Last month the focus was on the $200 MM of DST investments made by individual investors. August continued to see additional investment as DST offerings were funded. Many eyes are focused on the response of the Sponsor in securing additional properties and structuring into offerings for the large anticipated number of individual sellers of real estate prior to year end. The old phrase the “Dog days of August” did not really exist in the acquisition teams of the Sponsors. During the height of the COVID restricted activity, many due diligence teams could not physically inspect the properties that were the subject of future acquisition. Without following the strict compliance of evaluation of every property that would ultimately be offered to individual investors (either cash investors or 1031 exchangors) the investment would not be sound. Many of the sponsors have multiple DST properties in the process of final evaluation.
Many Sponsors are continuing to experience good rent collection results considering the current responses (moratorium) by states on eviction of renters who cannot pay the rent or choose not to pay the rent. The suspicion may be that the multifamily sector, as well as student housing would see a drastic drop in rental collection. Contrary to that suspicion, many have seen strong occupancy as well as strong rental collection. Even in areas like Las Vegas rent collection have been strong. As the colleges continue their individual decision on how to operate college classes (either in person or virtual) private student housing is seeing an uptick in leases signed. Many students are returning to the college towns even though the future of classes and college athletics are in flux. These two sectors (multifamily and student housing) make up nearly 60% of all DST offerings. However, the core competencies of each offering need to be strong. Meaning once we are on the road to returning to more businesses opening (such as in Las Vegas) are the demographics positive, are businesses expanding and hiring employees, and are the assets or properties those that would attract renters. The essential businesses in the retail sector continues to be stable. Food stores, pharmacies and the local economic drivers continue to have be demand. Industrial and self-storage are stable but new offerings have been slow to enter the pipeline. Many of the self-storage offerings have been relatively small (under $15 MM each) and are subscribed quickly. Medical and senior housing are still attractive.
The sponsors re active in getting new assets in the pipeline. Sponsor are completing the pre closing DST due diligence and expect to have multiple offerings coming on the market in the beginning of September. There continues to be equity and liquidity looking to purchase new DST offerings. Many investors will be seeking to balance their real estate holdings by end of 2020. Look for a robust 4th quarter.
Our DST Landscape Survey provides a snapshot of comparative data representing most available DST offerings based on actual data provided by DST Sponsors. This landscape survey is updated in real time as Sponsors provide updates on current properties and on their new DST initiatives.
DSTs are for accredited investors only. DST as well as all real estate investments carry risk. This is not an offer to purchase any security and all purchases must include a Private Placement memorandum (PPM) Please consult your CPA for questions regarding qualifications for 1031 tax deferred exchange
When an investor receives a letter or notice from a government agency that the entity wants to “take your property” there is a variety of thoughts that go through your mind. There is a tax deferred section of the IRC that may be a life line or rescue to replace your property. IRC §1033 may be utilized in the case of replacing your property when taken by eminent domain or condemnation.
By Al DiNicola, AIF®, CEPA ™ adinicola@namcoa.com May 8, 2023 DST 1031 Specialist NAMCOA® – Naples Asset Management Company®, LLC Securities offered through MSC-BD, LLC
1033 may also be utilized when your property is destroyed by a natural disaster. The 1033 may be the not so often used “cousin” to the 1031 tax deferred exchange. While there are similarities between 1031 and 1033 there are also differences to be addressed.
There is the ability to defer capital gains on real estate property used for business or investment purposes in both sections. The capital gains that may be due would differ depending on individual state of residency. Total capital gains tax may be 20% to 30% on the capital gains and potentially more depending on the state of residency. 1031 & 1033 are strategies that may temporarily mitigate taxes and offer alternatives.
The 45-day identification period and the 180-day closing period challenge investors to comply with the 1031. There is also the requirement to replace with like kind which has a broad interpretation. 1033 has a different set of rules which may be driven by the fact that the relinquishing of the investment property was outside the investor’s control. The property was either taken by a government entity or destroyed in a natural disaster.
Major benefits of the 1033 exchange
Potential access to a Cash Out option.
A few of the financial requirements in the 1031 exchange require the investor to reinvest all the cash and to replace the debt if there was a loan paid off. The other financial requirement is to replace the total value of the relinquished property. There are a few options in the 1033 exchange with the cash and debt components. Investors need only to match (or exceed) the total value of the relinquished property. The combination of cash and debt may be designed by the investor. Here is an example of a 1033 structure. The investor received proceeds from a condemnation of their property for building a new road. The total value of the property was $1,000,000 and the investor had a $300,000 loan on the property. The cash equity would be $700,000. The investor could purchase another property with a value of $1,000,000 and potentially obtain a loan of 60% ($600,000). This would require a cash equity component of $400,000. The remaining cash of $300,000 may be retained TAX FREE by the investor.
“Equal and Up Rule” Replacing Equity & Debt
IRC §1031
Equity in the replacement property must be equal to or greater than the net equity of the relinquished property. Equity cannot be replaced by additional debt.
The value of debt on the replacement property must be equal to or greater than the value of debt relieved on the relinquished property. Debt can be replaced with additional equity (cash).
IRC §1033
The cost of the replacement property must be equal to or greater than the net proceeds received. Equity can be replaced with additional debt.
The value of debt on the replacement property must be equal to or greater than the value of debt relieved on the property converted. Debt can be replaced with additional equity (cash).
Who needs a Qualified Intermediary?
Yes, you do if you are utilizing a 1031 exchange. Under IRC Section 1031 the investor may not take constructive receipt of any proceeds in a 1031. Taking constructive receipt (if even in an escrow account) would be subject to taxes on the capital gain. This is also considered “boot”. There is no requirement for an investor whose property was taken by eminent domain or destroyed by a natural disaster to utilize the services of a QI. What can an investor do with the money until the exchange is completed? The investor may invest the funds in a money market account, personal investment, or even the stock market. However, when the time comes to complete the exchange, the total value needs to be replaced.
Time is on your side.
We briefly reviewed the time constraints of the 1031 exchange. The flexibility of the 1033 exchange may give the investor a period of 2 to 3 years to complete their exchange. 1033 is considered a forced conversion. The other interesting requirement is there is no requirement to identify any specific replacement property and report to anyone. In the 1031 the 45-day identification list must be turned into the QI. This 1033 provision opens the door for the investor to identify almost any replacement property to finalize their purchase. The title is passed to the investor on the replacement property when the exchange is completed.
What to do with the cash?
There is the potential an investor may receive cash from two sources. The two sources may be when the government acquires your condemned property, or you receive the insurance proceeds on the destroyed property. Since you do not need a QI you can receive the cash. There is always the question of what do you do with cash? You are free to use or invest the proceeds in any vehicle you decide. Typically, a more conservative prudent investment would be suggested. The rationale would be you will need the proceeds to be reinvested to acquire the replacement property to complete the exchange. If your investment principal goes down (as in the stock market or risky investment) you will have less capital to complete the exchange. Remember the 1033 exchange requires the investor to match the entire value of the relinquished property in the replacement property.
Like Kind versus Like Kind versus Similar Use
The words “Like Kind” appear in both the 1031 and 1033 exchange requirements. However, there are differences between a 1031 and a 1033 exchange in the standard that is used to limit what you can buy as replacement property. In the 1033 exchange the replacement property must be “similar or related in service or use” to the property that was lost in the casualty or condemnation. This additional restriction is more restrictive than the like kind standard under IRC 1031. There is an alternative standard for replacement property, but only if the property is lost due to a condemnation and was held for productive use in a trade or business. In this case, the replacement property qualifies if it is “like-kind” to the converted property. Locating a replacement property that would be considered “like-kind” may be easier to comply with than the “similar or related in service or use” requirement. Bottom line if your office property was destroyed by a natural disaster then your replacement must be similar use (office). There is one other wrinkle with regards to replacement property. Under the 1033 you as an investor may purchase 80% control of a corporation that owns the replacement property. This would be rather than using the like kind for the exchange.
