Featuring special guest economist Michael Kester – Hosted by Kurt Reuss and Rupy Cheema
Special guest is Michael Kester, partner and lead economist of Impact DataSource, a Texas-based consulting firm that is a leader in EB-5. For the last nine years, Impact Datasource has conducted more than 450 EB-5 economic impact studies and over 1,000 EB-5 applicants in obtaining TEA certification.
This discussion deals with the significance and impact of the new EB-5 modernization rules on Targeted Employment Area (TEA) designation.
EB-5 investors will want to know that much has changed with TEA designations. Who must provide the proof, who now determines what is and what isn’t a TEA, how you can now combine census tracts, when an investor will know if TEA designation is approved Also, the new rules impact issuers and the EB-5 industry in general. Will big real estate projects still be the norm? Another consideration for investors will be rural TEA’s vs. high-unemployment TEAs: which kind is safer and less prone to change?
Read on to get answers to these questions and discover best practices for the very important consideration of what now qualifies for the lower EB5 investment amount as a TEA.
Kurt Reuss: Michael, on November 21st, 2019, we saw some pretty big changes to the EB-5 investment program through new regulations. The change that garnered the biggest headline was the increase to the minimum investment amount, from $500,000 to $900,000; but I think the biggest change to the EB5 program is probably the way targeted employment areas (TEAs) are determined.
Michael Kester: I would totally agree that the changes to TEA designations are probably the most impactful of any of the changes that occurred, the biggest being new rules that drastically limit the way you can aggregate census tracts to get recognized as a high-unemployment TEA.
Michael Kester: Under the old rules it was more or less left up to the states. As an economist, I could get as creative as the state would allow, as long as the census tract combination was contiguous. If it met the required 150% threshold [above 150% national average unemployment rate], then the state would sign off on it.
But the new EB5 investment regulations limit census tracts to only the EB-5 project tract plus the tracts that touch the project tract. The government’s terminology of this is ‘directly adjacent’ to the EB-5 project tract.
Michael Kester: The other big takeaway is that DHS (Department of Homeland Security) has removed the states from the decision making completely.
USCIS, which is part of DHS is now handling TEA certifications, so you can’t call up or email the state anymore and say, “Hey, I’ve determined, based on acceptable modeling, that this is a TEA; can you give me a letter?”.
Now the onus is on the petitioner to include independent evidence that the project location qualifies as a TEA. Instead of having a state letter as that evidence, the petitioner will now need to have a TEA analysis or opinion letter that shows how the new TEA qualifies.
In the past you’d get a state letter and you wouldn’t know 100% for sure it was acceptable until USCIS approved the I-526, but you had a pretty good comfort level because the states had been doing this for a long time. But now we’re not going to hear back whether the TEA is approved until the I-526 is adjudicated.
Kurt: So, not only do we not have clarity from the state confirming a TEA prior to filing, but we won’t get that clarity until our I-526 is adjudicated?
Michael: Exactly. Though DHS regulations did make some things simpler by specifying a limit to the way we can aggregate census tracts, which does eliminate confusion as some states would only allow you to use a single census tract and others would allow the use of as many census tracts as you want. Some states would have a limit on the number of census tracts and still, others would allow the use of block groups. In Texas, for example, we’d have to go to the city’s mayor and the county judges to get sign off.
So there was a lot of confusion under the old way. But there are a lot of questions and risks as we move forward. One of the biggest questions is what data and methodology can we use.
Under the previous EB5 Investment rules, the states would use what’s called a ‘census share methodology,’ which uses a combination of different data sets to get to a final answer. The new rules leave things a bit open-ended and say we can use a couple of types of data. They listed BLS data (Bureau of Labor Statistics) and (ACS) American Community Survey data as reliable and verifiable data to utilize.
The census share methodology that the states were using uses a combination of BLS and ACS. For most cases, if one methodology works, the other one usually works, however sometimes only one methodology works.
Kurt: So in your initial analysis of the datasets, are there times when you find yourself using BLS data and times you find yourself using the ACS data?
Michael: When a client sends us an address and asks whether their location will qualify, usually we look to see if it qualifies under both methodologies [census-share and ACS-only]. If it does we’ll have a higher comfort level. If it doesn’t qualify under both, we let the client know.
So it’s not really that one is necessarily better than the other. The census share methodology does trend the data forward to get a more current data point. But for our purposes, we’re more concerned about what is USCIS going to accept.
