👋Capital Calls: What Investors Should Do

Indianapolis, Indiana
Multi-Family and Apartment Investing
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👋Capital Calls: What Investors Should Do

Justin Goodin
Investor · Indianapolis, IN · Member since 2018 · 1k+ posts · 756 votes

First, let's define what this is:

A capital call (aka cash call) is the process when the general partner(s) attempts to collect additional funds from their investors to supplement the financing for a real estate project or transaction. This is done when a multifamily property needs more capital than originally anticipated to sustain operations.

Capital calls can indicate the investment is not as sound as investors originally thought, and is potentially at risk of falling apart. As such, capital calls can have a negative connotation among real estate investors.

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Due to the fact that capital calls usually require real estate investors to provide additional funds within a short time period, they can be seen as a source of financial burden and stress since investors may not have the necessary funds available.

Unexpected capital calls also indicate their investment is not as sound as they first thought and is potentially at risk of falling apart. As such, capital calls can have a negative connotation among real estate investors.

// So what should you do if a sponsor performs a capital call on a deal you are invested in?

Step 1: Read The Operating Agreement

If you invested in the offering, you read (or should have read) and signed the operating agreement. The operating agreement explains exactly how capital calls work for the deal you invested in. 

Step 2: Seek Professional Advice

Passive investors should seek professional advice from their attorney. Most likely, your attorney will ask what the operating agreement specifies (step 1). Comment below the name of your favorite attorney!

Step 3: Ask Questions

This is the time to ask the general partner(s) any and all questions. At this point, the general partner(s) should be over communicating with the investors and keeping them up-to-date with what is going on. Either monthly, weekly, or even daily.

The general partner(s) should have communicated the reason for the capital call, exactly what the money will be spent on, and outlined their proposed plan to success.

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Evan Polaski
Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
2y

In the traditional syndication model that many here are used to, this is good advice, with an emphasis on READ BEFORE YOU SIGN.  Some syndicators will simply dilute your ownership if an LP does not answer a capital call.  But others, effectively default your entire investment and may have rights to claim all funded capital, or a substantial portion of your capital, by choosing not to answer a capital call.  Unfortunately, if you don't read this and confirm it ON YOUR OWN before signing, you may find out too late.  


Additionally, while you should ask questions, as Justin points out, most well written documents have some form of indemnification that basically says the investor is relying SOLELY on the signed documents and any communication prior to that is not considered valid.  I.e. if you asked the syndicator in email how capital calls are handled if you don't fund and they respond "your ownership will be diluted", but the docs say your ownership will be relinquished: the docs are right.

And along the lines of needing more capital when things aren't going as planned, as an LP I would highly recommend you understand the rights of the GP to bring in pref equity ahead of your capital and/or make loans to the property/deal from their own pocket, also placing that capital in priority ahead of the LPs. While these may be viewed as a better alternative than an LP capital call, they can also be used as ways to make a deal appear that it is in better shape than it actually is. I highly recommend any potential LP require their syndications to share: Income statement, including all partnership level expenses, Statement of Cash Flow and Balance Sheet. As an LP, you should be able watch the movement of money in and out of a deal with these statements. I have seen many groups simply share the Income Statement down to NOI, which is not an adequate way to monitor the financial health of any type of deal (syndication or otherwise).

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  • Evan Polaski
    Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
    2y

    In the traditional syndication model that many here are used to, this is good advice, with an emphasis on READ BEFORE YOU SIGN.  Some syndicators will simply dilute your ownership if an LP does not answer a capital call.  But others, effectively default your entire investment and may have rights to claim all funded capital, or a substantial portion of your capital, by choosing not to answer a capital call.  Unfortunately, if you don't read this and confirm it ON YOUR OWN before signing, you may find out too late.  


    Additionally, while you should ask questions, as Justin points out, most well written documents have some form of indemnification that basically says the investor is relying SOLELY on the signed documents and any communication prior to that is not considered valid.  I.e. if you asked the syndicator in email how capital calls are handled if you don't fund and they respond "your ownership will be diluted", but the docs say your ownership will be relinquished: the docs are right.

    And along the lines of needing more capital when things aren't going as planned, as an LP I would highly recommend you understand the rights of the GP to bring in pref equity ahead of your capital and/or make loans to the property/deal from their own pocket, also placing that capital in priority ahead of the LPs. While these may be viewed as a better alternative than an LP capital call, they can also be used as ways to make a deal appear that it is in better shape than it actually is. I highly recommend any potential LP require their syndications to share: Income statement, including all partnership level expenses, Statement of Cash Flow and Balance Sheet. As an LP, you should be able watch the movement of money in and out of a deal with these statements. I have seen many groups simply share the Income Statement down to NOI, which is not an adequate way to monitor the financial health of any type of deal (syndication or otherwise).

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  • Justin Goodin
    OP
    Investor · Indianapolis, IN · Member since 2018 · 1k+ posts · 756 votes
    2y
    Quote from @Evan Polaski:

    In the traditional syndication model that many here are used to, this is good advice, with an emphasis on READ BEFORE YOU SIGN.  Some syndicators will simply dilute your ownership if an LP does not answer a capital call.  But others, effectively default your entire investment and may have rights to claim all funded capital, or a substantial portion of your capital, by choosing not to answer a capital call.  Unfortunately, if you don't read this and confirm it ON YOUR OWN before signing, you may find out too late.  


