Capital Reserves for Capital Calls in a Multifamily Syndication

[Jordan Burnett]

Hey guys,

For those of you who have invested in multifamily syndication or apartments for many years, how much do you keep in reserve for unexpected capital calls in case they occur during an economic downturn or while a property is held? 

Is there any rule of thumb you use? I.e. 5%, 10% of committed capital, etc? 

I realize this is probably rare, but considering the current environment I think it's worth discussing. 

Thanks in advance, 

[Brian Burke]

One thing to consider is the language in the operating agreement.  Some operating agreements stipulate that you are required to fulfill a capital call if one is to be made.  While this is common, and acceptable, in a fund where capital is called in stages and you are obligated up to the limit of your capital commitment, it's far less desirable in a typical syndication deal where you've already contributed your entire commitment.  Many investors won't invest in offerings that have a mandatory capital call provision.

Therefore, many operating agreements provide that the capital call is voluntary.  You can refuse to contribute more capital, but in exchange, the sponsor is allowed to raise additional capital from new investors and dilute you.  Maybe that's a better outcome for you rather than throwing good money after bad.  Not to say that raising more capital is easy if the deal is in trouble...

Having said that, even if you decided to contribute additional capital, you might be in the same position as flushing it down the toilet.  For example, if the sponsor is making a capital call because they can't service the mortgage payment, and the capital call is voluntary, and you are the only one that fulfills the capital call, your small additional contribution is likely not enough to solve their problem.  The lender will eat your capital call for breakfast.

This is a bit like closing the barn door after the horses are gone, but the best defense here is to only invest in offerings that are raising a significant enough cash reserve, are well underwritten with conservative debt terms (low LTV and/or low default ratio), and skippered by an experienced and well capitalized sponsor that has survived adverse market cycles before.

There have been comments in this thread about lenders requiring borrowers to put up substantial capital reserves (which is true, for now), and a suggestion that this provides additional safety.  Don't be fooled.  There is little to no guidance on how that capital can be accessed or how it can be used.  Instead, it will get locked up into a lender-controlled account and using it to save your a$$ will be somewhat like squeezing blood out of a rock.  Heck, it's hard enough to get lenders to part with renovation reserves for budgeted capital improvements!  My guess is these funds will be the last to be drawn, and even if those reserves are there, a sponsor could still have a need for a capital call if they run out of discretionary reserves and have other bills to pay or capital improvements to make.