👋Capital Calls: What Investors Should Do

[Justin Goodin]

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.

 -- 

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.

[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).