IRVINE, CA—Net lease has been one of the darling sectors in recent years, with investors flocking to the safe returns yielded by the most attractive properties. But it comes at the expense of at least one other opportunity in the sector: zero cash flow NNN. That's according to John Redfield, director with Faris Lee Investments, who notes that the rare and complex investment can offer tax advantages for most of the loan term, and then eventually turn into income-producing opportunities after the loan matures.
GlobeSt.com sat down with Redfield in advance of the ICSC Western Conference & Deal Making event to explore the investment more closely.
GlobeSt.com: What is a zero cash flow NNN investment?
John Redfield: A zero cash flow NNN investment has a special loan in place that falls under the 467 IRS code where the rent from the tenant equals the loan payment. This creates a net income of zero, and can create tax advantages for owners when incorporating depreciation to create a loss. Because of the high leverage with zero cash flow loans, lenders require strong creditworthiness, which is why drug stores such as CVS and Walgreens are the ideal candidates. The loans are typically set up with a 22-year fully amortizing loan, which is coterminous with the expiration of the lease (plus a three-year rent holiday for the tenant). Buyers can typically purchase these investments with a 10-20% down payment, which makes them great opportunities for the right investor.
GlobeSt.com: What types of investors are typically attracted to zero cash flow deals?
Redfield: The main types are 1031 buyers and private individuals.
Zero cash flow investments can be great opportunities for 1031 exchange buyers who are looking to replace a high level of debt from the sale of their down-leg. Because of the minimal down payment, creditworthiness of the tenant and timeliness on the loan assumption process (in some cases just over a week), this gives the 1031 investor tremendous security and flexibility for their up-leg investment(s).
Private investors looking to build trusts for their families or create long-term security are also good candidates for zero cash flow investments. Due to the minimal down payment; high credit worthiness of the tenant; and no management responsibilities, they are great opportunities to passively grow wealth and wholly own a secure investment at the maturity of the loan.
GlobeSt.com: What are the benefits, opportunities, and considerations for owners of zero cash flow NNN investments?
Redfield: Owners of zero cash flow investments typically start with tax benefits in the beginning of the ownership period. This is due to the opportunity to report a loss for tax purposes when incorporating depreciation to the zero net income caused from the 467 loan structure. Depending on how it is set up, this can be very beneficial for the owner for the first 10 to 15 years of the loan period. The owner needs to be aware of how their structure is set up to avoid obtaining “phantom income” a term used when the asset no longer runs at a loss and the owner is forced to pay taxes on the principal pay down of the loan. At that moment, it is important for owners to seek advice about next steps. In some cases owners have the ability to do a one-time pay advance feature and pull out additional proceeds from the property. In other cases, it is beneficial for the owner to sell the property while using the proceeds to pay down the loan and prepayment penalty while still achieving a healthy profit and overall return on their investment.
GlobeSt.com: What have you been seeing recently with this type of market?
Redfield: The market for zero cash flow opportunities is very hot. Faris Lee recently completed a deal obtaining an above-market debt over equity ratio, while saving a 1031 investor from having to pay taxes on the sale. There has been an increased demand for zero cash flow NNN investments, and more owners are starting to sell these assets free and clear. It is critical for owners to make sure the proper underwriting and due diligence is done to make the right decision in order to best maximize their returns for these investments.
Visit Faris Lee Investments at booth 603 in this year's ICSC Western Conference & Deal Making in San Diego.
Want to continue reading?
Become a Free ALM Digital Reader.
Once you are an ALM Digital Member, you’ll receive:
- Breaking commercial real estate news and analysis, on-site and via our newsletters and custom alerts
- Educational webcasts, white papers, and ebooks from industry thought leaders
- Critical coverage of the property casualty insurance and financial advisory markets on our other ALM sites, PropertyCasualty360 and ThinkAdvisor
Already have an account? Sign In Now
*May exclude premium content© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.
Geoffery Metz
Geoffery Metz is the content manager for ALM's GlobeSt.com, Credit Union Times and Treasury & Risk. Before joining ALM, he spent several years overseeing the newsroom at the financial wire service Business Wire, with special focus on multimedia presentation for the web.
