Typically those interested in zero transactions fall into one of three categories: Distressed Owners, Highly Leveraged Sellers, and 1031 Buyers looking to maximize the amount of cash they refinance out shortly after closing on a transaction.
Distressed owners are entirely interested in burying their former basis into a 1031 exchange replacement property as a means to defer an otherwise crippling tax bill. Zero’s are typically priced at somewhere between 8%-10% of the debt load on the underlying property – making them a cost effective solution.
Foreclosed properties are deemed to have sold for the balance on the debt owed. This is the amount needed to be covered in a new 1031 transaction to defer your gain. In simple terms if you defaulted on a $10Mil loan, you’ll need to replace that property with a new $10Mil property. Generally speaking that would cost between $800K and $1Mil. Compared to your potential tax bill a zero transaction could produce a savings of close to 50%.
A person in the second group (highly leveraged sellers) is in a similar situation. Their property is sold, albeit in an orderly transaction, but ultimately because they borrowed so much relative to the sales price they walk away from closing with very little money. Sometimes not enough to pay the tax bill. Once again, the zero provides a low cost way to defer the tax consequences.
The third and probably smallest group consists of 1031 buyers looking to use a structure commonly found in zero’s called “Paydown-Readvance”.
The “paydown” part involves dedicating all equity from your old property to the transaction (this is still a 1031 fundamentally). After the deal closes you “readvance” or draw on the loan to the point where only the minimum required equity remains in the deal. This allows a 1031 buyer to walk away from the closing table with extra cash. The downside is that you are left with a 20 year investment you can’t refinance and a property that doesn’t produce cash flow.
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Jonathan Hipp
Jonathan Hipp began his career in real estate over 25 years ago. In his early years as a broker, he ventured into the net lease industry and quickly began leading the US net lease market, closing over $3 billion in transactions. In 2005, Jon founded Calkain Companies, a company focused solely on net lease investment services. As President and CEO, he has been instrumental in building the firm into one of the leading Net Lease real estate companies, transacting over $12 billion of net lease deal volume over the past 13 years. He has expanded Calkain’s services to include brokerage, advisory, asset management, capital markets, and industry research. He has become a well-known resource, panelist, and speaker at various Net Lease and Industry conferences and is a regular contributor to GlobeSt.com on real estate trends. In June 2015, Jon’s passion for the real estate business was again recognized as he was nominated for the Top Real Estate Player in the DC area by SmartCEO magazine.
