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What kind of property can be made into a Zero Cash Flow Deal?
A Zero Cash Flow Deal is constructed like a bond. It must be backed by investment grade rated credit (AAA to BBB+), a very long-term lease (generally at least 20 years); and have tightly drawn lease provisions making the tenant responsible for effectively everything relating to the leasehold.
Why would I ever do a Zero Cash Flow Deal?
You are concerned that Cap Rates may go back to historic levels and want to protect your equity. If Cap Rates just go back to 8% from current 6% levels that will represent a 33% reduction in property values. If you own property and have a loan of 67% or greater, you will be wiped out. To repeat, YOUR EQUITY WILL BE WIPED OUT. By contrast, in a Zero Cash Flow Deal the income is “pre-sold” to the lender in the current low rate environment. Cap Rate and interest rate changes do not impact the value of Zero Cash Flow Deals. Why not let a willing lender take this risk?
You want to grow your portfolio in the safest, most riskaverse possible way. A Zero Cash Flow Deal let’s you leverage your tenant’s investment grade rating; and the Zero Cash Flow Deal structure to buy property worth 10 times your equity without personal recourse; with debt structures that generally don’t balloon for at least 20 years; and often are fully amortized by the tenant’s rental payments over the lease term.
When was the last time an investment involving a “zero cash flow” sounded appealing?
For most of us, that time would be never. However, there are times when “Zero Cash Flow” property can be of the most instrumental use. If used properly, they can allow someone to leverage a property with (if you can believe it) 90% debt. Of course that debt comes at a cost, namely all those rent checks that would normally be going to you, instead go to your lender (hence zero cash flow). However, after you are done paying off the debt, you would be left with a property completely paid off, most likely highly appreciated in value, and a deferment of the impending capital gains taxes.
Cons to a Zero Cash Flow Deal
Phantom Income: Phantom income is any income that is reportable as taxable income but that does not generate cash flow for the investor. In other words, the investor does not actually receive phantom income, but is taxed on it nevertheless. Earnings from limited partnerships often arrive in the form of phantom income. Phantom income can also come from zero coupon bonds, which do not pay interest but are instead sold at a discount and accrue “income” over the course of their lives. Phantom income can also occur in the form of a loan that was forgiven, whether by a business (such as a credit card company) or by a private party. The borrower is thus liable for tax on this phantom income.