"Loan Model" vs. "Equity Model" EB-5 Regional Center Investments

(This one is for Ann T. in Chicago :).)  The basic framework of the EB-5 regulations requires that an investor make an "equity" investment into a qualifying EB-5 program. A loan to a project with a guarantee of repayment does not suffice. This has not always been the case, however. When the program was first implemented, it was common for investors to invest with a cash down and a portion in the form of "promissory notes". The USCIS did away with that and has since made it clear that a loan is not an investment.

But many Regional Center investment projects are structured as a loan these days and clients who have read a lot of information on the internet about EB-5s come to me a bit confused with the following question: "If an EB-5 investment cannot be in the form of a loan, then how are the Regional Centers saying that their project will give them a 1% interest rate with the "loan" repaid in 5 years?"

This is because the investor is not making a loan to the project, but rather an equity investment in a limited partnership created by the Regional Center, which then in turn makes a loan to the EB-5 project. At this juncture, a diagram would be helpful.

Disclaimer: Julia Park went to law school, not art school.

A simple way to explain what is going on is that the EB-5 investor is taking an equity position in a debt fund. The EB-5 "loan" is then structured with the Regional Center Company in the picture (the lender) and the Project (the borrower) within the parameters of the EB-5 regulations. This usually results in a 5-year secured term loan. The security (담보/担保) that is provided would be whatever the borrower can give to cover the EB-5 loan. It can be related to the project itself, such as the land or business that is being developed or the expected cash flow from the project. Or it can be unrelated to the project itself such as a guarantee by the owner of the project, a parent company or even cross-guarantees. Some projects have even tried to introduce a third party insurance that covers the principal of the EB-5 loans. (There is still a bit of controversy surrounding this arrangement which I won't go into here, but this article provides a good analysis.)

An "Equity Model" investment has a completely different structure. There, the individual investor takes an equity position in the project itself. This is what an individual investor who makes an EB-5 investment into his or her own project in a so-called "direct EB-5" or "stand-alone EB-5" (which basically means no Regional Center is involved) will be doing.

What are the pros and cons to each model? Theoretically, one can't say one is better than the other, although the majority of Regional Center projects out there today employ the "loan-model" in their projects. The reasons for this are rather simple: the investor knows with relative certainty the mode and timing of the exit (i.e. repayment of the loan by the borrower at the end of the term of the loan). In an equity-model, after the investor successfully obtains a permanent greencard, the exit will depend on market conditions - if the market for whatever the equity interest is good, you should sell, if not good, you should hold. As a result, I know of people who invested in equity model EB-5s a long time ago who forgot about it and then were rewarded with a sizable profit after many years, almost doubling their principal. Some people didn't or couldn't wait for the market to improve so they sold early and as a result couldn't recover all of their principal.

Conversely, loan-model investors can expect regular interest payments (generally starting at about 1%; but once the Regional Center management fees are deducted, it isn't that much) and a specific period at which their principal will be returned. Of course, both the loan-model and equity-model carry the same kind of business risk. Think of it this way: you have $500K, a friend is opening a business. She needs some money and is offering you the option of 1) loaning her the money with a promise to pay you back in 5 years with some interest or 2) investing in her company with a promise to give you back your investment plus any additional profits she can share when her company is successful. In either scenario, the possibility of her business failing and her not being able to return the loan or your investment exists. There are also other possible scenarios. You have $500K. Your friend Jim is opening a shoe store and he wants you to lend him the money at interest. Your friend Sally is opening a deli and she wants you to invest the money. Jim is a smart guy but he has no experience in the retail industry. Sally, on the other hand, has successfully opened and operated five delis in the past. So here, obviously, going with Sally is the better answer. (Or is it? What if Jim already has a successful consulting business and is willing to secure his loan with proceeds from his existing business; while Sally just liquidated all her assets and gave it all away to Autism Speaks and is now starting on a fresh slate?) And on and on. I can flip it around and give it you different variations on this ad nauseum. In short, the lawyer's answer to which is better, the loan-model or the equity-model, is "It depends."

Recent Updates (including When Will Premium Processing Be Introduced?)

On January 11, 2012, the USCIS sent out a redline version of its new EB-5 policy memo. The redline shows changes against a draft of a new EB-5 policy memo that was released for comments a few weeks back. The changes to the draft, as well as a number of other issues, were discussed in a small group setting with Director Mayorkas in Washington, D.C. with interested parties dialing in. (But unlike quarterly stakeholder meetings, those not present at the meetings were not allowed to ask questions.)