Final Thoughts
There are advantages and disadvantages with every investment opportunity. The 1033 tax deferred exchange is a tool investor need to understand. Having the right understanding can improve the overall positioning of the investor. The disadvantage may be the extended amount of time that investors have to make the decision on replacement properties. We have seen investors waiting for something “better” to come along. Occasionally having extra time may not be a positive and creates a relaxed feeling. All investments need to have the proper due diligence.
Accredited investors seeking replacement properties with a passive investment will seek out Delaware Statutory Trust (DST). The advantage with the DST structure affords the investor with non-recourse debt on the prepackage investment alternatives. Contact us for additional information on the DST structure and function for your potential investment solutions.
DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.
This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin -Sherwood Rd, Suite 200 Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
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Social Media platforms are solely for informational purposes. Advisory services are only offered to clients or prospective clients where the advisory firm and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by NAMCOA unless a client service agreement is in place.
We have written many articles on the types of Delaware Statutory Trust (DST), the due diligence process we engage as well as advising on the best alternative for each individual accredited investor. We track our compliance requirements prior to investors engaging with a DST Sponsor. There is one question that we have not addressed in a few years. That question is how we (and you as an investor) evaluate the DST Sponsor.
UPDATED: April 28, 2023 Original Release: August 2019 By Al DiNicola, AIF®, CEPA ™ adinicola@namcoa.com DST 1031 Specialist NAMCOA® – Naples Asset Management Company®, LLC Securities offered through MSC-BD, LLC
One of the first areas of consideration would be to identify the sponsors who would be offering the different DSTs as either a direct cash investment or replacement property for a 1031 tax deferred exchange. The landscape of available DST properties has changed over the past 2-3 years. The number of properties that were available prior to, during, and post COVID is an interesting analysis. As we came out of COVID there was a pent-up demand for 1031 replacement properties and a limited supply. This placed additional pressure on everyone involved in the DST “pipeline” or “supply Chain”. Fortunately, we are in a position where the investor has more opportunity to investigate the alternatives that are available. These alternatives are created by Sponsors.
What is the role of the Sponsor?
The Delaware Statutory Trust is formed under Delaware laws. This is set up for the purpose of conducting real estate business. This is considered a specialized type of investment entity. The entity or party setting up the DST is referred to as the sponsor.
The sponsor creates the trust, finds the property to be acquired, utilizing specialized attorneys to create the Private Placement Memorandum (PPM), and structures the management of the property once acquired. The sponsor also seeks to raise the necessary capital. The capital is raised mostly through financial advisors and representatives. Many times, the capital is raised through independent representatives and not a direct employee or associate with the sponsor. We will cover that aspect a little later.
The role of the sponsor is critical as they hold a key component in the successful launch, management, and eventual disposition of the property. Many times, you will hear the word asset class associated with the property. Asset class refers to the type of property. This may be multifamily, student housing, senior housing, build for rent, industrial, manufactured housing, self-storage, medical office, necessary retail, life science. These assets are institutional grade properties and typically out of the reach of many individual investors. The sponsor will be in charge of the offering and often be in control of and protect the DST so to speak. Their supervision is one of the key elements of success.
Preparing the offering
There are many critical steps sponsors need to take in order to prepare and present the offering to the individual investors. The sponsor will focus on the property that will be acquired and then packaged structurally as well as functionally. The DST needs to be prepared with documentation to be submitted to the SEC and FINRA. Attorneys need to prepare the Private Placement Memorandum (PPM) as well as a review of the offering by a third-party evaluation firm. Firms such as Fact Right, Mick Law, Bowman and others review the offerings. The review is a non-biased evaluation of the offering and comparison to other current and past offerings.
Independent advisors, registered investments advisors and broker/dealer representatives will review offerings that sponsors bring to market. Some advisors will meet and establish a line of communication with the sponsor to have access to all the background on the asset. Some firms require their representatives to complete due diligence and compliance reviews prior to interacting with individual investors. We review new DST offerings every week and hundreds over the past few years. Not every DST is suitable for every investor. Suitability and timing are key in the selection of the DST for the investor.
Does the Sponsor Matter?
Over the past 20 years, with DST being approved as a viable option for a 1031 exchange replacement property, there has been an increase in the number of Sponsors. Each sponsor is independent and may have a different approach to their offerings. Some sponsors will only focus on a specific asset class such as necessary retail or multifamily offerings. The size and level of sophistication will differ. The track record of the sponsor will also be different. Many of the new sponsors have long histories in the financial sector such as Real Estate Investment Trust (REIT) sponsors. The transition to DST offerings becomes another product offering for REIT sponsors. As a note, REITs do not qualify for 1031 tax deferred exchanges. However, the track record of the sponsor is important to consider.
Communication is important between the sponsor and the investor. It is difficult for the investor to gauge the level of expected communication and actual communication they will have with the sponsor. This is where the independent advisor may be of value. Independent advisors who have previous investors and relationships with sponsors can shed light on the ongoing communication that new investors will experience. Communication of important end of year tax document becomes top of mind as a must have for the investor. These documents need to be delivered on time to avoid any tax filing extensions for the investors.
How are sponsors established or organized?
It may be a little confusing at first trying to evaluate who is offering the DST. There are many private equity firms raising funds for a variety of real estate offerings and other alternative real estate investments. How a DST sponsor may be like and unlike a Private Equity Firm may be unclear.
Entities that invest money (equity) in other companies and potentially their own real estate are referenced as private equity firms. There may be an offering of a DST by the private equity firms. If that is the case the private equity firm will be the investment sponsor.
On the flip side the DST sponsor could be a private equity firm but does not need to be. This has more to do with structure than function. The DST sponsor’s organizational structure is different but still enables the DST sponsor to create offerings. Many of the individuals within the DST sponsors firm have years of experience in real estate, finance, and operations they bring to the firm.
DST Sponsor Credentials
When evaluating the DST investment options the review of the sponsor credentials or pedigree is one the most important factors
Experience: The sponsors of DSTs who have a background in commercial real estate have a propensity for a better outcome than new comers to the commercial real estate arena. Large institutional REITs may be entering the DST marketplace and they bring decades of experience.
Size: The overall size of the sponsor of the DST is very interesting. Some of the older sponsors are smaller firms who specialize in a very targeted asset class. Other sponsors are very large organizations handling multiple classes of offerings. Some investors may seek out larger firms simply based on the size of the company. There are very experienced companies who are laser focused on a smaller number of offerings each year. Larger sponsors may have 30-40 offerings in a year while smaller sponsors may have 5-10 offerings. Advisors who perform due diligence on the individual sponsors have insight into the overall competency of the sponsor. Finding the best DST that is suitable for the individual investor is most important.
Asset Class: The same asset classes that exist in commercial real estate exist in DST offerings. Some sponsors of DST may be focused on a single asset class such as self-storage or multi family. Other sponsors may have a variety of asset classes in their offering menu.
Cost: There are costs associated with establishing the DST and Sponsors charge fees. The amount of fees may vary by sponsor but typically the range is minimal from an overall cost structure. The costs in DST are packaged within the offerings meaning individual investors do not come out of pocket for additional fees on top of their investment. Costs and fees are fully disclosed in the PPM. Part of investor due diligence should include comparison of costs and fees between sponsors. You may hear the reference to the “load” on the offering. The load would be all of the cost of establishing the offerings that is added to the acquisition of the property. This may be compared to buying a regular real estate property where the closing cost on the property, points on the loan, title insurance, as well as commission paid (by the seller) are included in the overall cost of buying real estate.
