I wanted to update this:
After @Bill S.'s comment, I researched further into HELOCs. That's a much better way of doing this arbitrage. US Bank HELOC is 4.21% interest only, no fees. Rate is even a quarter lower if you have a 780+ FICO. Running the numbers in this scenario is much easier since it's interest only coming in, and interest only going out. Take an example of $50,000 - if the fund pays the preferred 10% return, net cash flow per month is $241.25 after making the interest only payment on the HELOC (net roughly $3,000 per yr). Now, the prime rate could move up in that 3 year window during the fund term, but even if it moved up to 6%, you're still plus $167 cash flow every month. Also, you're able to write off the interest-only payment to the bank, so tax-wise, it also has advantages.
Risks:
- The fund could return less than the preferred rate and squeeze your return
- The prime rate could move up drastically and squeeze your return
- The fund could go out of business and lose your entire principle
Also in my risk category, I noticed the fund (PPR Note Co, in this case) uses investment dollars to fund their operations expenses, which is usually a red flag. In this case they're raising 5 million bucks, and using about 3.9 million for purchasing notes. The other 1.1 million is going to executive comp, office rent, consultant fees, operating expenses, etc. Is this typical in the note fund world?
