WS1921 Capital Call Strategies | Aleksey Chernobelskiy

In today's episode  we continued our enlightening conversation with Aleksey Chernobelskiy, an expert in advising both Limited Partners (LPs) and General Partners (GPs) on real estate investments. Aleksey, who has an impressive background managing a $10 billion portfolio at Store Capital and now provides invaluable advice to investors, shared his insights on the often daunting topic of capital calls.

Capital calls can be a source of stress for investors, and unfortunately, they're becoming more common in the current economic climate. Aleksey broke down the concept into two types: expected and unexpected capital calls. He emphasized the importance of understanding the difference and being prepared for both scenarios.

For LPs who might be facing a capital call, Aleksey provided a step-by-step approach to assess the situation. He stressed the importance of considering whether you have the liquid funds to invest and understanding the legal implications of not participating in the capital call. It's crucial to know the status of your initial investment and to evaluate whether reinvesting through a capital call is the best use of your funds compared to other investment opportunities.

One of the key takeaways from our discussion was the need for LPs to approach capital calls as a new investment decision, devoid of emotions. Aleksey urged investors to perform due diligence and ask the right questions to ensure they make informed decisions. He also highlighted the importance of verifying whether the capital call you're facing will be the last one needed for the project.

For those looking to dive deeper into the intricacies of capital calls and other investment considerations, Aleksey recommended checking out his articles on his Substack, LP Lessons, where he regularly shares his expertise with the investment community.

Remember, whether you're an LP or a GP, being well-informed and prepared can make all the difference when navigating the complexities of real estate syndication. Stay tuned for more insights on the Real Estate Syndication Show, and don't forget to like and subscribe to keep up with the latest in the industry.

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Transcript

Aleksey Chernobelskiy: for the capital call money, which you could invest in a new syndication if you wanted to, right? Like that a hundred grand, let's say, like, I'm just to give an example, like you invested 500 grand and let's say, sadly speaking, by the way, Whitney, I mean, this is probably more often the case than it's not. People call me not being sure what a capital call is.

Whitney Sewell: It is your daily real estate syndication show. I'm your host, Whitney Sewell. We are back again with our guest today, Aleksey Chernobelskiy . He previously ran Store Capital's $10 billion portfolio. He oversaw the firm's underwriting team. And I mean, just he's advising LP now and GPs on a number of things, but just a wealth of information. We're going to continue the conversation today, and we're going to be hyper-focused on capital calls. And he's advising lots of GPs and LPs in this matter right now. Unfortunately, it is something that is happening, and you're going to be better prepared, no doubt about it, whether you're GP or LP, by listening to the questions that he has you ask. right things to think through as you're you are approaching this unfortunate topic. Alexa, welcome back to the show. Honored to continue the conversation with you. And, you know, I know in yesterday's segment, I learned a lot. I know the listeners did as well. Uh, you know, if you did not hear yesterday's segment, I encourage you to go back and listen to Alexa talk through a number of things. Uh, if you're an LP, even if you're a GP, you need to be aware of the things he talked through yesterday in great detail. Uh, and, and so grateful to continue, continue the conversation, Alexa. Uh, let's dive back in. Awesome. So glad to be back. Well, Alexa, you know, you mentioned in yesterday's segment that, uh, you know, you're advising a number of LPs, right. But, uh, a lot around capital calls right now. Uh, and I know there's many listeners who have questions about that. They've received that call that they were hoping not to ever receive, right. Or they may not have even known it was a thing, right. You know, I mean, really, they may not have even thought that was ever an option. And all of a sudden they're getting a call from the operator they partnered with, you know, that's, that's needing some capital. Right. And so I, and they don't know how to, how to assess that. Right. Should I do this? Should I not, what does this mean? And I'd love to give you a minute to, you know, even walk through some of those things or some of the questions I know you, you know, you're having LPs ask you and how to assess, should I, Should I put more money in or should I not? And let's talk through that a little bit.