ACS and BLS data are updated throughout the year with new ACS census tract data coming out in December and BLS calendar year data is finalized in April. Unfortunately, USCIS did not provide us with any great guidance that says, when you file your I-526 you need to make sure that you’re using the latest and greatest data out there, so there is a question of how recent the data we use must be, and that’s very important because it can take a long time to raise EB-5 funds. On prior projects we’d get at least two letters from the state during the course of the project; sometimes we’d get three or four.
And we’re going to have the same issue here. I can tell clients that the location currently qualifies as a TEA, but it’s borderline and we don’t know for sure if it will continue to qualify when the investor actually invests and files. And USCIS hasn’t provided guidance on how long they will accept an analysis after new data comes out.
Rupy Cheema: So are there any red flags an issuer or investor should be concerned about when looking at a TEA designation related to changes that might happen in the future?
Michael: Yes. Under the old ways, it wasn’t uncommon to put together a four or five census tract TEA, and we usually had the flexibility to add more census tracts or get a little bit creative in order to rescue the TEA designation if necessary. But now we don’t have much flexibility because we can only use the project tract and the tracts that touch the project tract.
Currently, under census-share, the threshold is 5.9% (unemployment rate), so under the census share methodology if you have an area that’s only barely above that level, say 6% or 7%, then there’s a big possibility that it could fall out in the future, and if it does we don’t have many options since we are limited in how we can try to aggregate tracts.
For example, a client that we did an analysis for in November, which was just as the rules changed and it qualified as a single census tract TEA, but it was the only high unemployment tract in the area. I think it had about 7.5% unemployment rate, which is a decent amount above the 5.9% threshold that’s needed.
But when the new data came out in December, I took a look at it again and the data had changed enough that it had actually dropped below the threshold. I had to write to the client and tell him that. In the past, I could have probably figured out a different way of calculating it as a TEA, by using block groups or a different combination. But now there’s just nothing we can do.
Rupy: Well, it’s kind of ironic that on the one hand, the idea of the green card by investment program is to create jobs and to revitalize an area. And then if you successfully revitalize an area you might end up not qualifying for a TEA designation.
Kurt: So you want to keep an eye on the areas that surround the tract you’re invoking in your petition because if the surrounding area has lower unemployment rates, it may only be a matter of time before it starts to bleed into the tract used by the EB5 regional center, as it did in December.
Michael: Yeah. It’s just tough to predict because we’re not dealing with instantaneous data updates. We’re dealing with data at the census tract level that’s a bit outdated, so it’s kind of tough to say exactly what’s going to happen in the future, and especially if it’s the only high unemployment census tract in the area.
Rupy: It’s very risky for an issuer to put a lot of money into structuring an EB-5 offering based on it being in a TEA and then it changes. It’s very costly.
Michael: Right, exactly. EB-5 funds can take a long time to raise which makes it an even tougher decision on whether to move forward.
Kurt: Rupy, when you perform a due diligence analysis, one of the things you perform is a sensitivity analysis, right? Can you explain to us what a ‘sensitivity analysis’ is?
Rupy: Sure, typically in real estate we want to see the change in the valuation of a project if their income projections are not met. So if they miss by 10% or 15% or 20%, we plug in those adjusted numbers to see how the asset value changes. Its a comfort level we have about the value being placed on the asset.
Kurt: So Michael, do you think there’s some sort of sensitivity analysis that you’ll need to give issuers to give some comfort that a project location is likely to stay under TEA regulation throughout the fundraising period?
Michael: Well we let them know when it’s borderline or that we’ve identified risks to the TEA status. It’s just that the data at the census tract level is so unpredictable and can change from year to year, especially because we’re dealing with pretty small sample size. So we just communicate to our clients what we think.
Rupy: In that case, doesn’t it make sense to use the ACS data because it’s only updated once per year? So at least you have some comfort for about a year that it’s going to qualify.
Michael: Sure. I was responding to clients today that had this very scenario come up where they are only qualifying under ACS. And that’s exactly what I told them. This tract looks good until at least December, but I can’t guarantee that it’s going to stay a TEA after that. We just don’t know.
Kurt: Michael, what does 5.9% as a threshold refer to?
Michael: To be located in a Targeted Employment Area (TEA) you have to find a location that is 150% of the national unemployment average, which, under census-share, is currently 3.9%. So 150% of that is 5.9%, so that’s the rate we have to hit with our census tract combination. An ACS-only calculation has a different threshold you have to hit (which is currently 8.9%)
Kurt: I guess you’re also constantly looking at the national unemployment average to determine what you’re multiplying against.
