- Credit Tenants. In a zero cash flow deal, a bank will typically only agree to a loan that is conditioned upon occupancy by a tenant who has significant financial resources and very little risk of default. As a result, these zero cash flow properties tend to be leased by “credit” tenants with a proven track record of on-time rent payments. Such a “credit” rating is generally granted by a third-party agency-for example, Walgreens is a credit tenant with debt rated Baa2 by Moody’s, qualifying them as investment grade.
For those who understand the risks, the “loss” produced by a zero cash flow property can be a valuable offset to their alternate income, helping to round out their portfolio and reduce overall tax liability
- Low Down Payments. Understanding the benefits of having low-risk credit tenants, it follows that zero cash flow properties are often available to purchase and finance with relatively small down payments. Whereas a typical commercial real estate property may require a down payment in excess of 25% of the purchase price, a zero cash flow investment can require as little as 10% down based on the reasonable assurances that credit tenants are unlikely to default.
For those with the appropriate portfolio composition and risk profile, the benefits of a zero are clear-but as with any investment strategy, there are risks.
For those who understand the risks, the “loss” produced by a zero cash flow property can be a valuable offset to their alternate income, helping to round out their portfolio and reduce overall tax liability
- Tenant Repurpose Risk. Single-occupant, zero cash flow properties tend to be constructed to the exact specifications of the tenant. Consider the Walgreens example, or a fitness studio, fast casual restaurant or office space. In many cases like these, there is a risk that the tenant may decide not to exercise their lease extensions and may vacate, leaving the investor with one of two likely outcomes: either the property will sit vacant for some period payday loans in Lorain OH of time, or in the event that a new tenant is found, they may require extensive improvements prior to occupancy. In either event, it may be costly and time-consuming to re-lease the property.
For those who understand the risks, the “loss” produced by a zero cash flow property can be a valuable offset to their alternate income, helping to round out their portfolio and reduce overall tax liability
- Phantom Income. While many investors opt to buy zeroes for the tax benefits, it is possible that “phantom” income-that is, income that’s taxable but not actually received-can negate these benefits. This happens when the annual depreciation expense falls below the annual lease payments, which results in the appearance of profit. In a typical zero, this is likely to occur between years 10 and 15 of the investment, and as a result, many investors opt to sell prior to this point rather than accept the liability of phantom income.
For those who understand the risks, the “loss” produced by a zero cash flow property can be a valuable offset to their alternate income, helping to round out their portfolio and reduce overall tax liability
- Opportunity Cost. As with any investment strategy, there is the consideration of what could have been done with the same funds otherwise. These are the forgone benefits one might have gained from an alternative investment. Buying a zero cash flow property, by definition, will not produce any cash flow. As a result, there is some opportunity cost associated with investing when that same capital could have been used for something that does return cash in the short term.
Who Should Consider in Zero Cash Flow Investments?
Weighing the risks against the potential benefits, it’s apparent that zero cash flow deals are not for everyone. Many investors are not equipped with the resources to weather a decade or more without an initial return on their capital, and not all investors have the risk profile or portfolio makeup to make buying a zero an appealing option when compared to other investment strategies. Still, zeroes may be a sound choice for a very specific investor-one who earns significant income from a primary job, from other investments or both.
