Due Diligence of Economic Impact Studies
Rupy, as someone who performs due diligence on a regular basis, how do you approach due diligence of economic impact studies?
Rupy Cheema: We start off ensuring that the data in the economic impact study is consistent with the data in the rest of the projectís documents, i.e. the business plan, market feasibility study and the PPM. I donít think Iíve ever looked at a project where we did not find inconsistencies between these four documents simply because the economic analysis happened at a certain point and then thereís different versions of documents floating around and the changes donít get picked up. Those are some of the most common issues we find at the beginning of our review, just reconciling the discrepancies in the documents.
One of the things we thoroughly look at is financial projections and the market feasibility of the project. If we feel that the projections are aggressive or overstated or that the market feasibility is more positive than perhaps it should be, and the revenue inputs are being used in the economic analysis, we would point out in our due diligence that those jobs may then be overstated.
As far as construction documents, we want to see that the construction expenses or costs used in the economic analysis are supported by other documents. If there is a construction contract available weíll look for support for those numbers in the economic analysis.
Then we rely on an economist to look more closely at the technical aspect of the economic analysis, such as regional impacts, excludable costs and questionable methodologies.
Kurt Reuss: Would you mind posing a question to one of our economists?
Rupy Cheem: Sure. Michael, all of the topics listed on the displayed slide are things we look at in our due diligence. Would you please select and address one of them.
Michael Kester: Iíll talk a bit on the impact area under study. The multipliers that we use and the input output models are reflective of a certain defined area. For example, with RIMS II the smallest area you can order is a county. You can also order multipliers reflective of multiple counties, such as the counties that make up an MSA or a CSA.
A couple of key issues about the impact area of the study are, as Rupy had just mentioned, construction expenditures and revenue inputs which need to be supported. The economic study should support the impact area itís using which itself is reflective of the multipliers itís using, which are typically supported by the commuting patterns or general movement of goods in the area, suppliers, etc. All of which shows where the inputs and the labor for the project are coming from, so it makes sense for us to use this area to study.
For example, if youíre analyzing a McDonaldís or some very small restaurant and the multipliers used are statewide multipliers, then thatís something the USCIS could pick up on and question, whether a tiny restaurant could actually have a statewide impact. Thatís opposed to say, a very large oil and gas project, where oil and gas workers travel far distances. In that case, a statewide impact area might be reasonable to argue, but the larger the area, of course, the larger the multipliers as you have less leakage outside the area of inputs to the project.
Another thing to double-check regarding the impact area is the regional center your project is going to use and the county the project is in. If itís not currently in the regional centerís geographic scope, it will hopefully be close enough to where the impact area could overlap. If youíre trying to run a project in California and youíre trying to run it through a Texas regional center, thatís a way to create a distance to try to cover. Just another thing to consider when weíre looking at a project, is if theyíre renting a regional center or going through an existing regional center, what geographic scope does that have and how does that correspond with the impact area under study?
Rupy Cheema: Kevin, let me pose this scenario and then ask you a couple of questions. Say you have a client whoís forming a regional center and they come to you for a business plan or an economic analysis. The developers provide you with the construction budget and the projections, which are prepared at a specific point in time. Do the economists undertake any kind of verification to see that the information provided is reasonable? Or do you rely solely on the information provided to you?
Kevin Wright.: Iíd say that you have to verify everything, regardless of whether itís an exemplar filing or just simply a hypothetical plan; you still need to verify all of the revenue, then the construction budgets. Now, a lot of times in the regional center filing, itís a lot easier. You might not need a full-on construction bid or a market study and you can get by with third party verification of a developerís budget using, say, RS Means or some kind of other industry standard; one where you can compare costs per square foot and say, ďYeah, thatís works. Thatís within reason.Ē
The same thing goes for revenue projections, there are generalized HVS studies out there that are regionalized, so that you can compare the developerís estimates to actual industry standards and come up with reasonable comparisons. If youíre trying to do an exemplar filing, and we have a lot of clients who try to use RS Means or some kind of generalized statement of revenue, but itís not really advisable.
If youíre doing a hotel or assisted living facility or something like that, I would suggest that you get a very specific market study that dictates those revenue numbers. Then get actual construction bids to come up with exact figures and that will be a lot more accurate and a lot easier to get through the system with a lot less questions from USCIS.
Rupy Chemma: Rohit, many people donít realize that youíre not only an immigration attorney but an economist as well. Iím curious, when youíre looking at the economic report, what are you looking for, from a due diligence standpoint?
