Christopher Miller, MBA | Specialized Wealth Management
Originally Appeared in Apartment Management Magazine
I spent most of August in Japan on vacation with my family, so I didn’t get a chance to write an article for August. I am still pondering the feasibility of real estate investments here — an article on that topic is in the works for later this year. This month will be “Part 2” of my July piece on “Zero Coupon” properties.
What Are Zero Coupon Properties? A Quick Recap
To summarize July’s article, a “Zero Coupon” offering has very high leverage, so all of the property’s cash flow will go to pay debt service. Such an investment may be attractive to landlords needing a high leverage replacement property in order to finish a completely tax deferred 1031 Exchange.
In the last article, our example investor (based on a true story) needed an 85% loan-to-value (LTV) ratio to complete his 1031 Exchange. That is — he needed to buy $10 million worth of real estate with just $1.5 million of equity. We were able to meet his needs by using Zero Coupon, Partial Interest, properties and defer (potentially forever) a multi-million-dollar tax bill while preserving the growth potential of his equity.
Zero Coupon Offerings Are Also Valuable for Use in “Combo Exchanges” that Seek Current Income Potential.
This month, I’ll show how Zero Coupon offerings can be useful in more traditional exchanges as well: ones that aim to provide the potential for monthly income as well as tax deferral and growth.
A Sample Situation
For Example: an investor sells his apartment property and would like to exchange into partial interest real estate to reduce his property management workload. He would like to buy a mixture of apartment and NNN offerings for the “upleg” portion of his exchange. His net sales price was $3 million, he paid off a $1,800,000 loan and has $1.2 million of equity in his accommodator account. Remembering that, according to IRS rules, — that in order to finish a completely tax deferred 1031 Exchange, he’ll need to spend that $1.2 million of equity and assume at least $1,800,000 of new loans when purchasing his replacement property or properties.
To complete this exchange, our investor will need to find replacement properties with a combined Loan-to-Value (or LTV) ratio of at least $60\%$. Although there are occasionally partial interest offerings with leverage numbers that approach that, my investor would like to avoid a situation where he only has one option. He would like to pick from among several quality properties to select the investment that is right for him.
This Can Be Done With A Combo Exchange
Let’s say that our investor really loves a partial interest offering in the Atlanta, Georgia suburbs and has decided to buy it as a replacement property in his exchange. This property comes with an in-place “Hustler” loan at a $45\%$ LTV ratio. Putting all his $\$1,200,000$ of equity into this property would only buy him $(\$1,200,000 / (1-0.45))\$2,181,818$ of property – below the $\$3$ million needed for a completely tax-deferred (potentially forever) exchange.
By using a Zero-Coupon DST as part of a “Combo Exchange,” we can make these numbers work better. Some work on my spreadsheet indicates that $\$1,050,000$ of equity in the Atlanta property will buy $\$2,019,000$ of real estate when leveraged at a $48\%$ LTV. A $\$150,000$ of equity in an NNN-leased Zero Coupon DST with a tenant like Amazon or Federal Express, for example, will buy us $\$1$ million of property at an $85\%$ LTV.
This way, our investor can defer (potentially forever) his taxes, while preserving income potential from $87\%$ of his equity and maintaining growth potential from all of it.
Can A Zero Coupon Offering Help Your Next Exchange?
Using a little creativity and a Zero Coupon offering can potentially solve leverage-related $1031$ Exchange problems. Do you have a $1031$ Exchange coming up with a high leverage? Call my office toll free at $(877) 313-1868$ to see if Zero Coupon properties can help you.
