By Al DiNicola
Securities offered through MSC-BD
There are many articles centered on utilizing DST alternatives for completing an IRC 1031 tax deferred exchange. Relinquished real estate holdings may be replaced with a Delaware Statutory Trust (DST) asset(s). There are two reason why this works: The Internal Revenue Code, Section 1031 and Delaware’s statutory law. There may be tremendous stress in locating a real estate replacement within the 45 days (and not overpaying) and then ultimately closing with the 180-day period. The DST also provides the incentives of property ownership without taking on any of the management responsibilities.
How do you participate in the DST if you are not doing a 1031 Exchange and simply have cash to invest? Many sponsors of DSTs have investment options open to cash investors. For investors just starting out you may add real estate to your portfolio through a DST. You must be an accredited investor. Many DST sponsors have different minimum investment amount for a 1031 Exchange (typically $100,000) but for a cash investment the amount may start at $25,000. So, what would you receive for the $25,000? You would receive a fractional ownership in a large property that is professionally managed. Typically, a smaller amount would not permit you to purchase into a large portfolio of real estate. This is different than investing in a REIT.
The DST may provide you with a tax advantaged income. Owning real property provides you tax benefits including mortgage interest deduction. This is if there is financing involved with the DST. Typically, the leverage for DST may be between 50%-65%. Meaning the loan to value between the loan amount and the purchase price of the DST asset. However, the DST is the borrower and not you the induvial investor. The loan is non-recourse to you the investor. Each year you the investor may claim your share of the mortgage interest deduction. (Please consult your accountant to see how this may affect your personal situation). When you sign up for a DST that has leverage you don’t apply for the loan personally. However, you will receive annual statements for the interest deduction as well as the depreciation on the asset.
There are many stories about individuals (who want to become investors) finding a property, negotiating with the seller, filling out the loan papers, obtain approvals for closing, and even after a due diligence period the deal could still fall apart. Sponsors prepackage DST offering. The sponsor has done all the front work and DSTs are prepackaged. The sponsor has located the property, negotiated the purchase, completed the due diligence, and has all the management in place as well as any mortgage on the property. This eliminates all the stress. DST offerings are ready to go and can close in a matter of days not months.
What happens once you own a DST? There is the potential for monthly recurring income. Most DSTs make monthly distributions to investors. The investors are not actively involved in the real estate and this is considered passive income. This will show up in your mailbox (hence the term mailbox money) or you may prefer direct deposit to your banking account.
So, what is your liability you may ask. There is a reference to DST being bankruptcy remote. There are provisions in place to prevent this but in the event the Trust would go into bankruptcy your personal assets are not at risk. The amount you have invested may be affected but none of your other assets. Unlike other real estate loans where you may have recourse for the loan including potential having your other assets cross collateralize, the DST is the sole borrower.
What happens when it over? Over means the sponsor has decided to sell the real estate asset (DST). Sponsors have exit strategies ranging in time from 7-10 years. These would be covered in the Private Placement Memorandum (PPM). When this real estate venture is over you have many options. You will be notified by the sponsor of the sale and the pending closing date. Your plan of action may include taking your cash proceeds (initial investment and profit) and paying your taxes. You may also do a 1031 Exchange for another real estate property as a sole owner or partner in a deal. This would/may defer any capital gains. You may also do a 1031 exchange into another DST if the experience has been acceptable to you and your investment goals.
What are the risks? Any real estate investment should be considered an ill liquid investment. A DST is ownership of real estate and carries the same liquidity drawbacks. You will/may receive cash flow from the investment, but your initial capital and any profits are tied up until the property is sold. You may hear the term “cycle” meaning how long the DST is owned before the investment is completed and asset is sold. How long does the cycle take? Typically, sponsors reference this as a long-term hold which is 7-10 years. Occasionally the cycle maybe shorted. When the cycle is shorter the investors reaction may be one of “I wasn’t ready for this to be over”. Meaning the investor may want to DST to have a longer life especially if the monthly cash flow continues. There is not an MLS for individual ownership of DSTs. Investors cannot call up a broker to list their fractional ownership of the DST.
You don’t get to vote in any of the decision of the DST. Contrasting this to the Tenants in Common (TIC) where you needed unanimous consent to take any action. (Not to mention in a TIC all 35 potential members may be signing on the loan, but that is another article). You are investing in a deal where there is professional management who handles the leasing, capital improvements and all the other decision, including when to sell the assets. You will be relying on the sponsor and you need to have confidence and trust in the sponsor’s track record. Consult your investment adviser for additional due diligence on the specific real estate asset as well as the sponsor track record.
If you are searching for an easier way to get into the real estate investing market and want to invest your cash, a DST may be just what you are looking for in real estate. It may take all the fun out of locating, negotiating, due diligence, loan application, management and then dealing with tenants, trash and toilets. (The 3 T’s make it into the article). For a great starting point consult an Investment Adviser who specializes in DST investments.