We interface with all of the major sponsors and evaluate the newer sponsors entering the market place. Some of the more active sponsors are Inland, Capital Square, Passco, Exchange Right, Versity, Madison Capital, Cove Capital, Carter, NexPoint, Cantor-Fitzgerald and there are others we review and assist investors with their acquisitions.
DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.
This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin- Sherwood Rd, Suite 200, Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
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Social Media platforms are solely for informational purposes. Advisory services are only offered to clients or prospective clients where the advisory firm and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by NAMCOA unless a client service agreement is in place.
When an investor sells an investment property there is the ability to defer paying capital gains taxes (taxed at 0%, 15%, or 20%) as well as the recapture of depreciation (taxed at 25%) for payment at another time. The IRC §1031 enables you to exchange the property you are selling for another property.
By Al DiNicola, AIF®, CEPA™ April 20, 2023 Adinicola@namcoa.com DST 1031 Specialist NAMCOA® – Naples Asset Management Company®, LLC Securities offered through MSC-BD
This may be referred to as a like kind exchange. For the purposes of this writing, we will address investment property and not primary residential property. We are not providing tax advice and investors are encouraged to consult their own CPA.
Understanding basis in a 1031 exchange.
There are several types of basis, including:
Original Cost basis;
Adjusted Cost Basis;
Depreciated Basis;
Tax Basis;
Carried Forward Basis; and
Step up in Basis.
The confusion may begin with an investor wondering what happens to their basis when the property is sold. When the topic of depreciation arises there are a variety of questions. What happens to depreciation while I own the property? How long does it take to use up all the depreciation? How can I start depreciation over again with a new property? If I use up all the depreciation and I still want tax advantaged real estate, what do I do? Does the entire property get depreciated? All of these questions and more may be traced back to the original property to establish your basis. There may be a long paper trail needed if you do multiple exchanges.
Hypothetical example
Jack & Diane are selling a rental house in New Jersey. They paid $175,000 for the property in January 2002. They also paid 15,000 in closing costs. They invested another $25,000 to add a garage. They accept an offer for $400,000 on the property (December closing 2022). They have owned the property for ten years. They have located a property in Daytona Beach for $400,000.
Original Cost Basis
The original cost basis is the original purchase price, associated closing cost at the time of acquisition of the relinquished property. The original cost basis in the home would be $190,000 ($175,000 original purchase price, $15,000 in closing cost).
Adjusted Basis
The adjusted basis would be the original cost basis plus the $25,000 for the garage. If there were any other major renovation or cost that adds to the value of the home those cost or investment would be added. For this example, the total adjusted cost basis would be $215,000.
Depreciated Basis
Depreciation is an interesting situation. The IRS assumes you have taken the depreciation whether you utilized that depreciation or not. The property was depreciated each year. The depreciation schedule is 27.5 years for residential property (commercial property is 39 years). However, the entire purchase price of $175,000 is not depreciated. Only the structure can be depreciated and not the land. For this example, we will assign a land value of $25,000 to the property and $150,000 for the structure plus the closing cost of $15,000 and addition of the garage $25,000 for a total of $190,000. The depreciation taken was $6,900 each year for a total of $138,000. In this case the property has a depreciated basis of $77,000. In some cases, the depreciated basis may be zero if the property was held for the entire depreciation period.
Original Purchase
$175,000
Closing Cost
$15,000
Original Cost Basis
$190,000
Garage Addition
$25,000
Adjusted Cost Basis
$215,000
Depreciation taken (rounded)
$138,000
Depreciated Basis (rounded)
$77,000
Tax Basis
One of the first items an investor may want to know is the tax basis in order to determine if the investor wishes to enter into a 1031 tax deferred exchange. The tax basis would be used to establish the capital gains on the property as well as the recapture of the depreciation over the years. The New Jersey home has an adjusted cost basis of $215,000 and sold for $400,000. The cost of selling the New Jersey home was $20,000 and that is subtracted from the selling price to arrive at the net selling price used to determine the capital gains. This would be $380,000. The net selling price on the property would be $380,000 minus the $77,000 depreciated basis taken for a Tax Basis of $303,000. For federal tax purposes this amount is divided into recapture and capital gains. There will be recapture of the $138,000 depreciation taken is taxed at a rate of 25%. The remaining $165,000 would be taxed at the capital gains rate. This would depend on the individual tax payer (0%, 15%, 20%). Individual states such as New Jersey have taxes that are also due upon the sale and would use the entire $303,000 for calculations. There may also be (depending on tax payer income level) a 3.8% NIC tax on gain. These taxes would be deferred if utilizing a 1031 tax deferred exchange.
Carry Forward Basis
The $77,000 depreciated basis is the carried forward basis. The property in Daytona Beach is the same price as the New Jersey home being sold. This is a very important fact because the price of the new property is a big factor that affects many items. Actually, they are buying equal. Because they bought equal the basis in the new property is the same as the remaining basis in the New Jersey home. The basis rolls forward to the new Daytona Beach property.
The original date (2002) of the New Jersey home is what appears on the future depreciation schedules. The depreciation schedule carries over as if they were still depreciating the New Jersey home. In this case there is no additional depreciation time other than what is remaining on the $77,000. That would be seven- and one-half years remaining.
If you had a mortgage on the relinquished property this will be noted.
The depreciated basis on an investment property can appear to be allusive to determine. One of the most important factors is the purchase price of the replacement property. This dictates many items that will affect you.
How to increase basis in replacement property.
The question many investors ask is how do you change the dynamics on the exchange and potentially increase tax favored write offs? One strategy would be to purchase up, meaning a more expensive replacement property. Rather than buying a $400,000 property in Daytona Beach hypothetically they purchase a $500,000 property. Their basis in the property would be increased by $100,000. This is a combination of the rollover $77,000 plus the $100,000 for a total of $177,000. There would be 7½ years remaining on the $77,000 and the $100,000 would start on a 27 ½ year depreciation schedule. The updated depreciation schedule shows the continued depreciation of the New Jersey homes (as if they still owned it) and the acquisition of the Daytona Beach property portion as of the date they closed on the Daytona Beach property.
Bring more cash or acquire more debt!
In order to increase the purchase price, the investor would need to bring additional cash or arrange for a mortgage or loan for the $100,000. This may involve applying for a loan. In most cases the investor would need to sign for and be liable for the loan. To avoid personal liability for a loan, some investors utilize Delaware Statutory Trust (DST) as a replacement property especially when leverage is present. DST have non-recourse debt. This eliminates the need for Jack & Diane to apply for or be liable for any of the assigned debt on the new acquisition. We have guided investors who have fully depreciated their investment properties who acquired a DST with 50% Loan to Value. This would increase the basis by an additional the amount of the debt assignment ($400,000 for example). Acquiring additional debt is not for all investors. If the investor utilized a future 1031 exchange the acquired debt (or balance paid off) needs to be replaced. The other consideration would be the overall goals of the investor when acquiring a property and in this example the Daytona Beach property may have other uses in the future.
Step Up in Basis
The final basis would be referenced as the step-up basis. This strategy benefits the heirs of the investor. When the investor passes away there is an adjustment from the original basis to the current market value. If the original property was purchased for $175,000 fully depreciated (over 27.5 years) and now worth $750,000 that is the new basis. The basis has been stepped up to current value. If the property is sold there would be no capital gains taxes due and there would be no recapture of depreciation taken. This strategy may be utilized to build generational wealth.
