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