My Investment Has a Capital Call, What Should I Do?
In this episode of the Invest Like a Billionaire podcast, co‑hosts Ben Frazier and Bob Fraser break down the concept of capital calls in real‑estate investments and give investors a practical framework for deciding whether to contribute additional money. They start by defining a capital call as a sponsor’s request for extra equity when a deal runs short of cash, noting that participation is usually optional but non‑participation can lead to dilution or loss of the entire investment. The hosts discuss how capital calls can be used to protect equity but also introduce risks such as cram‑down dilution and potential lawsuits. They outline a decision‑making process that begins with diagnosing the cause of the shortfall—mismanagement versus external economic forces—then evaluating operational trend lines (occupancy, market rent, NOI), the path to cash flow, and the ability to service debt (DSCR, interest‑rate caps, bridge debt maturities). A large portion of the conversation is devoted to the capital stack, explaining senior debt, mezzanine, preferred equity (hard‑pay vs soft‑pay), and common equity, and how each layer’s rights affect dilution and recovery prospects. They stress the importance of understanding refinancing prospects, especially agency loan requirements (DSCR ≈ 1.25, leverage limits), and warn that highly leveraged deals (80‑90% total leverage) have a low probability of surviving current market conditions. Finally, they advise investors to default to a “yes” (participate) unless the capital call clearly fails to buy enough time or improve cash flow, and to keep a liquidity reserve for unexpected calls. The episode ends with a call for listener questions and a promise of more deep‑dive content.
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Welcome back to another episode of the Invest Like a Billionaire podcast. I am your co-host Ben Frazier, joined by fellow co-host Bob Fraser. If you've invested in real estate for the past couple of years, even recently, and you've heard this term capital calls, you're going, what is that? Should I do this? Well, we have some news for you. If you invest in real estate and expect to for a period of time, you will be asked for capital calls. It's just kind of part of the deal. But the question is, is this worth doing? Am I putting good money after bad, or is this something that really will protect my capital? And help me not lose capital. So stay tuned. We're going to dive into all the things you do to understand if this is something worth doing. This is the Invest Like a Billionaire podcast where we uncover the alternative investments and strategies that billionaires use to grow wealth. The tools and tactics you'll learn from this podcast will make you a better investor and help you build legacy wealth. Join us as we dive into the world of alternative investments uncover strategies of the ultra-wealthy, discuss economics, and interview successful investors. Looking for passive investments done for you? With Aspen Funds, we help accredited investors that are looking for higher yields and diversification from the stock market. As a passive investor, we do all the work for you, making sure your money is working hard for you in alternative investments. In fact, our team invests alongside you in every deal, so our interests are aligned. We focus on macro-driven alternative investments so your portfolio is best positioned for this economic environment. Get started and download your free economic report today. So Bob, what is a capital call? Give us a real quick just breakdown of what that means. People hear this term, it's kind of floating around, and people might not know what that means.
Capital call is when a capital guy comes knocking on your door and says, write me a check. So you've made a passive investment. So maybe you put $100 grand into apartment deal, multifamily deal or something, and the operators come back and say something went wrong. We've got an issue and we need a little more money. And, and so because you put in money once, you you know, you can, you got to put money in again. And of course, there's rarely an actual obligation to put in money, so you don't have to. But the issue is, you know, a lot of deals that if there's not additional capital coming in, you could lose the entire investment. So if I put $100,000 in, I could lose the entire $100,000. If you're in the equity part of the stack, you're the, you're the last capital to get paid. You get the the most bang for your buck if it works and you're— but it's also the riskiest if it doesn't. And so, you know, it's really protective capital a lot of ways. So let's say, you know, rates went up, they got a delay, they're rehabbing this apartment complex. So they had a, you know, a bunch of delays or something for some reason. And all of a sudden now they, you know, they just don't have enough money to finish the rehab. And because it went longer, they had more interest payments. So now they're coming and saying, hey, we need another $30,000 from you. So that's a capital call.
