Managing multiple “Funds of Funds,” I’ve encountered numerous capital call requests in 2023 and 2024 and expect to see even more in 2025. As investors in multifamily, storage, industrial, shopping centers, and other commercial real estate (CRE) assets, we’ve seen the full spectrum—the good, the bad, and the ugly—when it comes to capital calls. Additionally, we’ve played a role in structuring “rescue and recovery” capital investments. Given the variety of deals, sponsors, and market conditions, it can often feel like the Wild West out there.
Not All Capital Calls Are Justified
Some deals warrant additional capital, while others simply don’t. In certain cases, projects are so far underwater that no amount of fresh capital can salvage them without major debt restructuring and lender cooperation. Based on current market conditions, I see three common deal categories:
- Upside-Down Deals – Properties where the current value is close to or below the outstanding loan balance.
- Value-Add Deals with Potential Upside – Properties with significant upside potential through renovations and forced appreciation, making additional capital justifiable under conservative ARV assumptions.
- Equity-Rich but Cash-Poor Deals – Properties with substantial existing equity but struggling with liquidity in the short term.
This article will focus on how to best structure capital for categories (2) and (3) and how Limited Partners (LPs) should approach capital calls—whether to participate or influence the Sponsor/GP to structure them more favorably.
Category (1) deals, on the other hand, are often unsalvageable without complex lender negotiations, which are increasingly difficult in today’s rigid lending environment. These deals rarely justify fresh capital investments.
Determining Whether a Capital Call is Justified
A detailed underwriting review is essential to determine whether a deal is upside down, has potential equity gains through renovations and leasing, or already has sufficient equity to justify a capital injection.
Common “Good” Uses of Capital Call Funds:
- Paying down bank debt and covering required reserves (interest, taxes, insurance).
- Completing renovations necessary to execute the business plan.
- Providing sufficient operating reserves to stabilize the project and allow for an orderly exit.
“Bad” Uses of Capital Call Funds:
- Repaying GP loans.
- Catching up on unpaid management fees to the GP.
The focus of rescue and recovery capital should be to ensure the business plan is successfully executed, allowing the property to either stabilize for refinancing or be sold under non-distressed conditions. Strong sponsors recognize this and defer their own compensation (GP loans, management fees) to the back end of the deal.
Comparing Capital Calls vs. Member Loans / Mezz Debt
Why Most “Standard” Capital Calls Are Bad for LP Investors:
1. New money doesn’t take priority over previously invested capital.
- Capital calls typically come in as additional common equity, sitting behind any GP loans or Preferred Equity investors. This means LPs contributing new funds are improving the position of those senior to them in the capital stack—without additional protections.
2. LPs lack control over how the capital is used.
- Sponsors may use the funds to repay GP loans or cover management fees instead of funding critical project needs.
3. Capital calls often lack a full re-underwriting.
- Many are merely stop-gap measures to keep a struggling deal afloat rather than fully restructuring the project for long-term viability. This can result in investors throwing “good money after bad.”
What’s a Better Alternative? Member Loans / Mezz Debt
A properly structured Member Loan or Mezz Debt loan is a superior option, treating new capital as a fresh investment that sits higher in the capital stack. Ideally, it allows current investors to participate first but also opens the door for external investors if needed.
A well-structured Member Loan or Mezz Debt loan should include:
- Full re-underwriting and updated proforma
- The deal should be reassessed to ensure new capital makes financial sense and will be repaid with full market interest.
- Last-In, First-Out (LIFO) structure
- New money should be subordinate only to senior debt, ensuring it gets repaid before previously invested Preferred and Common Equity.
- GP loans and management fees should also be subordinate to the new investment.
- Market-rate returns to attract investors
- Given today’s conditions, 18-20% interest rates are typical.
- Depending on the deal, an “equity kicker” could further incentivize investors.
In some cases, additional collateral from the GP may be necessary—especially if the project is still in a heavy value-add phase and lacks sufficient safety for new capital.
How LPs Can Influence the Structure of Capital Calls
While individual LPs may not have the power to force a sponsor to change their approach, they can influence the sponsor to consider a Member Loan structure instead of a standard capital call.
Industry Trends in Capital Call Participation:
- Standard capital calls typically see 30-40% investor participation because many LPs refuse to invest without additional protections.
- Member Loan / Mezz Debt structures greatly improve participation rates, as they provide better investor protections and enhance the chances of raising the required capital.
Good sponsors recognize this and act in the best interest of the project by adopting a Member Loan / Mezz Debt approach. Bad sponsors, on the other hand, attempt to push capital calls that primarily serve their own interests.
LPs Can Join Forces to Negotiate Better Terms:
- Partnering with other LPs or larger investors can provide more leverage when negotiating deal terms.
- External Mezz Debt providers will often bring their own attorneys to structure loan agreements—LPs should insist on similar legal representation to ensure their interests are prioritized.
Best Practices for Structuring Member Loans / Mezz Debt
- GP negotiates with the primary lender.
- Full re-underwriting and updated business plan.
- GP secures buy-in from large LPs to ensure alignment.
- Member Loan terms are structured with proper legal oversight.
- GP communicates with all LPs, presenting the risks and rewards clearly.
- External investors are engaged if internal participation is insufficient.
- Capital is deployed, and the updated business plan is executed.
Key Questions LPs Should Ask Before Investing in Rescue & Recovery Capital
- What is the safety of the new money, and what return does it offer?
- What is the opportunity cost of participating versus sitting out?
- How much of my previously invested capital could this help recover?
Understanding Risk vs. Reward
- If a $30,000 Member Loan investment has a high probability of recovering $100,000 of previously invested capital, it may be worth considering.
- If that investment also earns an 18% return, the upside potential outweighs the risk—creating an asymmetric return profile.
Final Thoughts
Not every rescue and recovery opportunity is black and white. Even in cases where the new Member Loan appears relatively safe, it can be difficult to assess whether previously invested capital will be fully recovered. That’s why structuring these investments properly is critical.
A Member Loan / Mezz Debt approach provides clear protections and a defined repayment path, ensuring new capital serves the right purpose. Additionally, it gives investors confidence that the project can reach full stabilization, raise rents, and ultimately exit in a stronger market.
One last thing—trust matters.
If trust in the GP or sponsor has eroded, investing additional capital may not make sense. Open, transparent communication and a demonstrated commitment to LP interests are essential in these situations. If the GP is still actively working toward a successful outcome and investors have faith in their ability to execute the business plan, a well-structured rescue and recovery capital injection can be a strong opportunity.