As previously stated, we are not CPA. We have guided many investors with a list of questions for their CPAs and assisted in countless 1031 exchange consultations. We have also assisted in the acquisition of DST utilizing the 1031 process. Call with any questions you may have. DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.
This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin -Sherwood Rd, Suite 200 Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
SOCIAL MEDIA
Social Media platforms are solely for informational purposes. Advisory services are only offered to clients or prospective clients where the advisory firm and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by NAMCOA unless a client service agreement is in place. Thank you.
A frequently asked question is why a Delaware Statutory Trust (DST) potentially better than a Tenants in Common (TIC). This question comes up especially when considering a IRC § 1031 tax deferred exchange.
By Al DiNicola, AIF®, CEPA™ March 30, 2023 Adinicola@namcoa.com DST 1031 Specialist NAMCOA® – Naples Asset Management Company®, LLC Securities offered through MSC-BD
Is deferring taxes similar to kicking the can down the road? Many investors will review the sale of their real estate and wonder how taxes may be deferred. The 1031 tax deferred exchange often is the immediate solution. Many investors who are selling their actively managed real estate are searching for hands free or passive investment so they can avoid any active management. Over the years we have heard from investors, qualified intermediaries (QIs) as well as CPAs that the best intentions of the investor to execute a 1031 exchange were not always successful. What solutions are there to defer taxes? One recent solution (which does not need a 1031 exchange) is an investment in an Opportunity Zone. We will elaborate on OZ & OZ Funds in future articles. The two other choices involving a 1031 exchange are Tenants in common (TICs) and Delaware Statutory Trust (DSTs). The success of the DST has nearly replaced the TIC to a large extent.
Opportunity Zone -Short Version
An opportunity zone enables an investor to retain the basis in the property and only invest the capital gains into a qualified Opportunity Zone offering. The offering may be a single site or a fund with multiple properties. Taxes are deferred until the end of 2026 (payable April 2027). If the investor retains their interest in the OZ for a period of 10+ years, then any profits from the sale of the asset are tax free to the investor. You are free to use the basis however you want to use the proceeds. However, capital gains taxes as well as the 25% tax on the recapture of depreciation will be due April 2027. We are well versed in the structure, review, comparison to a 1031 exchange, and recommendation of OZs. Contact us for an in-depth conversation if this may be one of your options.
What is a TIC (short version)
This is a type of co-ownership with multiple investors where funds are pooled to invest in a property. Each property owner typically receives a separate deed and title insurance for their percentage of interest in the property. There may be up to 35 individual investors in a TIC. Depending on how much each investor has contributed there will be an undivided interest but not equal interest and benefit in the property. Each investor will be responsible for their percentage share of income, appreciation (loss) and any tax shelter (depreciation) from the property. There is also financial liability for investors.
What is a DST (short version)?
The Delaware Statutory Trust (DST) has become very popular over the past 19 years. This structure enables many more investors than a TIC (potentially unlimited but up to 499 investors). Each investor would purchase a beneficiary ownership interest in the property (referenced as the asset) of a trust. Limited partnership occasionally gets compared to a DST with regards to the structure. However, there are many differences aside from the ability to utilize a 1031 exchange with a DST. DST Overview – DST Education and Market News (dstnews.org)
TIC and DST Differences & Similarities
There will be a separate deed for each investor under a TIC structure (noting their percentage of ownership based on the financial contribution). In a TIC structure there is also voting right associated for each investor. TIC owners also may transfer their ownership interest to another party without the consent of the other TIC investors. In a DST an investor will need to wait for the sponsor to sell the property.
There are several similarities between the TIC structure and the DST structure. For investors when selling, both may qualify for a 1031 as a replacement property. DST have professional management and many TICs will also utilize a professional manager.
If an investor is seeking diversification as a strategy, then both structures may provide an alternative. DSTs have a low barrier to entry with many only requiring $100,000. TIC may also have lower entry levels depending on the overall investment.
Determining which structure is better- decision or conflict.
One of the structural elements some investors find attractive in the TIC structure is the ability to make decisions. That is if there is a unanimous decision among all the investors. There could be as many as 35 investors in a TIC and obtaining a unanimous decision may be problematic. This may result in conflict. Imagine if there are 20 members of a TIC and eighteen want to sell and there are two who do not. This would enable the minority to dictate the process. Many TICs were caught in the greet recession (2008-2009) with the inability to take swift action and resulted in many TICs failing.
Recently the Delaware Statutory Trust investment strategy has been preferred by investors over Tenants in Common. In the DST structure the sponsor has the lead on all aspects of the DST. This includes when to sell the property. Investors who want to be able to make decisions are not the right fit. The entire decision process is in the hands of the sponsor. Investors who are seeking passive ownership evaluate this as a benefit.
What is the ante or buy in?
If you are in Vegas visitor (gambler) will search out which tables to sit down based on the posted minimum bet necessary to play. The DST minimum typically is $100,000 for a 1031 exchange investor ($50,000 in some cases for a cash investor). In addition, there are many more potential investors when compared to the 35-investor limit in a TIC. For example, if there was a $35 M property each TIC investor would need to invest $1M to pay cash for the property. The same $35 M property could have 350 DST investors each investing $100,000. This enables investors to diversify their investments in many more additional DST assets.
If the same $35M property was to be leveraged with 50% LTV each TIC investor would need to come up with $500,000 cash portion and be personally responsible for a $500,000 loan. In addition, if any other TIC investor default on their portion of the loan the other TIC investors are responsible for making the payments. In a DST structure each investor would come up with $50,000 and have a non-recourse debt assignment for $50,000. There is only one entity responsible for the debt and that is the DST Trust.
The flexibility in the DST structure with the non-recourse loan and lower capital investment enables smaller accredited investors to invest in a larger institutional property. When an investor borrows to fund the TIC real estate investment that debt will most likely appear on their credit profile and should be included on a personal balance sheet as a liability. Some TIC investors may utilize their other investment and create a cross collateralization of assets. This does not happen with the DST investment vehicle, where the debt is all non-recourse debt.
Beat the Clock- Meeting the 1031 requirements.
The two critical time periods of the 1031 exchange are the 45-day identification period and then the 180-day closing time period. The process for the TIC investment structure may be obtaining consensus on the properties to identify especially within the 45-day period. The other potential issue with the TIC (if structuring a new TIC) is the requirement for each investor to provide funding if any of their funds are being borrowed. Each borrower would need to apply for their own loan and go through the underwriting process.
When an investor starts the acquisition process for a DST the time from start to finish may be 7-10 days. This may include 2-3 days for the initial paperwork (once the asset is identified) interaction with the QI and then 2- 3 days include a weekend and then closing can occur. Contrast this quick period with the challenges in structure and function of the TIC, especially with the 45-day identification timeline places the TIC as not the preferred option. The other toxic situation that may implode the TIC exchange may be if one of the members does not obtain financing for their respective portion of the acquisition. That could jeopardize the entire exchange for all parties. Compare that situation with the non-recourse structure of the DST acquisition where the DST comes with prepackaged financing.
The limiting or qualifying factor for a DST is the status of the investor DSTs require that all investors are accredited. A TIC does not have the accredited investor status.
Here is a graphic view of the two structures.
