Sponsors Moving into High Gear with Due Diligence and Acquisition of Future DSTs  

May 2022 DST Monthly Landscape Commentary

By Al DiNicola, AIF®

May 15, 2022

DST 1031 Specialist

NAMCOA® – Naples Asset Management Company®, LLC

Securities offered through MSC-BD, LLC

Sponsors Focus on Alternative Opportunities.

Many of the larger DST sponsors offer alternative real estate investments.  These offerings include not only Delaware Statutory Trust but also include Opportunity Zones (OZ) or Qualified Opportunity Zones (QOZ). Alternatives also include other offerings such as Real Estate Securities, Private Equity/Debt, Hedge Funds, Public Equity/Debt, Energy, and Infrastructure among others. When focused on the Real Estate sector, structure and function is key when determining the strategic product selection.  The DSTs may comprise most of the alternative offerings. However, other structured offerings include the Limited Liability Structure (LLC), REITs, Limited Partnerships, Preferred Securities, Closed End Funds, Bonds, and Tenant in Common (TICs).

Because of the many alternative types of structures there continues to be challenges in securing the initial acquisition of the real estate. Then sponsors determine how to package the offerings for accepting investor’s equity. Fortunately, the robust real estate market provides a vast potential supply for selection. The DST offerings satisfy not only the cash investors thirst for passive real estate investing but also the large pent-up demand for 1031 tax deferred exchange investors.

Investors continue to seek the DST structure as a potential solution for their current and future wealth creations and planning.  

Sponsors seek out real estate opportunities and assemble in what is known as a sponsor’s “pipeline”.  There are real estate assets located nearly in every state. In the first four months of 2022 there has been a record amount of equity moving not only into alternates but the DST space. While there is a big demand, sponsors have a responsibility to conduct due diligence and structure the offerings.  The rising interest rates may create challenges in the structure of DSTs.

The all-cash DSTs (without debt) have always been straight forward. By design there are few all cash DST since many 1031 investors require a debt replacement strategy to comply with the IRS requirements on replacing debt to avoid mortgage boot. The majority of DST will have a debt component (non-recourse to the investors). Over the past few months newer offerings have seen a decrease in the loan to value (LTV). Looking back a few years the LTV structure of the DST have been between 55%-65% LTV. This may have been driven by the lower cost of borrowing over the past few years.  In a potential rising rate environment, we are experiencing a decrease in the LTV to under 50% LTV and many moving into the mid to lower 40% LTV. This may create a more conservative under writing process. It may also create challenges for investors in certain situations. We will cover debt replacement strategies in other writings.  

Locations for DSTs continue in many states and markets.

The rationale for selecting acquisition of the DST by the sponsor focus on the fundamentals for each asset class.  Multifamily, which comprise the majority of offerings, has a check list of must haves for sponsors to consider the acquisition and ultimate packaging for the eventual individual investors. The location, access, jobs, schools, and other site selection prerequisites continue to be mandatory. Industrial offerings may be more focused on transportation accessibility such as the last mile distribution and logistics centers. Self-storage, student housing, senior housing, Manufactured housing all continue to become available with offerings that are in demand. The limited supply increased the investment pace. Meaning, if there is one self-storage offering for every 5 multifamily offering the period of time the self-storage offering is available maybe limited.  

The primary large markets in the US may not always be a mandatory and the only the priority for the sponsor selection committee.  There are opportunities arising in many states and location that have not only the fundamentals but have growth opportunities.  The prices for acquisition of many of the properties are increasing. Secondary and tertiary locations are checking all the boxes so the speak and now are very appealing for individual investors. The increase of rental rates in the multifamily sector in many markets continue to validate the investment into multifamily. However, the borrowing rate and increase acquisition cost do create a squeeze on the bottom-line cash flow.  

Private Placement Memorandums (PPM) contain details on the offering.

There are many details on the DST offerings. One of the elements would be the financial structure of the offerings.  A key component would be how much equity would be offered and how much debt would be secured. Sponsors who offer DST with a debt structure typically create a purchase structure with both equity and debt component. The cash flow model may reflect an interest only debt structure as well as potentially a combination of interest only and amortize loans.  When looking at the proposed annual distribution projections an investor may see a distribution rate at a certain level for a number of years and then a potential decrease once the loan converts from an interest only loan to an amortize loan. In theory the reduction of direct distribution or income to the investor is shifted to paying off the loan on the asset. Investors may realize this benefit (or loan payoff) upon the sale of the asset.     

Sponsors will continue to secure assets, conduct their due diligence, structure the acquisition and present to representative.  Investment advisors will review the offerings and perform their own due diligence and evaluate the merits of the offering for recommendation to investors.  The individual investors will determine with the assistance of the advisor the suitability of the investment.  Currently sponsors are in full acquisition mode as the industry is responding to the demands of the markets.

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 adinicola@namcoa.com.

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). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 410 Peachtree Parkway Suite 4245, Cumming, GA 30041. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.

Thank you.

NAMCOA® – Naples Asset Management Company®, LLC

About the author

Al DiNicola, AIF, CEPA, specializes in 1031 Exchanges utilizing DST as a viable alternative for accredited investors. He also is well versed in Opportunity Zones and Alternative Real Estate Investments. Mr. DiNicola has more than 40 years of experience in commercial & residential sales and development. Al has extensive experience in real estate land acquisitions, development, investment and real estate securities.

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