Rohit Kapuria: Quite often, itís what youíve already discussed, Rupy, and what you guys do on your end, as well. And you guys do a tremendous job of it so it tends to save us time if we see a report that comes directly to us. The reasonableness of the multipliers is something that we definitely pay a lot of attention to. Basically, what Michael talked about in terms of a McDonaldís restaurant, if theyíre using multipliers they may count the entire state or count more than a fair share of number of counties. That, obviously, is going to ring a lot of bells for us and we worry about how the USCIS is going to react to it.
Separate from the verification of the inputs, itís what inputs are being used for the studies. So we really get into the nitty-gritty of the budget and there are certain items that jump out at you. Itís easy enough to see hard construction costs and soft construction costs, FF&E; those are basics that can be thrown into a lot of deals. That being said, if the developer simply provides the economist with the items, sort of in bulk, and doesnít really break down the budget into a more detailed format, then itís very difficult to parse out what items may be excludable and have been incorrectly included in, say, hard construction costs.
Once that gets broken down we then look at what those numbers are and sometimes there are things such as service and warranty or legal and title, which depending on what the project is, may or may not be appropriate to include in this bid. Some economists differ in terms of whether theyíre comfortable using it, some take the plunge and say, ďWell, throw the kitchen sink and see how USCIS reacts to it.Ē And some, on the basis of previous RFE history with USCIS, might say, ďWell, hold on. Iíve seen a couple of deals where this was questioned and so I donít recommend using it.Ē
From our standpoint, unless the job count is really tight, I tend to want to be as conservative as possible, just because why delay with an RFE down the line, which is just basically going to cost another four or five months of the project life, meanwhile investors are struggling. Sales and commissions are things that have been seen a lot more, particularly when weíre dealing with condos or apartments. Management fees are also inputs that we see a lot, which weíre relatively comfortable with. Things like legal and title, service and warranty, or HOA-related expenses, we kind of say, ďWell, do we really want that? Do we really want to count insurance,Ē for example? Those are things that are up in the air for us.
Rupy Cheema: What kind of job cushion do you like to see?
Rohit Kapuria: If weíre talking about whatís marketable versus what we like to see from our end, thatís obviously different, and the more cushion, the better. I am seeing a lot of requests for things with 50% job cushion, and those are much easier to market. It used to be that 20% cushion was sufficient, but now that the market is flooded with a lot of deals the agents are becoming very picky. In a deal where itís a small job number and the cushion is, letís say, 15% or sub-15%, I start to get worried, because in the event the project is unable to meet their projections, then some investor is going to suffer.
Now from a construction standpoint, if weíre looking at using hard and soft cost construction and if weíre looking at something thatís less than two years and so only indirect and induced jobs, Iím okay generally if thereís a cushion on those costs. But if we have to dip into, say, operations jobs just to get us over the hump for the job count, then I start to get really worried. Generally, thatís because from a construction standpoint the developerís proposed budget is conservative, at best, and in most cases they are going to outspend it.
On the operations side, if they donít meet the projections theyíre utilizing for revenue, then the investors could be in serious trouble. To answer your question about job cushion, itís twofold. First, itís what exactly is accounting for the cushion and second, in terms of a numerical proportion, Iíd prefer to see the cushion above 30%.
Rupy Cheema: So youíre saying that you prefer to see the job requirements being met mostly by construction spending and not having to rely on operations?
Rohit Kapuria: Yes.
Rupy Cheema: Thatís interesting because we see a lot of projects that wouldnít meet that requirement, that are relying on operations.
Rohit Kapuria: Not to say that itís not going to work, itís just I worry about that potential. If they construct and they build, fine, theyíve created the jobs, but then if they donít meet the projections on the operations side, then investors are going to be in trouble.
Kevin Wright: I talk a lot with agents in China and theyíll have me recalculate things and they might say, ďletís just pretend for a moment that the ADR stays the same. If this is a hotel and the job count is X, and then we take away all the construction jobs and assume theyíre all going to be created, well, youíre projecting that youíre going to have an 82% occupancy rate in this hotel, but what if you donít? What if itís much lower than that? What is the occupancy rate thatís needed for everybody to get a green card?Ē
In China a lot of the larger agents have caught on to this, and thatís the calculation that weíll sit there and do. Itís not necessarily accurate because as occupancy rates go up and down, your ADR would as well. If you assume the ADRís the same, and then you just kind of do the math backwards, you can tell, a lot of times, we need a 42% occupancy rate for everybody to get a green card. Then they can make their determination of whether theyíre comfortable with that or not.