That's a capital call. And so to your point, it's not usually a requirement, right? So it's a sponsor will come to you and say, hey, we need X amount of dollars spread across all of our, you know, limited partner investors. This is how much pro rata we need everyone to contribute. And then usually it's qualified by if you don't contribute, you will at a minimum be diluted, right, in your equity, because they're bringing more equity to, you know, make it a bigger pie from the initial pie. And so you will be diluted, meaning your ownership of that equity goes down if you don't contribute. But even—
and let me just make a point. So some deals are called cram-down deals, and that's where they are very dilutional. So the truth is that new money is always worth more than yesterday's money. Yeah. And so, you know, maybe they raised $10 million to buy this apartment complex and they only need 2 more. And maybe you got, you know, you got for $10 million, you got, you know, a certain percentage of the deal. But the $2 million is a lot more valuable money. And so those guys can come in and say, I want a bigger percentage of the deal. And so you do what's called a cram down of existing investors. Now, I haven't seen any real estate deals that are doing cram-downs, but it's very common in capital calls to do cram-downs. And that's where it is very dilutional. You could literally be, you know, really diluted, heavily diluted. So it's very protective, but it opens up the operator to lawsuits, you know, investor lawsuits.
Sure. Yeah. So it's maybe less common in real estate, but it is a possibility. And if a sponsor gets desperate enough, they have to make it attractive enough for the new equity coming in. Right. So but to your last point, if they don't meet this capital call, if they don't get the funding requirement, it's possible that the deal doesn't make it right. And then at that point, since you are common equity, you are the last person paid in the line of capital on the capital stack. You have the highest risk of loss. And so It's really, really important right now because we're kind of entering into this, the beginning parts of a lot of deals that are struggling. A lot of loan maturities are hitting over the next 18 to 24 months. Interest rates are, you know, 500 basis points higher than when most of these deals were initially underwritten and has completely changed the landscape. And so we want to come on, break down like what are the things you should be looking at?
Should you write a check or not?
Write a check.
So we're going to answer that question.
Yes. And it's interesting too, because part of the reason I had this idea to talk about this is I think investors are feeling this, right? They've been hearing it. And we've talked with a lot of investors here in the past few weeks that are just saying, hey, I just need to hold on to my cash. I'm trying to get as much liquidity as I can because I was expecting a lot of capital calls in 2024. And so if you haven't been called yet and you've been investing in real estate, you know, Lucky you, but you might be getting some calls here pretty soon. So we're going to kind of break down some of the key things you want to look for. So kind of set the framework. I think first you have to understand and ask the question of what happened, right? That's the first question you got. You got to answer. And I think it comes down to a few broad categories. It's usually not, you know, one or the other. It's probably a combination of both. But I put the two big categories are mismanagement and missteps of the sponsor. And then things that they couldn't control in the economic and external environment that they're in that have impacted the deal and changed the deal from the initial underwriting. Right. Because when a deal is initially underwritten, they're always building reserves and they're always building some sensitivities and stress tests in. But we've had one of the biggest and fastest shifts in the commercial real estate market that we've seen in the past several decades with the interest rates rising as fast as they have. It has completely changed the game on what credit looks like, what, you know, getting new capital and new equity looks like and just risk tolerance from banks, lenders, etc. And so you really have to understand, was this predominantly due to mismanagement of, you know, the budget, the operations, you know, things that could have been foreseen or at least could have been handled better, right? What's been the communication of the sponsor since the deal was started? Have they actually shown you everything has been going rosy? Hey, we're 2 years in this deal, we're going great. And then all of a sudden, out of nowhere, hey, we only have 3 months left. If we don't get this capital, deals are going to foreclosure, right? That's, that's not a good sign, right? If it's kind of been swept under the rug, I think you want to see some, some transparent communication. But then also realizing like real estate is a business, you know, on the active side is the sponsor. This is an active operating business that they are doing. And there's things that you can't foresee. There's, there's, you know, plans that don't happen and things that do happen you don't expect. And, you know, we always do really good underwriting. I believe in all of our deals. We try and think through every option, stress every conceivable thing we can think of. But at the end of the day, I know that I'm never going to hit 100% of my pro forma. It's just impossible because I can't predict the future.