Much was discussed on the call including new language in the redline that indicated that the USCIS was reviewing the possibility of allowing something similar to a fund model where investors can share jobs created by multiple businesses and thereby spread the risk. But it was apparent that there was still a lot of confusion internally about the specifics of how that model would work and, to be clear, this is not a "blind pool" or "private-equity" model that many people ask me about. (Meaning an RC will pool funds to invest in job creating enterprises that are identified after the funds have been pooled.) The EB-5 regulations require that the job creating entity be identified for at the I-526 business plan phase.

There was a little bit of discussion regarding when Premium Processing will be introduced. One could tell that the USCIS wasn't against the idea, but they could not give a firm time frame given the current backlog in processing caused by a surge in applications in recent years and lack of personnel. In addition, the USCIS has previously announced that even if/when Premium Processing is introduced, it would start with shovel-ready I-924s (Regional Center applications with ready to go projects). In short, investors shouldn't be holding their breath, waiting for Premium Processing to happen.

Clarification on the Buy a House Get a Visa Bill

As soon as the Wall Street Journal article relating to a new bill introduced by Senator Schumer(D-N.Y.) and Senator Mike Lee (R - Utah) which aims to allow foreigners to "buy a house and get a U.S. visa" hit the airwaves, I received three emails from friends and colleagues asking about what this meant for the EB-5 program. Now that the dust has settled somewhat, the verdict is in and the answer is "Not much."

First, there are two types of U.S. visas: 1) Immigrant Visas (IVs, a/k/a greencards) and 2) Non-Immigrant Visas (NIVs). An example of a NIV would be B1/B2 (tourist visas), F-1s (student visas) or H-1Bs (specialty occupation visas a/k/a "work visas"). A NIV is by definition a temporary visa tied to the original purpose of the visa. So if someone gets a student visa by attending a U.S. law school, for example, once they graduate from the program, the visa is no longer valid. Same for the work visa - once you are no longer employed by the employer who sponsored your visa, the visa becomes invalid. In the case of a tourist visa, the amount of time you can stay is determined by the border official when you enter the country (usually three to six months).

The visa being proposed is a NIV which hinges on ownership of property. In summary, the legislation would create a new homeowner visa that would be renewable every three years. To be eligible, a person would have to buy a primary residence of at least $250,000 and spend a total of $500,000 on residential real estate. (The idea being that you can buy a house to live in and another to rent out.) The properties have to be purchased in cash with no mortgage or home equity loan allowed. And the property would have to be bought for more than its most recent appraised value so no buying up undervalued property on the short sale market. The buyer would have to live in the home for at least 180 days each year and buyers would no longer be eligible for the temporary visa if the property were sold. The final point most likely comes from IRS regulations that state that a person is deemed a U.S. resident for tax purposes regardless of their immigration status if they reside in the country for 180 days or more.

What the bill does not address is the status of the spouse and children. (Click here for a copy of the actual bill. Skip to Section 8.) But it is not unreasonable to expect that spouses and children will get derivative benefits similar to other NIVs. For example, a child of a H-1B holder will get a H-4 derivative visa; a child of a F-1 student will be the recipient of a F-2. These derivative visas will allow the spouse and children to reside in the United States on a valid status as long as the primary recipient's status is current. The problem, however, arises in the definition of child. Under immigration laws, a child is defined as "an unmarried person under 21 years of age."

Which brings us to why this bill, even if passed, won't really affect the EB-5 program. EB-5 visas are Immigrant Visas giving permanent residency to holders of the visa. If you get an EB-5 visa, your child, as long as he or she is unmarried and under 21 years of age, will also get a greencard. Once you get a greencard, you are on a "path of citizenship" which basically means if you retain your status for five years, you are eligible to apply for naturalization. (There are a number of requirements, such as the "physical presence test" that one has to meet, but I won't go into the specifics here.)

It is a well-known fact that many people considering EB-5 visas do so for the future of their children. So why would anyone choose to get a NIV that you have to renew every three years if once your children reach 21 they are no longer eligible to stay in the United States? I can see a use for this visa for older people who are retired and want to have some sort of presence in the United States. But for the majority of people who want to "immigrate" to the United States so that their children can build futures here, this visa really doesn't help that much. Once you are in the United States on this visa, you can't earn income or run a business (other than getting rental income from any property you might have purchased for investment purposes). You will get none of the benefits of a greencard holder or U.S. citizen, but will be taxed as a U.S. resident (i.e. pay taxes on worldwide income).

In conclusion, I don't see the bill in its current form dampening investor appetite for the EB-5 visa. That said, I have heard that the mere introduction of the bill has caused confusion among potential investors. If you could buy a house for half a million dollars and get a greencard, would you invest the same funds in a venture by its very definition is "at-risk"? I sure wouldn't.