DST
TIC
Number of Investors
Unlimited, though typically capped at 499
Up to 35
Investor Ownership
Percentage of beneficial ownership in a Trust that owns the property
Undivided interest in the property
Number of Borrowers
1 (the DST)
Up to 35 (each investor is a borrower
Reporting on Credit Profile Report and Balance Sheet
NO
YES
Major Decisions
No investor voting rights
Equal voting rights and unanimous consent
Bankruptcy Remote
Provided by DST structure
Investors must form Single Member LLC
Investor Guarantees
Not needed
Investors generally require to provide “carve-outs”
IRS Guidance
Revenue Ruling 2004-86
Revenue Procedure 2002-22
If you’d like to learn more about DSTs and 1031 Exchanges schedule your free 30-minute call today.
DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.
This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC.8215 SW Tualatin- Sherwood Rd, Suite 200, Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
SOCIAL MEDIA
Social Media platforms are solely for informational purposes. Advisory services are only offered to clients or prospective clients where the advisory firm and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by NAMCOA unless a client service agreement is in place.
Congratulations! You have successfully followed all the rules and completed your exchange on time. You utilized the services of a Qualified Intermediary (QI) so you are in full compliance with IRC §1031.
February 19, 2023 By Al DiNicola, AIF®, CEPA ™ adinicola@namcoa.com DST 1031 Specialist NAMCOA® – Naples Asset Management Company®, LLC Securities offered through MSC-BD, LLC
You purchased a property equal to or in excess of the property you sold. You used all the cash proceeds and replaced the debt that was paid off on the property you sold. Now it is time to report the details of the exchange as required by the IRS. SO, exactly what does the IRS want to know about the exchange. Maybe not everything but there are key elements of your exchange you need to submit.
CPAs for Complete Answers
We are not CPAs and would suggest consulting your CPA for full compliance. This may serve as an overview on what to expect.
The Internal Revenue Service provides several forms that need to be completed reflecting your exchange details. Everything starts with form 8824. Real estate investors who have utilized the 1031 exchange are required to fill out this form. This reflects the transactions from the previous tax reporting period. There is a complication that occurs when the sale of the relinquished property and the acquisition of the replacement property does not occur during the same tax reporting year. For example, if you sold your property in August 2022 and completed your exchange in December 2022 the process is straight forward. However, if you sold your property in August 2022 (identified your replacement properties with the prescribed 45 days) and are waiting to close in February 2023 there is an extra step required. You would need to fill out form 8824 and attached to your 2022 tax returns. You would complete the reporting when filing your 2023 returns.
Fill in the Blanks- Correctly
To avoid any unnecessary penalties or liabilities for taxes the forms need to be filled out correctly. The IRS typically may want answers to Who, What, Where, When, how much, and more questions that will be on Form 8824!
What was the property exchanged or a description?
Did you make any money (gain) or lose money (loss) on sale of other property you sold or gave up that was not part of the exchange?
What was the dates of the replacement properties identified and when the property was closed, or title transferred?
What were the proceeds from the sale, was there a mortgage paid off, or any other Cash received or any other relief of liabilities?
Were there any related parties to the transaction.
What was the adjusted basis on the property that was relinquished. And what was the gain.
What was the fair market value of the property that was acquired.
There are four section to Form 8824.
Part I Information on the Like-Kind Exchange
Part II- Related Party Exchange Information
Part III- Realized Gain or (Loss), Recognized Gain, and Basis of Like-Kind Property Received
Part IV- Deferral of Gain from Section 1043 Conflict of Interest Sales
Part I (lines 1-7) as stated includes information on the exchange. This would include description of the relinquished property which is a full address or other acceptable description (occasionally referenced as the down-leg), the date you transferred title to buyer, when you identified your potential replacement properties (45-day replacement notification) to your Qualified Intermediary (QI), and finally the date you closed on one or more of the identified properties on your list (occasionally referenced as the up-leg).
Part II (lines 8-11) addresses any related party exchange information. If you had an interest in or stake in a property with a related party translated as any family member, spouse, grandparents, sister, brother, a partnership, etc. would need to be reported. There a few noted exception including death of related party. As always consult your tax advisor.
Part III (lines 12-25) focuses on the financial numbers related to the exchange. This is how the IRS tracks the financial details of your exchange. Topics and questions include references to fair market value, adjusted basis of relinquished property, gain on property, cash received, adjusted basis of like kind property, realized gain and other financial related questions.
Part IV (lines 26-38). This would be a special situation and used only by officers or employees of the executive branch of the federal government or judicial officers of the federal government (including certain spouses, minor or dependent children, and trustees as described in section 1043) for reporting nonrecognition of gain under section 1043 on the sale of property to comply with the conflict-of-interest requirements. This part can be used only if the cost of the replacement property is more than the basis of the divested property.
Understanding and Execution
Many CPAs and especially tax advisors understand the process especially those who handle 1031 exchanges on an ongoing basis. The execution of filling out Form 8824 should be very easy for those professionals. CPAs who are engaging with an investor for the first time may need to ask a lot of question of the investors. A big part of the solution will come back to the individual investor understanding the relinquished property details when acquired (typically found on the closing documents) as well as all cost involved during the ownerships that may add to the basis in the property.
Standing by to assist
We deal with 1031 exchanges all the time and are happy to engage with CPAs on the initial question for your exchange. We have engage with CPA on clarifying the acquisitions of Delaware Statutory Trusts (DSTs). DSTs have been utilized by investors for about 20 years. However, many CPAs do not see as many exchanges involving DSTs as compared with traditional real estate. There are a few more details when a DST is acquired or relinquished. Typically, those details may be in the description and percentage of ownership.
Future Discussion.
There are occasions when investors engage in a partial exchange. This is either by design or by one or more of the properties identified falling out or a failed exchange. We will address partial exchanges in an upcoming post.
DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.
This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin- Sherwood Rd, Suite 200, Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
SOCIAL MEDIA
Social Media platforms are solely for informational purposes. Advisory services are only offered to clients or prospective clients where the advisory firm and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by NAMCOA unless a client service agreement is in place.
When faced with selling an investment property besides the amount of proceeds to pick up at closing the investor may consider the taxes that may be due. Investors may utilize a tax deferred 1031 exchange for all or part of the transaction.
By Al DiNicola, AIF®, CEPA ™ adinicola@namcoa.com February 17, 2023 DST 1031 Specialist NAMCOA® – Naples Asset Management Company®, LLC Securities offered through MSC-BD, LLC
Tax deferred 1031 Exchanges and Boot
When faced with selling an investment property besides the amount of proceeds to pick up at closing the investor may consider the taxes that may be due. Investors may utilize a tax deferred 1031 exchange for all or part of the transaction. If you take proceeds off the table, the proceeds are referenced as boot. In addition, if you are doing an exchange and do not replace the loan that was paid off (either with another loan or fresh cash) you will be liable for mortgage boot. Understanding your overall tax liability should be a starting point.
The Internal Revenue Code does not formally use the term “Boot”. It is used in discussing the tax implications of a 1031 Exchange. In searching for a potential meaning here is a reference. Boot is an old English term meaning “Something given in addition to.” “Boot received” is the money or fair market value of “Other Property” received by the taxpayer in an exchange.
Many consultants and investors agree that when done properly a 1031 exchange can provide a host of benefits to the investor today and in building an investment portfolio. The major benefits would be the deferral of capital gains as well as the deferral of recapture of depreciation.
There are situations where an investor believes they are executing a 1031 exchange but may fall short for a few reasons and end up owing money to the IRS.
When do you create Boot.
Cash boot.
You acquired your relinquished property for $400,000 and sell your relinquished property for $1,000,000. (For this example we will not attempt to account for any commission or cost of sale). If the replacement property is $800,000 and you collect a check for $200,000 that would be considered boot and taxes would be due. This is income and would be taxed at the taxpayer capital gain rates. It is extremely advisable to contact your CPA. It may become more involved in determining your exact tax responsibility based on other factors such as recapture of depreciation taken under what maybe referenced as a partial exchange.