It's all projections and assumptions. We all have to make assumptions now, but we've seen a lot of underwriting out there and, and we've seen very aggressive assumptions, right, in some of the underwriting. And, you know, you're going to get 20% returns and here's all our assumptions. You know, you're going to see super low cap rates, you're going to see this and that and the other. And it's all these assumptions. And, you know, it's a real mistake. So it is hard for a novice to, to look at underwriting and figure out if it's aggressive or not. And so, you know, we had to do another, another show on really, you know, how to look at the assumptions underlying these, uh, these, this underwriting. But, but a lot of times, a lot of times, you know, as you point out, they— it's not the fault of the operator. But even if it is the fault of the operator, The question is, are they, are they doing stuff that's right? I mean, I was just in a capital call and these guys, they, they partnered with a pref equity company and the pref equity company says, we have a manager, a new management company that we're starting. We will give you the money on the condition that we can manage the property. So they agreed. Well, this property manager did a terrible job during, during COVID You know, not doing proper credit checks and letting all the wrong people in. Well, it just nuked the project, but they're doing everything right to fix the project. So, so there's just lots of missteps that can happen, especially when you got big complex deals like, like that and lots of things where they're really, really somebody really dropped the ball. The question is, are they really doing— do they have a plan going forward?
Right. And so I would say kind of first get the understanding of what happened, right? You want to have a good story that makes sense, right? Like what you just said, like that, that makes sense, right? And so I think in that scenario, they put a lot of tenants that shouldn't have been renting, they did terrible screening, and then COVID hit and they couldn't evict. So now they have just cash flow burn like crazy that they couldn't predict, and they are operationally getting the project back on track. So they've gone through all the eviction process, they've replenished new tenants that are paying, that are higher quality tenants, you know, occupancy is trending upward. So the first thing that I say you gotta look at is look at the operational trend lines of the project, right? Because real estate at the end of the day, it's location, location, location, right? So if it's in a good area, if it's in a, if it's a good property in a good area and you're starting to see positive trend lines. So the positive trend lines I would look at are, are you seeing, you know, the gross potential rent, which is what's the market rent, you know, in that submarket for similar type properties? Is that holding strong or growing? Right. And then are you— is the deal trending closer to that? Right. From both a market rate standpoint for what you're actually charging on, you know, on the units and then also occupancy, because a lot of times the breakeven occupancy, depending on the leverage and the capital stack, it's probably going to be somewhere in that 70 to 80% range. And so it's— they're all right in the bubble, right? So maybe it's 65%, but they're pre-leased to 70%, which means they have new leases that have been signed but not yet moved in. And so you're seeing these positive trends toward the right direction. So that's something you really want to see. And then you want to understand too, I mean, the other kind of piece of this is to throw in just their interest rates, but you may not be aware, but the whole insurance market is completely in upheaval. We're seeing insurance renewals on a lot of properties, especially in the South Southeast, 100% increases year over year. Double. We haven't seen these types of increases really ever on insurance. And so you're seeing all these surprises, right? Aside from just the interest rate challenges. So understand what's going on on the, on the expense side as well. And then what's the path to cash flow, right? That's the key thing. If you can cash flow—
two main things we want to look at, and these are two big questions you need to answer to get your yes and your no. And that is, do they have a path to cash flow? We'll talk about that. And then the second is, do they have a path to clear the capital stack to basically pay back all the lenders and investors? So path to cash flow. So what does that look like, Ben?
That's what I've just been saying. So you want to look at what's the trend line for your revenue, right? Because that's going to create the margin. If you can continue to grow revenue, whether that's through higher market rates and higher occupancy, those are your two real levers. Right. And then you want to understand what's the expenses, or have they absorbed a lot of these new higher expenses? And that creates your net operating income. And what's that currently right now? And where does that kind of trend going over the past 3 months? And, you know, where's kind of the, the next 3 months look like from a pre-lease standpoint or just, you know, getting new leases in? And so you want to kind of see the trend lines go in the right direction and then you want to see that path to cash flow. Because if you start getting the higher occupancy, you get your expenses under control, you get your market rates then that, that, that cash flow number is hopefully not too far away, meaning you're, you're the NOI, the net operating income on your property will be able to service all your debt and continue to, you know, keep the property afloat. Because if you can get the cash flow, you can ride through the storm. Right. So that's really the story.
