Keeping it real: a capital call hits the inbox

If you have been reading this blog, you'll know that we have actively invested in dozens of real estate syndications. Our investments are mostly in multifamily apartment complexes but we have exposure to a few other asset classes as well, including self-storage, hotels, office, and parking.

Our portfolio of multifamily apartment buildings has overall performed well--so far as we can tell. It's hard to know, of course, how each private deal is performing exactly. It's hard to know how they are doing in an absolute sense (are they gaining in value?) and even harder in a relative sense (how are they performing compared to other, comparable investments?). This lack of clarity and transparency is one of the great challenges of private syndication investing--and one of the reasons for this site to exist, as a resource for sharing data and information together to get a sense of how our investments are doing and comparing notes on whether it makes sense to invest in this business at all.

One way to know how things are going is to assess the cashflow we receive each month. Some deals have performed exactly as we expected--half or more than half, I'd say, are right on track. We get a steady stream of cash transferred to our bank account on a regular basis, as suggested (note we do not say "promised") in the pro formas we received before we invested. In a couple of cases, the syndicators have outperformed--rare, yes, but wonderful when it happens.

In the case of two syndication deals, the results are especially disappointing. In one case, cashflow got started and then it stopped abruptly. The communications also seemed to stop. The syndicator then promised more communications and delivered to some degree, only to miss their promised communications cadence--stop and start. They have suggested that they may need to sell the asset, refinance it, or issue a capital call. Oof. No word yet but it has been about a year of this and the news has not been good. I imagine a capital call is forthcoming.

This week, a second asset--which has been performing much less well than anticipated in the monthly reports--resulted in our second-ever capital call. This was not foreshadowed or expected at all.

The syndicator sent out an email to say that the capital call will be for about 30%-35% of the initial investment. In other words, if you put in $100,000 in the original investment, you would need to put up $30,000 to $35,000 in new cash. If you do not, you will be diluted in terms of the percentage ownership of the deal overall.

What might that "dilution" mean? What we figure is that the preferred cash flow would still accrue (say, 7% for this particular class of investment). So no certain negative there if you do not participate in the capital call. But the pain would come in upon sale or other liquidity event, perhaps. If the original investment gave the investor, say, 1% of the equity in the deal, then after "missed" capita call, the investor might have 0.75% of the equity in the deal (totally made up numbers). The point is that the final distribution might be much lower than it would have been had the investor kept his/her/their pro rata investment intact by meeting the capital call.

Yes, we plan to meet the capital call. We have never taken any cash out of the business we maintain for these syndications, so the cash is sitting there in the bank account for this kind of contingency. We are not pleased about--it suggests the operator has missed the mark in their initial projections that they have come back to us for more capital--but it is part of the cost of doing business in real estate and other types of private investments. The returns are higher and the risks are higher. We have had one capital call in the past (two years ago, in the depths of COVID-19, on a hotel deal, which was understandable) and expect these may not be our last. Our cost basis for the investment will go up, we expect no cash flow while the operator gets the deal stabilized, and we hope this new cash in will enable the operator to get the business plan back on track. In 3 to 5 years, the payoff should be worth it. In the meantime, it is a good reminder to stay at least somewhat liquid.