Aleksey Chernobelskiy: Yeah, sure. Um, so I, I guess first I'll just define, uh, capital calls because I think there's some confusion. Um, there's something that I would call an expected capital call and an unexpected capital call. Um, an expected one is typically as a result of like investing in a fund, for example, or maybe a construction project where at the outset you and the GP had an agreement that, you know, they'll, they'll pull on, I don't know, a quarter of your principal, uh, every quarter for a year. or whatever it may be, or as necessary. So if a GB reaches out to you in that case, other than sort of understanding what's happening, et cetera, et cetera, and the economic landscape and the viability of the deal, which I always recommend, those are of particular concern, and those are not generally what's being discussed in the marketplace today. What I spend a lot more time talking about, both publicly on iMySubStack and and also just receiving calls from clients is the unexpected ones. In other words, you bought into a transaction, you and the GP, hopefully, both had the intent that the deal was fully capitalized. They won. In other words, no more capital would be needed. To your point, many LPs did not even understand that getting more capital was a thing. Right? Because it was just so obvious that, you know, we, we bought the property, like, well, why would you need more capital? So, so now fast forwarding to today, obviously the past two years have been, um, pretty challenging for the real estate markets. And, and as a result, um, a lot of LPs are getting capital calls. Um, um, I think what I would recommend from a decision perspective, um, is first just, I would always say, just take a step back and realize that what's in front of you is an investment opportunity. Like this is not an emotional thing. This is an investment and you can either decide to invest or not. And that sounds silly in a sense, but I can't tell you how many times I get calls from LPs almost freaking out because if they don't invest, they're gonna get diluted. If they don't invest, maybe the thing is going to end up in foreclosure. You sort of have a lot of different communication styles from GPs, ranging from very transparent and honest and well communicated, right, early, all the way to like complete surprise, like, you know, we're going to lose a property in a few days if you don't send the money now. We don't even have a plan. I've seen everything. And some of it is healthy. A lot of it, I would say, is pretty not healthy and not enough information to make capital calls with. So just, again, know that it's an investment decision. Know that just like at the outset when you were able to ask questions to the GP. So similarly here, like there's nothing stopping you from doing diligence and asking questions to the GP, right? That's the first thing I would say as a broad strokes. And if you sort of want to go through the typical steps that it goes through, I can, I'm happy to do that too.

Whitney Sewell: Yeah, nothing stops you from asking questions. I think it's, it's great to just pause and take a breath, right? Like you said, take a step back. I appreciated that stance. And even I've not heard anybody say it like that, you know, realize that what you have in front of you is an opportunity or investment opportunity, right? You can invest or not. Right. And try to assess Is this still a worthy investment to move forward with or not? I would, I would love for you to elaborate a little bit or us dive into some of those questions. Cause there may be a time you do want to continue.

Aleksey Chernobelskiy: Yeah. Yeah, exactly. So, so typically the, the steps that I go through are, they're pretty simple. Um, and, and you'd be surprised that like how quickly things weed out for many people. Um, the first one might surprise you. It's like, do you actually have the money liquid? Um, I've, I've heard people, like, they wanted to pull on their 401k. Uh, which would be sort of like, uh, that would be needed to pay back. With with with interest if they did that. I've heard people wanting to borrow from an uncle or mom or whatever. And all of that is, I'm not saying that's good or bad, it just further complicates the equation. In other words, if you have the money sitting in your bank account, and you don't need it per se for any emergency, that is sort of like step one. And many people don't even pass that stage. So I think it's kind of a silly place to start, but it's also like a really important place to start. The next thing is, I would say, you'll have to understand legally what happens if you don't invest. In other words, what is the cost to you, so to speak, for not investing? And this differs across GPs. I think some GPs are what I would call, I guess you can say like more favorable to LPs and they say, look, like we kind of messed up here. We're not going to dilute you if you don't invest, but if you do invest, like, here's kind of like the upside that you can participate in. So that way, you know that if you don't invest. The worst case scenario is you just get diluted by the new investors, but not penalized for not investing. And those two things are very different. You're obviously going to get diluted by new equity, because if you don't contribute, your shares will naturally get diluted. But that is very different than getting diluted because you didn't contribute to that new investment. Those are two separate things. And it's important to just simply understand, legally speaking, what will happen if you don't invest. And again, you'd be surprised how many sort of like capital call emails I've seen. Honestly, it's probably more than 50%. Where the GP emails the LP, of course, it's sort of like a mail merge across all DLPs. Many times this is like big funds that I think should know better, but they just don't state what happens, like in either direction, whether it's good, so to speak, and you don't get diluted if you don't invest or bad and like you really get penalized. And oftentimes the legal agreements are actually not super clear on these matters. So it's really important to get clarity there. I guess let me stop there before I continue. I have a few others, but any questions?

