A notable characteristic of the real estate capital markets over the last 20 years has been the ability to access non-traditional sources of capital for both debt and equity investment in U.S. commercial real estate. One such source is the EB-5 investment/visa program. Created by Congress in 1990, the EB-5 program creates a fast track for non-U.S. citizens toward a green card in return for capital investment in qualifying U.S. domestic businesses and projects. The EB-5 program has garnered its share of controversy for possible abuses, but can also lower the cost of equity capital for a developer.
An often overlooked issue is the interplay of EB-5 financing with the requirements of a CMBS lender, where the developer, EB-5 investor and CMBS lender have objectives that are in conflict, at least initially. In particular, the EB-5 investor may seek decision-making and investment accrual rights not acceptable to CMBS lenders.
The essence of the EB-5 program is that, in return for an investment of $1 million in a U.S. business or project that will generate permanent full-time jobs, the U.S. government will provide an expedited path toward legal immigration status in the country—a green card. Since this immigration status is the principal motivation for those willing to provide funds through the EB-5 program, the rate of return and timing and likelihood of ultimate repayment of the investment (and therefore the cost of equity capital to the developer) are typically less than would be required by a third party seeking market terms in the absence of any special incentives.
With equity in place from the EB-5 investor, and once a project is generating reliable cash flow, the developer will likely seek a first mortgage on the real estate, often from a CMBS lender. The three principal criteria for the CMBS lender will be to confirm that the EB-5 financing will not (1) result in a change of control of the borrower, (2) put too much stress on property cash flow or otherwise trigger a default during the term of the mortgage loan and (3) present a meaningful refinance risk (i.e., that the CMBS loan will not be able to be refinanced at loan maturity). The key issue for the CMBS lender is that these conditions will apply even if the developer defaults on its obligations to the EB-5 investor.
Change in control
In a typical commercial mortgage financing, but especially with CMBS, the lender will as a matter of course prohibit any transfers of interest, pledges of equity or other actions that could result in the developer no longer maintaining control of the borrower and the underlying real property. This means that the EB-5 investment mortgage loan documentation will contain express provisions to that effect, cutting off any rights the EB-5 investor might otherwise attempt to negotiate for a share of control or voting rights if the developer fails to make required payments under the EB-5 financing.
Stress and default
The issue remains that a shortfall in property cash flow will lead to the developer’s inability to make the required payments on the EB-5 financing (unless the developer goes “out of pocket” to make the required payments). The CMBS lender’s concern is that the accrual of unmade payments on the EB-5 loan creates additional stress on property cash flow and can adversely affect the developer’s behavior in its operation of the property. If the mortgage loan defaults (either during the term or at maturity) and the CMBS lender forecloses on the real estate, then the EB-5 investor would be left with nothing, but an unsecured claim against the developer. To avoid this doomsday scenario, the EB-5 investor should be incentivized to agree to the refinance of the mortgage loan, to at least keep some hope alive for repayment if property cash flows improve over time. While compelling, this argument is unsettling to any first mortgage lender, who typically underwrites assuming minimal fuss at refinance to the extent that the property value and cash flows at such time support the deal. The prospect of a dispute between the developer and EB-5 investor pushing a loan into default at maturity that would otherwise be refinanced is not a risk that a CMBS lender (or any first mortgagee) prices into its loan.
If the principal balance of the EB-5 financing remains unpaid as the maturity of the mortgage loan approaches, this could have a chilling effect on refinancing the property if the EB-5 investor failed to consent to the refinance. To protect against this, the CMBS lender will require the EB-5 investor to agree to a mechanism that takes this refinance risk off the table. This will likely be an agreement in advance, whereby the EB-5 investor agrees (1) not to compel a sale or refinance of the property unless there are sufficient funds set aside by the developer to pay off the CMBS loan in full, together with any required defeasance or prepayment premiums, as well as to retire the EB-5 investment, and/or (2) to write down the outstanding balance of the EB-5 financing above a certain predetermined balance. The first of these is non-controversial since everybody wins. The second scenario creates a difficult choice for the EB-5 investor: agree to a write-down of the EB-5 investment or potentially risk a foreclosure by the CMBS lender, wiping out the interests of both the developer and EB-5 investor. This scenario highlights the role of the immigration incentives at the heart of the EB-5 financing program (and their effective trade for sub-market equity terms), and also provides a mechanism to enable the EB-5 investor, developer and CMBS lender to obtain an optimal outcome: The developer raises equity on below-market terms, the EB-5 investor has access to the accelerated path toward a green card and the CMBS lender is able to securitize on market terms.
Carson Leonard is a partner with Alston & Bird.