There is also another situation where mortgage boot may be present.
You acquired your relinquished property for $400,000 and sell your relinquished property for $1,000,000. There is a balance of $200,000 on the relinquished property. (For this example we will not attempt to account for any commission or cost of sale). Once the mortgage is satisfied you have $800,000 in cash. If the replacement property is $800,000 and you pay cash for the property without a loan the $200,000 loan that was paid off would be subjected to what is known as mortgage boot (debt reduction) and taxes would be due. Again, it is extremely advisable to contact your CPA. There is another consideration on this example which we will cover later in this article under Delaware Statutory Trust reference.
Rule Compliance.
IRS rules for 1031 tax deferred exchange compliance are straightforward. Boot would be created in several scenarios. There are basically three main IRS rules or stipulation on being eligible or complying with the 1031 rules. That compliance would enable the exchanger to fully defer capital gains taxes.
The basic rules are:
The replacement property needs to meet or exceed the market value of the relinquished property.
The investor must use all the proceeds from the relinquished property to purchase the replacement property.
If there is a debt satisfied (mortgage) upon closing, then the same amount of debt must be replaced, or the investor can substitute additional cash into the exchange.
Utilizing the rules from above.
Meet or exceed market value. IF you are selling a property for $1,000,000 you must purchase a property for $1,000,000. There would be an offset for closing cost, commission and a few other items that would reduce the replacement price of the property.
Use all the proceeds. If you receive $1,000,000 in proceeds all the proceeds need to be used.
Replace debt. IF you are selling for $1,000,000 and have a loan paid off of $200,000 you need to have $200,000 in debt on the replacement property and use the additional $800,000 in proceeds towards the replacement purchase.
Exchange Guidance
Exchange guidance may be available from the Qualified Intermediary (QI). Many Qis assist investors with the required forms and adherence to the dates mandated for identification of the replacement properties. In addition the QI may also be able to provide some guidance on balancing the exchange if they understand the terms of the purchase. Technically this may fall outside their scope of services. When an investors submits the replacement list to the QI the entire market value for the replacement property is stated with out the breakout of cash (equity) invested and the debt component making up the full value. CPAs and Financial advisors who deal with 1031 exchanges on a regular basis may be better suited for balancing the exchange.
There will be Boot can I still exchange?
If you did not satisfy all the requirements for the IRS for a full deferral you can still enter into and execute an exchange. The 1031 tax deferred exchange is not an all or none strategy. Partial exchanges are possible.
Delaware Statutory Trust (DST) may assist with mortgage boot issues.
There are times in an investors life when they simply don’t want to apply for, sign for, or be financially responsible for another loan on the replacement property. Recently we assisted an investor with and interesting challenge. The exchange was rather large and started with the sale of an apartment property. The sale was for $6.1 million but conceptually can be utilized in a lot of situations. Upon the closing of the relinquished property the investor retained $300,000 to pay for personal items. This would be recognized as boot and taxes due. Taking boot occasionally serves a purpose especially when there are other financial needs. There was a loan paid off on the property of over $2M. The investor wanted an additional cash extracted from the exchange in the amount of $400,000. This created an issue with balancing the remaining cash and satisfying the replacement of debt. The solution was to create a diversified portfolio of DSTs with Non-recourse debt to the investor that balanced the total exchange. The investor was seeking a solution that would avoid signing for any debt responsibility. DST are all structured with non-recourse debt. The balancing exercise blended DSTs with a variety of loan to value property enabling the investors to avoid any potential taxes on mortgage boot. There would be taxes on the cash taken out of the transaction. In addition, we also balance the overall replacement market price of the relinquished property. One helpful addition to the solution was the investor’s CPA who we engaged with early on to fully understand the investor situation.
Final word
We welcome calls from investors and CPAs on the 1031 exchange process as well as how DSTs may simply the exchange process. If you are in the midst of selling your property and looking for a few suggestions, please contact us.
DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.
This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin -Sherwood Rd, Suite 200 Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
SOCIAL MEDIA
Social Media platforms are solely for informational purposes. Advisory services are only offered to clients or prospective clients where the advisory firm and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by NAMCOA unless a client service agreement is in place.
June 30, 2022- DST.EDU (Series B- Part 10) Retail Asset Class Editor’s note- this is part ten of a ten-part series on DST asset types.
Part 10: Necessary Retail Asset Classification Discussion
By Al DiNicola, AIF®
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC, member of FINRA/SIPC
Why Investing in Retail Makes Sense
Delaware Statutory Trusts (DSTs) continue to gain in popularity among cash investors and 1031 tax deferred exchange investors. Investors seeking diversification may refocused on a specific style of retail investment.
Driving around most cities and towns we see many businesses that provide valuable services to the public. Retail has been a major driver of the economy over decades. There is a wide variety of retail space that exist from small strip centers, neighborhood centers, regional centers, power centers and major lifestyle centers. In some areas of the country, we are surrounded by retail. In rural areas you may need to drive miles to purchase groceries and other necessary items for daily life. With the potential of lifestyle centers all retails have one goal in mind and that is to sell services or goods. Over the past 5 years there has been an acceleration of the e-commerce sector (driven by technology) creating competition to the brick & mortar outlets. Many of the brick & mortar stores have opened on-line outlets. There are active sponsor of DSTs structuring offerings with the potential for higher-than-average risk adjusted return especially with rising borrowing rates. However, the investor needs to understand the dynamics of the various retail sector.
Understanding the Retail Asset Class
As with all asset class investors need to understand what can create a successful investment. With retail there may be more variables that may be out of the control of the development company or in the case of a DST the sponsor. The success of a retail investment can be directly linked to the property. The US economy has a direct correlation to the success of many retail properties. Indicators including job creation and increased earning across all employment sectors do add to consumer confidence. The tenant who would be renting the property actually create the value of their business enabling the business to make a profit and afford to make lease payments to the underlying investors. Retail that can build a brand that consumers have confidence in the quality of service or effectiveness of the products prompting the consumer to buy will add to the tenant success. That would equate to tenant renewals for the landlord or investor.
Retail includes an overwhelming list of types of buildings, locations, and designs. We will provide a brief overview prior to a deeper dive into the DST style offering.
Lease Types, Anchors and Duration
We frequently hear the term Triple-Net Leases or if in type NNN. Landlord (investors) may prefer the NNN structure. The main reason is the tenant is responsible for all taxes, maintenance an dinsurance on the property. There may be variations to this structure. The landlord shifts the financial risk to the tenant. One concern for the investor may be how well the tenant maintains the building and potential problems failing to maintain properly.
In prior years stores such as Sears and others no longer in business were considered “Anchor” Properties. Today the anchor tenants many have changed but these anchors continue to drive traffic that smaller retail tenants may benefit from exposure. More traffic may result in increase in potential rents that tenants are able to pay.
Long term leases may benefit both the landlord as well as the tenants. Leases may be as short as a few years up to 20 years. Having a longer lease may assist the tenants to building their name recognition, brand and longevity in a neighborhood or location.
Is E-Commerce a Threat
When we hear E-Commerce, we may have visions of everyone ordering on line for many goods and services. Investor may be nervous of the word e commerce and the potential effect on the retail property success. True there are tenants moving from a traditional storefront and seeking a position online with brand identity seeking to create or in some cases recreate a business. E commerce and internet sales will continue and can be a threat to certain retail. The other dynamic is the increased physical stores for some online seller. For example, Amazon will continue to increase their physical presence. There are also strategic relationships with online sellers offering customers to ability to return unwanted merchandise at a physical location.
