Capital Calls Make Everyone Sick

As a physician and real estate investor, I’ve found that the problem-solving strategies of medicine—diagnosis, treatment planning, and patient care—translate well to commercial real estate. Both fields demand a deep understanding of complex systems, careful risk assessment, and a focus on long-term outcomes over short-term gains. Given the current turbulence in the market, I believe it’s only fitting to take a clinical approach. So, what’s my diagnosis of the market, and what’s the treatment plan for navigating these challenges?

What’s my Diagnosis on Capital Calls: Lifeline or Liability?
As someone who’s been in the trenches of the commercial real estate sector for decades, I’ve seen firsthand how quickly market sentiment can shift. But the current environment has been particularly challenging, with a perfect storm of historically high interest rates and loan maturities—aftereffects of the pandemic’s easy money.

From a global standpoint, $1.5 trillion in commercial real estate loans will need refinancing within the next 18 months. Within the United States, the Federal Reserve has finally begun the long-anticipated rate cuts this September. However, it’s worth keeping in mind that rates are still three times higher than the average between 2009 and 2019.[1]

What’s striking—and deeply concerning—is how many firms are responding to these pressures by passing the buck onto their investors. The buzz among industry professionals paints a picture that you won’t find in many headlines: investors are being squeezed and it’s bringing morale down.

This isn’t just an anecdotal observation. While publicly available data might be thin—these are, after all, privately held funds—the reality is that many firms are struggling to maintain their footing. Defaults are rising, and to shore up their balance sheets, many real estate sponsors are resorting to unplanned capital calls.

Overall, this may not be a significant hurdle for institutional capital, whose participants are more likely to have reserves in place to handle these requests. However, these demands are placing significant stress on high-net-worth investors, who are already navigating a complex economic environment themselves.

Stop the Bleeding
As chairman of Encore Enterprises, a private equity firm and commercial real estate sponsor, our Board has made the strategic decision to avoid issuing capital calls. We’re not immune to the pressures facing the industry, but we believe that placing additional financial burdens on our investors should be undertaken only as a last resort. One which we carefully avoided for more than 25 years by focusing on disciplined management of our corporate balance sheet and maintaining a diversified portfolio at the corporate level.

This approach is particularly important in today’s market, where contradictions abound. There’s a record amount of dry powder—capital ready and waiting to be invested. This is money that could, in theory, be used to snap up distressed assets, take advantage of lower property valuations, and capitalize on the eventual market recovery, if only buyers and sellers could close the yawning gap between them. It’s a paradox that’s slowing down the deployment of this capital, creating a kind of gridlock in the market.

Other firms may appear to be stuck in short-term thinking, but this often stems from the need to address immediate financing, or capital expenditure demands due to high interest expenses or unmet debt covenants. An urgency to shore up their assets’ financial futures can lead firms to issue unplanned capital calls or new layers in the capital stack that take priority over existing investments, which risks alienating investors. While it’s easy to label this as shortsighted, for some sponsors, it may be the only option to prevent a total loss of assets. However, long-term trust and relationships remain paramount, and balancing the need for capital with a thoughtful plan is critical to maintaining that trust.

Treatment for Long-term Health
My long-term advice to both investors and sponsors is to remain patient and strategic, especially in times of market uncertainty. This is not a time for short-term fixes or reactive moves. Instead, it’s a time to make calculated decisions that may not pay off immediately but are designed to preserve and grow capital over time.

While admittedly not a financial luxury all sponsors can afford, lengthening hold periods may be a smart strategy to maintain income and preserve investors’ capital while waiting for valuations to recover, even if it feels difficult in the moment. For investors eyeing fresh opportunities, focus on sectors like multifamily housing and grocery-anchored retail, and avoid sectors that are struggling to adapt to the new realities of the market, like office real estate.

The market is in a state of flux, and patience will be essential as investment return timelines shift. At Encore, we believe this patience will pay off. By strategically avoiding capital calls, we’re preserving the trust we’ve built with our investors over the years. In addition, we’re solidifying our financial position and maintaining transparent communication with our investor network, so we’re ready to capitalize on the opportunities that will inevitably emerge as the market stabilizes.

Prescribed Patience
What’s clear is many firms may be in an unsustainable position, the pressure on investors is real, and there’s a deal-flow bottleneck that has so far prevented the market from moving forward. At some point, hopefully soon, the gears will start turning again—the dry powder will be deployed, and capital will flow back into the market. When that happens, you want to be aligned with sponsors who are in a position to act decisively and understand that investors are partners, not just sources of capital.

In the meantime, stay the course. It’s a challenging time, no doubt, but it’s also a time of opportunity to partner with sponsors who are willing to think differently, act responsibly, and stay true to their investors.

[1] Greg Friedman, “The Fed’s Rate Cuts Won’t Save Commercial Real Estate,” Barron’s, Sept. 20, 2024. https://www.barrons.com/articles/fed-rate-cuts-wont-save-commercial-real-estate-3c13babd.