Step by Step — Understanding a DST

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.