June 30, 2022- DST Education Series B- Part 10 Retail
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.
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 firstname.lastname@example.org.
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).
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NAMCOA® – Naples Asset Management Company®, LLC