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 project’s documents, i.e. the EB5 business plan, market feasibility study and the PPM. I don’t think I’ve 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 there’s different versions of documents floating around and the changes don’t 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 we’ll 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 Cheema: Sure. Michael, all of the topics listed on the displayed slide are things we look at in our EB5 due diligence. Would you please select and address one of them.
Michael Kester: I’ll 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 it’s using which itself is reflective of the multipliers it’s 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 you’re analyzing a McDonald’s or some very small restaurant and the multipliers used are statewide multipliers, then that’s something the USCIS could pick up on and question, whether a tiny restaurant could actually have a statewide impact. That’s 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 EB5 regional center your project is going to use and the county the project is in. If it’s not currently in the regional center’s geographic scope, it will hopefully be close enough to where the impact area could overlap. If you’re trying to run a project in California and you’re trying to run it through a Texas regional center, that’s a way to create a distance to try to cover. Just another thing to consider when we’re looking at a project, is if they’re 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 who’s 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.: I’d say that you have to verify everything, regardless of whether it’s 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, it’s 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 developer’s budget using, say, RS Means or some kind of other industry standard; one where you can compare costs per square foot and say, “Yeah, that’s works. That’s within reason.”
The same thing goes for revenue projections, there are generalized HVS studies out there that are regionalized, so that you can compare the developer’s estimates to actual industry standards and come up with reasonable comparisons. If you’re 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 it’s not really advisable.
If you’re 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 don’t realize that you’re not only an immigration attorney but an economist as well. I’m curious, when you’re looking at the economic report, what are you looking for, from an EB5 due diligence standpoint?
Rohit Kapuria: Quite often, it’s what you’ve 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 McDonald’s restaurant, if they’re 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, it’s 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. It’s easy enough to see hard construction costs and soft construction costs, FF&E; those are basics that can be thrown into a lot of EB5 projects. That being said, if the developer simply provides the economist with the items, sort of in bulk, and doesn’t really break down the budget into a more detailed format, then it’s 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 they’re comfortable using it, some take the plunge and say, “Well, throw the kitchen sink and see how USCIS reacts to it.” And some, on the basis of previous RFE history with USCIS, might say, “Well, hold on. I’ve seen a couple of deals where this was questioned and so I don’t recommend using it.”
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 we’re dealing with condos or apartments. Management fees are also inputs that we see a lot, which we’re relatively comfortable with. Things like legal and title, service and warranty, or HOA-related expenses, we kind of say, “Well, do we really want that? Do we really want to count insurance,” for example? Those are things that are up in the air for us.
Rupy Cheema: As per EB5 visa requirements, what kind of job cushion do you like to see?
Rohit Kapuria: If we’re talking about what’s marketable versus what we like to see from our end, that’s 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 it’s a small job number and the cushion is, let’s 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 we’re looking at using hard and soft cost construction and if we’re looking at something that’s less than two years and so only indirect and induced jobs, I’m okay generally if there’s 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, that’s because from a construction standpoint the developer’s proposed budget is conservative, at best, and in most cases they are going to outspend it.
On the operations side, if they don’t meet the projections they’re utilizing for revenue, then the investors could be in serious trouble. To answer your question about job cushion, it’s twofold. First, it’s what exactly is accounting for the cushion and second, in terms of a numerical proportion, I’d prefer to see the cushion above 30%.
Rupy Cheema: So you’re 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: That’s interesting because we see a lot of projects that wouldn’t meet that requirement, that are relying on operations.
Rohit Kapuria: Not to say that it’s not going to work, it’s just I worry about that potential. If they construct and they build, fine, they’ve created the jobs, but then if they don’t 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 they’ll have me recalculate things and they might say, “let’s 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 they’re all going to be created, well, you’re projecting that you’re going to have an 82% occupancy rate in this hotel, but what if you don’t? What if it’s much lower than that? What is the occupancy rate that’s needed for everybody to get a green card?”
In China a lot of the larger agents have caught on to this, and that’s the calculation that we’ll sit there and do. It’s not necessarily accurate due to the long EB5 processing time, because as occupancy rates go up and down, your ADR would as well. If you assume the ADR’s 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 they’re 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 you’re looking at a projection with an occupancy rate of, let’s say, 82% to use your figure, and it’s 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 let’s say it’s 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, “Hey, here’s what the numbers say.” Whether you interpret that to mean that it’s okay because it’s 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.