Whitney Sewell: Yeah, no, I love your stance on it too. I mean, like I said, you know, taking a step back, but then thinking through these things, you know, and it's interesting, you know, you talk about something as simple as, well, do you have the money to invest? And you also mentioned, I like this, and if you do have it liquid, Are you sure you don't need it yourself? Right. You know, is it is it ready to just deploy somewhere? Because if not, then it's kind of a pointless conversation. Right. Yeah. Yeah.

Aleksey Chernobelskiy: Yeah, exactly. And at that point, like it I mean, it's perhaps painful to realize that. But it's like if you if you need the cash for something else or you don't have it, like I mean, there's just no decision to make. and you sort of like take yourself out of that decision. Yeah, okay, so once you realize, or I should say understand what the implications are to not investing, the next step I would say is just understanding where your existing position sits. Like to put it simply, let's say you invested 500 grand. Do you still have 500 grand? Do you have 700 grand in there or a million? Because like the property is worth a lot more or perhaps do you have nothing? And, and this is a whole article that I wrote at length about which deal the article, I think it's called to sunk costs matter in capital calls because there's sort of like this I think dishonest connection between the last investment and the new investment, the capital called sort of marginal capital, in that you almost want to just forget the last stuff and say, oh, that's a sunk cost. I'm just going to ignore it. I'm just going to focus on whether I want to invest today or not. But the reality is, I think as far as capital goals go, it is true that it's a sunk cost. You can't get the money back. But these things are actually extremely connected. And knowing where your original position stands and sort of like how you can get that money out and the business plan for that should have very direct consequences on your plans on returns for the capital call money, which you could invest in a new syndication if you wanted to, right? Like that 100 grand, let's say, I'm just to give an example, like you invested 500 grand and let's say Sadly speaking, by the way, Whitney, I mean, this is probably more often the case than it's not. People call me not being sure what a capital call is. In the middle of that conversation, as I help them with diligence, it becomes apparent that the 500 grand that they invested is gone. Like, it's not officially gone, right, because the property hasn't sort of marked market and sold. But in terms of the equity worth, based on a realistic outcome or outcomes, you can even do a sensitivity analysis, whatever, it's essentially gone. So at that point, you have to think that I they want another 100 grand relative to my original 500 grand. That 100 grand I can put into treasuries today and make 4% or 5% or whatever. I can sort of invest it in the stock market. I can invest it into alternatives such as syndications. And that is a totally new bet, new GP potentially. And perhaps that's a good investment. What is going to convince me, and this is important, you should be convinced, just like you were convinced with the original deal, you should be convinced that doing the capital call is a good idea. And so what is going to convince me that the 100K is going to earn more by reinvesting it back into this property compared to investing it elsewhere? And the original status of that position is pretty important. in that analysis, because I don't know if I want to get into the weeds. This might take a long time. But for anyone that wants to sort of see this live in a model, again, I would recommend the article that I wrote specifically on this, which is, do sunk costs matter in capital calls? There's like a literal model that I go through to explain how these things are related. And look. The last thing I would say is just, um, how do you know, and this is like, probably missed at least 50% of the time. Like, are you sure that this is the last capital call? I mean, in other words, I can't I can't tell you how many times. GPs will sort of freak out and look, I want to be sensitive. It's scary to be a GP in difficult times. That's probably another episode in its own right because I've seen it from the inside. Sometimes a GP will react to a piece of news like, we can't pay debt service next month. Oh no, okay, we need to issue a capital call. Okay. But then, from an LP perspective, like, all of that is understandable. But from your perspective, you need to know, like, is there a plan to ensure that we're not going to need another one? Right. And that another one might be because in six months, the rate cap expires. Or in six months, we're going to have some other issues or there is a refinance. And instead of a cash out refinance, it's going to be a cash in refinance, which is another topic that I think LP investors are sort of like learning slowly. So, yeah, let me I know I kind of said a lot, but like those are generally the steps that I go through.

