As the multifamily and commercial real estate (CRE) sector navigates an extended period marked by rising interest rates, economic uncertainty, and increasing expenses, property values are facing downward pressures. As of November 2023, according to Greenstreet, multifamily values have fallen 14% in the last 12 months while the broader Commercial Property Price Index (“CPPI”) is down 8% overall. That, and we still see a significant bid-ask spread, which means things can get worse before they get better.

In this challenging environment, real estate syndicators will try everything they can to avoid the dreaded capital call in 2024 — a scenario where investors are asked to contribute additional funds, often viewed negatively for both operational and reputational reasons.

Capital calls are generally more detrimental for syndicators compared to larger private equity real estate (“PERE”) funds for a few reasons. First, syndicators often have a more personal relationship with their investors, built on trust and direct interaction. A capital call can erode this trust, as it signals potential mismanagement or unforeseen problems with the investment. Second, syndicators typically manage fewer, more focused investments than funds, meaning the impact of a capital shortfall is more concentrated and potentially more damaging to their reputation. Funds, with their diversified portfolios and larger investor base, can absorb the impact of a capital call with less reputational harm and greater ease in distributing the financial burden across a wider range of investments. This distinction makes capital calls a more sensitive and potentially damaging event for syndicators.

Here are 6 strategies that a syndicator can employ to avoid this undesirable scenario.

1. Work it out with the Lender

Negotiating with the lender can be a strategic move for real estate syndicators facing financial challenges. This involves discussing potential adjustments to loan terms, such as extending the loan period, modifying interest rates, or restructuring payments. Effective communication and a strong track record can facilitate these negotiations, helping to ease immediate financial pressures without resorting to a capital call.

2. Introduce New Senior Debt

Introducing new senior debt involves arranging a new loan that pays back the current lender. This strategy can provide immediate liquidity if there is sufficient value and cash flow to underwrite a cash-out or cash-neutral refinance, so it is particularly effective when property values have not drastically fallen. It's crucial, however, to carefully assess the terms of this new debt to ensure it aligns with long-term investment goals and does not overly leverage the property.

3. Introduce New Subordinate Financing (Mezz/Pref)

Implementing subordinate financing, such as mezzanine debt or preferred equity, provides an influx of capital without diluting existing equity positions. While typically more expensive than senior debt, it offers more flexibility and can be a viable option when traditional refinancing is not feasible. Beware, however, that mezzanine debt can be a double-edged sword, raising the risk of default which could lead to losing all the equity in the property.

4. Cross-Collateralize

Cross-collateralization involves using the equity in one property to secure financing for another. This approach can be advantageous when a portfolio includes properties with substantial equity, allowing for the leveraging of assets to raise capital. It requires careful balancing to avoid over-leveraging and potential risks associated with linking the financial fates of different properties.

However, this approach may not be appropriate if the only other properties in a syndicator’s portfolio are also syndicated or have different equity partners.

5. Bring in a Co-GP Equity Partner

Introducing a co-general partner (Co-GP) can infuse new equity into the project. A Co-GP contributes capital in exchange for a share in the partnership, offering a way to raise funds without a capital call to LP investors or existing partners. This strategy also brings in a partner who may add value through expertise, connections, or additional resources.

6. Sell the Asset

In some cases, the best option might be to sell the asset. This approach is drastic but can provide significant liquidity to cover debts and other obligations, thereby avoiding a capital call. Selling will be considered in tandem with other recapitalization strategies by many distressed property holders in 2024.

These strategies, when applied thoughtfully and in alignment with the broader investment strategy, can help real estate syndicators navigate financial challenges and avoid the need for a capital call in order to maintain investor trust, or simply to salvage a deal that could otherwise be a complete loss of equity. We do not know how deep or how long this downturn will last, but it’s best to be prepared to exercise all options on the market to protect your investments.