How to handle call-downs

Today I want to talk about a little-discussed area of money management: How to handle call-downs.

First, what’s a call-down? In most real estate deals, the investors don’t send all their money for the whole deal on the day of closing. Instead, they agree to commit a specific total amount to the project and then leave it up to the investment managers to call it down when needed.

The advantage for the investment manager of this arrangement is pretty straight-forward: Most docs call for preferred return (“pref”) to be paid only on funds called down, as opposed to committed. (So, for example, if you commit to $500k at a 7% pref and I only call $100k in year 1, then I only owe you $7k in pref, not $35k.)

The advantage for the investor is that she doesn’t necessarily have to have all the funds available at the exact instant of closing, but can instead pay over time as the company calls the money down.

But this leads to the problem of how much the company should call at any one time.

On the one hand, investors typically prefer not to have hundreds of thousands or millions of dollars sitting in the project’s bank account doing nothing, both because there’s no interest being earned and because it’s just odd to have so much of your money sitting in someone else’s hands not being used. This argues for smaller, more frequent call downs.

On the other hand, call downs are annoying for most investors. These are, by and large, busy people. It’s painful for them to go to the bank and arrange a wire. Making them do it over and over again for trivial amounts of money is a good way to make sure that they won’t invest in your next deal.

So, how do you handle? Well, I like to discuss this tension with the investors up-front, before we sign the docs for the project. I let them know I understand both sides of the issue and that we’re going to try to do our best to balance the competing forces. Then, I usually opt for 3-4 call downs over the investment period. Any more risks pissing off the money people who are, after all, your most valuable constituents.