Rohit Kapuria: Kevin, do they ask you to reach out with these on the basis of a project being in a non-metropolitan area? For example, if youíre looking at a projection with an occupancy rate of, letís say, 82% to use your figure, and itís in downtown Manhattan, that could be a comfortable number just on the basis of what flag it is and what star level, so it may be entirely reasonable. But letís say itís a hotel in the middle of Indiana. Do you see them worrying about that more or less?
Kevin Wright: Well, I tend to try and stay out of the conversation in terms of that portion of it, and say more directly, ďHey, hereís what the numbers say.Ē Whether you interpret that to mean that itís okay because itís in a better metropolitan area, obviously New York has a much higher occupancy rate than rural Indiana, but I leave those determinations to the agents and to the people who are reading it, and try to just do the math myself.
This post originally appeared on EB5 Diligence. Reprinted with permission.
Kevin Wright, Principal with Wright Johnson. Mr. Wright is considered one of the foremost experts on the EB-5 Immigration Visa program. As an accomplished researcher, analyst and professional author, Kevin has assisted many entrepreneurs in receiving Regional Center designation and subsequent approval of the specific projects that are developed and put into operation through the Regional Center mechanism. As an IMPLAN software specialist, Kevin has authored numerous econometric impact studies, in many divergent industries, that demonstrate the employment and economic impacts of these various projects to the USCIS. The Regional Center application process requires Kevin to have an expertise in business plan writing, econometric analysis, complexities of government reporting requirements all coupled with the ďhands onĒ experience necessary to successfully work within this highly specialized industry.
Micahel Kester, Michael Kester is the lead EB-5 economist at Impact DataSource, LLC, an economic research, analysis, and consulting firm which operates out of Austin, Texas. Since 1993, the firm has completed more than 2,500 high-quality economic impact analyses in all industry sectors throughout the country. In tandem with this specialty in fiscal and economic impact analysis, Impact DataSource provides economic analyses for developers seeking EB-5 funding, with Mr. Kester at the helm of the EB-5 team since 2012. The team of economists at Impact DataSource has successfully conducted over 60 comprehensive EB-5 economic impact studies over the past five years. Mr. Kester also oversees the firmís TEA team, which has evaluated more than 1000 potential Targeted Employment Area sites, and helped clients to obtain 100-plus TEA certifications. Mr. Kester understands the evolving program requirements provided by USCIS and applies this knowledge to the economic consulting services and deliverables he provides to EB-5 clients. Specifically, Impact DataSourceís EB-5 services consist of Targeted Employment Area assessment, along with TEA analysis for designation-purposes. The firm also offers a preliminary EB-5 economic analysis, which indicates the possibility of TEA designation for the project in question, provides job creation numbers, and predicts how much EB-5 capital can be raised. The detailed EB-5 economic impact analysis which the firm provides for proposed EB-5 projects and regional centers relies upon USCIS-approved methodologies. One of the firmís past approved studies also successfully utilized a special methodology which included indirect job creation both outside and inside the EB-5 regional center. Each report provides a comprehensive and objective perspective on employment impact, along with other economic impacts required for EB-5 approval. Throughout the process, Impact DataSource works collaboratively with project applicants, immigration attorneys, and the regional center. Prior to joining Impact DataSource, Mr. Kester worked as an actuarial healthcare consultant in New York City, for the company Deloitte. A native of Kansas, he graduated from Kansas State University with his bachelorís degree in Mathematics.
Rupy Cheema, Co-Founder and President of EB-5 Diligence. Ms. Cheema is the industry's leading authority on EB-5 due diligence, having extensively reviewed offering documents of the largest, most prestigious EB-5 investments in the market as well as small EB-5 offerings including franchise opportunities. Ms. Cheemaís career began as a business auditor for Canada Revenue Agency and then as CFO of two startups, including 13-years with Internet startup Contractors.com. Ms. Cheema earned her CGA (Certified General Accountant) designation after graduating from York University in Toronto.
Rohit Kapuria, Associate Attorney with Klasko Law. Rohit currently works with U.S. based developers to help structure EB-5 compliant projects, either through the creation of a Regional Center or else under the auspices of an existing Regional Center, to attract foreign capital for job creating activities in the U.S. In this capacity, Rohit works collaboratively with economists, business plan writers, securities attorneys, investment managers, and other professionals in preparing I-924 and I-526 petitions for filing with USCIS. Rohit also conducts immigration due diligence reviews of EB-5 projects for foreign investors. Rohit has a graduate degree in mathematical economics and prior to entering the legal profession, he worked in the non-profit sector as an economist and fund manager where he created and analyzed predictive donor fund models for capital campaign projects. Rohit is a member of the Illinois State Bar.