The Almost Free Lunch - Techniques For Capturing More Cheap Capital

Recent posts have explored the so-called "trapped equity" present when purchasing property at a discount, forcing appreciation, or present in paid-down properties with outstanding loans.  The whole concept of having equity trapped is that these are dollars that could be used more optimally in other investments.  

There are obvious tradeoffs with this line of thinking.  Traditional lenders will still see the debt when you apply for loans and thus your borrowing will have to take place at higher rates or less favorable terms.  Higher rates or less favorable terms are real costs for future investments.  This squares with traditional finance theory that is based mostly on studying the publicly-traded securities.  

Upon closer inspection there are a number of standard real estate techniques that produce an *almost* free lunch:  

1.  Private money - Potential private money lenders are unlikely to account for incremental risk for extra leverage because it is not their business to underwrite and price risk.  Thus one should be able to borrow at pretty much the same rate with or without the extra leverage that occurs when one untraps equity

2.  Private equity via a PPM - Investors are likely to place capital in a fund based on the strength of the opportunities or the management team running the fund.  A highly-leveraged sponsor that untraps equity is unlikely to get a lot of questions about the sponsor's personal balance sheet unless the investment relies critically on the promoter's personal guarantee for a loan.  This is not really common because funds this large frequently invest using asset-based financing or in project large enough where a personal guarantee is not required

3.  Subject-to purchases - One can purchase additional product subject-to.  This introduces call risk from the lender from the due-on-sale clause.  With servicers being compensated for performing loans on behalf of their investors in conforming product it is unlikely they will be in a rush to call the loan.  However, one can really design away much of this risk by employing an attorney like Torak that will defend suits if the sub-to purchase is done through his title company.  Torak even has a lender lined up to refinance the property if the loan is called.  The title company's closings cost more than traditional closings and the loan would presumably be on less favorable terms than one originally had, but the risk of the loan being called is so small that from a probability standpoint this is almost a free lunch

Traditional finance theory doesn't seem to work perfectly for real estate investing.  Additional borrowing and untrapping of equity carries little real cost if the investor has the tools needed to avoid traditional lending for financing future investments.