Ashcroft capital: Additional 20% capital call

[Jon Zhou]

After many of the Ashcroft capital syndications paused distributions, I get this surprise email this morning saying all LP investors need to pay additional 19.7% of invested capital call  

anyone have experience with capital calls and syndications? Is there ever a position outcome to these or are we putting more money into a failing syndication?

“Thank you for your patience as we continue to navigate our way through this current economic cycle and unprecedented time in the capital markets. We recognize that this email contains a substantial amount of information, which is why a member of our Investor Relations team will be contacting you shortly to address any questions.

We need to solve for three major factors as it pertains to Elliot Roswell:

1. Allow the multifamily market time to stabilize.
   
2. Meet liquidity needs for the rate cap, capital expenditures and unexpectedly high debt payments.
   
3. Resume renovations which have been temporarily paused.
   

How do we achieve this?

Based on feedback from our existing lender, other potential partners, and the significant capital requirements to potentially buy down the loan to refinance, we determined the best path forward is a successful LP capital call of 19.7%. This will allow us to maintain flexibility to potentially sell the property within 24 months.

This is Ashcroft’s first capital call, and while it’s regrettable to take this step, our primary focus remains safeguarding your investment. Therefore, all LPs must participate 

Elliot Roswell is a strong asset that is poised for a strong rebound in value as markets improve. This is due to the property’s institutional quality and the continued growth within the Atlanta market. Moreover, demand and absorption rates are currently at 25-year highs and are continuing to trend in that direction with a 70% reduction in new construction permits and drop off in deliveries in early 2025.

We will maintain flexibility to sell Elliot Roswell as markets improve and anticipate doing so within the next 24 months. In the meantime, we need to cover rate caps costs and resume renovations so that we are best positioned to maximize your potential return.

Why is a capital call necessary?

• Preserving Capital: If this capital call is not successful, we will have to sell Elliot Roswell in an inopportune market. This would result in selling the asset below our basis and incurring a significant loss of LP-invested equity. Specifically, if forced to sell now it would be a total loss of capital for both Class A and Class B.
  
• Replacing Rate Caps: Our rate cap is expiring this year, and the projected replacement cost is $736k.
  
• Resuming Renovations: Given rising inflation and labor costs, our capital expenditure exceeded initial underwriting. This prompted a temporary pause to renovations. However, resuming renovations is essential to increasing revenue, and a capital infusion allows us to resume both interior and exterior renovations. We will consistently evaluate the cost vs. benefit, adjusting the renovation scope as necessary.
  
• Maintaining Lender Requirements & Loan Covenants: We (Joe & Frank) will consistently support you and our other investors through both favorable and challenging times. We’ve already extended a $2.9M interest-free short-term loan to cover various unexpected expenses, including the replacement rate cap over the past 12 months. While this was meant as a temporary solution, it must be repaid promptly to maintain compliance with loan agreements and ens

[Brian Burke]

@Jon Zhou I don’t know anything about this deal so my comments here are intended to be general because I have a feeling that a significant percentage of passive investors will be faced with a capital call in the near future from a large array of operators, and maybe this will be helpful to them, too. I’m not an attorney, just a syndication sponsor who has survived 34 years in the investment arena, so this is not intended to be legal advice, either.

The first question you face is whether you “have to” meet this capital call. I doubt you have to, despite the language in the letter you shared stating that “all LPs must participate.” Letters to investors are not governing documents—whether you are required to fulfill this capital call depends on the language in the operating agreement, so I’d start there. It should say whether capital calls in excess of your capital commitment are voluntary or mandatory, and if they are mandatory, it should state what the penalties are for failing to fulfill it. By that, I mean the contractual penalties, not the practical penalty such as loss of principal due to foreclosure of the property, dilution, and so on.

Then, you must decide whether you “want to” meet this capital call. There is a lot to consider here.

The letter you posted states that the sponsor has extended a $2.9 million loan to the entity to cover expenses, which “must be repaid promptly.” On one hand, it’s a good sign that the operator stood behind the deal to keep expenses funded with their own cash as long as they could. On the other hand, it could be a sign that they waited too long to issue the call, or that getting their cash back from the proceeds of the call plays a role in their decision to now issue it. Maybe it’s not a factor for this sponsor, but it could be with others…just something to consider.

To address your concern of whether you “are putting more money into a failing syndication,” your mission is to analyze whether there could potentially be a positive outcome, and if you can earn a return on the additional money.

The decision is actually a bit easier in a scenario such as this where a total loss of principal is on the table. In the case of a partial loss of principal, you also have to factor in the return you could make on the principal you got back from an immediate sale. That calculation doesn’t apply here.

If a sale today would result in a 100% loss, but a sale in the future resulted in only getting all your money back (original plus the additional call), but zero profit, you are getting a 5X return on the called capital (putting in $20K to get $120K back, for example). If it took 5 years, that’s a 20% return on the 20K (in the simplest terms). Probably a decent investment. If you got half of your original investment back plus the additional, that’s a 2.5X return on the called capital, or 10% over 5 years. Still not terrible.

But the question is, can such an outcome be achieved? Only hindsight will reveal the true answer, but I have personal experience that it is possible. I was there in the great recession of 2009 and had a deal where we were totally underwater and bleeding cash but 6 years later sold and returned all capital plus a profit.

But you have to weigh all the factors to gauge your odds. You need two things for this to work: 1. you can’t run out of time, and 2. you can’t run out of money. So is a 20% capital call going to get the job done, and provide enough money to go the distance? And if it will, is there enough term left on the loan (and if not, what’s the plan to fix that)?

Here are some things to consider in your decision (i.e. questions you might want to ask):

1. When does the loan mature? (perhaps the most important question of all)
2. What was the loan-to-purchase-price ratio when the property was bought?
3. How much is the property worth today?
4. What is the loan amount?
5. When does the rate cap expire?
6. What is the monthly cash burn, including reserves to purchase replacement rate caps?
7. Is income/occupancy holding up?
8. What are the market rent growth and occupancy forecasts for the next few years?
9. Are renovation bumps supported by the market?
10. What happens if some investors fulfill the call but others don’t? i.e. if the sponsor doesn’t get enough money to solve the problem, what will they do with the capital that was just contributed?
11. What place am I in the capital stack? Is there preferred equity or Mezz Debt at a higher priority than me?
12. What are the uses of the new funds?
13. And a question for you: If you are invested in multiple syndications, do you have enough reserves to fulfill capital calls from all or many of them? And if not, you need to prioritize the ones that have the most likely positive outcome.

You also want to think about the market and subsequent recovery. If you zoom out, real estate goes up in value. Maybe not year to year, but certainly decade to decade. I remember people saying in 2010 that prices would never get back to the 2006 peak. But by 2014 prices had not only reached the 2006 peak but exceeded it. How long will it take for the next recovery cycle to bring you back to right-side up? I’d guess five to seven years, but I could be way off base. I’m a bit of a market pessimist lately which is why I’m not invited to a lot of parties.

BP is doing a podcast on the topic of capital calls and I’m one of the two panelists. Maybe listen to that when it comes out in a couple weeks and see if any other nuggets of info come up in the discussion.