Rescue-capital real estate funds often use new investor money to repay loans the fund managers made themselves, letting them escape risk. Check the sources-and-uses table in the fund documents: if most new capital goes to paying back the sponsors, that's a red flag. The disclosures are required, so you can spot it if you look.
That's the great thing with PPMs is you can't really hide because it has to be disclosed and it has to be written down. And so hidden in the sense of maybe it's in a section that's more obscure, but it still all has to be disclosed. And, you know, one of the things that I saw last year, and there were several groups doing this that, you know, we've talked about other podcasts about these rescue capital pref funds, right? Where they go and effectively raise new capital from investors and to infuse that capital into older projects that they're trying to either finish stabilizing financing, or they need to extend the hold period for, and they need more cash for a variety of things.
It's rescuing deals that have gone bad, basically.
Yes. And, you know, there are cases where it makes sense to do that. Hey, we think we have a good potential outcome here, but we need to extend the loan, we need to get a new loan and, you know, wait for the market to recover. So it can be okay. But one of the big red flags that I started to see is go to the use of funds. And this is one of my favorite places to go, the sources and uses, and they break down where's the capital coming from and what's it being spent on, right? And as a banker, that was something we spend a lot of time on when we're underwriting deals is really understanding what is the capital being used for, because you have to disclose where it's going. And the majority of the capital that was being raised in this Rescue Capital Fund was going to pay back member loans, or these were loans from the general partners that had been putting capital into these deals to help them along with their negative cash flow. And they're paying back significant portions. I mean, this was multiple millions of dollars and a large percentage of the overall capital being raised to pay back the GPs.
So they can get their skin out of the game.
Yes.
So they can put all the risk back on their investors and then they don't have— they don't carry any risk.
Yes. That's a pretty big red flag. And we talk about this in the book. But one of the most important things as you're reading through the PPM, you're looking through the sections that we outlined that you go through. One of the biggest questions is alignment of interests and skin in the game. These are two critical things that you want to look for and to be able to trace through all these different areas, whether it's fees, whether it's the waterfall and how cash gets dispersed, whether it's the sources and uses of funds. All these things can be indicators indicators of, is there real alignment of interest between the GPs and the LPs, or is there not? And skin in the game is lacking.
