a hands-off investment strategy
Especially during this time of uncertainty, many investors are considering more passive investment options. Delaware Statutory Trusts (DSTs) are one lesser-known option for real estate investors wanting to take a more hands-off approach while deferring the capital gains tax associated with selling investment properties.
We sat down with Nir Regev of Regev Group to learn more.
What is a DST?
A Delaware Statutory Trust (DST) is a separate legal entity created as a trust under the laws of
Delaware in which each owner has a “beneficial interest” in the DST for Federal income tax purposes, and each owner is treated as owning an undivided fractional interest in the property. In 2004, the IRS released Revenue Ruling 2004-86 which allows the use of a DST to acquire real estate where the beneficial interests in the trust will be treated as direct interests in replacement property for purposes of IRC §1031.
Why haven’t many people heard of them?
Securitized DSTs have been around for a while and many investors have found this reinvestment option to be fitting, yet are still not widely known. People in general – including many CPAs and attorneys or even commercial real estate agents – are not aware of them in large-part because these investments are offered to accredited investors only.
DSTs cannot be generally solicited. I cannot present a DST offering to anyone until it has been established that they are an accredited investor. Even advertising specific offerings must follow strict guidelines.
So folks, professionals or otherwise, usually aren’t going to stumble upon these opportunities unless seeking them out.
What’s an accredited investor?
DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities. If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and attorney.
Could you tell us a bit more about how DSTs work?
1031 exchanges in the commercial property arena, often called like-kind exchanges, originally mandated same type only to qualify; in other words, the definition was literal so if you owned a warehouse you would need to replace it with a warehouse and so on.
But then the rule was broadened so that warehouses could be exchanged into multifamily, multifamily into land and so on. Fast forward again, and the rule was broadened again to include securitized real estate which, when done properly, would potentially qualify for a tax-deferred exchange to meet the needs of certain investors. These investors are typically those who are “done” with particular real estate ownership and no longer wish to have direct ownership, control, or management of a property; these folks are often surprised to learn there are turnkey solutions that fit those needs. DSTs aren’t the right instrument for people who want to temporarily park their money until the next opportunity comes along or for those who want direct involvement with a property.
What about if the investor has cash left over after identifying their replacement property?
This is the one instance where investors who are still in the midst of ongoing activity may benefit from a DST. Let’s say a relinquished property is sold for $10MM and the replacement property purchase price is only $9MM. This property will not completely satisfy the 1031 exchange because the identified property needs to be equal to or exceed the relinquished property’s value. However, the $1MM differential can potentially be satisfied by an exchange into a DST and eliminate what’s called “boot” in the industry; potentially all of the tax will be deferred in this scenario.
Typically, three replacement “slots” or properties are allowed to be specified in an exchange. So long as rules are followed, reinvesting dollars from the sold property can be split up among these three slots. This not only can provide diversification, it also can provide a backup should other aspects of a deal fall apart.
What exactly do you own when you invest in a DST?
DSTs are trusts which own real estate. An investor owns beneficial interest, or if you will a portion, of that trust. What is owned by the DST might be an apartment complex, a self-storage facility, a distribution center, or in some cases a few properties in one investment.
Investing in a DST provides fractional ownership of a property or properties, one owns a portion of an investment which may have a total value of $10MM or even upwards of $100MM, these offerings can be sizeable. Sponsors, as they are called in this industry, seek property types and source real estate which they believe will be beneficial to investors in the next 5-10 years. For instance, they nowadays are being mindful about properties that may benefit from rising interest rates should those come about.
Due diligence and conversations are very important; one of my passions is educating investors and making sure they understand what they are buying. The process can be enlightening and very rewarding.
Investing in a DST has risks which are related to an investment in real estate: Real property investments are subject to varying degrees of risks including, but not limited to, the speculative market and financial risks associated with fluctuations in the real estate market; loss of principal; variations in occupancy which may negatively impact cash flow; limited liquidity; limits on management control of the property; and changes in the value of the underlying investments. Beneficial Owners possess limited control and rights. They have no right to participate in the management of the trust, do not have legal title, and do not have the right to sell the property. The trust will be operated and managed solely by the Trustee.
I’ve also heard of a REIT. How does a DST differ from a REIT?
The stipulations and structures are different. For example a REIT, or Real Estate Investment Trust, will generally have several properties whereas a DST typically will not. Although there are similarities, these two structures satisfy different objectives.
What can I expect in terms of fees and investment horizon?
All the fees of the DSTs we offer are built-in and fully disclosed in a private placement memorandum (PPM), they vary by way of each offering and should always be reviewed. We always provide this document well in advance of a purchase so that it can be reviewed, it is important to me that any question which may come up is answered before a decision is made. All the legal information is contained in the PPM; but also other due diligence particulars such as demographic studies, traffic counts, competition studies, and thorough descriptions which include pictures are contained in the information packet. Although there are no guarantees, the PPMs normally contain pro-formas and time horizons based on the sponsors’ expectations which generally show a ten-year period. If and when a DST has a liquidity event, sometimes called “going full-cycle,” an investor may elect to repeat the process by way of a 1031 exchange into another DST or other properties thereby deferring the taxes again.
Curious about whether a DST is the right choice for you? Talk to one of our 1031 exchange experts about Delaware Statutory Trusts today.
The contents herein constitute neither an offer to sell nor a solicitation of an offer to buy any security, as such an offer can be made only by prospectus. Investing in real estate securities may not be suitable for all investors and may involve significant risks. These risks include, but are not limited to, loss of principal, lack of liquidity, adverse changes in real estate markets and conflicts of interest. Investors should also understand all fees associated with a particular investment and how those fees could affect the overall performance of an investment. Past performance of investments is no indication of future results.