Cash Investors Welcomed …DST Not Just for 1031 Exchanges

Al DiNi­co­la DST Invest­ments- Reg­is­tered Invest­ment Advi­sors

Novem­ber 2019

There are many arti­cles cen­tered on uti­liz­ing DST alter­na­tives for com­plet­ing an IRC 1031 tax deferred exchange. Relin­quished real estate hold­ings may be replaced with a Delaware Statu­to­ry Trust (DST) asset(s). There are two rea­son why this works: The Inter­nal Rev­enue Code, Sec­tion 1031 and Delaware’s statu­to­ry law. There may be tremen­dous stress in locat­ing a real estate replace­ment with­in the 45 days (and not over­pay­ing) and then ulti­mate­ly clos­ing with the 180-day peri­od. The DST also pro­vides the incen­tives of prop­er­ty own­er­ship with­out tak­ing on any of the man­age­ment respon­si­bil­i­ties.

How do you par­tic­i­pate in the DST if you are not doing a 1031 Exchange and sim­ply have cash to invest?  Many spon­sors of DSTs have invest­ment options open to cash investors.  For investors just start­ing out you may add real estate to your port­fo­lio through a DST. You must be an accred­it­ed investor.  Many DST spon­sors have dif­fer­ent min­i­mum invest­ment amount for a 1031 Exchange (typ­i­cal­ly $100,000) but for a cash invest­ment the amount may start at $25,000.  So, what would you receive for the $25,000?  You would receive a frac­tion­al own­er­ship in a large prop­er­ty that is pro­fes­sion­al­ly man­aged.  Typ­i­cal­ly, a small­er amount would not per­mit you to pur­chase into a large port­fo­lio of real estate. This is dif­fer­ent than invest­ing in a REIT.

The DST may pro­vide you with a tax advan­taged income. Own­ing real prop­er­ty pro­vides you tax ben­e­fits includ­ing mort­gage inter­est deduc­tion. This is if there is financ­ing involved with the DST.  Typ­i­cal­ly, the lever­age for DST may be between 50%-65%.  Mean­ing the loan to val­ue between the loan amount and the pur­chase price of the DST asset.  How­ev­er, the DST is the bor­row­er and not you the indu­vial investor. The loan is non-recourse to you the investor.   Each year you the investor may claim your share of the mort­gage inter­est deduc­tion. (Please con­sult your accoun­tant to see how this may affect your per­son­al sit­u­a­tion). When you sign up for a DST that has lever­age you don’t apply for the loan per­son­al­ly. How­ev­er, you will receive annu­al state­ments for the inter­est deduc­tion as well as the depre­ci­a­tion on the asset.

There are many sto­ries about indi­vid­u­als (who want to become investors) find­ing a prop­er­ty, nego­ti­at­ing with the sell­er, fill­ing out the loan papers, obtain approvals for clos­ing, and even after a due dili­gence peri­od the deal could still fall apart. Spon­sors prepack­age DST offer­ing. The spon­sor has done all the front work and DSTs are prepack­aged.  The spon­sor has locat­ed the prop­er­ty, nego­ti­at­ed the pur­chase, com­plet­ed the due dili­gence, and has all the man­age­ment in place as well as any mort­gage on the prop­er­ty. This elim­i­nates all the stress. DST offer­ings are ready to go and can close in a mat­ter of days not months.

What hap­pens once you own a DST?  There is the poten­tial for month­ly recur­ring income. Most DSTs make month­ly dis­tri­b­u­tions to investors. The investors are not active­ly involved in the real estate and this is con­sid­ered pas­sive income.  This will show up in your mail­box (hence the term mail­box mon­ey) or you may pre­fer direct deposit to your bank­ing account.

So, what is your lia­bil­i­ty you may ask.  There is a ref­er­ence to DST being bank­rupt­cy remote.  There are pro­vi­sions in place to pre­vent this but in the event the Trust would go into bank­rupt­cy your per­son­al assets are not at risk.  The amount you have invest­ed may be affect­ed but none of your oth­er assets. Unlike oth­er real estate loans where you may have recourse for the loan includ­ing poten­tial hav­ing your oth­er assets cross col­lat­er­al­ize, the DST is the sole bor­row­er.

What hap­pens when it over? Over means the spon­sor has decid­ed to sell the real estate asset (DST).  Spon­sors have exit strate­gies rang­ing in time from 7–10 years. These would be cov­ered in the Pri­vate Place­ment Mem­o­ran­dum (PPM). When this real estate ven­ture is over you have many options. You will be noti­fied by the spon­sor of the sale and the pend­ing clos­ing date.  Your plan of action may include tak­ing your cash pro­ceeds (ini­tial invest­ment and prof­it) and pay­ing your tax­es.  You may also do a 1031 Exchange for anoth­er real estate prop­er­ty as a sole own­er or part­ner in a deal. This would/may defer any cap­i­tal gains.  You may also do a 1031 exchange into anoth­er DST if the expe­ri­ence has been accept­able to you and your invest­ment goals.

What are the risks?  Any real estate invest­ment should be con­sid­ered an ill liq­uid invest­ment. A DST is own­er­ship of real estate and car­ries the same liq­uid­i­ty draw­backs.  You will/may receive cash flow from the invest­ment, but your ini­tial cap­i­tal and any prof­its are tied up until the prop­er­ty is sold.  You may hear the term “cycle” mean­ing how long the DST is owned before the invest­ment is com­plet­ed and asset is sold. How long does the cycle take? Typ­i­cal­ly, spon­sors ref­er­ence this as a long-term hold which is 7–10 years.  Occa­sion­al­ly the cycle maybe short­ed. When the cycle is short­er the investors reac­tion may be one of “I wasn’t ready for this to be over”. Mean­ing the investor may want to DST to have a longer life espe­cial­ly if the month­ly cash flow con­tin­ues. There is not an MLS for indi­vid­ual own­er­ship of DSTs. Investors can­not call up a bro­ker to list their frac­tion­al own­er­ship of the DST.

You don’t get to vote in any of the deci­sion of the DST. Con­trast­ing this to the Ten­ants in Com­mon (TIC) where you need­ed unan­i­mous con­sent to take any action.  (Not to men­tion in a TIC all 35 poten­tial mem­bers may be sign­ing on the loan, but that is anoth­er arti­cle). You are invest­ing in a deal where there is pro­fes­sion­al man­age­ment who han­dles the leas­ing, cap­i­tal improve­ments and all the oth­er deci­sion, includ­ing when to sell the assets. You will be rely­ing on the spon­sor and you need to have con­fi­dence and trust in the sponsor’s track record. Con­sult your invest­ment advis­er for addi­tion­al due dili­gence on the spe­cif­ic real estate asset as well as the spon­sor track record.

If you are search­ing for an eas­i­er way to get into the real estate invest­ing mar­ket and want to invest your cash, a DST may be just what you are look­ing for in real estate. It may take all the fun out of locat­ing, nego­ti­at­ing, due dili­gence, loan appli­ca­tion, man­age­ment and then deal­ing with ten­ants, trash and toi­lets. (The 3 T’s make it into the arti­cle). For a great start­ing point con­sult an Invest­ment Advis­er who spe­cial­izes in DST invest­ments.

For more infor­ma­tion on how to prop­er­ly set up an IRC 1031 Tax Deferred Exchange or if you are an accred­it­ed investor and would like addi­tion­al infor­ma­tion on a DST con­tact Al DiNi­co­la at 239–691-8098