What Real Estate Investors Need To Know About DSTs
Commercial real estate may be considered an “alternative” asset class, but there’s no denying it has moved into the mainstream as of late. Investors, large and small alike, are clamoring to add stabilized commercial property to their portfolios. One of the challenges, of course, is that commercial real estate is typically expensive and has high barriers to entry. Few people can access high-caliber deals on their own.
This is one of the primary reasons why Delaware Statutory Trusts, or DSTs, are so popular. DSTs allow investors to fractionally invest in real estate alongside experienced sponsors who manage a portfolio of properties on their behalf.
In many ways, DSTs are somewhat similar to the limited partnerships or LLCs others use to invest in real estate. In short, a sponsor pools the capital from accredited investors (or in this case, DST “beneficiaries”) to invest in real estate deals. The DST sponsor will have already acquired the real estate assets using its own capital. Those properties are then held in a trust. When someone invests in a DST, they obtain a pro rata share of ownership in that trust. This continues until the property first acquired by the DST is wholly owned by the various fractional investors.
Most DSTs require a minimum investment of at least $100,000. To invest, someone must first qualify as an accredited investor.
DSTs include several asset types, including multifamily, office, industrial and retail, as well as senior housing, medical office and self-storage. The typical DST hold period ranges from five to seven years. During this time, investors can potentially earn monthly cash flow distributions. Upon sale of the property, the investors will receive their proportional share of the sales proceeds including any gains from potential appreciation.
DSTs Deemed ‘1031 Exchange’ Eligible
DSTs are particularly attractive among real estate investors looking to conduct a 1031 exchange. The IRS has deemed DSTs 1031 exchange eligible, meaning investors who sell their real estate assets can defer paying capital gains tax by rolling the proceeds from the sale into another “like kind” asset. DSTs are considered a “like kind” asset, and since 2004, they have qualified as replacement property by the IRS for those looking to conduct a 1031 exchange.
Benefits Of Investing in a DST
There are several reasons why individuals might want to consider investing in a DST—via a 1031 exchange or otherwise. Here are some of the possible advantages DSTs have to offer:
• The ability to move quickly. Anyone interested in doing a 1031 exchange will find that the IRS has strict guidelines that must be followed. For example, investors only have so much time to identify and then close on a replacement property. If they miss this deadline, the transaction no longer qualifies for a 1031 exchange, and the owner will be subject to capital gains tax. One benefit of DSTs is they potentially allow investors to close quickly on their 1031 exchange replacement property or properties. The DST sponsor will have already established the trust, filed all necessary paperwork, conducted due diligence on properties and acquired those assets before soliciting DST investments.
• Access to institutional-grade properties. Although DSTs can own real estate of any quality, assets held by DSTs are usually institutional-quality assets. This includes Class A real estate in major urban areas as well as highly desirable properties in secondary markets.
• Risk diversification. DSTs have a relatively low minimum investment threshold, typically $100,000. This allows real estate investors to spread their risk across property types, geographies or with different DST sponsors. For example, someone may invest $100,000 into a DST focused on healthcare assets and another $100,000 into a DST focused on multifamily apartment buildings.
• Passive ownership. The real estate assets held within a DST are managed by experienced real estate operators who oversee the assets on the investors’ behalf. In other words, DST investments offer investors potentially passive income.
• Estate planning benefits. Once the proceeds of a real estate sale are invested into a DST, the DST investor can place those beneficial ownership interests into their personal trust for the benefit of their heirs. Upon the owner’s death, the real estate assets held in that trust receive a stepped-up basis, meaning that the property’s value is assessed based on the time of the owner’s death rather than the value when it was first acquired.
While DSTs offer many benefits, they are illiquid securities with no secondary market for selling them.
Like all real estate, the value of the property could decline. While DSTs typically pay investors on a monthly basis, there is always a risk that cash flow distributions to investors could be reduced or eliminated. Also, if the property is leveraged and is unable to pay the mortgage, there is also a potential risk of foreclosure. Investors should also consider the costs and fees associated with investing, as well as potential tax law changes and their income bracket as well as their tax status.