Step by Step- Understanding a DST
By Al DiNicola
June 10, 2020
DST Investments, LLC, Registered Investment Advisor
I attend more and more real estate investment meetings and the big question that comes up is “What is a DST”?
DST is the acronym for the Delaware Statutory Trust. As the name implies it was established in Delaware. However, you don’t need to live in Delaware to invest in a DST. DST may be located anywhere in the US. Recently it has become the investment choice of many participants. This is a fractional ownership of real estate permitted by the IRC Section 1031 tax deferred exchanges. DST are rapidly replacing Tenants in Common (TICS) for several reasons.
Large national well know sponsors and a few newer sponsors are providing investment opportunities within single properties or portfolios that include multiple properties. These sponsors typically are national real estate companies and are offered through securities broker/dealer or Registered Investment Advisers.
The replacement properties that are represented within a DST are typically out of the purchasing reach of smaller investors. Today many baby boomers are utilizing this vehicle to invest in institutional quality properties. Many investors seek passive income because real estate is not their primary business. Many baby boomers who created their portfolios of real estate may have started with one or two rental home and then progressed to large properties. As one would imaging there is a certain level of management expertise needed to oversee the property. When boomers were in their prime the challenge of active management was what the boomers were seeking. Something happens when you reach retirement age. Many seek a strategy on cashing in their real estate portfolio, through some sort of tax deferral naturally, but they want to avoid all the management headaches that may still be lingering in their minds. The tenants, toilets and trash are referenced many times! This situation and many other reasons are supporting the strategy to use a DST as a solution. Future articles will deal with many of the advantages of the DST. One of the main benefits of the DST is the opportunity to identify DST assets even as a back up to a traditional 1031 Exchange. The 45-day period from closing on the relinquished property slips by so quickly. A good adviser can assist you in the identification efforts.
Let’s look in the rear-view mirror.
Less than 20 years ago the US experienced a real estate boom and the real estate securitized industry grew rapidly. Up until 2007-2008 real estate was doing well. Then came the bust and commercial real estate as well as residential suffered in many areas of the US. Securitized real estate sponsors before the bust were many. After the bust the industry contracted.
Tenants in Common (TICs) as mentioned previously were the predominate ownership in a fractional form prior to the crash. We will address the differences in detail in future articles. Safe to say TIC created many problems with joint ownership, recourse loans as well us required approval for taking action. These issues and others were the impetus for the DST structure. Prior to the recession DST were just getting started. In 2004 the Internal Revenue Code published Revenue Ruling 2004-86. At that time there were only a few major sponsors. Inland Private Capital was one of the first to provide DST offerings. After the recession many other sponsors use the DST almost exclusively rather than TICs.
Fast forward to Today.
Mountain Dell Consulting is a market research firm providing a great deal of information on what is currently going on in the 1031 exchange marketplace specifically in the securitized arena. As of the beginning of September 2019 there was $2.4 Billion raised in equity. The predictions for year end 2019 are $3.3 Billion. That is a daily raise of $9.125 Million.
DSTs are now front and center as a vehicle of choice.
There were a few changes with the Revenue Ruling 2004-86. One would be a rule that mandates only passive real estate qualifies for IRC Section 1031 treatment in a DST. That is not all bad. Translation may be- headaches are gone with active management. So what properties qualify? Net-leased properties (referenced as NNN), or real estate, such as multifamily apartments. In all cases there needs to be a master lease in place. There are no new leases (with the master tenant) during the life of the DST. In a multi-family situation individual leases for tenants will be acceptable.
The cost for the DST is simpler and less expensive than the TIC structure. In a TIC everyone signs on the loan. In a DST only the DST Trustee signs on the loan. The loan (if applicable since some DST are all cash) is completely “nonrecourse” to the individual investors. TICs are limited to 35 investors but with DST there are many more participants. Normally the minimum investment in a DST (with a 1031) is typically $100,000. The acquisition process is very simple with one agreement for the investor to sign. The 1031 Exchange QI arranges the transfer of funds.
DST Asset Classes follow Commercial Asset classes. Investors may continue to pursue their favorite sector of commercial real estate. Typically, multifamily (including student housing) make up nearly 50% of DST acquisitions. However other sectors including self-storage, office, industrial, health care, hospitality all have their sweet spot for investors.
Making it on the 45-day list!
You may have heard about the three-property traditional list you need to provide to your Qualified Intermediary if doing a 1031. If you are identifying a DST with multiple properties in the portfolio more than likely your QI will use the 200% rule. You as an exchanger can identify as many properties as you like for the 45-day list if the combined total does not exceed 200% of the property you just sold (relinquished property). Recently the DST was intended to be a back up to other properties that were placed under contract during the 45-day period. Fortunately, the exchanger identified several DST because the original property fell apart and required the exchanger to sign on a recourse loan that was cross collateralized with other real estate the exchanger owned.
One last thought, since DSTs may be purchased in small amounts this is a perfect solution for any leftover proceeds (known as potentially boot) to avoid paying taxes or at lease defer paying taxes.
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.