By Al DiNicola, AIF®
October 15, 2022
DST 1031 Specialist
NAMCOA® — Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC
DST Investment Reach New Levels.
As we start the fourth quarter of the year sponsors of Delaware Statutory Trusts (DSTs) continue to bring product to a thirsty market. Cash investors as well as 1031 tax deferred exchange investors seek refuge in Securitize Offerings. DST offerings are found in the same asset classes as other commercial real estate but with a security wrapper around the asset. DSTs are structured to enable individual investors the ability to invest in larger and potentially more expensive properties (along with other investors) to benefit from higher value assets. Underlying demographics , i.e., the aging of baby boomers, have arrived at a point in their lives where their goals have changed. Goals may include moving out of active management of real estate and seeking hands-off management. There are also the benefits of the passive nature of DSTs as well as the potential generational wealth strategy afforded to all 1031 tax deferred exchanges when there may be a step up in basis. A step up in basis would occur when the investor passes the asset to their heirs. The step up in basis may result in the elimination of capital gains and other benefits.
2022 Potential Record-Breaking Year for DST investment
Earlier this year we reported the dollar volume of equity invested into DSTs during 2021. $7.4 Billion was invested in 2021. That amount was more than the previous two years combined. At the end of September 2022 there is a reported $7.76 Billion of equity invested. There is an expectation that the total equity could reach $10 Billion in 2022. There has been a major shift in the asset allocation of equity being invested. Multifamily which typically represents 50% of offerings and 50% of equity invested has been reduced. Multifamily invested equity as a percentage of equity is about 39.1%. Industrial has become more available and currently represents 26.2% of the invested equity. Retail is at 9.2% and Self-storage 8.4% of the equity invested. Office does have a following at 6.5% and Senior Housing at 5.9%. The other asset classes will make up the rest of the invested equity. There have been limited offerings in Hospitality, Manufactured Housings, Student Housing and Medical Office. The balance of the year may reflect similar results since multifamily and Industrial each make up 41% of the available equity (totally 82% of all offerings).
Timing is the Key
Investors and advisors are focusing on availability and process to ensure successful acquisition. One of the typical metrics in the residential real estate market is called “Days on Market”. The same analysis can be performed in the DST space. The average days on market has dropped over the past three years:
• Average Days on Market (2020): 200 days, Median: 164
• Average Days on Market (2021): 107 days, Median: 69
• Average Days on Market (2022): 88 days, Median: 82
Offering Size Increases
Of interest may be the scale of the assets that are being offered.
• In 2015 the average offering (deal) size was $10.2 M.
• In 2019 the average offering moved up to $20.4 M.
• In 2021 the average offering size increased to $27.9 M.
• At the end of September 2022, the average size offering is $42.6 M.
This was a dramatic increase. When we contrast the average days on market decreasing (selling quicker) and the offering size increasing(size of offering becoming larger) there is a real urgency to understand the dynamics of the market. Advisors need to align the investor needs and goals with the potential offerings. The good news for investors is that the shelf life or the number of offerings that are available may correspond to your 45-day identification period. Cash investors have always been able to pull the trigger on their selection.
Market Demand continues to be strong
The demand for the DST offerings continues to be strong. The weekly absorption of equity may illustrate the strength of the market.
• The average equity raised per week in 2021 was $155 M.
• Average equity raised through September 2022 was $199.7M.
There is no secret with rising interest rates that the projected returns may be lower than in past years. However, the overall appeal to the passive income, no management duties, and tax favored return entice many investors take an interest in the DST option. Similar to new home sales and home price index, 1031 exchanges (including DSTs) are considered to be a lagging indicator.
Full cycle Exit strategy.
There is one item that is noteworthy with regards to full cycle activity. The definition of full cycle is the successful acquisition of the asset by the sponsor, the successful subscription of the offering or asset by investors and then the ultimate sale of the asset at an acceptable profit by the sponsors to the benefit of the investors.
As a note the investor at the full cycle event will typically have three options.
- Accept proceeds and pay capital gains.
- Arrange 1031 into another DST.
- Arrange a 1031 into a traditional real estate asset.
Some DST may offer a 4th option of moving into a 721 UPREIT.
Over the past year (2021) as real estate values increased in many areas of the country DST sponsor sold assets or properties. Rents were increasing resulting in an increase in net operating income (NOI). The increase in NOI correlated to an increased valuation or purchase price. Current DST assets (for example multifamily) are experiencing high occupancies, and stable cash flows. The increase in interest rates for acquisition (a full cycle sale to another party) has demonstrated a slowdown in DST selling or going full cycle. There is no urgency for sponsors to sell the properties especially with strong cash flows. Many sponsors calculate an exit strategy or a target exit sales price that protect the investor equity as well as an internal rate of return metric. Sponsors (actually the Master Tenant) will simply continue to collect the rents and return distribution to the individual investors.
Fourth Quarter Crystal Ball
The industry may or may not hit the $10 B mark of invested equity. What we have seen is an increase in the number of offerings and the geographical diversification of the offerings. A key element for any investor is to fully understand the DST acquisition process with the assistance of your advisor. Investors using a 1031 tax deferred exchange need to understand the local real estate dynamic and how your local market will respond to the potential sale of your property. However, as a 1031 investor as well as cash investors it is never too early to seek guidance and education.
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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. 1719 NW Edgar Street, McMinnville, OR 97128 MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
Thank you.
NAMCOA® — Naples Asset Management Company®, LLC