Your Investor Just Wrote a Smaller Check: Raising Equity When Investors Cover 80%

On Thursday I had a call with a capital placement firm, the people who find debt and equity for real estate deals and talk to those investors every day. If you are raising money for a deal this fall, what they told me could change how much of your own money that deal will need.

The equity investors this firm works with are writing smaller checks.

In the deals this firm places, an investor and a lender together used to cover 85% of a project's cost, sometimes up to 90%. Together, they now cover about 80%. Some will stretch to 82% or 83%. Getting to 85% is hard. The pullback is on the equity side. Lenders, they said, are offering borrowers better terms than they expected. I told them that matches what I am seeing.

What changed

Interest rates. The 10-year Treasury closed Monday at 5.31%. Last week I wrote that every investor now compares your deal to a bond paying more than 5%. This is what that comparison does in practice: investors put in less, and they ask more of the deal before they put in anything.

The firm put the second part in one number. The investors it works with want a yield on cost of at least 7%. Some will accept 6.5%. Below 6.5%, they are not funding the deal. When I run the numbers, I use 7% to be safe.

Yield on cost is the property's yearly net operating income, the income left after operating expenses and before the loan payment, divided by everything it cost to buy or build. A $20 million project that produces $1.4 million a year has a 7% yield on cost.

What it does to your check

Take that $20 million project and hold the loan at 60% of the cost, $12 million, so the only thing that moves is the split between the investor and you.

When the investor and the lender covered 90%, the investor put in $6 million and you put in $2 million.

At 85%, the investor puts in $5 million and you put in $3 million.

At 80%, the investor puts in $4 million and you put in $4 million.

The project did not change. From 90% to 80%, your check doubled. From 85% to 80%, it grew by a third.

If your plan assumes 90% and the market gives you 80%, you are $2 million short on a $20 million project, and you may not find out until late.

It can change at the last minute

I have had an investor cut the equity. When I bought my hotels in 2024, the investor came back right before closing, cut its share of the equity from 90% to 80%, and changed the structure. We closed, but I had to find the difference fast.

The lesson I took: a term sheet is not a check. Until the money is wired, the amount and the terms can move. Read the final terms as closely as the first ones, because what an investor changes at the end tells you where they see the risk.

Where the difference comes from

You have 5 places to find it, and each one costs you something.

1. Your own balance sheet. The simplest answer, and it ties up cash you may need for the next deal or a bad quarter.
2. Preferred equity. An investor whose agreed return and repayment come before yours, but after the lender. Your lender has to allow it. It fills the gap and you stay the sponsor, but the preferred investor usually gets approval rights over major decisions. It also makes your share riskier, because more money stands ahead of yours.
3. A mezzanine loan. A loan that sits behind your first mortgage and ahead of preferred equity. Unlike preferred equity, it is a loan, not an ownership interest. You owe the interest whether or not the property earns it. It is usually secured by your ownership in the company that owns the property, so if you default, the mezzanine lender can take that ownership. Your first lender has to approve it.
4. A partner. Someone whose balance sheet or track record closes the gap, in exchange for a share of the profit. I wrote about how I do that last month.
5. A lower cost. If the project cannot clear 7%, a bigger check from you will not raise its yield on cost. If the income is $1.2 million a year, not $1.4 million, the project has to cost $17.14 million or less to clear 7% ($18.46 million at the 6.5% absolute floor), not $20 million. That means a lower price, a smaller scope, or a different deal.

Which one fits depends on your deal. If you want it, I will go deeper on each in a later letter.

What to do this week

1. Rebuild your capital plan at 80%. Assume the investor and the lender together cover 80% of the cost. You cover the rest. Write down that dollar amount.
2. Check your yield on cost. Yearly net operating income divided by total cost. If it is under 7% (6.5% is the absolute floor), fix the cost before you fix the raise.
3. Name where the gap comes from. Your cash, preferred equity, a mezzanine loan, a partner, or a lower cost. Know what each one costs you before an investor asks.
4. Line up a backup. Have a second option ready to pivot to: another investor, a preferred equity or mezzanine source, or a partner. If the first check shrinks the week before closing, you will not have time to start looking.

If your deal works at 80%, say so before the investor asks. If it does not work, you found out before your closing did.

Planning for the smaller check gives you a better chance of closing this fall.

-Damon

Damon C. Healey, Founder, Eternal Companies

If you own real estate and need someone to package your deals, review your investor and lender terms, or help you decide whether to grow, bring in a partner, or sell, reply to this email and tell me what is stuck.

I read every reply.

P.S. You are reading the private edition. Between letters, when a market move changes the math on your properties, I will send you my read here, drawn from my own assets and the owners and operators I work with every day, along with what we are learning at Eternal Companies.

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