Zero Cash Flow & 1031 Exchange – A Smart Option for Investors
Also known as “Zero”, a zero cash flow transaction is structured as a bond and also debt- financed due the high credit rating of the (single) tenant. In zeros, all the rent paid by the lessee or tenant goes to the lender to pay off the mortgage debt on the property. They are an ideal investment, if the focus is on growing a property portfolio but with low risk. They must be backed by investment grade rated credit (AAA to BBB+) and a very long-term lease of generally 20-25 years. The zero cash flow occurs because the net cash flow to the investor is essentially zero, since the net income or rent from the property is completely erased by the interest payable on the debt used to finance the property.
Why buy Zero Cash Flow Property?
Investors that are concerned with the fact that Cap Rates may go back to historic levels and want to protect equity, will be perfect buyers for zeros. Should Cap Rates fall to 8% from a 6% level, this will cause a 33% reduction in property values. Moreover, if a property has a LTV of 67% or higher, any equity will be wiped out when cap rates fall. However, in a Zero Cash Flow transaction, the income is pre-sold to the lender at the current low cap rate. Cap Rate and interest rate changes do not impact the value of zeros. If an investor wants to grow a portfolio in the safest manner, investing in zeros will allow the leverage of a single tenant’s investment grade credit rating to buy property worth 10 times equity, without personal recourse.
Essentially, zeros are long-term lease products in which cash flow is not an investor need. Once the property loan is fully amortized, zeros offer great residual value and attractive, secure cash flows. They are the highly effective investment for meeting 1031 and 1033 exchange replacement property requirements. 1031 exchanges and zeros are now widely used to defer depreciation recapture and capital gain taxes that can arise in the sale of highly leveraged properties.
Major Benefits of Investing in Zero Cash Flow Deals
- Allow the leverage of investment grade credit rating of a single tenant to buy property worth 10 times invested equity
- Enable investors to buy depreciable basis’ with minimum equity
- Enable the cash out of capital gain and postpone tax recognition
- Enable the use of fully-amortizing debt, which ends 3 years before the end of the primary lease term
- Offer high leverage (typically 85% to 90%) investing to cover large debt requirements with very low equity ( generally for 1031 trades)
- Single Tenant pays operating expenses, real estate taxes and insurance, maintenance, repairs, etc. under NNN leases
- Allow purchase of absolute or NNN net leased property for minimal equity
- Financing is assumable, fixed-rate, non-recourse, and often fully amortizing
- Low cost investment vehicle to obtain the unique and substantial tax benefits arising from such transactions
- Excellent structure for investors looking for a quick and effective completion of a 1031 or 1033 exchange
When to Invest in Zero Cash Flow Property?
There are times when “Zero Cash Flow” property can be the most lucrative. If used properly, a zero will allow the leverage of a property purchase with upto 90% debt. And after the debt is fully paid off, the investor is left with property that is completely paid off, highly appreciated in value, and permits deferred capital gains taxes.
Buyers and Sellers of Zero Cash Flow Property
Generally speaking, zero cash flow deals are used by large corporations, REITS, mutual funds, insurance companies and other big businesses. They are in demand for tax purposes and to build wealth from property portfolios. Buyers of these properties are usually 1031 exchange buyers. Zeros are in fact highly-leveraged assets backed by a long-term lease guaranteed by a high credit-tenant. They are ideal option for those who look for large-dollar tax mitigation solutions.
What to Consider While Investing in Zero Cash Flow Deals
Investing in zeros comes with pros and cons. If you are a new investor, it is important to act very carefully, else your investment may have dire prospects. Some tips: select a property that is in good condition, so cash outflow is minimized. Make sure the property is in a prime rental area that is appreciating in value. Finally, lease the property to an investment grade, national tenant, who comes in and starts paying down the mortgage to the lender.
Keep in mind that zero cash flow transactions require a skillful broker who can match the property to the investor’s needs. Plus, expert NNN brokers will know how to make the most of the tax consequences, and who can advise on long term benefits and ownership issues related to the zero cash flow asset. The Triple Net Investment Group has been assisting a vast number of clients in the purchase and sale of zeros since our inception. Get in touch with our experts to make the most out of your zero cash flow property and its 1031 exchange options.
