All Forum Posts by: Chris Kane

@Isaac SInger

The ‘play’ for ZCF investments is locking away bad basis until a person dies and the basis is stepped up. If you had a big liquidity event and want to play the waiting game between Uncle Sam and Father Time, it’s a good option and you can get some really nice institutional quality real estate for pennies on the dollar.

In ZCF or ‘zeros’, you can structure a pay down readvance feature that unlocks some basis, and with the right debt product and structure, you can actually break out your bad basis in the form of a loan and be net positive for your anticipated tax (phantom income / income tax) carry for the next several years. But, seeing as though you are looking to buy-in and not originate, this feature is likely off the table with the deals you are looking at.

As for the exit... all good things come to an end and the debt encumbrance that creates a zero, eventually gets paid off in full (generally the case) or requires a balloon to retire (less common). At this stage, you have either died or you wrote checks for all those years of carry. In this case, you have a fully paid for property and its a good day. Of course, it is likely that your credit tenant (or structured credit via something way more exotic) is long gone and you will need to re-tenant and improve the property for your next big play.

As said earlier... you are just deferring not eliminating with a zero. Personally, I’d stay away from them unless you have huge bad basis problems and/or you are getting towards the end of your actuarial lifespan and are using the zero as an estate planning device. If you are looking to originate zeros, that is an interesting play... but that is not for the faint of heart or those with out several tens of millions on their balance sheet ready to dive in head first.

Happy hunting! -CK

@Matthew D. Don’t know if you had your question answered... but, yes. It is common to buy hotels fee simple and ‘bifurcate’ them. The bifurcation process is as simple as writing a well crafted ground lease (leased fee estate) that won’t hurt the value of the improvements (leasehold estate).

The pros of this kind of transaction is that you will likely experience a positive arbitrage between buying a fee simple (ie conventional) deal versus a bifurcated deal. In my experience, you generally net about 20% more than your initial purchase price. The cons are that the buyer pool for leasehold hotels is smaller, leasehold debt is tricky to procure and you will need to pay attention to items like the franchise agreement, access agreements and easements, etc. Importantly, you may have some tax implications that you will have to work around.

I exclusively focus on these types of transactions around the US and they get done all the time ... so don’t let anyone stop you or tell you some nonsense. Get some good help and don’t try and DIY it on the formation of the ground lease. Good luck!

In answering your ‘supplemental’ question... Developers are excited to enter into these deals because they can do so with little or no equity into the deal. By selling the leased fee (the dirt) and entering into a high leverage loan on the leasehold (the improvements), they might be as high as 105% LTV on both pieces. Keep in mind that as long as he holds the real estate with the loan... he doesn’t pay any income tax on the excess proceeds. Layer that with a healthy developer fee and a number of other tax benefits related to zero cash flow and Section 467, and these deals wrote themselves. Problem is that generally the leases are flat and owning high $/SF real estate when your tenant vacates is a very serious issue.