And one of the biggest issues of cash flow. Yes. Occupancy, as you just said, are they— are the trend lines good? But then is the debt— can the debt be serviced? And a lot of times they may be talking about bringing in new debt. Right. And so while can that debt be paid right out of, out of cash flow and still you want to know, can it get to cash flow positive? And you want to understand, too, a lot of the lenders have a debt service covenant, a covenant where you have to have a certain coverage ratio. And it's usually somewhere around 1.25, meaning that the property has to have enough cash flow to cover the debt service at 125% of the debt service. And so you want to do all that math and, you know, and ask and really push on that. Now, a lot of times when people do capital calls, they will have a webinar, they will have a call and they'll be available to ask, ask questions. So these are the questions you need to ask is show me the path to cash flow. Show me what this, what this looks like. And, you know, and it may not be clear, may not be a clear answer. You know, one of the other deals I'm looking at, they're getting ready to do a capital call and basically they need— because interest rates spiked and they're seeing a maturity in their, in their bridge debt, they need $1,000,000 just to, just to put a rate cap in place for one more year. So it buys you one year. So then the question is you got to ask, well, what does that 1-year buy you? What after 1 year? What if the rates don't go down? Is it the same story again? And the answer is probably yes. Another, another capital call and not good, right? Not, not good. So, so it's not always a clear-cut decision on the cash flow. You know, when you have these, these big one-time expenses, you know, you have to make assumptions on interest rates and you have to make assumptions on, on insurance and on taxes, right? We see huge, big tax raises recently, some for some reason. So you got to make assumptions on all that.
Yeah. And I think that's a great point, right? We— a capital call should hopefully be a one-time thing, right? So the next kind of part of the questions you should be asking is how much time does this buy you? Right. And in this case, you just gave of interest rate cap that they're buying for one more year, which basically limits the, the interest rate that they're paying on their debt service. And they're basically buying, you know, a swap so that they can, you know, keep a fixed rate at a lower rate, continue to pay the debt service at that lower rate versus the readjusted higher rates. But they're very expensive right now for obvious reasons, because interest rates have gone up so much. And if that, you know, capital call only buys you enough time for one year, you better see really strong performance within a few months. Like service not only the current debt service, but adjustment in the interest rates after a year. And if you don't, then you should ask the question, what happens if we're a year from now, we've got a little bit of improvement. Are you going to do another capital call? Right.
Because that's because another capital call generally is not an option. You know, generally you— I've never seen a second capital call work ever. Yeah, you know, generally you got one shot, right? You got one shot to convince investors. And I've seen a lot of mistakes where, where they say, okay, we need, we need X bucks. We— they divided about up amongst all their LPs, and then they get only about 50% of people respond. Well, they only raised half of their required number. You know, you have to get that, you know, so you get— it's all or nothing with these capital calls. If you need $3 million, we need $3 million, you know, and that $1.5 million isn't going to do it. So a second capital call is not, not, not going to work. So you want to really look hard at, does this, does this capital call, will it get them over the hump cash flow-wise?
Yeah, 100%. And I think the other, um, kind of main thing we'll look at, you said earlier, is how do they clear the capital stack? And so what do you mean by that?
Explain that.
Yeah, so we've talked about capital stack before, and it's very, very important right now if you're doing a capital call to understand what does the current capital stack look like, right? Is it, you know, a bridge debt lender with a short maturity with some preferred equity on top that's hard pay, which it means they actually have takeover rights if they're not being paid current. And then you're kind of the last, you know, sliver here.
And I want to dive in a little bit deeper on that and just talk about hard pay, soft pay and the capital stack. So just because we want to be, you know, really explain this to people that this may be a new concept. So capital stack starts with the senior lender. Yeah. And typically that's a bank or, or bridge lender and that's the senior mortgage and they have a lien on the property. And guess what? They get money, they get paid off 100% before anybody gets anything else.
Right.
