When an investor joins one of our real estate funds for the first time, they are usually surprised when we ask them to keep their money until a later date. Investors are used to buying a stock or investing in a single real estate property, where their money is collected immediately. However, Origin, along with most other firms in the private equity industry, utilizes a capital call approach.
A capital call approach means that an investor legally commits a specific amount of money and that money is collected (or “drawn down”) as we acquire assets for a fund. To request the money, we email a formal account statement that shows the exact dollar amount and explains the intended use. Investors then have up to seven business days to wire the money to our account.
Why Does Origin Use The Capital Call Model?
The capital call model is the best way to remove conflicts of interest between the manager and the investor. If we were to take all of the capital upfront, we would be incentivized to invest as quickly as possible. It takes time to build a high-quality portfolio of properties and one of our biggest strengths is our disciplined investment strategy. We generate strong risk-adjusted returns by purchasing the right properties at the optimal price. On average, our acquisition team reviews more than 1,000 deals per year across our eight markets, and we typically acquire between three and eight deals in any given year.
Having a pool of committed capital also allows us to close on deals quickly and with certainty. In a competitive bid process, this is often the primary reason the seller selects us as the buyer over other groups that still need to cobble together capital, even if we aren’t the highest bidder.
What Happens If an Investor Doesn’t Fund a Capital Call?
The investor’s commitment to the fund is a contractual agreement. The Fund’s Operating Agreement spells out the specific penalties for those who do not fund. In general, the manager has the right to forfeit their investment in the fund equal to the amount not funded and could also forfeit their entire investment. In all of our years of running funds, we have never had an investor default on a capital commitment. That being said, before investing, you should ensure that you will be able to meet your obligation.
How Do Capital Calls Work?
To use a real-life example, Origin Fund I began accepting commitments via signed subscription agreements in late 2010, but the entire amount wasn’t funded upfront. Instead, the money was drawn down periodically over a 21-month period as we acquired properties and assembled the portfolio. In total, there were 11 different capital calls that ranged from 4% to 11% of the total commitment. The timing and amount of the capital calls were unpredictable, but we gave investors at least three weeks of notice in the event they needed to liquidate other assets or transfer funds.
The table below shows when the capital was called and how much money was collected for a $1 million commitment in our first fund:
Capital calls allow us to be patient and selective on what assets we purchase and have played an integral role in generating a 28% net IRR in this fund, outperforming the S&P by 220%.