Real Estate: What is it Good For? Absolutely Nothing…

Yes nothing. Actually, Zero. 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. The benefits lay in the tax implications for those performing 1031 transactions, 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.

Here’s how it works:

Say someone, Mr. Fornit for example, needs to sell a property worth $7 million, with only $1 million in equity and the rest in debt. The property was originally bought in 2000 for $2 million and if sold today, faces a $5 million capital gains tax liability. To avoid the impending capital gains tax, Mr. Fornit needs to enter into a 1031 but that means the new property must be of equal or more value. After satisfying the $6 million debt obligation, Fornit only has $1 million of cash to reinvest in a property that must be worth at least $7 million to comply with the 1031 rules. To buy a property you need to provide at least 30% of its price in equity. In this situation, Mr. Fornit’s equity would only equal 14% of the total cost.

By entering into a zero cash flow transaction, he can avoid these problems. A zero cash flow transaction is structured almost like a bond, so a bank will invest the $6 million needed into Mr. Fornit’s property and in return will receive the properties rent checks to pay off the debt. In this way the bank recoups its investment and Mr. Fornit ends up with a wholly owned property that satisfies his 1031 and defers his pesky IOU to Uncle Sam.

Note: This kind of transaction only works with investment grade properties to ensure payment stability.

So you may ask: what do zero cash flows from properties have in common with anti-hawkish music by Edwin Starr? One common theme: the best interests of the common man may not be directly aligned with the interests of Uncle Sam. So avoid your unnecessary taxes and stick it to the man!

Will the sun come out tomorrow?

What is the state of the economy? Today this question seems more existential and philosophical than reality based. Over and over we hear things like “signs indicate a possible recovery” or “X number could be a sign things are leveling off”. It almost reminds one of ancient shaman looking at the stars, studying the flight patterns of birds, or sifting through bones to predict the future. It seems each day brings us a new set of “signs”, and a new set of prognosticators telling us how close, far, or indeterminate our situation is from recovery.
Take for example two reports, one from the Wall Street Journal and one from CapLease, both published only days apart in July. CapLease cites employment data and states:

“After 18 months of economic decline, we are seeing signs that the deepest recession in a century may be close to hitting bottom and the economy gradually recovering. The Labor Department reported that 345, 000 jobs were lost in May – well below the 650,000 average monthly job loss in the first quarter and the 504,000 loss in April.”

Now compare this to the Wall Street Journal story, subtlety titled “The Economy is Even Worse than You Think”

“The Bureau of Labor Statistics preliminary estimate for job losses for June is 467,000, which means 7.2 million people have lost their jobs since the start of the recession. The cumulative job losses over the last six months have been greater than for any other half year period since World War II, including the military demobilization after the war. The job losses are also now equal to the net job gains over the previous nine years, making this the only recession since the Great Depression to wipe out all job growth from the previous expansion.”

Here we have two reports using relatively the same numbers, with both coming to wildly different outlooks of both the present and future (in the case of the Wall Street Journal a near apocryphal vision). One side claims to see the light at the end of the tunnel, while the other maintains we make Alice look like Sir Francis Drake. This is not to fault the process (it is really the only thing we can do) it just demonstrates how differently the filtering mechanisms of disparate brains can sort things out. So in the spirit of “and now for something completely different”, Net Lease Insider will illustrate a set of trends and facts and let you be the judge.

Note: All information was gathered from CapLease inc. You can read their full report by clicking on "July 2009 Newsletter" at this page.
Of Homes:

• Home prices dropped 7% in the first quarter of 2009, while home sales saw an increase in March and April.


• 45% of home sales this year were distressed properties sold in foreclosure auctions.


• Since their peak in 2006, home prices have fallen 32% and now match their 2002 levels.


• It is estimated that housing is 18-20% below fair value at today’s prices; three years ago it was estimated to be overvalued by 35%.


• 5.4 million out of 45 million homes in the U.S. (12%) are either delinquent or in foreclosure, with the number continuing to rise.


• By February 2009 the number of prime mortgages delinquent for at least 90 days, in foreclosure, or turned over to a lender was at 1.5 million, totaling over $224 billion in loans.

Of Consumerism:

• The Consumer Confidence Index hit 54 in May, it’s highest point since last September and up from 40.9 in April. This constituted the greatest gain since April 2003. A Reading of 90 is considered “normal”.


• Between March and April, personal after tax income rose by $131.5 billion (1.1%). $121.8 billion of the increase resulted from reduced taxes and increased unemployment benefits. $44 billion could be traced back to stimulus programs.


• Consumer spending declined 0.01% in April, as consumers saved 5.7% of their after tax income. In March they saved 4.5% and one year ago they saved 0%. Consumer Spending is estimated to make up nearly 70% of GDP.


• Mortgage debt now accounts for 70% of GDP, in the 1990’s it averaged about 46%. Household debt is at 96% of GDP, it was less than 50% in the 1980’s.

Of Other Factors:

• Total industrial production saw an annualized decrease of 20% in the first quarter of 2009. This continues a trend of four periods of harsh declines.


• Commercial paper volume is at $1.5 trillion. Companies sold $55 billion of stock between January and May, making that the busiest period since 2000.


• It is estimated that 60% of CMBS loans made between 2005 and 2007 will not qualify for refinancing at maturity.


• Unemployment is at 9.4%.

Now, it should be noted that the report contained a whole host of information which was not reprinted here, so if you really want to engross yourself with numbers and analysis, be sure to check it out. Nevertheless, the numbers provided, combined with a persons own intuition, should be enough to induce valuable insight. So pick a circle and vote, even if the only thing that knows when the recession will end for sure is the dastardly thing itself, and maybe Bernie Madoff.

15 Year Depreciation, “I’m Lovin’ It”

Amid the hundreds of pages contained within the Emergency Economic Stabilization Act of 2008, there potentially exists an extremely valuable tool for those interested in real estate investment. A new law enables restaurant buildings and improvements to be depreciated on a 15 year basis if they are placed in service within the calendar year of 2009 and more than 50% of their square footage is dedicated to “the preparation of, and seating for on-site consumption of, prepared meals”. What does this mean for the investor? Well, restaurant real estate generally has to be depreciated on a 39 year basis, which means one could increase their depreciation tax shield by close to 40% if they act within 2009. That translates into large dollar sign increases on after tax income.

Below is an illustration of just how much a depreciation shield increase of close to 40% could affect one’s cash flow. For purposes of the comparison, we will be using a McDonald’s and a Burger King, both with solid credit ratings, placed in service in 2009 and 2007 respectively. Since the McDonald’s was placed in service in 2009 it can take advantage of the accelerated depreciation schedule, unlike the Burger King.


What is evident from this example is that restaurant real estate is the place to invest in 2009. In this case we saw an after tax cash flow difference of $55,671 in favor of McDonalds for one year. If all else holds equal, over 15 years that becomes an $835,065 difference. This could make a huge difference to all who are thinking of investing in 2009 and goes to show that change on Capital Hill can turn into cash in your pockets.

“This analysis is not provided as legal or tax advice. We simply intend to illustrate the benefits of a new beneficial tax-rulemaking. Any literal interpretation of this analysis on your specific situation should be discussed with your own tax advisor”