Is the EB-5 Regional Center “Pure” Rental Model Sustainable?
Over the last few years, there has been a remarkable growth in the number of EB-5 regional center designations. This rise was partially driven by the perceived demand for regional center geographic coverage. Real estate developers seeking access to EB-5 capital largely shied away from the administrative burdens and ongoing responsibilities associated with the regional center business. Setting aside the legal and rather insignificant government application fees, the barriers to entry in the regional center market have been low. USCIS actually simplified the process when, in the May 30, 2013 EB-5 Adjudications Policy Memorandum (“May 30 Memo”), it obviated the need for offering documents if the Form I-924 application was based on a “hypothetical” project. To put this in perspective, there were less than 25 I-924 applications approved in all of 2012 as compared with the few hundred that have been approved since the May 30 Memo was issued. Some of the dramatic increase in application adjudications could also be attributed to the efficiency with which the new Washington DC adjudicators are handling the I-924s in stark contrast with the confounding backlog applicants previously faced with the California Service Center. Whatever the reason though, the increase in I-924 designation numbers has not been welcomed by veteran regional centers that previously had a much stronger grip on the EB-5 market. Even more vexing for such veterans, however, has been a spike in the general acceptance and usage of the regional center rental model. To be clear, while there are different rental models with varying degrees of regional center involvement, the focus of this article is on the pure rental model (hereinafter simply referred to as the “rental model”).
The prevailing wisdom, of late, has been that unless a developer is looking to develop more than a single project within a certain geographic area, especially in rather crowded regional center markets like New York City, one need only rent an existing regional center outfit as opposed to spending the time, energy, and capital to secure and maintain a new regional center designation. Developers who like the rental model often appreciate the regional center’s non-interference in the development process. After all, not all regional center principals have real estate development experience, and as such, are usually not in a position to dictate the development terms. Therefore, separate from (perhaps) an initial review and subsequent sign off on the project documents, execution of a regional center sponsorship agreement, and later communications to gather data for the annual Form I-924A and (hopefully) the Form I-829, leased regional centers are largely removed from the overall project process. From the perspective of the leased regional center, as long as it has conducted sufficient due diligence to vet the developer for possible fraud and other relevant infractions, the rental model could translate into a relatively painless transaction. Since the developer usually has its pick of regional centers, in this saturated market, a regional center’s demand for more involvement could mean losing out on the transaction.
As of January 4, 2016, there were 790 approved regional centers around the country. While there is an expectation that this number will be, at least slightly, whittled down in the next few months, due to non-compliance with the annual Form I-924A requirements, there are likely still a number of new regional center applications currently pending to make up for such loss. Therefore, the 790 number is unlikely to be dramatically affected unless a legislative push comes into play.
What seems to be clear from the 2015 legislative gymnastics is that regional center integrity is of great import to Congress. One need only scan through the first EB-5 bill introduced in 2015, entitled S. 1501 and sponsored by Senators Grassley and Leahy, and the last EB-5 bill, entitled S. 2415 and sponsored by Senators Flake, Cornyn, and Schumer, to get a hint of what changes are expected to be coming down from Congress. Irrespective of whether the above two bills end up dead in the water, the war drums in Congress are focused on Integrity. The path to such integrity will require greater regional center involvement in EB-5 deals. As such, I expect that these impending changes are going to have a consequential impact on the regional center rental model.
For example, consider a few (non-exhaustive) requirements delineated in S. 2415 such as:
- The requirement that the regional center file exemplar applications that contain disclosures: of fees, pending or past litigation/bankruptcies/adverse judgments affecting any of the project associated entities, and conflicts of interest between any and all of the project associated principals. In order to ensure compliance with such requirements, regional centers will have to conduct extensive due diligence of the Developer entity and its respective affiliates. As such, the vetting process will necessarily have to be a lot more involved and likely have some expense associated with it. With regard to the aforementioned conflict of interest issue, barring use of a neutral third party General Partner or Manager of the new commercial enterprise, it is not uncommon, in the rental model structure, to find affiliates of the job creating enterprise managing/directing the affairs of the new commercial enterprise. As such, separation between the EB-5 Lender and EB-5 Borrower are not exactly clear cut. While securities attorneys have traditionally been the professionals pushing for appropriate disclosure in the offering documents, the relevant textual applications have not always been pronounced (and in some cases even missing). Regional Centers may soon be forced to take more focused positions on these requirements.
- The requirement that the regional center annually certify that both it as well as all project associated entities are complying with securities laws. Pause and reflect on this. It could be a scary prospect for leased regional centers because it is not a small burden. Leased regional centers are typically not involved in the securities offering, do not play any managerial role in the new commercial enterprise, and do not participate in the marketing seminars conducted abroad (or onshore if appropriate). Without such involvement, how exactly can a regional center make such annual attestations? If one examines some of the other proposed annual certification requirements contained in S. 2415, it reads like the Form I-924A on steroids. Contrast these proposed attestations with the current rules; you will notice that annual regional center compliance has, till date, been rather innocuous.
- USCIS site visits to the regional center and new commercial enterprise. For those regional centers that have assumed a mom and pop type office atmosphere and/or which do not have an official separation between the regional center entity and the principals’ other commercial enterprise(s), this possibility is going to be of some concern. One would assume that the USCIS officer, conducting the site visit, will closely review the regional center’s infrastructure. Typical rental regional centers that have failed to formulate and maintain appropriate infrastructure and more importantly, that have failed to ensure collection of applicable project and investor documentation, may be in a predicament. On this latter note, Nicholas Colucci appeared in front of the full Judiciary Committee on February 2, 2016. He was asked, by Senator Grassley, whether USCIS would be willing to conduct site visits to regional centers. Mr. Colucci noted that even if legislation is delayed, USCIS has already begun plans for random site visits and an audit program that he expects will go into effect sometime this fiscal year.
The point of this article is not that the above outlined requirements are the most important considerations nor does this mean that S. 2415 will pass in its current form (in fact, small chance of this latter point); rather, the big picture issue is that Compliance has never been more important. As such, the key takeaway is a necessary focus on how Compliance measures will help address the Integrity issues weighing on the minds of the members of the Senate Judiciary Committee.
In the context of this article, Compliance appears to be charging in the direction of greater regional center involvement in the offering process. After all, how else can a regional center meet its (proposed) annual certification requirements without getting more actively involved in the project’s lifecycle? How else will a regional center pass a random site visit without having its own, and the relevant sponsored Project’s, affairs in order for the USCIS adjudicator’s audit? Limited communications with the issuer of the EB-5 securities, in efforts to collect Form I-924A relevant data, might no longer cut it.
This post originally appeared on klaskolaw.com. © 2016 Klasko Law. All Rights Reserved. Reprinted with permission.
Rohit Kapuria is an Associate Attorney in the Firm’s Chicago office and a member of the Firm’s EB-5 practice. 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.