Never say never

Happy Sunday!

Have you ever seen a real estate deck from a GP that says one of the following?

• “We have never done a capital call” (or sometimes even we will never do a capital call)

• “We’ve never lost LP capital”

To clarify up front, I think many (most?) GPs have good intentions when they’re including these statements - they’re proud of the fact that they’ve avoided challenges and in some cases even funded capital gaps themselves. The challenge is that both track records and self funded related party loans are tricky topics as I discuss in Track Record Audit and Capital calls to pay off a GP loan.

Today I’d like to explore this topic deeper in three parts:

• Why the “never” statements are typically deceptive to the reader

• Why the “never” statements typically have the opposite impact of what you’d expect

• Suggest a better way of rephrasing your “never” statements

Let’s get into it:

• Why the “never” statements are typically deceptive to the reader

• “We have never done a capital call”

• Just because you haven't done a capital call doesn't mean you won't need to in the future

• Many times the statement is deceptive to the reader because while a GP hasn’t done a capital call to date some of the equity in the portfolio is impaired (more on this soon!)

• The statement reinforces the idea for LPs that capital calls are bad, while in my opinion they can definitely be in the best interest of both the GP and the LPs

• Furthermore, the capital call definition is vague - for instance if you raised external capital instead of raising money from existing LPs (perhaps without even notifying them about their newly subordinated position!) should you still be able to say that you have never done a capital call?

• “We’ve never lost LP capital”

• Anyone reading this should (hopefully) read this is as “we’ve never technically lost LP capital”

• The reason why I insert technically is because the GP typically has a portfolio and unlike the stock market there’s no “mark to market” in private real estate investments

• Said another way: while a GP hasn’t technically lost LP capital through a sale of a property, half of their portfolio as of today might be underwater (aka they’ve lost LP capital on paper, but are just choosing to hold onto them to avoid recognizing and publicizing that loss)

• How does a GP keep holding properties that have a material embedded equity loss? Usually through questionable practices and unethical capital calls

2 - Why the “never” statements typically have the opposite impact of what you’d expect

• Sophisticated LPs probably don't like seeing these statements because they can see past them - and thereby you likely lose those investors immediately (PS those tend to be the highest investment amounts)

• Less sophisticated LPs probably don't understand the full picture and invest thinking that “never lost LP capital” means their capital is totally safe and that “never issued a capital call” means that you’ll never issue one to them … and the only question I have there is, did you actually win as a GP by getting an investor on board who clearly has unrealistic expectations?

3 - Suggest a better way of rephrasing your “never” statements

• Let’s think through what a GP is actually trying to say with these two statements:

• The two statements are: “We have never done a capital call” and “We’ve never lost LP capital”

• PS I refuse to cover “we will never do a capital call” because I don’t think this is a reasonable statement to make, ever.

• It’s one thing to make a potentially deceptive statement about the past, but it’s a completely other topic to make a statement about the future that is simply false in probability.

• If you do enough deals a single deal will need a capital call eventually, and in such an event either the GP (1) is getting the money from the LP base and being transparent or (2) is hiding behind their previous no capital call promises while getting even more expensive money from a third party.

• Both of these statements are signals of (1) portfolio health and (2) fiduciary duty.

• The first can be answered in the most accurate way with math and facts - show the LPs your portfolio with current NOIs and assumed exit cap rates and let the math on the equity valuations speak for itself.

• To be clear, I’m not saying you should do this in the deck or do it without an NDA - in fact if you don’t want to do it, you don’t have to do it at all! What I am saying, however, is if you’re not willing to do this exercise in private why would you put these “never” statements in front of LPs?

• If you’re trying to showcase your fiduciary duty and events where you plugged a capital need without asking for LP capital, that’s also great - but then just include that case study in the deck (or under NDA) as oppose to leading with general statements - just my 2 cents.

More broadly, I’d just say that any serious GP (and LP hopefully!) knows that a capital call or an investment loss will happen at some point - the question is never "if" but rather "when."

If a GP wants to lead with actual information to prove your point as I laid out in (3) above, then all the power to them … if, on the other hand, you’re giving half of the information to the reader (LP) and leaving a chance for it to be deceptive then I think you might be hurting your own fundraising efforts.

As always, this is just my opinion and I'm sure many will disagree with me - open to any and all feedback! 🙏🏼

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