Michael: I’m expecting the threshold to decrease to around 5.5% or 5.6% [under census-share], because the unemployment rate across the country is so low. There’s not much more room for it to go down right now.
Kurt: We’re using the national unemployment rate for all tracts, not comparing against the state unemployment level?
Kurt: One of the reasons why I think the regulatory changes to TEA designations are even more significant then the increase to the minimum EB5 investment amount is because 96% of investments were previously considered to be located in a TEA under previous EB 5 immigration rules, but now if your ‘job-creating entity’ is outside a TEA, the investment amount is going to be at a minimum $1.8 million.
Michael: Yeah. From $500k to $1.8m. It’s a big jump for many EB-5 projects.
Kurt: When two census tracts touch at a point, but they don’t actually share a common border, how does that play into your calculations?
Michael: This is another one of the bigger questions that USCIS did not address. We’re only able to aggregate tracts that touch the project tract, or in the words that USCIS uses, is ‘directly adjacent.’ So if the only way to make a TEA work is to aggregate a tract that touches at a single point, or what we call a ‘vertex connection,’ it’s a big question as to whether that’s acceptable.
My hunch is that DHS will allow these vertex connections to qualify as TEAs, but we can’t be sure. I’ve never seen one questioned in the past and I’ve certainly obtained several TEA letters from various states that use vertex connections.
Considering the fact of how big a restriction we’re seeing from the new regulations, my hunch is they will be accepted, though I try to avoid them. But if the only way we’re going to be able to make this work is to use these vertexes (touching at a single point) then I let the client know that. I believe DHS will allow this but they did not specifically state that in the rules.
Kurt: What do you think the future holds for EB-5 issuers? Do you think we’re still going to see an abundance of real estate projects? And how do you think the changes to the TEA regulations definitions are going to impact the projects that are preparing to come online.
Michael: I can tell you what I’ve been seeing so far. Since the rules changes, we are getting a ton of inquiries about whether a location qualifies as a TEA or not, but right now not a lot of people are moving forward. I think people are just getting their bearings.
I think we’ll likely see smaller projects as opposed to the huge real estate projects of the past. And potentially we’ll see more rural projects, which I believe a lot of people were hoping would happen with these new rules. I haven’t been getting too many inquiries about rural, but that may be because it’s a bit more obvious when locations qualify as rural.
For example, when you’re using our online map, it’s much easier to tell if something’s rural than whether it will qualify under high unemployment determinations. And people are figuring that out on their own without needing to ask us to confirm them.
I expect we might also see more infrastructure or solar projects that are multimillion-dollar projects that potentially could be out in rural areas. Those are slam dunk TEAs, because the new rules, for all practical purposes, did nothing to change the rural side of TEA definitions.
And that’s a nice thing about having a rural project compared to what we’ve been talking about, high unemployment projects in metropolitan areas. There’s very little risk of a rural TEA ever falling out of rural status.
Kurt: How is ‘rural’ defined?
Michael: It’s the same as under the old rules. The first criteria is that it needs to be outside a metropolitan statistical area (MSA), which are defined at the County level. So if you’re in a County that is outside of an MSA, and not attached to an MSA, then you have a good chance of being rural.
The only other criteria is that your project can’t also be within a city that has greater than 20,000 population. So right now the 2010 census is where we’re looking for population numbers, but that’ll change whenever the 2020 census gets finalized.
Kurt: Typically investors will take a few months, from the time they decide to proceed with an EB-5 petition and invest in a project until they file their I-526 petition. So if the project is using BLS data which is frequently changing, should an investor get an updated TEA determination at the time they file?
Michael: I think as a best practice, investors definitely should utilize the latest data that’s available at the time they file. I would say on the (Bureau of Labor Statistics) BLS side of things, which really only comes into play if we’re using the census share methodology, BLS data is updated throughout the year on a monthly basis and almost all states used to just go off a calendar year, so they’d only update once a year.
Kurt: It’s probably best practice for me to check with you before telling an investor to go ahead and wire their money, just to make sure, in your opinion, the location is still in a TEA.
Michael: Yeah. That’s a good idea just to have someone experienced in TEAs look at things. There’s a lot to keep track of when the new data comes out and especially since we’re not going to know for sure for two-plus years from the time the I-526 is filed, so its best to button up things as best we can at the beginning.
Investors and issuers should know the EB5 news is that TEA regulation changes are significant in both number and impact. It could represent a $900,000 difference so anyone involved with an EB-5 petition should make sure to get it right.
Here are some key takeaways from this podcast:
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