Capital calls are becoming a growing challenge for limited partners (LPs) in real estate syndications. This is particularly true in the multifamily sector. With shifting market conditions, rising interest rates, and compressed cap rates, capital calls have gone from being a rare occurrence to something closer to the new normal. For IRA investors participating in syndication deals, understanding how to handle capital calls is essential.
Scott Trench, CEO of BiggerPockets, recently shared his experience navigating capital calls as an LP on the Best Ever CRE Show. Though historically a conservative investor who focuses on small multifamily properties, Trench ventured into syndications during 2020–21. Unfortunately, like many investors, he found himself caught at the market peak, investing in deals with compressed cap rates in Phoenix, Arizona, which later faced significant financial challenges.
What Is a Capital Call?
A capital call occurs when a real estate syndication sponsor requests additional funds from investors to cover unexpected costs, maintain operations, or avoid a distressed sale. These calls often arise due to unfavorable market shifts, such as unexpected increases in interest rates, operational expenses, or a decline in rental demand.
For syndication LPs investing through an IRA, capital calls pose unique challenges, particularly regarding liquidity. Most IRA investments are illiquid, so navigating capital calls effectively requires careful planning.
Lessons from Scott Trench’s Experience
Scott Trench has faced two capital calls in his syndication investments, with one still outstanding. While one of the deals was handled well enough for him to contribute more capital, the other deal didn’t align with his investment strategy, so he declined to contribute further funds. His experience provides valuable insights for IRA investors who may face similar decisions.
Here’s a breakdown of Trench’s key advice for LPs dealing with capital calls:
1. Evaluate the Fundamentals of the Deal
Before making any decision on a capital call, Trench recommends investors take a hard look at the underlying fundamentals of the deal. Ask yourself whether the capital call is likely to resolve the current issues or if it’s a temporary Band-Aid. In some cases, further investment may not be the best course of action, especially if the property is fundamentally overleveraged or in a market with poor long-term prospects.
For IRA investors, the stakes are even higher. A poor decision can lead to significant losses within your retirement portfolio. Thoroughly review the financials and consider consulting with an advisor to evaluate whether additional capital will improve the outlook.
2. Assess Your Liquidity
Capital calls can create liquidity stress, especially for IRA investors. If your IRA is locked into illiquid assets like real estate or private equity, accessing cash to meet a capital call can be challenging.
Trench highlights the importance of assessing your liquidity. If contributing to the capital call requires liquidating other assets or dipping into savings, it may not be worth the risk. In IRA investing, where distributions are often restricted, you’ll need to carefully consider whether your retirement account can afford to contribute additional capital.
3. Consider the Long-Term Impact
One of the biggest risks in declining a capital call is the potential for dilution. If you don’t contribute, your ownership stake could be reduced, meaning your share of future profits might shrink significantly. On the other hand, contributing to a capital call could secure your position in the deal and potentially yield long-term benefits.
Trench’s decision to contribute to one capital call but decline the other was based on his analysis of the long-term potential. IRA investors should similarly weigh the potential future gains against the immediate risk and determine if the investment is still aligned with their retirement goals.
4. Be Prepared for Dilution
If you decide to decline a capital call, be prepared for dilution. Your stake in the syndication could be significantly reduced if other investors participate. For some investors, especially those nearing retirement, preserving liquidity and avoiding further risk may outweigh the downsides of dilution.
5. Plan for Capital Calls in Advance
Finally, one of the best ways to navigate capital calls is to plan for them before they happen. Trench suggests that conservative investors like himself should expect potential capital calls as part of their overall strategy in syndications.
For IRA investors, this could mean setting aside a portion of your funds in more liquid assets to handle any future calls. Being proactive can help you avoid having to make difficult decisions under pressure.
Conclusion
Capital calls are an inevitable part of real estate syndication investing, and they’ve become more common in today’s shifting market. For IRA investors, who face added complications related to liquidity and the structure of retirement accounts, careful planning is critical. Following Scott Trench’s advice—evaluating the deal’s fundamentals, assessing liquidity, considering the long-term impact, and preparing for dilution—can help you make more informed decisions when faced with capital calls.
Ultimately, the goal is to protect your retirement portfolio while making sure any additional investment aligns with your long-term strategy. As syndication deals evolve in this new landscape, IRA investors must be cautious, deliberate, and well-prepared.
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