The relationship between the E-commerce sector will continue to evolve with the physical retail stores and may not be hurting the retail sector just creating a new relationship. There are consumers who want to be in a retail environment.
Is Any Retail Insulated?
There is another type of retail section that is worth mentioning. We may reference this as “the Insulated Retail Tenant”. The profiles of the retail tenant, (that may be included in a Retail DST), would address those that e-commerce sector that are impossible to replace. Services like a dry cleaner, specialty restaurant, such a juice vendor, ice cream, a clinic, nail salon, and other that involve labor to provide the service to the customer. Overall seeking diversified and desirable Retail tenants that can fill the parking lot with repeat customers, whether its weekly, monthly, or quarterly.
DST Retail Alternative
The DST retail offering seek a somewhat different approach to a typical retail offering. Over the past few years (and especially during the COVID environment) the offerings have focused on necessary retail. Recent portfolio offerings have included Walmart neighborhood stores, Kroger supermarket, Publix Grocery stores, NAPA Auto Parts, CVS, Walgreens, Dollar general, Fresenius Dialysis center, tractor supply and other similar types of stores. These physical locations would also have long term leases. This portfolio would not include a small unbranded retail store in a strip center. The other dynamic of a diversified portfolio of product type would be a geographic diversification. Many of the portfolios would include assets located in a variety of markets or states. A portfolio may have 18 different properties located in 9 states. There have also been single asset retail offerings. For example, there have been BJ Wholesale stores or Cabela’s Bass Pro shops that have appeared in DST offerings over the years.
Conclusion
The importance of spending by consumers cannot be questioned as a critical part of the economy. Many of the same investment criteria for investors in a non-DST investment is used for DST offerings. However, there may be an expanded vision of retail with a DST offering. The main difference may be the ability in a DST to obtain diversification both with markets and number of assets that may assist to mitigate risk for the investor. An investor with $1 MM to invest in a traditional real estate may have one location and with leverage may be forced to sign for a recourse loan on the asset. With a diversified DST portfolio, the same $1 MM may provide the investor with many more assets in their portfolio, non-recourse debt (if leveraged) and potentially geographical diversification. In addition, the passive nature of the DST with no management responsibilities may relieve investors of other concerns.
DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.
This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). NAMCOA’s corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 1719 NW Edgar Street, McMinnville, OR 97128 MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
Thank you.
NAMCOA® – Naples Asset Management Company®, LLC
Editor’s note- this is part nine of a ten-part series on the various asset types of DST offerings. Part 9: Medical Office Building Asset Classification Discussion
By Al DiNicola, AIF®
June 23, 2022 DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC, member of FINRA/SIPC
Why Investing in Medical Office Buildings Makes Sense
Delaware Statutory Trusts (DSTs) continue to gain in popularity among cash investors and 1031 tax deferred exchange investors. Investors seeking diversification may include Medical Office Buildings (MOB) in their portfolio. The need for medical services continues throughout the United States. Large and medium hospitals service the needs of a vast amount of the population. For the purposes of this article, we will focus on the smaller medical facilities that handle outpatient services that do not require an overnight stay. There are a variety of outpatient services that include kidney centers, surgery centers, orthopedic offices and many more. There has been growth in many areas of the country and not just in southern states where many retirees tend to relocate. The performance of this asset class has been consistent. The MOBs may be single site offering or there may be a portfolio of locations in an offering. Specific performance of the MOBs asset class may be hard to zero in on because many MOB have been included in the overall office asset class. Some typical office asset class offerings may have concerns for occupancy with the ability for employees to work from home. However, the MOB require full staffing to handle the growing needs of patient services. The MOB provide medical professionals facilities to handle the variety of needs of patients including surgery centers. When the facilities are professionally managed physicians and medical specialist can focus on the needs of the patient. Investing in DST as well as MOB are not for everyone. However, there are reasons to consider investing in the asset class. Based on the variety of medical services, procedures and requirements of the population of the US, the medical office asset class may be worth considering.
Strong Historical Performance
There has been a steady growth of the medical real estate space when compared with the general office space. In addition, long-term occupancy rates in MOB have steadily increased when compared to other office space. According to the CBRE 2021 Healthcare Real Estate Investor & Developer Survey Results, 90% of CRE firms stated that between 2020 and 2021 the occupancy of their medical office portfolios either remained stable or increased from the year prior.
When you visit a medical office building you may be aware of the amount of equipment that has been installed and other specialty build out components. The features of certain buildout include not only the waiting room and offices but all high-tech testing devises, monitors, plumbing needs, operating rooms, recovery rooms, special wiring for electronics, specialty gases and many more features. With all these tenant improvements it is easy to understand tenants staying longer than traditional office renters who may be running a business such as a law firm. There would be a tremendous cost involved with moving equipment and switching to a new location. For this and other reasons there is a stable occupancy rate for MOBs and have demonstrated consistent rent growth over the past years. This stability has also enabled landlords to increase the dollar per square foot rents.
DST sponsors recognize Investor Demand
DST sponsors recognize the strength of the MOBs historical performance over the past few years. Especially in the sun belts (southwest and southeast US) where there is an expansion of the medical office asset class. For this reason, sponsors are seeking opportunities to offer cash investors as well as 1031 exchange investors quality offerings. However, the task to bring on offerings is more difficult than you would imagine. There is competition for the assets for institutional investors and private investors. There are more REIT offerings than DST offerings.
Even during the Great Recession, the medical office building sector demonstrated resistance to the market slowdown. This may have provided an indication of how the asset class would perform in future turndowns as well as the COVID pandemic. The resilience to a downturn and the performance of the MOB drove the increase in investor interest.
Outpatient Locations
Many Americans have experienced taking someone to an outpatient center or going yourself. The innovations in technology and efficiencies in surgery centers provide exceptional care and results for patients. There are also several other specialty services such as kidney dialysis centers, orthopedic centers and a variety of other facilities. Numbers of outpatient centers continue to increase and do not show any signs of slowing down. The rationale for the increase may be connected to the patient looking for more access to healthcare (potentially being more affordable) and convenient locations. The traditional “in hospital” locations tend to be more expensive and by patients utilizing outpatient centers it may reduce the patients out of pocket expenses.
MOBs Asset Class may be recession resistant
COVID 19 accelerated the virtual or telehealth alternative to the traditional office visit. However, as well executed this new technology performed this type of online medicine is not an acceptable substitution for traditional medical services. The use of telehealth also prompts other questions such as what is the long-term efficiencies, quality and safety not to mention all the in person needs such as lab work, x-rays, and physical exams. As with any new technology the medical professionals need to monitor the effectiveness for the safety and health of the patients. Not to be overlooked would be the COVID-related elective surgery centers being closed.
Tenant Credibility & Responsibility
In a DSTs there will be a master lease that reflects underlying credibility and credit worthiness of the tenant occupying the space. The tenant may occupy a single site location or may have multiple locations in a portfolio. In many MOBs, including DST offering, the tenant typically enters into a triple net lease (NNN). This limits the investor exposure to escalation of expenses. The secure distributions may not have as much upside elasticity but will offer consistent returns. The Private Placement Memorandum (PPM) that all DST investors need to receive prior to investing will layout many aspects of the offering including the potential risks associated with the investment. Also, the background of the tenant leasing the space, terms of the lease, rental increases and other analysis would be illustrated.
