosing the right structure for your EB-5 investment, schedule a free one-on-one consultation with our EB-5 experts today.
