Last month I spoke at four conferences in four cities across the United States on topics related to the EB-5 Visa and issues concerning EB-5 project risk and the potential for failure in light of the difficulty to obtain credit from commercial lenders, the increased volatility and unpredictability in global financial markets and the claims being made by certain EB-5 Regional Centers, agents and promoters of these projects, both here in the U.S. and abroad.
Our panels stressed to the audience the importance of the need to independently verify the claims and assertions being made by the promoters and agencies as while this is a standard best practice in commercial lending and investment banking, it is not typically performed in the EB-5 investment project selection process.
Overseas agents and U.S. based "finders" or "consultants" are claiming to perform rigorous due diligence for their clients, but rarely do and in any event are conflicted from giving their clients independent advice as they are being paid large fees by the EB-5 Regional Centers to sell their projects. Any negative news given by the agent to their clients would not result in higher sales and would adversely impact their commissions, profitability and ability to deliver the numbers of investors promised to their Regional Center clients.
This should be a concern to not only the EB5 visa investors, but their attorneys and advisors in light of recent project failures and in reviewing historical data on commercial enterprises failing in over a relatively short period of time, especially most recently with the increased volatility in the global capital and credit markets.
These conferences were:
- 2011 Fall National AILA EB-5 Visa Conference, San Antonio, Texas
- 25th Annual AILA Central Florida Chapter Fall Conference, Clearwater, Florida
- 2011 International U.S. - Mexico - Canada Cross Border Tax Issues, San Diego, California
- EB-5 Business Boot Camp, Los Angeles, California
The growing popularity of the EB-5 visa, both by foreign nationals and the U.S. developers looking for funding, was evident in the large attendance present at each of the venues and all of the speakers and panelists offered good advice and caution to the enthusiastic audiences in attendance.
For the AILA conference our panel, which consisted of me, Christopher Helm and Beth Hurst, can be found here: Risk, Value & Due Diligence in EB-5 Investments.
Presentation to AILA National EB-5 Conference: Risk, Value & Due Diligence
Our discussion for the AILA National San Antonio audience began with a discussion of perception v. reality with an illustration of why certain EB-5 visa projects are promoted as being ?safe? but in reality, may be quite risky when the data on the industry, asset class and other factors are evaluated. I brought up the point that nearly all EB-5 investment decisions were made using very little data analysis and due diligence and were based more on the assurances given to them by the agents and promoters:
This slide shows that there are four possible outcomes for an EB-5 visa investment three of which would probably be considered a failure by the investor and their immigration attorney:
The rest of the presentation then focused on the historical nature and reasons why businesses of all classes fail, the relatively large number of projects which fail for any number of reasons (lack of available capital / other sources of funding, incompetent management,more competitive environment, etc.). As well as the fact that a relatively small percentage of new businesses actually survive for more than a few years, and that most of the largest bankruptcies in United States have occurred in the past several years.
Here are some example slides from the presentation, these ones on current market volatility:
This is principally due to the fact that start-up costs are high, capital is finite, and expenditures, if they exceed revenue and capital beyond the reserves, the commercial entity will cease to operate. To paraphrase an old song, money is like oxygen, without it the business will die. If the developers are unable to bring in more revenue than expenses they will use all available capital until they can no longer continue to operate, a condition commonly referred to as "lights out".
This is often overlooked by investors and not mentioned (or diluted) by the promoters, who usually repeat overly optimistic valuations & revenue projections and underestimate expenses, yet should be a key consideration of any foreign national considering which project to invest in.
This slide shows what could be the potential losses to the EB5 industry if asset class failure rates are extrapolated from historical data failure rates:
An example of Commercial Property Systemic Risk. This is an important slide as it shows the very high valuation and return for this asset class from 1998 - 2005, nearly double that of any other. The next slide, however, points to it's high standard deviation, meaning that it has a very high probability to reverse those gains; it is a volatile asset category.
This is the result of having an investment in such a volatile asset class as shortly after the near collapse of the credit markets in late 2007 involving overexposure to commercial and residential real estate, this class fell further than nearly all others. Most EB-5 visa investments are made in commercial real estate so the high volatility and standard deviation rates inherent in this industry should be taken into consideration before committing to an illiquid investment in this asset class.
EB-5 investors who invested in commercial property prior to 2008 will most likely have a lower value to their limited partnership interest which could affect the principal returned at term. The lower equity valuations could also affect debt covenants and trigger calls for additional capital should the Loan-to-Value (LTV) ratio on existing debt be revised based on new market assessments that could negatively impact the developer's ability to continue operations if they are unable to raise the additional capital required by the lender.
This could also impact job creation and the developer's ability to show sufficient economic activity to remove conditions at the I-829 stage and ultimately the ability to repay any other obligations, debt or equity.
Examples of Bank Failures across the country:
Examples of a number of hotels, restaurants, Senior Care facilities and even U.S. municipalities going bankrupt recently:
Most of America's largest commercial failures have occurred in the past few years:
Examples of recent EB-5 Visa Project Failures:
I will comment on the other presentations in posts to follow. Thank you to all in the AILA National EB-5 Visa conference for your positive comments following the presentation. Since this was the first time the subject of risk, valuation & due diligence was given a platform at a National AILA conference we were all very interested to gauge the audience's interest on these complex issues of vital importance to their clients.
Chris, Beth and I were all very pleased by the questions and feedback that we received following the talk and invite all who have an interest in this area to continue to provide us with your comments and suggestions on how we can improve the standards and best practices for assessing risk and performing the necessary due diligence in the EB-5 legal community.