Cash on the sidelines. Dry powder. Stored liquidity.
These and other terms give the impression of vast piles of cash or cash-equivalent assets held in static storage. According to these thoughts, investors armed with money might stand ready to acquire real estate properties whenever market volatility stabilizes, and the Federal Reserve starts cutting its Effective Federal Funds Rate (EFFR).
Shaking that dry powder and cash loose and preparing it for real estate investments is a nice idea. But the reality of that in-the-wings liquidity is a little more complex. Money is out there. But it’s not sitting around and doing nothing.
To better understand this, let’s examine various real estate capital sources.
The Traditional Path
Banks and credit unions represent the traditional capital sources for real estate owners and developers. Or they did, until the last two or three years. Many of these financial institutions have considerably reduced their real estate exposure. They still finance “sure-thing” deals only through stringent underwriting processes.
Today’s banks are supposedly sitting on huge piles of cash. So what’s preventing that liquidity from making it to the investors that want it? A few things:
Ongoing uncertainty. Traditional financial institutions are helpful lenders when the economy is stable and inflation is controlled. The economy is volatile at this point, while inflation has yet to be fully tamed.
But it’s important not to blame bank and credit union executives for hesitancy. They must respond to stakeholders, shareholders, directors – and federal and state regulatory agencies. The institutions need enough cash on hand to fund interest on deposit accounts. They’re required to keep a certain percentage of capital reserves on hand.
So yes, liquidity technically exists. But it’s not all that accessible. And adding to the issue is . . .
Bond investments. Rather than flowing liquidity toward riskier real estate, lenders parked a good chunk of their excess cash into long-term Treasuries and bonds, which are perceived to be more stable. Whether this was a good investment is up for debate and isn’t the point of this article. The fact is that the money invested in bonds isn’t readily available when the time comes. Traditional lenders need to await maturity dates before accessing those funds. Then there is the situation of . . .
Unrealized losses. Following the collapse of Silicon Valley Bank and Signature Bank in early 2023, various articles reported that U.S. banks were sitting on unrealized losses ranging from $620 billion to $1.7 trillion, depending on the source. Unrealized losses are assets held that decreased in value but haven’t yet been sold. The cause of these losses? Rising interest rates continue to erode the value of these assets. Lower asset valuations can reduce banks’ liquidity and capital availability.
Friends, Partners and Family: Equity Capital
Another source of real estate investor capital is what we refer to as “Uncle Billy.”
Uncle Billy isn’t an actual entity. Instead, it’s a catch-all name for equity sources from which the investor might tap for capital. These can include funds raised from friends, business partners, family offices, angel or corporate investors, venture capital or crowdfunding sources.
Unlike the situation with traditional lenders, Uncle Billy isn’t limited when it comes to how much he can provide. He could be sitting on piles of cash. But like those traditional lenders, Uncle Billy reads the headlines. He also understands the current economic volatility and is eyeing the ever-upward EFFR.
From Uncle Billy’s perspective, the higher EFFR means a better rate of return by putting his money into a money market or CD versus the riskier real estate investment.
While the Uncle Billys of the world might have the dry powder, this isn’t necessarily cash available to invest in deals when things settle down.
The Gap Financing: Private Debt Funds
Private debt funds are enjoying their day in the sun, especially as traditional lenders continue pulling back on financing real estate deals. These instruments supply real estate investors with mezzanine loans to cover funding gaps and help get deals over the finish line.
Private debt funds aren’t held to the same state and federal regulations as their traditional lender counterparts. Nor do they have to keep enough cash to meet capital requirements or fund deposit accounts. This means that private debt funds are in an excellent position to provide creative financing options to real estate owners and developers.
But these funds don’t raise money to have that money sit around. Instead, that money is funneled to borrowers and reported as assets under management. Assets under management is a nice number. But AUM doesn’t spell “immediate liquidity.” That money isn’t available until it’s paid back. If it’s never paid back, the private debt fund can take ownership of the asset to create value. But again, this is not immediately available capital – or dry powder.
Dry Powder: Understanding Myth and Reality
None of the above should suggest that there’s a lack of cash. There’s plenty of cash. But it would be a mistake to picture this cash piled up on the sidelines, waiting for better times to roll around. In reality, liquidity held by traditional lenders, equity sources and private debt funds is being put to other uses.
The takeaway is not to hope for an anticipated tsunami of cash to come barreling in the direction of real estate projects during some unspecified future time frame. The better course is to develop a realistic capital stack plan to meet the needs of current real estate investments.
Certain information herein reflects the opinions, estimates and projections of Revere Capital, an Investment Adviser registered with the U.S. Securities & Exchange Commission. All information provided is for informational purposes only and should not be deemed investment advice or a recommendation to purchase or sell any particular security, and no representation is made that expectations will be achieved. The opinions contained herein are based on what Revere Capital believes to be reasonable and accurate information that may have been provided by industry participants, research and analytics providers, and other primary and secondary sources.