So that's called priority. And they have, they have the top priority. So every bit of cash coming out, they have priority. Then the second part of the stack is a MAS, a MAS debt, if there is any. Now, that's uncommon, but it would be a second lien, a second lien in essence, and they get paid the next money after the first, the senior lender gets paid off, then they get the next money before they get paid off 100% before anybody else gets a dime. And then the next— and those are, those are fairly simple. People understand those are mortgages, right? Then is preferred equity, pref equity. And this is where this is actually— this is equity, but they get paid off a lot of times 100% before common equity gets in. And then common equity is what you and I typically invest in as a limited partner. So we get paid last. Okay, so talk about pref equity and we'll talk about bridge first. Talk about bridge, the nuances of bridge, and talk about— then talk about pref equity.
Yeah, so bridge is— you're referring to as bridge debt, which is, you know, generally senior debt and generally non-bank debt. So this was very common kind of in the 2020, '21 kind of era where a lot of deals were done at pretty high valuations. And there's a lot of attraction for doing this as a sponsor. We've talked about this in the past, but they generally get very high leverage, you know, 80% on purchase price plus 100% of renovations.
So if you're doing a deal and you're getting 80% bridge, that means you only have to raise 20%. So it's a good deal, right?
Good deal. It's non-recourse to the sponsors, meaning there's no personal guarantees except for fraud. And so, you know, pretty attractive, really high leverage. I'll raise my check. I don't have any— I don't have any personal guarantees on the line. So it's, you know, it was very attractive. But the issue was they're always floating rate. They're floating rate notes unless you bought an interest cap, interest rate cap. And so—
and that's usually a max of 3 years. And so what's happening, a lot of the deals are now maturing. These bridge debt and the floating rates are spiking up 100%.
So that's where a lot of these deals were initial 3-year terms. They're starting to hit their maturities. Yeah, we've talked about this in past episodes, but at least 25% or more from what we're seeing so far will not qualify for refinance. Right. So they don't have— they haven't hit the operational targets and NOI necessary to achieve the valuations to get new debt that would pay off their current debt. So that's where a lot of deals are at. And so preferred equity.
Yeah.
So preferred equity generally sits on top of that and increases your effective leverage even more, right? So they come in and, you know, take anywhere between, you know, 70 to 80% or kind of that 75, 85.
I've seen it from 80 to 90. So you only raise 10% common equity and you're 90% leveraged. I mean, Now, this is an example of very risky underwriting. And there— but the 25% IRRs, yeah, that's if everything goes great, you know. But anyhow, so.
Right.
Back to pref.
So back to pref. I mean, there's generally kind of two common types of pref: hard pay, soft pay. So preferred equity generally is structured where they have a current pay portion that they are expected to get on an ongoing basis. So what does that have to say? It's a preferred return. It's kind of a— almost like an interest rate where they have to pay that every month. Okay.
It's cash though. So the property has to pay cash, a portion of it.
And so that's usually somewhere in the 6 to 8% range paid out every month, just like you pay your senior lender. And then they have a back-end fee, which is somewhere between, say, 6 and 8% that gets paid out not in cash, but once the property sells or refinances and they get paid off, that accrues every year. So it's, it's, you know, expensive, but it can effectively increase your leverage. It can help increase returns for the, for the equity investors. But the kind of big distinctions are hard pay versus soft pay. So a hard pay for equity group, if they are not being paid on their current portion that has to be paid out in cash every month, that 6 to 8%, they have the rights generally to fire the manager, which is the sponsor, and take over the deal and make decisions on the strategic and/or force a sale. And/or force a sale.
Now, if they force a sale, they don't really care about the common equity on top of them. They just want to get paid off. So anybody down the capital stack, you know, forces a sale generally will mean a wipe, 100% wipeout for the equity guys. So if you get the senior lender starts forecloses, the junior lender forecloses, or the, or the, the pref equity guy take over a deal to force a sale, all those cases, you will see the equity guys, the common equity guys get wiped out.
