The protective advance clause I read three times and still priced at zero

The cap expiry date is now the second question I ask, right after who signs the loan. Not the strike, the date. I had one last year where the sponsor's deck said "rate protection in place" and the confirmation showed 18 months against a 36 month hold. They hadn't lied, they just hadn't put the date on a slide.

Question for you though. Did anyone at the fund tell the co-invest group the affiliate was going to be the lender on that advance, or did you find out after? Because those are two very different failures and only one of them is yours.

@canton is asking the right thing. Warrant, in most of these stacks the protective advance language lives in the property-level JV agreement, and the co-invest LLC's operating agreement just says the manager may cause the company to consent to amendments at the JV level. So you can read your own docs cover to cover and never see the clause that eats you, because it's one document down.

The affiliate lending piece is the part I'd have chased. An affiliate of the sponsor making a 15 percent priority loan into a deal it also manages is a related party transaction, and most institutional LPAs route those through an advisory committee or an independent consent. Did that vehicle have one? If yes, somebody voted. If no, that's a governance gap you can screen for next time in about ten minutes.

Whether the consent was actually required in your case depends on the exact wording and on the state law governing the LLC, so that's a read for your own counsel, not for me.

Running your numbers. A twelve month cap quote at roughly $5,100 a door on 466 units is about $2.4M. Against a purchase around $95M gross that's 2.5 points of the basis appearing as a cash requirement in a single month, with no offsetting NOI.

Here's what bothers me. The 24 month cap on a 30 month plan wasn't a rounding error, it was a six month hole that existed on the day of closing, and the cost to fill it was unknowable in 2022 because it depends entirely on where the forward curve sits when you go to buy. So the deal shipped with an open-ended liability of unknown size and a stated intent to refinance before it landed.

Did the fund model show any cap replacement cost at all, or was line one of the exit assumption "refi month 26"? I've seen both and they're not the same level of sin.

My bridge lender on a 96 unit made me escrow monthly toward the replacement cap starting month one. I complained about it loudly at the time. It cost me maybe $9k a month in cash flow I wanted for turns and it's the single reason I'm still holding that asset. So the mechanism warrant needed exists, it's just usually the lender imposing it rather than the equity asking for it.

I stopped writing co-invest checks under a million because you get zero governance for the money. You're a passenger with a spreadsheet. The economics look better than the fund interest (lower fee, sometimes no promote until a hurdle) and then something like this happens and you find out the cheaper economics bought you exactly nothing in a fight.

Warrant, if you do another one, what's the check size where you think the terms actually change?

Everyone's on the clause and I think the clause is downstream. You bought at $205k a door in spring 2022. That was the top, or within a quarter of it. Values sat 20 to 30 percent under that peak afterward and your exit at $168k is right in that band. The cap and the advance decided who ate the loss inside the stack. The basis decided that there'd be a loss to divide.

Not a criticism of the doc work. Just that no amount of participation rights saves a 2022 entry price with floating debt.

Slower question from someone on the outside of this. A rate cap is a thing you buy from a bank that pays you if the index goes above a set number, and the lender makes you buy it so you can still cover debt service? And the price of it moves with rates the same way, so when rates go up the cost of protecting yourself goes up too, right when you can least afford it?

Saw the property level version of this from the management chair. Sponsor's renovation funding went to zero in about a week and my team kept getting asked why leasing velocity dropped on a half-renovated unit mix. Nobody told us there'd been a capital event upstairs. We found out from the vendor who stopped getting paid.

Two things I don't follow. "Came out around 31 cents" means you got back 31 cents for every dollar you put in? And what's a dilution formula actually doing to you if you can't fund the call anyway?

@ember yes on the 31 cents, $400k in, roughly $124k back.

The dilution formula is the punishment for not funding. Say new money comes in and the agreement says anyone who doesn't participate gets their ownership recalculated, often with the new money counted at two or three times its face value for that purpose. So a $2.4M advance can behave like $5M or $7M when the percentages get redrawn. You can go from owning 4 percent of a deal to owning 1.2 percent without anyone doing anything improper. And in warrant's case he couldn't have funded even if he'd wanted to, because the co-invest had no participation right at all. That's the harsher version.

Is an affiliate of the sponsor lending into its own deal at 15 percent normal or is that the sort of thing people get angry about? Genuinely can't tell from this thread whether warrant got played or just got the standard treatment in a bad year.

@plumb both happen and the paperwork looks the same either way. That's the problem.

I'll push back on @parcel a little. Term matching is right in principle, and in 2021 and 2022 you often couldn't buy a 36 month cap at a strike that any lender would accept without it eating a full point of the purchase price. So plenty of good sponsors bought 24 months knowing it was short. The distinguishing behavior isn't the cap length, it's whether they sized a reserve for the replacement at close and told you what curve they used to size it.

I now underwrite three replacement cap costs at every deal: the forward curve number, that number doubled, and the number the seller's broker used. If the deal only survives the third one, I'm out. It's crude and it's caught two deals for me in eighteen months.

@sextant reserve sizing on warrant's deal, roughly. If you'd wanted twelve months of replacement cap covered at close, at 2022 forward pricing you might have reserved $700k to $900k and been badly short of the $2.4M the market actually charged later. At your doubled number you'd have reserved maybe $1.8M and still been short, though a co-invest funding pro rata into a $1.8M reserve is a completely different outcome from a $2.4M priority loan at 15 percent sitting above you.

So the reserve doesn't have to be right. It has to be big enough that the fix stays inside the existing equity instead of importing new capital with teeth.

That's the cleanest statement of it in the thread. The reserve is a governance tool wearing a cash costume.

Warrant, last question and then I'll leave you alone. Did that co-invest have an MFN letter or any advisory board seat, and did the fund LPs on the same asset get better treatment than the sidecar did when the advance went in? I've seen sidecars take the full dilution while the fund vehicle was made whole through a side arrangement, and if that's what happened here it's worth a very direct conversation with the sponsor before you decide whether this was a market loss or something else.