Real Estate Horror Story – Capital Calls
One of the first things about investing you should know is you can lose all your money. If you do not know and understand that as of yet, then you may want to hold off on investing until you can stomach that. Of course, the point of investing is not that you would lose money but the opposite; you invest so you can gain money. With this goal in mind investors select the investment option that has the highest chance of returning a positive gain.
There are many types of equity investments. Real estate investing in multifamily apartments has shown to be one of the most recession resilient investment vehicles around. Not everyone has the time to manage a multifamily apartment themselves however, so multifamily real estate syndication allows passive investors the opportunity to provide a source of private equity (i.e., investment funds) which can be used by active investors to purchase and manage these investment properties for the benefit of passive investors.
Real estate goes through cycles of expansion and contraction which can impact the level of returns gained by investors. When the real estate market is transitioning downward from expansion to contraction (often sensationalized by using the word “real estate crash”) not all investments do well. Similarly in a real estate boom there are some investments that may not do well due to poor management by the investment sponsor or unforeseen circumstances.
Whether it is due to market factors or poor asset management, there is the risk that investments do not go as well as planned. When this happens there is potential for one of the scariest words in investing to come into play – a “capital call.”
What is meant by the term capital call in real estate investing?
A capital call is the a legal right of a deal sponsor (i.e. general partner and/or the asset manager of the syndication) to request additional capital from investors (i.e. limited partners/ passive investors). To put this simply, the investment manager has run out of money and needs to get additional money from investors to keep the investment successful. A capital call is a lifeline that can mean the difference between an investment that fails and one that can be turned around to provide returns for all investors involved.