Whitney Sewell: I love the questions that you're asking. And I think every LP needs to needs to know these questions, especially in what you know, in our economy right now, as many of these are happening, unfortunately, across the industry. And but it's interesting, you talked about, you know, as your investment going up or down, right? What is the what is your position currently? And, and I think it's a I would think that most assume that it is gone, right? More times than not, or when would you see the position, you know, favorably, right? They invested the 500k, but, you know, there's a capital call and their current position is 800, you know, or 700.

Aleksey Chernobelskiy: Yeah, I think there are actually quite a bit of examples like that. I do think it's the minority. But I'll just give you an example. A developer is developing a brand new apartment building. They're 2 years in, and they're just a little bit over on costs. So they're 90% done, almost done, but it's a phenomenal area. The apartment, so to speak, from a valuation perspective, is well in the money. And they just need the 10%. maybe half of it will come from construction loans, right, from the existing, but like the lender didn't want to put up the entire percentage because of over, you know, going over budget. And so there's like a tiny capital call to get them to the end. But like, as far as the business plan goes and the overall valuation, things are more or less, I mean, they've probably got impacted in the past two years. So it might not be, you know, the 2.5x multiple, you expect it, it might be a 1.5, but you're probably in the money still. Whereas what's happening a lot of times now is, to your point, I think probably the majority of the calls I get, and there might be some bias there in terms of people calling me for certain reasons, But certainly the majority of people that call do have their wife, either wiped out equity, or it's like at least, you know, let's say 50% impaired.

Whitney Sewell: Yeah, yeah, no, that's interesting. I just wondered, or if you see any, it's a great example, though, a development type projects, obviously, there's no cash flow, right? You know, and they may still they may have had more expenses than they expected, or something like that. But I wondered if you see that at all in a typical value add deal or some kind of, you know, already construct, you know, something that's not a construction type project. Yep, exactly. And let's see, you said, uh, yeah. And is this the last capital call? A great point as well, uh, in thinking through, uh, you know, anything there that would, uh, help you to determine that, uh, you know, cause I think that that could be hard to determine for most LPs, right. They're not going to be as sophisticated as you at, at underwriting to think through, well, you know, how would I know, you know, if this is going to be the last capital call or not?

Aleksey Chernobelskiy: I mean, the first thing I would say is, just ask the GP. And as always, don't ask them in a yes or no way. That's a whole kind of topic that I I wrote another article called 26 questions to ask your GP. The introduction to the article, it sounds funny, but it's like, how do you ask questions? And the way to not ask questions is yes, something that can have like a very minimal information as far as the answer. So the way not to ask the question is, do you think this is, the only capital call we'll need? Or even worse, do you think this capital call will be enough? Like enough for what, right? And in other words, perhaps a better way of asking the same question would be, hey, I appreciate all the information, blah, blah, blah. I noticed in the deck, I'm just making this up, but like I noticed in the deck that the uses, in other words, what the capital will be used for, is for cash flow constraints today. In other words, like operationally, the property is sort of underwater because let's say, you know, they're in the middle of rehabbing the units and they're not cash flowing enough. But I also noticed in another slide, you mentioned that we have a capital call coming due. I'm sorry, a recap coming due at the end of next year. So what is your plan on the capital call? Or we have a maturity coming due, a debt maturity. So like, what is your plan on the refinance? Unfortunately, these questions aren't so simple. You know, Whitney, I think it does require a certain, I mean, one is just experienced, but two is just being thoughtful and Yeah, I guess, you know, just being like really thoughtful and thorough. And I think, I'm hoping you were thorough at the outset, right? And my bigger point is, you should be just as thorough, or maybe more thorough, I would argue, at the point of a capital call. Because at that point, Um, I'm like, I'm not here to point fingers. Like there's a market change that happened. Right. But at the end of the day, like something not good happened. And the same person that was a steward of that capital is now asking you for money. So sort of like the level of knowledge that got you to invest the first time should be not enough to get you to invest again. Yeah. Right. Like you now have new information. um, that I think should require you to sort of like, um, inquire more and understand more.

