Real estate developers often obtain more than one loan when acquiring and developing properties, thereby substituting more debt financing for equity financing. Even if the developers have the funds themselves, they often prefer to minimize their use of equity capital. In doing so, a developer would be able to take on a larger project or simply a larger number of projects.
One such way developers have been able to increase the debt financing on a project is by adding EB-5 mezzanine loans. Senior lenders have permitted them to add EB-5 mezzanine debt on top of the first mortgage in the capital stack. Therefore, mezzanine loans are similar to second mortgages except that such loans are not often secured by a lien on the property but are rather secured by the equity interest in the project company (i.e. the project LLC or Limited Partnership).
So what exactly does this mean for an EB-5 investor? Well, if the project company that owns the property fails to make payments, the EB-5 Regional Center that made the mezzanine loan to the developer may have the right to foreclose on the ownership interests of the project company in a matter of weeks, compared to the 12-18 months it often takes to foreclose on a traditional commercial mortgage secured by real estate. So by simply taking over the ownership interests of the project company, a mezzanine lender would be able to acquire control of the project from the developer. This may however, be a double-edged sword.
Before a potential EB-5 investor considers investing with a Regional Center that plans to make a mezzanine loan to a developer, the EB-5 investor must first figure out the relationship between the Regional Center and the real estate developer. Is the regional center simply a subsidiary of the developer? If so, the developer faces no real downside risk. Also, if the Regional Center wishes to offer a mezzanine loan, what prior experience does the Regional Center have with mezzanine loans in general? Are they prepared to take over the project and properly oversee it to completion? How has the Regional Center negotiated the inter-creditor agreement with the senior lender?
Ultimately, each EB-5 investor must decide whether or not the increased risk profile resulting from mezzanine financing arrangements is appropriate to their specific situation. While mezzanine financing often provides a higher rate of return, it comes at the price of increased risk.
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