For hotel developers, securing the right capital stack can be one of the most important decisions in getting a project from concept to completion. Traditional commercial real estate funding sources, such as construction loans, mezzanine financing, private equity and developer equity, remain the primary tools used to finance hotel projects. However, EB-5 funding can offer a distinct alternative or complement to these conventional sources.
While EB-5 funding has specific immigration-related requirements that developers must understand, its characteristics as a source of project capital can be particularly attractive for hospitality projects. The structure, cost of capital, repayment expectations and relationship between the developer and the capital provider can differ substantially from traditional commercial real estate financing.
EB-5 Funding Can Provide an Alternative Source of Capital
Traditional hotel financing typically involves some combination of senior construction debt, mezzanine or preferred equity, and sponsor or developer equity. Each source has its own return requirements, underwriting standards and expectations regarding repayment.
EB-5 funding adds another potential source of capital to this equation. Rather than relying exclusively on banks and institutional lenders, a developer can potentially use EB-5 capital as part of the project’s overall capitalization. This can provide greater flexibility when structuring a transaction and may reduce the amount of higher-cost capital that otherwise would be required.
For hotel developers, this can be particularly relevant when a project has strong fundamentals but requires additional capital to make the overall financing structure work.
The Cost of Capital Can Be Different
Traditional commercial real estate capital is generally priced according to risk and expected financial return. Senior construction debt may carry an interest rate, while mezzanine debt, preferred equity and private equity typically demand progressively higher returns in exchange for taking on additional risk.
EB-5 funding operates differently. EB-5 investors are generally motivated by the potential immigration benefits associated with qualifying investment, in addition to the financial return on their investment. Consequently, the economics of EB-5 funding can be different from those of conventional equity capital.
This does not mean that EB-5 capital is necessarily inexpensive or that every EB-5 structure will have the same economics. Developers must consider administrative costs, legal and immigration-related expenses, investor servicing and other transaction costs. Nevertheless, the return expectations associated with EB-5 capital can potentially make it an attractive component of a hotel’s capital stock compared with certain higher-cost forms of capital.
EB-5 Funding Can Be Used Alongside Senior Debt
EB-5 funding does not necessarily replace traditional commercial real estate financing. In many hotel projects, it can work alongside a senior construction loan.
A typical capital stack might include senior debt, EB-5 funding and developer equity. Depending on the project and its structure, EB-5 capital can occupy a position subordinate to the senior lender but senior to the developer’s equity. This can create a capital stack in which the bank receives the protection it requires while the developer obtains an additional source of project capital.
For developers, the key is to understand how the EB-5 financing fits within the lender’s requirements. Intercreditor arrangements, repayment restrictions, collateral, guarantees and cash-flow provisions all need to be carefully coordinated before closing.
EB-5 Funding Has a Different Underwriting Process
One of the biggest misconceptions about EB-5 funding is that it is simply another form of commercial real estate financing. In reality, EB-5 projects are subject to an additional layer of underwriting.
A traditional lender will focus heavily on factors such as loan-to-cost, loan-to-value, debt-service coverage, construction costs, sponsorship, market fundamentals and the property’s ability to repay the loan. EB-5 underwriting incorporates many of these same considerations but also places substantial emphasis on job creation and the project’s ability to satisfy the requirements of the EB-5 program.
For hotel developers, this means the project needs to make sense from both a real estate perspective and an EB-5 perspective. Construction budgets, development timelines, operating projections and the project’s job-creation methodology can all become important components of the financing process.
Job Creation Is Central to EB-5 Funding
Perhaps the most important distinction between EB-5 funding and conventional commercial real estate capital is the role of job creation.
A bank does not generally provide a construction loan because a hotel will create jobs. An EB-5 investor, however, must invest in a qualifying project that satisfies the program’s job-creation requirements.
For hotel developers, this can be an advantage. Hotels can be particularly well suited to EB-5 financing because development and construction can generate substantial employment, while hotel operations can continue to support employment after opening. Depending on the project’s structure and methodology, those jobs can provide the basis for satisfying the EB-5 program’s requirements.
This makes job creation not simply an economic benefit of the project, but a fundamental component of the EB-5 funding strategy.
EB-5 Funding Requires Greater Attention to Structure
The potential advantages of EB-5 funding come with additional complexity. Developers need to understand that an EB-5 financing is not simply a conventional loan or equity investment with an immigration benefit attached.
The project structure must be designed to comply with applicable EB-5 requirements, while also satisfying the expectations of senior lenders and protecting the developer’s interests. Offering documents, securities compliance, fund administration, job-creation analysis, source-and-use schedules and investor reporting can all require specialized expertise.
For that reason, developers considering EB-5 funding should involve experienced EB-5 counsel and professionals early in the capital-raising process rather than attempting to retrofit an EB-5 structure onto an existing financing package.
EB-5 Funding Requires Greater Attention to Structure
Hotels have several characteristics that can make them compelling candidates for EB-5 funding. They are tangible real estate assets, they typically require significant construction and development expenditures, and they can generate substantial employment. In addition, hotel projects can often be evaluated using established operating metrics and comparable properties.
For developers, the opportunity is therefore not necessarily to choose between EB-5 funding and traditional commercial real estate financing. Instead, the more useful question may be how EB-5 funding can be integrated with conventional sources to create a more efficient capital stack.
Senior debt can provide low-cost leverage. EB-5 funding can provide patient project capital. Developer equity can provide sponsorship and alignment. Together, these sources can potentially create a financing structure that balances risk, cost and control.