Whitney Sewell: Like you need to, you need to re underwrite the deal, the opportunity again, all over.

Aleksey Chernobelskiy: Yeah. Yeah. And look, I think that's sort of somewhat unrealistic for like an average LP, but, but I would say at least again, at least understand the catalysts, right. And, and understand what could go wrong.

Whitney Sewell: Yeah. No doubt about it. Alexa, we got to jump to a few final questions. I feel like you have added a ton of value to the investors listening, and hopefully they don't get that call, right, for capital. But however, if they do, they're going to be better prepared now, because of, man, just the last 20 minutes, no doubt about it. Alexa, I get asked this all the time. And I would love your thoughts. I know the listeners would on, man, what do you expect to happen right over the next 6, 12, 18 months? And how's that informing the, you know, the decisions or the investment decisions that you're making now?

Aleksey Chernobelskiy: Yeah. I'll give you a sort of a two pronged response. First, I think a GP should follow the capital markets, right? And be informed and to some extent have an opinion, right? But I think they should be strong opinions loosely held. In other words, the fanciest and most educated economists in the world couldn't have predicted what happened. They still don't know what's going to happen next year. And so if you're sitting as an LP thinking about the future, and in front of you is a GP that is not only convicted about a macro move, but convicted enough to base their entire deal based on that macro move, Such as cap rate compression, let's say, um, I would be pretty wary. You know, in other words. Uh, this is, um. I don't know, perhaps a little a little raw, but, like. if you're so certain about rate moves, I think you'd make more money trading rates instead of buying real estate, which is like a very indirect way of trading rates. You know what I'm saying? So just go trade them directly. And if you're not that certain, so make sure that you have a sensitivity table showing investors what would happen if you're wrong. And as I always say, you can assume whatever you want, as long as you show investors what happens if that doesn't happen, right? If you're transparent about the sensitivities of your, let's say, somewhat aggressive assumptions, there's no problem with that. And if an LP looks at that and says, hey, listen, I tend to agree that, let's say, there's going to be four cuts next year, and this is how it's going to impact exit cap rates. If that happens, I'm going to 3x my money. If it doesn't happen, I'm still going to do 1.5 based on the sensitivity table that I'm comfortable with, blah, blah, blah. And that's good. I'm comfortable with that. That's great. But then at least you gave DLP the information to make that decision. So that was the first comment. The second thing is what's going to happen in terms of existing deals. I mean, I'll just be candid. I don't I don't think it's going to be great. I think there's a lot to work through in twenty twenty four in particular. I think a ton of rate caps are expiring. A lot of maturities are coming due. To be clear, this is not a blanket statement across all of real estate. I'm just saying, as far as retail money, which is what I sort of, that tends to be my clientele, as far as retail money that is sitting in existing syndications, I mean, I just got back from New York, met with a lot of people, and one of the things that I wrote uh, to, to, you know, to, to the sub stack list of, of people that I write to is like, if, if you don't know where your LP positions sit at today, you really should. Um, in other words, you might not be able to do something with that information, but the, but the small probability. of you being able to influence the GP to make a certain decision or think about something new that they might have not thought about is, I think, worth the time. Because information is, in some sense, power. I think it's limited, right? Because at the end of the day, an LP can't make the decisions. But coming to a realization of where your LP positions sit is pretty important, because you don't want to be surprised.

Whitney Sewell: What's your best advice for passive investors right now in just a few sentences?

Aleksey Chernobelskiy: I don't know if it's particular to now. I think it's the same advice as always. I'm very independent of any, I don't know, GP or real estate in general. I think many people, I'll just say this very candidly, I think many people who invested in syndications shouldn't have. They weren't in a financial position to do that. Many people who are not investing in syndications, I think should. And, and, and I think a lot of that depends on sort of your risk tolerance, your overall net worth. Right. And so. I mean, just get educated. You know what I'm saying? Like, I, I, I think, um, maybe sometimes I'll get calls from LPs and they're like, Hey, I just had an exit. I have 5 million to place. Like, can you tell me where to put it? And, and first they say no. Um, and then they're like, okay, but like, can you send me, you know, like someone you trust? Um, and I say, no. like and they're like okay but like i don't have a lot of time and i'll say i i just immediately say if you don't have a lot of time yep or you don't have any time i just recommend not investing in syndications like it takes time to vet these things, even if you know someone. And knowing someone is a whole other topic, which is, you know, number two on my top 15 list. You know, I think people tend to overweight what they think are relationships, but they're more like acquaintances.

