The Pros and Cons of Zero Cash-Flow Deals

Can you imagine ever investing in a property that produces no cash flow? Believe it or not, there are actually times when such deals can be advantageous, but they come with a warning label. While zero cash-flow assets do have a place–especially when it comes to single-tenant net leased properties, they’re certainly not for everyone. Hence, enter such opportunities with a trusted real estate adviser as well as your tax and legal counsel.

What is a zero? It’s just a property with a loan whose debt service is equal to the NOI. To make one, typically you need a credit tenant on a long-term lease. This makes it possible to get the highest possible leverage. So high that the debt service coverage ratio equals one. There’s no handy way to convert that to an LTV because each deal is different, but historically it’s been close to 80 percent LTV.

So why do that? Isn’t cash flow the whole point of investing in real estate? It is, except for when it isn’t. One situation immediately comes to mind.

First, let’s say you find yourself in the unfortunate situation where you need to hand the keys back to a lender. If that happens, you’ve triggered a sale (for tax purposes). The sales price is the balance on the loan, and your basis is whatever it is. It’s not uncommon for a longstanding owner of a property (who therefore likely has low basis) to have refinanced out some equity from time to time during their ownership. What happens when you sell that property, by your choice or otherwise, and are left at the closing table with little to no cash with which to 1031 and defer your built-in gain?

If you can’t find a suitable replacement property with which you can obtain enough leverage to cover your gain, or come up with additional cash to do so, you’re getting a tax bill.

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