1031 Exchange Buyers and DST's The Basics.....

Delaware Statutory Trusts - The Basics...

If you’re like me, you have probably heard a lot of talk about DST’s in the real estate investing industry lately, and also like me, probably didn’t know a whole lot about them (even as a so called industry expert). Over the course of the past year, we have had a number of investors, especially on the single tenant front ask about them and whether they may be right for them to look at. We've also transacted with a number of sponsors who have purchased assets as a part pf DSTs. Below are a few high level data points to hopefully help you better understand DST’s whether they are right for you or your clients, and what their potential effect on the real estate market may be.

What are DSTs? As most probably know by now, DST stands for Delaware Statutory Trusts. DSTs were created in 1988 Investors, own fractional interests in the trusts which is the legal owner of the trust’s assets. In 2004 the IRS ruled that DST's could solve for an investors 1031 Exchange need. The IRS treats each investors interests as a direct property ownership and as such, it is eligible for 1031 exchange program both upon entry and exit.

How do I invest in DST’s? DST’s are typically formed by real estate companies called sponsors. These sponsors either buy properties with their own capital and then offer fractional shares of the DST that owns that asset to investors, or DST monies are committed to the sponsor for a particular asset and once the funds are fully committed, the sponsor closes on the property purchase. Investors end up becoming passive owners of the asset like a typical Limited Partner would in other real estate deals. Investors must find accredited dealers to invest in DSTs and they must be accredited investors. Accredited investors are individuals with income above $200,000 for two consecutive years ($300,000 for married couples), and with a net worth above $1 million. The value of your primary residence does not count toward the $1 million threshold. Typical investment minimums are $100,000.

Can my real estate company form a DST? In short, yes. Anyone can form a DST regardless of experience. This makes it crucial to do as much research as possible on the sponsor before investing. Examples of existing DST sponsors who are real estate companies include Inland, Pasco, and ExchangeRight.

How do the debt markets effect DSTs? Like traditional real estate investments, the debt markets have a direct effect on returns of DSTs. Typical DSTs will place 10 year fixed debt on assets and do not have the ability to renegotiate or refinance that debt. Traditional real estate transactions typically have 5 year debt placed on it and factor in a capital cash out event when refinanced over the hold period.

What are the benefits of that investment? Since the trust is recognized legally as a separate entity, creditors cannot come after the assets held therein. Like other real estate funds, reits, and syndications, DSTs can potentially give small investors the opportunity to invest into bigger and potentially higher quality deals than they could invest in by themselves. Unlike potential individual investments, there can be no additional capital calls for DST investors.

What are the potential negatives of an investment? While some investors like the idea of being completely hands off in DSTs, others, with operational experience in their investments may not like that they do not have a seat at the management table or any voice in management decisions. The performance of the DST can be completely dependent on the quality of the sponsor. Just like any real estate investment, there is a risk of loss of equity and returns. While you can not increase your leverage through a DST investment, it can solve for the replacement of the debt you are looking to replace as a part of your exchange so long as you are looking at leveraged DSTs.

What are typical returns for DSTs? Is there Upside? Factors such as property type, location, mortgage balance and interest rates determine return objectives for DSTs; however, annual return objectives between 3% and 6% are common. Total returns can potentially be higher or lower due to tax benefits and property appreciation.

Do I get distributions throughout the hold period? Generally, if an asset is producing cash flow, investors are able to get paid dividends on that cash flow throughout the hold period. Each DST is structured differently and should be referenced prior to a potential investment.

Can I own 100% of the shares in a DST? Yes. In theory, a singular investor can own 100% of the shares in a DST. Some investors do this for the benefits of lack of management and liability.

How do I exit a DST? DSTs have a typical hold period of between 5 and 7 years and as a result are a relatively illiquid asset that can not be traded out of quickly. If an investor wishes to exit a DST early, they would need to sell their shares to another accredited investor. When a DST asset is sold, funds must be distributed back to the investors and can not be reinvested.

What has been or will be the effect on the real estate market from DSTs? In short, DSTs have given real estate investors one more options when evaluating investment vehicles and 1031 options.

So where do I invest? Individually, REITs, syndications, funds? As you would imagine, there is not a straight answer. It all depends on your investment objectives, accessible capital, existing financial health, and risk and management tolerance. DSTs are just one tool in the toolbox of investing in income producing real estate and have proven to be reliable vehicles for those whose investment objectives they meet.