    Additionally, while you should ask questions, as Justin points out, most well written documents have some form of indemnification that basically says the investor is relying SOLELY on the signed documents and any communication prior to that is not considered valid.  I.e. if you asked the syndicator in email how capital calls are handled if you don't fund and they respond "your ownership will be diluted", but the docs say your ownership will be relinquished: the docs are right.

    And along the lines of needing more capital when things aren't going as planned, as an LP I would highly recommend you understand the rights of the GP to bring in pref equity ahead of your capital and/or make loans to the property/deal from their own pocket, also placing that capital in priority ahead of the LPs. While these may be viewed as a better alternative than an LP capital call, they can also be used as ways to make a deal appear that it is in better shape than it actually is. I highly recommend any potential LP require their syndications to share: Income statement, including all partnership level expenses, Statement of Cash Flow and Balance Sheet. As an LP, you should be able watch the movement of money in and out of a deal with these statements. I have seen many groups simply share the Income Statement down to NOI, which is not an adequate way to monitor the financial health of any type of deal (syndication or otherwise).


     Wow! Amazing points. Thanks for mentioning this. 
    I totally agree that GPs should make the complete financial statements available to view. I would think only sophisticated LPs would be able to make their way through these. But not a bad idea at all to ask. 

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  • Solomon Rosenberg
    Investor · Rockland County, NY · Member since 2018 · 46 posts · 55 votes
    2y
    Quote from @Justin Goodin:
    Quote from @Evan Polaski:

    In the traditional syndication model that many here are used to, this is good advice, with an emphasis on READ BEFORE YOU SIGN.  Some syndicators will simply dilute your ownership if an LP does not answer a capital call.  But others, effectively default your entire investment and may have rights to claim all funded capital, or a substantial portion of your capital, by choosing not to answer a capital call.  Unfortunately, if you don't read this and confirm it ON YOUR OWN before signing, you may find out too late.  


    Additionally, while you should ask questions, as Justin points out, most well written documents have some form of indemnification that basically says the investor is relying SOLELY on the signed documents and any communication prior to that is not considered valid.  I.e. if you asked the syndicator in email how capital calls are handled if you don't fund and they respond "your ownership will be diluted", but the docs say your ownership will be relinquished: the docs are right.

    And along the lines of needing more capital when things aren't going as planned, as an LP I would highly recommend you understand the rights of the GP to bring in pref equity ahead of your capital and/or make loans to the property/deal from their own pocket, also placing that capital in priority ahead of the LPs. While these may be viewed as a better alternative than an LP capital call, they can also be used as ways to make a deal appear that it is in better shape than it actually is. I highly recommend any potential LP require their syndications to share: Income statement, including all partnership level expenses, Statement of Cash Flow and Balance Sheet. As an LP, you should be able watch the movement of money in and out of a deal with these statements. I have seen many groups simply share the Income Statement down to NOI, which is not an adequate way to monitor the financial health of any type of deal (syndication or otherwise).


     Wow! Amazing points. Thanks for mentioning this. 
    I totally agree that GPs should make the complete financial statements available to view. I would think only sophisticated LPs would be able to make their way through these. But not a bad idea at all to ask. 


     As an lp you always want to read through the ppm, at first it may seem overwhelming but after looking through a few you learn what to look for,  as for capital calls you want to get a clear picture of what the capital will be used for and will it be enough to help the situation, putting more money on a bad deal may just increase your loss. 

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  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    2y

    @Evan Polaski

    Great feedback. Along with balance sheet and profit and loss ask for an updates proforma. Then ask a bunch of what ifs based on the assumptions. What if you cannot refinance at X or what if we do not hit Y occupancy…

    Also ask the question “what if you sold today what would it look like?”

    Also ask if the sponsor is not taking a fee, giving back any fees or what “pain” are they taking on?

    This will give more insight into the sponsor

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  • Kevin Kohler
    Real Estate Broker | Investor | Property Manager · Plantation, FL · Member since 2015 · 228 posts · 68 votes
    2y

    This is also another reason why you should always look at deals where the sponsor also has money invested and not only the sweat equity.  For a GP to have "skin in the game" means they will be as cognizant of the consequences and at the worst case they will at least try to protect the investment because it protects their own equity (as well as that of the other investors, which should be the GP's primary concern as a fiduciary).

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  • Evan Polaski
    Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
    2y

    @Kevin Kohler, while I agree, I think many sponsors have learned how to market this well.  I was discussing on another thread.

    The typical question: who much are you (the sponsor) investing in this deal?  The answer is almost always some amount that will be noted as to why it is significant: for the sponsor putting $50k in, maybe that is every dollar of liquid capital they have. For the established syndicator, maybe it is $200k, maybe $500k.  

    But, I come back to: how much are they MAKING as soon as the deal closes?  If the sponsor is making a 3% acquisition fee on the purchase price, and they are under contract on a $50mm deal, that equates to $1.5mm.  Even if they have $500k in the deal, they just made $1mm over and above their $500k in the deal.  If they have a loan guarantee fee or financing fee on top of that, well they just made more.  

    There is no right or wrong answer with this.  It is just a data point to understand, where motives may lie and more importantly, that "skin in the game" can very well be an optical illusion.

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  • Robert Rixer
    Investor · Miami, FL · Member since 2015 · 355 posts · 268 votes
    2y
    Quote from @Evan Polaski:

    But others, effectively default your entire investment and may have rights to claim all funded capital, or a substantial portion of your capital, by choosing not to answer a capital call. 


    I would run for the hills if I ever read something like this in an offering
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  • Evan Polaski
    Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
    2y

    @Robert Rixer, agreed, but you hit on the main point: many people don't read the PPM before they sign.  

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