Whitney Sewell: Yeah, no doubt about it. And that's a whole nother topic as well, right? But what would you say are some habits, Alexa, that you're disciplined about that have produced the highest return for you?

Aleksey Chernobelskiy: I mean, I'm sort of just big on relationships personally. I was sort of the opposite in college. I got four majors. And the idea there was, let me just get a bunch of education, I'll get the best job. I graduated and slowly realized that like America doesn't work that way. I came to the US when I was 11. So from that point on, I've started developing relationships, speaking to people, understanding what's going on, like information is incredibly powerful. And I think any LP that's investing actively should try to seek it out. Certainly not at any price, but I think directionally speaking, I think people undervalue information when investing and they sort of like trust themselves too much. This is sort of like a statement across you know, hundreds of people that I've spoken to and the outcomes of those conversations. And there's certainly exceptions. I'm just saying there's sort of like this, almost like a psychological aspect to not asking someone for their thoughts, because like, I don't need someone's help. But then sometimes, like, I hear stories of people losing millions of dollars. And it's like, at that point, they call me and they're like, I wish I knew you years ago. or someone like you. I'm not saying, you know, I'm the know-it-all like you people. Go talk to someone else, you know, as long as they're not biased to tell, you know, sometimes they'll. Sometimes I'll go ask someone else, but that someone else is incentivized to tell them something good about that GP or whatever, but you always have to keep, you know, incentives in mind and try to seek out relationships wherever you are. That's been super important to me.

Whitney Sewell: That goes right into my last question is how you like to give back.

Aleksey Chernobelskiy: I think mentorship. I spend a lot of time with college students, helping people find jobs. Probably spend more time than necessary on Twitter, responding to people's questions and whatever. Yeah, I think it's super important and just fulfilling too. It's really nice to be able to give someone what you learned after 10 years. You know, for example, I recently, I recently tweeted, like, how old were you when you realized that any high paying job requires, like, a fairly strong, it's something like this, like, fairly strong sales skill set, right? Like, I graduated college with the mentality of, like, sales, that's, like, for marketing people, like, I'm, like, a nerdy guy, like, I want to be an Excel model. And then you realize like you go to a bank and then you get promoted. And then 10 years later you realize, oh shoot, like the guy way at the top is like doing sales, you know? And that's essentially true in like, I think 80% of cases, right? So like sometimes I speak to like, you know, people in college and I just tried to accelerate their learning curve based on what took me way too long to understand.

Whitney Sewell: Yeah, that's incredible. That's, uh, that's a very wise, uh, to think about or to help others. Uh, and, uh, I mean, I think I wish I had known those things 20 years ago. Right. No doubt about it. Well, like I said, grateful again for your time and you've shared a lot and helped our investors and, and all the LPs. And I think GPs as well, in a big way that are listening to this segment today and thinking through and that call that you may get, unfortunately, or if you do get a capital call, some things you need to think through and questions and even to step back and just breathe a minute and think through these questions that Alexa showed us today. Again, he advises many passive investors. I encourage you to go look at his blogs and very informative, to say the least. Again, we're not endorsing each other by having him on the podcast, but I'm grateful for the connection, Alexa, and to get to know you. But again, so listeners can know, you know, where can they learn more about you? Where can they find you?

Aleksey Chernobelskiy: Yeah. Google my name or just go directly to lplessons.substack.com. And I write there twice a week and, you know, get involved and comment and ask questions.

Whitney Sewell: Thank you for being with us again today. I hope that you have learned a lot from the show. Don't forget to like and subscribe. I hope you're telling your friends about the Real Estate Syndication Show and how they can also build wealth in real estate. You can also go to lifebridgecapital.com and start investing today.