Yeah. So that's the capital stack. And I think going back to the initial question is how do they clear the capital stack? And what that means is what's the path? They got the path to cash flow, but then what's the path to get fully stabilized? Meaning they kind of hit higher occupancy, they're hitting their projections on their net operating income. And then whenever— if they have a bridge debt lender, that is, their note is maturing in a year, they're going to have to either refinance or sell. And based on the valuations, based on the current net operating income, what are the assumptions that they're making to refinance that? What's the interest rates that they're using in their analysis? What's the valuation they're using in their analysis? And what you want to do— so path to cash flows first, because that saves a property from getting behind in payments and having foreclosure. But if there's not enough operating income to support the value and the values have gone down a little bit right now, right, because interest rates are higher, well, then they're not going to be able to clear the capital stack. And with us, the refinance or a sale, and that impacts you as an equity holder where you're not going to be able to— they're going to have to continue to figure out the capital stack with that gap that they have. Right. We talked about it. So You know, those are kind of the real big things.
Novice figure that out. You know, if the cap rates are real and the assumptions on the refinancing, the clearing the capital stack are accurate.
Yeah, those get a little more technical. The kind of simple thing I'll say, here's a simple kind of heuristic to use because most deals will refinance into agency loans. So this is Fannie Mae or Freddie Mac. These are agency, you know, government-supported lenders that have generally more attractive financing than, you know, other banks and bridge lenders. And they only generally lend on stabilized assets. Right. So it's a perfect fit for kind of refinancing into more permanent financing. They're kind of— I'd say primary thing they look at is debt service coverage ratio. And they want to see right now a 1.25x debt service coverage ratio. So what that means is they have enough net operating income, you know, divided by their, their now new debt service from the Fannie, Fannie or Freddie loan at a 1.25 ratio. So they're having a 25% coverage of 9.5% coverage. So that's the simple one. So look at—
are those amortizing? Are those fully amortizing or interest?
They're usually interest only, but they will— the 125 is based on amortizing debt service.
Gotcha. So that means for the paying interest and the principal portion as well. So you got to ask that. And then what are their LTV limits? Because that's another issue that properties are having.
Yeah, LTV is less of an issue because they'll generally go up to higher LTVs. But with, with current debt service at the interest rates right now, inevitably the LTVs have to be a lot lower. That's usually the constraint is debt service because of interest rates higher. So right now, probably really the main thing is 65% leverage ratio is it.
And, and there you go.
And here's the last thing I'll say on capital stack because we're kind of getting really in the weeds here, but a highly leveraged deal on the front end, let me say this, the higher the leverage from senior debt to mezz to pref and that kind of whole stack ahead of you as common equity, the more that that is of the capital stack, the harder the plan— Everything is harder because in this environment, you know, credit has tightened, leverages are coming down, interest rates are higher, everything's more expensive. So the chance of success goes down in my mind exponentially the higher the leverage that you have. And so I think that's just a simple thing to understand is what was the initial underwriting leverage? If it was 80%, 90%, you know, combined, it's a very, very, in my mind, small chance that deal is going to survive.
Right. You know, and let me say, let me say one final thing here. You know, so getting back to our yes versus our no, I think your first, your first approach should be this is a yes looking for a no, right? Your default should be a yes because you realize that if the— your answer is no. And if this doesn't work, you will get wiped. Probably. You're probably looking at, you know, depending on the market and everything, but you're looking at probably 100%, losing 100% of your investment. So you should be saying, let me go and be protective about this unless there is really a reason why this is definitely good money after bad. This is not going to get me— this is a bridge nowhere, right? This is a capital call that gets me— doesn't get me across the, the, you know, the chasm. And then it shouldn't. But if it can get you across, you really should do— you really should do the capital calls. And then smart investors always reserve a little bit for capital calls. I understand that even the best deals and the best operators have a deal sometimes that just goes, goes, goes a little haywire, right?
So hopefully this is informative to you and helpful. And we're planning on doing a lot more of these kind of in this vein because we know this is a really important issue for investors over the next few months. So feel free to write in questions, other things that we can spend more time on. And we really appreciate you listening. Hopefully you got a lot of value out of this. We appreciate your feedback, any reviews, sharing this with folks, and hopefully you tune in next time for another episode of our podcast. Thanks so much.
