LOS ANGELES-Pegasus Investments, an investment advisory firmthat operates from offices in Century City and Encino, has closedon a highly structured zero-cash-flow 1031 transaction that is thelatest step in “an extremely detailed portfolio repositioningstrategy” on behalf of Los Angeles-based Inglewood Family Corp.Inc. This is according to president Ken Chasin and executive vicepresident David Chasin of Pegasus. The closing of the transaction,in which Pegasus acted as the lead adviser in Inglewood Family’sacquisition of a CVS pharmacy in Prattville, AL, “helps the buyercontinue a complex unwinding of an 11-property retail portfolio,”David Chasin says.

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The property, which is located within Montgomery, AL's mostdensely populated suburb, sits as an outparcel to Pratt Plaza andacross the street from a neighborhood grocery center anchored byWinn Dixie. The site includes numerous other outparcels withtenants such as Colonial Bank, Wendy's and Hardee's. Although thebuyers were at first unfamiliar with the Montgomery suburb, Pegasusrecommended it to the buyer after an extensive review of the siteand surrounding area.

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"At first glance it would be easy to dismiss Prattville as atertiary location, however there are very strong demographic,traffic flow and site fundamentals which contribute to ourexpectation that this will continue to be a dominant site for CVSfor many years to come," David Chasin explained. "The store is arelocation from within the same center. CVS moved from its in-linespace to its newest prototype, which is a freestanding14,000-square-foot building with a drive-through," Chasin added."The fact that CVS already knew what its sales were before makingthis type of investment added another layer of confidence wealready had in the site."

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A Complex Unwinding

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Pegasus was first retained by the buyer in 2009 to provideadvisory services in connection with a portfolio of 11 propertiesthat the buyer had recently inherited in Los Angeles. Upon itsinitial review, Pegasus valued a significant portion of theportfolio less than the outstanding debt and determined that thebest strategy would be to prevent the defaulted loans fromaffecting the healthy, performing properties. "Given thecross-collateralization and cross-default provisions, the trickhere was to carve out [via sale] the toxic assets from the healthyassets within the client's portfolio," Chasin explained. Within afew months, Pegasus had completed sales on seven of the assets inthe portfolio and recapitalized the remaining four. The net effectof this strategy was that the Portfolio began cash-flowing again,the negative equity in the underperforming properties had beenrecapitalized with the substantial equity in the remaining balanceof the portfolio, and the client “had avoided what was aninevitable catastrophe,” Chasin says. "The next problem we neededto solve was how to accomplish a 1031 exchange when the sale of the'toxic 7' had netted zero proceeds to the seller," Chasinadded.

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10% Down, Zero Cash Flow

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The concept of a highly leveraged, zero-cash-flow deal isnothing new, according to David Chasin. "There are plenty of assetsfloating around the market with high leveraged bond financing onthem, and they've been popular with many of our clients seeking atax shelter during a 1031 exchange," Chasin commented. He explainedthat this type of financing is most commonly found collateralizedby a single-tenant, investment grade-rated tenant on a long termlease. They can range from CVS stores, to Wal-Mart distributionfacilities, to government office buildings. Since the minimum debtservice coverage ratio on a bond-financed deal can be as low as1.01, the leverage can get up to 80% to 90%. “The lender will oftenpeg the amortization term with the remaining lease term, therebyrecouping its entire loan by the termination of the base term ofthe lease,” Chasin points out. "In the example of the CVS inPratville we just sold, the property was engineered as azero-cash-flow deal from the start, thus the cap rate, interestrate, amortization, etc. were all structured together."

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This type of niche investment has been growing in popularityover the years because the buyer doesn’t need a large equitycontribution to buy one and it allows the buyer to replacesignificant debt in a 1031 exchange. "For the Inglewood FamilyCorp., this was ideal because it accomplished the 1031 exchangerequirement without having to come to the table with 40% equity,"the Chasins say. They note that it is important to point out thatthere are future tax consequences associated with these types oftransactions which present themselves 10 to 20 years down the road,depending on the basis the investor is exchanging out of. Theyrecommend that anyone considering a transaction of this typecontact a tax adviser.

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The Remaining Portfolio

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Since the acquisition of the CVS Zero, Pegasus has completed thesale of one more asset within the Los Angeles Portfolio and will beclosing shortly on the subsequent 1031 exchange property. There arecurrently only three remaining properties within the portfolio andare currently being offered for sale by Pegasus. These propertiesare nearly 100% occupied and being offered at cap rates of 9-10% onexisting NOI.

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