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US real estate pain leaves foreign investors in the lurch

Investors who backed developments in return for US visas have less leverage than most in a cash-strapped economy

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Roughly 2,000 EB-5 investors poured US$1 billion into Hudson Yards through deals under EB-5, a programme meant to promote investment in rural areas, as well as urban locales with high unemployment.

New York

FOREIGN investors who backed real estate projects in return for US visas are emerging as losers in the pandemic-driven commercial property crisis.

In Manhattan, Chinese investors who helped fund Related Cos' Hudson Yards have called for arbitration to pressure the developer into returning their money. On Long Island, a separate group assumed the lease to the Nassau Coliseum, after billionaire Mikhail Prokhorov's Onexim Sports and Entertainment decided to walk away from the project.

The investors, who backed development deals through the US Citizenship and Immigration Services' EB-5 programme, are not the only ones getting hammered by the Covid-19 pandemic, which has kept mall-goers, hotel guests and office workers home, pushing commercial-property owners into delinquency.

But EB-5 investors, who cared more about coming to the US than the financial returns, have less leverage than most.

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"Cash is king during Covid-19, and developers are reluctant to let go of any cash," said Mona Shah, a New York lawyer who works on EB-5 deals.

"It doesn't help that there are some developers who show distinct lack of respect for EB-5 money," she added. "It's easy money."

She said she represents a hotel developer who is looking to reduce the principal owed on an EB-5 loan, because the property closed due to the pandemic and is unlikely to return to profitability quickly.

In other cases, developers are seeking to extend loan terms or withhold payments entirely, she said.

At Hudson Yards, roughly 2,000 EB-5 investors poured US$1 billion into the Manhattan project through a series of deals, said a demand for arbitration filed recently by Chicago lawyer Doug Litowitz.

The investors were unsophisticated about US real estate, said Mr Litowitz, and were told by the Chinese firm that helped Related raise money that they would be repaid following approval of their work visas, known as green cards.

But the funding was structured as a preferred equity investment, not a loan, and there was no fixed timetable for returning the money.

After Neiman Marcus Group, the luxury retailer that was the anchor of the upscale mall at Hudson Yards, declared for bankruptcy, Mr Litowitz asked Related to tell his clients when they could expect to get their money out of the project. He also asked the developer to open its books so his clients could determine whether the pandemic had diminished the value of their investment.

"The Related deal is interesting because the terms given to the Chinese are so bad that it's almost like a test case for how bad a structure can be and still be legal," he said.

Related has been unmoved by those requests. "Financial investment returns are a function of the market economy and obviously this is a challenging time," said Related spokesperson Jon Weinstein. "We were off to a good start, but now we need to be patient."

EB-5 was a sleepy programme until the 2007-2008 global financial crisis, when developers like Related looked overseas to replace traditional financing sources.

They found a bonanza: foreign investors who viewed US real estate as a safe asset and were principally concerned with obtaining visas - meaning they were willing to accept returns as low as 1 per cent and sometimes even less.

The programme, which provided visas to foreign investors who sank at least US$500,000 into US projects that created at least 10 jobs, was meant to promote investment in rural areas, as well as urban locales with high unemployment.

But gerrymandered districts allowed EB-5 funding to flow to developments such as Hudson Yards and an Extell Development tower on Manhattan's Billionaire's Row.

Roughly US$36 billion in EB-5 capital flowed into the US from 2010 to 2019, showed estimates from trade group Invest In the USA, although the programme has become less popular as the backlog of applications grew and the investment threshold increased.

The scheme attracted scrutiny when Kushner Cos, the developer formerly run by US President Donald Trump's son-in-law Jared Kushner, sought EB-5 funds from Chinese investors.

It also gained a reputation as a Wild West, rife with false promises and conflicts of interest. Theoretically, lending money to big projects should have been more solid, but even marquee developers have not been shielded from the pandemic.

As Covid-19 cases surged through the New York City area this spring, Mr Prokhorov's Onexim cancelled sporting events and concerts at the Nassau Coliseum. By June this year, the company decided that the pandemic had made the events business unappealing, and signalled its intention to hand the arena lease over to lenders.

On Aug 20, Nassau County announced a deal with the US Immigration Fund, which funnelled EB-5 capital into renovations at the arena.

As part of the agreement, an affiliate of the EB-5 group assumed the lease, promising to operate the building so the National Hockey League's New York Islanders team could eventually return to the ice.

Maureen Hanlon, the chief executive officer of Nassau Events Center, which had operated the building for Onexim, said she was sorry to abandon the arena, but happy to reach an agreement that allows "the county to receive its rent and, most importantly, for the fans to have a functioning arena as soon as health guidelines allow".

Gary Friedland, who has studied the programme as a scholar-in-residence at New York University's Stern School of Business, expects that plenty of other borrowers will walk away from an EB-5 projects in the months to come.

"For years, I've predicted there would be a flood of defaults," he said. "It's risky capital. If there's a reduction in values, it's going to get hit." BLOOMBERG

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