The “capital call” is an important concept, one that every moderately experienced real estate investor should be familiar with. A capital call refers to the process of collecting funds from investors for a specific real estate investment and are frequent ingredient in commercial real estate execution.
In this post, we’ll explain in detail what capital calls are and how they relate to real estate investments. We’ll also provide some key takeaways for self-directed accredited investors and some details on how EquityMultiple operates vis-à-vis capital calls.
What Is a Capital Call?
A capital call is the process of collecting funds from investors to supplement the financing for a real estate project or transaction. This is done when a real estate investment manager needs more capital than originally anticipated to complete a project or purchase a property. Commercial real estate investments (particularly large properties with many units) entail complex business plans that may require nuanced financing and legal activity. Hence, the timeline between initial capital raising and close may be lengthy, and the revisions to cost or revenue estimates may necessitate a capital call. The capital call is usually made by the fund manager, who will provide investors with an estimated timeline for when the funds are needed and how much is required.
Say, for instance, that an investor commits $500K to a real estate private equity fund, with 20% paid upfront. That leaves $400K in uncalled capital. Later, the fund manager could issue a capital call to collect another $100K of that commitment to help close on a new property acquisition.
Capital Call Definition
The process of collecting funds from investors to supplement the financing for a real estate project or transaction. This process is often initiated after the preliminary closing of the transaction, due to unanticipated or fluctuating costs.
In order to make a capital call, the investment manager must first have a pool of LP (limited partner) investors who have committed to invest. These investors must agree to make their capital available to the GP (general partner) when needed. The possibility of a future capital call should be made explicit in initial investor documents. Most often, investors will have the opportunity to abstain from participating in the capital call, but consequently the investor’s interest in the investment would be diluted.
A Few Important Concepts
There are three key terms that usefully describe critical aspects of the capital call process:
- Committed capital is the total an investor agrees to contribute.
- Paid-in capital is the portion of that commitment already transferred to the fund.
- Uncalled capital refers to the remaining portion that could be collected via future capital calls.
How Capital Calls Function in Real Estate
Capital calls are an important part of the real estate investment process, as they provide much-needed capital to fund real estate deals. Without capital calls, real estate operators would not have the flexibility to react to new conditions and fine-tune the financing of their transaction or project. In some cases, investments that may ultimately be quite successful would not be able to close without the use of a capital call.
Capital calls are especially important for large-scale real estate investments, such as those involving multi-unit properties or commercial developments. These types of investments require large sums of capital to complete, and capital calls provide the necessary funds.
For self-directed investors, understanding capital calls is essential to successful real estate investing. Here are some key points to keep in mind:
- Capital calls are a critical and widely accepted instrument for rounding out financing on equity real estate investments.
- As a self-directed investor, it is important to understand the details of the capital call. For example, why was the capital call issued, and what changed versus the original underwriting of the investment?
- That said, a capital call does not mean that the investment or the sponsor should be viewed suspiciously.
- Be sure to read the investor documentation when making your initial investment to assess the possibility of a capital call occurring in the future. (This is always made explicit in EquityMultiple’s investor packets.)
What Happens if an LP Fails to Meet a Capital Call?
Capital commitments from limited partners are legally enforceable agreements. In the event an LP misses or defaults on a capital call, there are potential repercussions described by the contract they initially signed. These consequences, which are meant to uphold the contractual obligations, can involve partial loss of equity in the fund, interest fees, sale of debt to third parties, and compensation for damages incurred by the fund. While not desirable outcomes for any party, the stipulations ensure capital calls are taken seriously by investors.
Do EquityMultiple Investments Use Capital Calls?
EquityMultiple offers debt, preferred equity, and equity investments. While a capital call could be used as part of preferred equity financing, it is much more likely to be used as part of an equity investment. Some of EquityMultiple’s equity investments have indeed made use of capital calls to ensure necessary financing for sponsors to execute on transactions or business plans. As of October 2023, 10 of EquityMultiple’s 193 investments have made use of a capital call in which the sponsor capital call was approved by the EquityMultiple Investment Committee.
Should a capital call be used, EquityMultiple investors generally have the option of funding into the capital call or abstaining. If investors do abstain, their pro rata share of ownership of their equity position will change, along with the target return figures for their investment. The details of the capital call and timeline for funding are made clear via Asset Management updates in the ‘My Activity’ feed within the EquityMultiple platform. The potential for a capital call and mechanics (should one occur) are always made explicit in the investor documents for each EquityMultiple investment, so always be sure to understand these details before making an investment.
Use of Member Loans in Capital Calls
As of 2024, EquityMultiple has opted to structure capital calls as member loans, whereby each participant in the loan (individual EquityMultiple investors) act as lenders to the sponsor of the investment (the GP). The member loan structure has a couple of key advantages versus equity-based capital calls:
- It gives participating investors an explicit timeline for repatriating the additional capital devoted to the capital call.
- It provides payment priority over equity positions, hence a layer of protection for additional capital that individual investors contribute to the investment.
Especially in the current environment we look to structure capital calls so that investors have options and so that we are imposing as little as we can given liquidity sensitivities.
– Clay McMickens, Director of FinOps at EquityMultiple
As of 2024, interest rates have climbed precipitously for over a year. At the same time, inflation continues to affect key inputs for real estate operators, including labor, construction materials and (on the plus side) rents. As such, the inputs for modeling returns and underwriting investments are more fluid than in past years. While not every investment will require a capital call, these factors make capital calls more likely now than in past years. EquityMultiple has adopted the member loan structure to offer investors more potential stability in investments.
As an EquityMultiple investor, you can always speak with Investor Relations should you have questions about capital calls.