Choosing the right EB-5 project is paramount to minimizing risks and ensuring a timely repayment of investments. One key factor that should play a pivotal role in this process is the evaluation of a project’s sunk financing costs. In this blog post, we’ll explore what sunk financing costs are, why they matter in real estate developments, and how opting for a project with low sunk financing costs can significantly impact the likelihood of success for an EB-5 project.
Understanding Sunk Financing Costs:
Before delving into the importance of low sunk financing costs, let’s define what a sunk cost is. A sunk cost refers to money that has already been spent and cannot be recovered. In the context of real estate development, sunk financing costs are expenditures directly related to the funding of a project that cannot be recouped, such as interest costs or origination fees.
The Significance of Minimizing Sunk Financing Costs:
Successful real estate projects hinge on effective market timing and cost management, particularly with regard to financing. Even projects with less-than-ideal financial structures can thrive if they enter the market at the right time. Conversely, those with poor financial structures that fail to time the market are vulnerable, especially in times of economic downturn, as seen with various EB-5 developments that failed during the COVID-19 pandemic.
What if the Sunk Financing Costs are not Sustainable:
In times of economic hardship, a developer facing default on a senior loan has the option to invest more equity or allow the project to default. The decision often depends on the level of sunk financing costs or additional debt to repay. Projects with high sunk financing costs may lead developers to turn the project over to the bank as there is not much light at the end of the tunnel, with the senior lender recovering its losses before EB-5 investors see any returns.
Mitigating Risk through Low Costs:
Given the unpredictability of market conditions, mitigating risk becomes crucial. Controlling costs, both in construction and financing, is a proactive approach to risk management. Low sunk financing costs enable developers to weather economic downturns, investing more equity while waiting for better times in hope of turning a profit in the future.
Evaluating Sunk Financing Costs with 3rd-Party Regional Centers:
Many EB-5 investors may not fully realize the extent of sunk financing costs their projects sustain, especially when working with 3rd-party regional centers. These entities often charge fixed interest costs which the project cannot recover. The interest delta retained by a 3rd-party Regional Center, typically around 8%, adds significant costs to the project over the loan duration. This can amount to as much as 20% in additional project expenditures, depending on the size of the EB-5 capital raise.
The Advantage of Vertically Integrated Regional Centers:
A vertically integrated Regional Center and Developer using genuine low-cost EB-5 capital and not retaining an interest delta minimizes sunk financing costs thereby avoiding costly EB-5 debt. This enables the project to significantly reduce expenditures, providing a higher margin at any given sales or rental price. This approach optimizes the benefit of EB-5 capital, allowing investors to earn a higher return in exchange for a Green Card while simultaneously lowering risks for all project partners.
In the complex landscape of EB-5 real estate developments, the decision of minimizing sunk financing costs emerges as a strategic move for success. A vertically integrated Regional Center and Developer, such as Houston EB5 and DC Partners, showcases the effectiveness of this approach, yielding 100% success in repaying EB-5 investments and achieving project approval rates for both conditional and permanent green cards. By focusing on low sunk financing costs, projects can enhance their resilience and increase the likelihood of success for the EB-5 investors.