Put $75k into a development LP and learned what a capital call is the expensive way

Writing this for people at my level, which is the level where you read the deck and think you understand it.

Two and a half years ago I put $75k into a 60 unit ground-up apartment deal as a limited partner. Total raise was $6.1M. The sponsor had built four things before, the market was one I knew a little, the projected timeline was 24 months to stabilization and the projected hold was five years. The deck showed a range of outcomes and the low end still looked acceptable to me.

What actually happened. Permitting took seven months longer than the schedule. Then a steel package came in over budget and the site work found rock. By month 19 the sponsor sent a letter saying the project needed another $940k and was calling capital pro rata. On 1.23% my share was about $11,600.

I did not have $11,600 liquid at that moment. I asked what happens if I don't fund. The answer was in the LP agreement I had signed and had genuinely read, in the sense that my eyes went over the words. Non-funding partners get diluted, and in this document the dilution was punitive, the funding partners' new money counted at a multiple for purposes of recalculating percentages. My 1.23% went to something under 0.7%.

The building is now leasing, 39 months in against a 24 month projection. It may still return capital. I have no idea when and I have no say in it.

Three things I'd do differently, said plainly.

I'd read the capital call and dilution sections first, before the projections, and I'd ask the sponsor to walk me through the arithmetic of a call on a specific dollar amount. Not whether there could be one. What my number would be if the budget went 15% over.

I'd ask how the contingency line was sized and what it covers. This deal had 4% hard cost contingency on a project with unknown subsurface conditions and no geotechnical work done at the time of the raise.

And I'd hold back reserve capital against every LP position instead of committing my whole allocation. If you can't fund a call, you don't get to make a decision, you get whatever the document says.

Anyone considering an LP position should have their own attorney look at the agreement. Mine would have flagged the dilution multiple in ten minutes.

2 replies

3angela_burkeServicePRO6

The 4% contingency with no geotech done is the number I'd point at. On a ground-up with unknown soils, that's the sponsor telling you the budget is a hope. Rock is the classic one. It doesn't show up on a survey and it doesn't show up in a title report and it turns site work into a different project.

The dilution multiple stings but it's a fairly standard tool. It exists so that the people who do write the second check aren't sharing upside with people who didn't. Harsh and defensible at the same time. The part I'd be annoyed about is that 39 months against 24 means you're paying interest for fifteen extra months on borrowed money, and that comes out of everybody's return whether they funded the call or not.

1ryanmck27SC2C

The line I'm taking from this is holding back reserve capital against a commitment. I would not have thought of that at all. I'd have assumed the check I wrote was the whole exposure, which I now realize is what the word commitment was trying to tell me.

Sorry it cost you the difference, meridian.

Put $75k into a development LP and learned what a capital call is the expensive way

2 replies