What is a capital call?
Unplanned capital calls grant the sponsor or general partner the power to go back to investors and request additional investments on top of their existing equity commitment. These capital calls typically stem from unforeseen circumstances like operational shortfalls, changing financing requirements, or budget overruns.
Generally, the legal right to issue a capital call is standard in private equity real estate partnership or joint venture agreement. The details of these capital calls (structure, amount, timing, etc.) should be stated in the investor’s offering document or agreement.
Capital call provisions are highlighted on each offering’s detail page. To find an offering’s capital call details, navigate to “The Deal” section on its detail page and expand the “Investor Return Structure” tab. For a full explanation of terms, always review the offering documents fully before investing.
What is a planned vs. unforeseen/not planned capital call?
- Planned: When capital calls are planned (or scheduled), investors know in advance the amount of capital that the sponsor will request.
- Unforeseen/Not Planned: Sponsors can also issue unplanned capital calls in the case of unforeseen circumstances, which can be both operational or market-level.
Why might an unforeseen capital call occur?
Each capital call scenario is unique to the investment, but generally there are four common reasons sponsors may issue unplanned capital calls:
- To fill refinancing gaps during market stress
Market volatility can affect property valuations and often the amount of loan that can be acquired upon refinancing. Many deals that were financed with variable or floating rate debt are seeing their debt service increase substantially, especially as the rate caps are expiring on many of these deals. Simply put, deals that were financed with previously low rates are now being reset to significantly higher rates upon refinancing. Therefore, sponsors who had not accounted for these potential hikes in their initial financial planning are struggling to cover the escalated mortgage due to increased debt service costs. Capital calls may be issued to satisfy any changing financing requirements.
- To compensate for budget overruns
A budget is typically created at the onset of a development project and is based on future cost estimates. Construction costs, however, may overrun these estimates, which can introduce financial risk to a project, especially during periods of market volatility.
- To make up for operational shortfalls
The financial health of commercial real estate properties hinges largely on their income. Any unforeseen shortfalls in operations such as tenant turnover, capital expenditure, tax increases, or natural disasters can reduce the property’s net operating income.
- To help enhance profitability
Sometimes a new opportunity may arise that can compel the sponsor to request additional capital. Consider, for instance, an office or a retail project: imagine a new tenant wants to sign a lease at the property and significant tenant improvements and other costs are involved for the sponsor to lease the space to the tenant. The sponsor may issue a capital call to collect additional funding to potentially help push up the occupancy and therefore potentially enhance its profitability.
What is the process for capital calls?
Sponsors can choose to either lead the capital call themselves or enlist CrowdStreet’s services to help facilitate the process.
In the case of a sponsor-led capital call, the sponsor will be responsible for notifying all CrowdStreet investors of the capital call, funding instructions, deadlines, etc. Documentation that needs to be collected will be handled by the sponsor team and the sponsor will answer any investor questions. Once the capital call has been finalized, the sponsor team will upload any documentation for investors to reference within their Investor Room in the Documents section. Depending on the investment, a new Investor Room might be created for a capital call.
In the case of a CrowdStreet-led capital call, CrowdStreet will manage the capital process on behalf of the sponsor, including sending investor communications, providing and facilitating the signature of documents, and hosting a capital call webinar. Please note for CrowdStreet-led capital calls, funding instructions are still provided by sponsors, and funding occurs directly between the investor and sponsor.
Should I participate in a capital call?
Each investor should consider their own personal circumstances when determining whether to participate. Please carefully review all of the information provided to you by the sponsor prior to making a decision, and consider working in consultation with your legal, financial, and tax advisors.
What happens if I do not participate in a capital call?
The consequences of not participating in a capital call are explicitly outlined in the legal documents for your offering; seek guidance from financial and legal advisors to understand what happens if you fail to answer a capital call.
Generally, investors who do not answer capital calls have their investment positions effectively diluted due to the contributions of additional capital made by other investors. Called capital is at times paid in preferred returns (or otherwise granted preference to cash distributions and/or sale proceeds) ahead of the original capital contributed, as a way to offer financial incentives to those investors who contribute additional capital. In some cases investors who do not answer capital calls may lose voting rights or other rights granted through their offering legal documents.
For more information about capital calls, check out these articles: