Zero Cash Flow Investments

What is a “Zero Cash Flow Investment”? Sometimes referred to as “Zero-Coupon” or just “Zero’s,” these properties are just what they sound like - properties that that provide no cash flow to the owner or owners. These are highly leveraged assets, with loan-to-value (LTV) ratios of 80+%. All Net Operating Income (NOI) cash-flows are directed to debt service with the intention of quickly paying down principal and interest.

To acquire such aggressive levels of debt financing, these properties are leased to companies with investment grade credit ratings that are able to provide corporate guarantees. The properties can be corporate headquarters, industrial centers, or necessity-based retail. Regardless of the tenant, the leases are typically absolute triple-net such that the landlord has no responsibility for property maintenance or taxes of any kind.

1031 Exchange Debt and the Zero-Coupon

While a zero-coupon investment may sound odd at first, these structures can be extremely useful to investors performing 1031 exchanges with large amounts of relinquished debt. Investors and real estate professionals well-versed on the 1031 exchange know that the value of replacement properties must be equal to or greater than the value of relinquished properties. If an investor buys for less than they sold, the difference in price is known as “boot” and that boot is taxable.

This also means that any debt associated with the relinquished property must be replaced with new debt or additional equity when purchasing the replacement. Any debt that is not replaced is known as “mortgage boot” and is taxed as gain.

Replacing debt within the confines of the 1031 exchange is not always as easy as one might hope. For those investors selling properties at 60+% leverage points, zero-coupon investments can be a part of the solution, providing debt-replacement to meet 1031 exchange requirements with minimal equity investment. Through principal paydown, they also offer the potential for equity growth. When included in the Delaware Statutory Trust structure, these zero-coupon investments provide the added benefit of non-recourse debt and institutional rates and terms. 

Case Studies & Application of Zero-Coupon DST’s in the 1031 Exchange

The Delaware Statutory Trust (DST) is a multiple-owner real estate investment structure approved for use in the 1031 exchange per Internal Revenue Ruling 2004-86. Real estate sponsor companies acquire institutional-quality assets and package them in the DST structure to offer as passive replacements for investors performing 1031 exchanges.

With a little creativity, zero-coupon DST’s can help to accomplish a variety of goals in the 1031 exchange. A few of the ways we’ve helped investors include:

1. An investor uses a zero-coupon DST investment as one his replacement properties and a piece of raw land as the other. Because the zero-coupon DST allowed the exchanger to replace his 1031 exchange debt, he was able to buy the land without obtaining financing. As a result, he doesn’t have to worry about debt-service on non-cash flowing land while still satisfying the requirements of his exchange.
    
2. An investor has a high leverage point on their relinquished property (60%+ LTV) but is only able to obtain 50% LTV financing on their desired replacement property. The investor was able to move forward with his 50% LTV purchase while utilizing a small equity investment in the zero-coupon DST to cover his mortgage boot.
   
   
3. An investor sells a relinquished property with 50% leverage. He identifies a 0% LTV DST and a 40% LTV DST that he would like to use as his replacement properties. Taking advantage of a small equity investment in the highly levered zero-coupon DST, the investor is able to invest the majority of his monies into his desired DST. At the same time, he is able to replace his relinquished debt with non-recourse financing. In the process he has created a multi-asset, multi-market, diversified portfolio of DST investments.

For real estate investors exploring their options, the 1031 exchange, the Delaware Statutory Trust, and Zero Cash-Flow Investments are just a few of the strategies available. It is important for investors to consider all options available to them and identify those that best suit their specific goals and objectives. Just as important is working with the right team of tax, legal, and financial advisors. We hope to be a part of that team.

For questions around the 1031 exchange and other real estate investment strategies, please reach out to our team at Fortitude Investment Group and browse our articles and replacement offerings here.

Important Disclosures

This is for informational purposes only and does not constitute as individual investment advice. There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Past performance is not a guarantee of future results.  Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to sell any securities. DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney.

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS
The case study does not reflect actual clients. Any reference to securities is based upon historical data that is public sourced. No statement made herein is to suggest stock market performance or future performance, and no case study is used to imply future performance. The case study is intended to illustrate services available through the adviser. They do not necessarily represent the experience of any clients. Fortitude Investment Group does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Diversification does not guarantee a profit or protect against a loss in a declining market.  It is a method used to help manage investment risk.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services through Concorde Asset Management, LLC (CAM), an SEC-registered investment adviser. Insurance offered through Concorde Insurance Agency, Inc. (CIA). Fortitude Investment Group is independent of CIS, CAM and CIA.

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