Aside from a family health emergency, it’s one of the worst phone calls you can get. You’re a real estate operator, and one of your largest investors in an upcoming project is informing you he can no longer participate due to unforeseen circumstances.

Back in March, when it seemed like the world was crashing from every angle, I received three of these phone calls. All were extremely painful. Two were from potential investors, and one was from a buyer on a deal we were 48 hours from closing.

Here’s what happened in each instance:

1. On March 23rd, a $500K commitment was withdrawn on a $5M equity raise.
2. Three days before closing, a buyer backed out on a $1.35M purchase, wherein we were planning to use the proceeds on a project already under construction. The move effectively wiped out $400K of proceeds that we desperately needed.
3. A $750K private money loan was withdrawn on a six-unit multifamily property we were planning to purchase the first week of April.

Thankfully, when I received these calls, we were in a healthy cash position due to several large refinances that allowed our company to provide the liquidity needed to fill the gaps.

This year, my company has been working on a multifamily syndication since February. (For more on syndication, check out this article on BiggerPockets.) The project falls under the Department of Housing and Urban Development (HUD), which includes a 3-4 month approval process that needs to be completed prior to closing.

After the inspection process in March, we sent a deal memorandum to our group of accredited limited partners (LPs) and hosted tours of the property on a regular basis. In a short time, we were able to get commitments from a small group of people in excess of what was necessary to close on the project and perform the necessary value-add construction. Each LP signed subscription documents containing their investment amounts and things seemed to be falling into place.

Recently, we finally received HUD approval, and it was time to finalize closing. Keeping our investors up to speed throughout the entirety of the process, we were proud to report we had reached the end of the acquisition process and were ready to receive funding.

But 24 hours later, I received a phone call from one of the largest LPs for the project.

As soon as I saw the call come through, I had a bad feeling in my stomach, similar to the one I experienced on multiple occasions back in March. The investor proceeded to say that his personal financial situation had changed over the previous couple of months. Due to the election, pandemic, economic uncertainty, etc., he no longer wished to invest in our project.

This particular investor was a partner in other projects of ours, so we had a good relationship and ended the call on a positive note. I told him I completely understood, and we would love to have him in future deals.

Although on the outside I was very calm and understanding, inside my mind was going a thousand miles a minute, trying to figure out how we were going to come up with the $500K shortfall we needed to fill this investor’s position.

How to Bring the Necessary Capital & Close the Deal When Funding Falls Through

Here are the steps I recommend to remedy similar situations to what I recently experienced.

1. Call the top three investors who are familiar with your business model and already committed to the project. Explain the situation, be fully transparent about what happened, and inquire if they would like to increase their investment amount.
2. Call private money lenders that are familiar with your business model and who have lent to you in the past. Explain the situation, and see if they would be willing to agree to monthly or quarterly interest payments (based on their preference).
3. Call/email other potential investors who have expressed interest in partnering with you on future deals, and see if they have any interest in being part of this project.
4. Depending on how those conversations go, consider tapping into the company reserve account or business line of credit to fund the shortfall to close on the property.
5. If there are committed LPs in which an increased investment amount would be desirable, perhaps sweeten the pot by altering terms for a specific individual. An example might be awarding a small portion of the general partnership if they invest over a certain amount. Typically, this type of incentive is appropriate for LPs investing upward of 10-30% of the total project raise.

Key Takeaways

In times of economic uncertainty, it is not a question of “if” but “when” you will have investors back out of deals.

To prepare for that scenario, focus on the following:

• Stay in constant communication with your LPs. This instills confidence and an increased comfort level with the company as a whole, as well as the current project they are committed to investing in.
• Continue to market the project and have conversations with additional LPs—even after you have received the necessary commitments to fund the project. Oversubscribing a project by 10-15% (depending on the project size) is a good rule of thumb. It’s easier to let LPs know before closing that less capital is needed due to the project being oversubscribed, rather than the alternative of asking for additional capital due to the deal being undersubscribed.
• Always have at least three backup options in place consisting of: personal liquidity (cash or lines of credit), private lenders, and backup LPs.
• When planning for and calculating your equity stack, create a column for “expected,” “committed,” and “closed.” Don’t assume a dollar value communicated six weeks ago is still relevant today. When you are headed to the closing table, the sum of “closed” is the number that counts.

Have you been in a similar situation? How did you handle it?

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