Potential Distributions & Exit Strategies
The PPM would also illustrate the projected annual distribution (typically paid monthly) and the exit strategy for the potential sale of the asset. The exit strategy as with other DST offerings include receiving potential proceeds from the sale (at which time the investor would be responsible for their capital gains taxes to be paid), execute another 1031 into DST offerings, or execute another 1031 into a traditional brick and mortar real estate. Recently some sponsors have introduced an alternative in a 721 UPREIT. Details on the IRS 721 will be featured in future articles.
DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.
This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission).
NAMCOA’s corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 410 Peachtree Parkway Suite 4245, Cumming, GA 30041. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
Thank you.
NAMCOA® – Naples Asset Management Company®, LLC
Editor’s note- this is part eight of a ten-part series on the various asset types of DST offerings. Part 8: Industrial Asset Classification Discussion
By Al DiNicola, AIF®
June 16, 2022
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC, member of FINRA/SIPC
INDUSTRIAL ASSET CLASS
Industrial is one of several commercial asset classes and is also offered by sponsors of Delaware Statutory Trust (DST) . Cash investors as well as 1031 tax deferred exchange investors seek out industrial to add to their portfolios. There are different types of industrial buildings but many of the DST offerings are focused on the larger distribution centers, industrial manufacturing facilities and potentially building that house production facilities. For the purposes of this writing, we will focus on the larger buildings and not the smaller flex spaces (while very popular). The rationale may be the smaller buildings are not in much demand of DST offerings.
Over the past few years and surely aided by the COVID 19 pandemic, the large warehouses have become very popular in all commercial offerings. This may be a Real Estate Investment Trust (REIT) investing in a new distribution center (AMAZON) including a last mile distribution center to a very large (2 million square feet) automobile motor parts distribution facility. The industrial DST offerings may be a single site offering or a portfolio of industrial facilities. The portfolio may also have geographical diversification meaning located in several markets or states. The Industrial asset class has had fewer offerings when compared to the multifamily DST asset class. When offered the Industrial DST asset tend to sell out quickly.
Structure and function of industrial buildings.
Over the past five to ten years Logistics has been a buzz word for describing many aspects of the economy. This is also true on the storage and distribution of goods that are found inside industrial and manufacturing buildings. The industrial buildings are very large and typically there is minimal office space. Suffice to say industrial space is important in all regions of the country. The purpose of this article is to focus on the investment into industrial space. The continued development of manufacturing facilities in the US has had it challenges with many products being made offshore. However, once these products (even though produced abroad) may need to be assembled, stored, and ultimately deliverer to market for the consumers. There is a move to bring manufacturing back to the US known as “onshore”.
Industrial development considerations
Many areas of the country have seen an increase in the development and delivery of industrial space. Most notably the south has seen an increase compounded by increased migration of population. That does not mean other areas of the country are not seeing growth especially along the major transportation interstates. Every product that is purchased in the store or on line may move through many steps while being produced, packaged, loaded and delivered to the final destination. (Although at my home many of the Amazon deliveries are returned, but that is another topic). Where the individual facilities are located needs to be vetted as to the best location to handle the specific requirements of the delivery process or supply chain needs.
Some structures and properties may be owned by the end user of the building but if not, is owned by an investor. The investor then would lease to users of the space. The larger facilities are typically owned by public entities because of the sheer size and cost of the building. These public companies may be REITs either publicly traded or non-traded. Sponsors of DSTs will seek out well located industrial buildings to package the property. These packaged offerings will facilitate the needs of cash investors as well as 1031 tax deferred exchange investors.
Fast facts on Industrial Asset class
Location is very important for a number of reasons. Yes- location, location, is still valid.
Access to all transportation methods: highways, railways and air transportation should be motivating considerations.
Moving goods via truck is a vital primary component of the supply chain. The location of buildings with close adjacency (and visibility) to interstate highways becomes an added benefit.
New needs force new designs. Long gone are the days of shaky buildings with outdated facilities (amenities) inside and out. The bar has been raised on what the long-term users expect from the environment. The institutional investors are on board with providing the necessary capital to entice specific users to engage for long term. The end result is an increased appeal for the physical structure which may be a valuable consideration when ultimately sold.
The overall size in square footage and cubic volume is increasing. The warehouses (bulk storage) are becoming larger and larger. Not only the building sizes but the overall size of the land mass that permit potential expansion and more truck and trailer storage.
Raise the roof! Looking in the rear-view mirror 24 feet clear ceiling height was the standard. Currently the desired height is 32 feet and 36 feet. You may hear the reference clear ceiling heights and that would be calculated from the floor to the ceiling. Higher ceiling means more volume for goods. Recent improvements in the storage capacity of the racks inside the buildings (racking systems) increase the bulk storage capacity (volumetric storage space).
The depth of the newer buildings is a factor that is becoming more important. Typical industrial buildings may have a depth of 150 to 160 feet (larger than flex at 120 feet). The newer building may have depth as long as a football field and up to 400 feet deep.
There is a need for additional outside space. Occasionally we neglect to consider what goes on OUTSIDE the warehouse. To expedite the movement of goods there have been noticeable changes adding to the efficiency of the operation. There is need of ample tractor trailer storage as well as parking and providing a safe space for maneuvering the big rigs. The need for extra space equates to larger overall sites.
There have been building efficiencies improvements including added insulation and other advancement in protecting mechanical components. There may also be considerations for needed air conditioning for the items being stored even temporarily inside the warehouse. Certain buildings may also have dedicated frozen sections as well.
The investment Focus
Nearly every offering Private Placement Memorandum (PPM) includes a section or disclaimer on the COVID 19 potentially disrupting business. Some companies may have increased inventory which currently may create other unintended consequences as the consumer is rethinking their buying habits and needs as a result of inflation. However, AMAZON and others continue to secure well located bulk storage facilities with larger truck courts as well as facilities known as Last Mile Distribution Centers. Many consumers utilize e-commerce and have packages delivered nearly every day to their doorstep. We are all familiar with the delivery vans (originating from the last mile distribution centers) that show up nearly every day of the week to our homes.
Typically, DSTs (and other NNN) require the tenants to take care of repairs. However, there are occasions where the investors or sponsors are responsible for structural components. Those details would be included in the lease agreement along with renewal options, rent increases and other details.
Investment structure will vary depending on the sponsor offering.
DSTs are long term assets that may range between 7-10 years.
By design many of the DST offerings are structured with leverage. However, there are a few all-cash offerings from time to time.
The leverage is non-recourse and may satisfy the investor’s IRS requirements of replacing the debt under the 1031 tax deferred exchange.
There may also be offerings with increased debt or loan to value (LTV). By design a higher LTV may be in place to offset higher debt replacement needs.
Distribution will vary depending on the individual offerings.
There is also a structure referenced as Zero Distribution (similar to a zero coupon). Rather than paying an annual distribution to the individual investors all distributions are dedicated to paying down the loan on the property. The investor may benefit from a lower loan payoff when it comes time for the property to be sold.
Tenant quality
The tenant quality may include a local single user to a national credit rated quality tenant.
There has been single tenant user who have owned their building for many years and have equity in the property. These users include private and public companies. These users may execute a sale lease back (pulling cash out of the property) and then execute an extended long-term lease. The cash would be used to make improvements to an existing structure.
Large users (Amazon, major auto manufacturers, etc.) will make a substantial investment inside the building including robotics to assist in the processing and needs of the business.
Conclusion
Industrial has demonstrated a track record of a stable investment asset. There is a growing need for additional industrial space in many locations throughout the country. DSTs may provide tax favored returns. If you are considering an investment, please consult your financial advisor for additional information.
DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.
This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission).
NAMCOA’s corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 410 Peachtree Parkway Suite 4245, Cumming, GA 30041. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
Thank you.
NAMCOA® – Naples Asset Management Company®, LLC
