November 2022 DST Monthly Landscape Commentary ~ All Cash DST Offerings Increase      

By Al DiNi­co­la, AIF®
Novem­ber 15, 2022
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC

Struc­ture and Func­tion of Debt in a DST  

Typ­i­cal­ly, by design Delaware Statu­to­ry Trusts (DSTs) were con­ceived to pro­vide an alter­na­tive to the Ten­ants in Com­mon (TIC) struc­ture. When the IRS approved the DST struc­ture there were notice­able dif­fer­ences between the DST struc­ture and the TIC struc­ture. One of the com­po­nents was the abil­i­ty for the DST to offer non-recourse debt for investors.  The non-recourse debt would enable investors to sat­is­fy the require­ments of the 1031 tax deferred exchange. Any debt paid off on the prop­er­ty being sold must be replaced when the replace­ment prop­er­ty is acquired.  Replace­ment of debt can be accom­plished by obtain­ing a mort­gage on the new prop­er­ty, hav­ing the sell­er hold a pur­chase mon­ey mort­gage or bring more cash replac­ing the mort­gage. When an investor acquires an inter­est in a DST there is an assign­ment of debt that is cal­cu­lat­ed on the amount of equi­ty invest­ed and based on the loan to val­ue (LTV) of the DST. In the TIC struc­ture each investor would be liable for the debt and typ­i­cal­ly must sign per­son­al­ly on the loan. In a DST the debt assign­ment is non-recourse and there is no appli­ca­tion for the debt or lia­bil­i­ty for the debt by the investor.

Lend­ing Rates Increas­ing   

Over the past year the Fed­er­al Reserve (FED) has raised inter­est rates in an effort to curb the infla­tion rates. Bor­row­ing rates have increased, and the effect is notice­able. On the res­i­den­tial side of the mar­ket the pur­chas­ing pow­er for indi­vid­ual bor­row­ers has been reduced.  Last year an indi­vid­ual  bor­row­er may have been able to afford a $500,000 home based on bor­row­ing rates near or under 3%.  Inter­est rates have dou­bled, and the effect has reduced the abil­i­ty for a new bor­row­er to pur­chase a home.  The $500,000 home becomes a $250,000. Hous­ing stock is still an issue for many Amer­i­cans.  The increase in bor­row­ing rates also effects the acqui­si­tion of prop­er­ties that may be pack­aged as DSTs. While rents con­tin­ue to increase in cer­tain areas on the coun­try the increased cost of bor­row­ing will reduce the poten­tial dis­tri­b­u­tion that ulti­mate­ly reach­es the indi­vid­ual investors.

DST LTV Struc­tures

Spon­sors have  tak­en action to min­i­mize the effects of increased inter­est bor­row­ing rates on dis­tri­b­u­tion.  When inter­est rates were near 3% many DST spon­sors would struc­ture the acqui­si­tion of the prop­er­ties with 50% to poten­tial­ly 60% loan to val­ue. The ben­e­fits to 1031 exchange investors enabled the investors to eas­i­ly sat­is­fy the debt replace­ment require­ments of the exchange. With the increase in inter­est rates DST spon­sors have reduce the LTV to the 30% — 40% range. This may reflect a more con­ser­v­a­tive approach to under­writ­ing. The effect on investor need­ing debt replace­ment can also be seen. With few­er DST struc­tured with low­er LTVs an advi­sor needs to be aware of all the options avail­able. The effect on the DST cash flow may be few­er dol­lars need­ing to be allo­cat­ed to debt ser­vice that may min­i­mize the reduc­tion in poten­tial dis­tri­b­u­tions to indi­vid­ual investors.

All Cash DST Increas­ing

Pri­or to COVID there were a lim­it­ed num­ber of all cash DST offer­ings.  For exam­ple, if there were 30 DST avail­able (through the major spon­sors) there may have been one all cash DST. Because of the lim­it­ed sup­ply of an all-cash DST, the offer­ing would sub­scribe (sell out) quick­ly. COVID had direct effect on spe­cif­ic asset class­es. There were trav­el restric­tions, lock downs, iso­la­tion and a total dis­rup­tion of busi­ness as we knew it.  The hos­pi­tal­i­ty indus­try may have suf­fered the most since the restric­tion of trav­el, can­cel­la­tion of meet­ings & con­fer­ences, and vaca­tions vir­tu­al­ly shut down the indus­try. When hos­pi­tal­i­ty offer­ings start­ed to emerge again (pre inter­est rate rise) the offer­ings were struc­tured as all cash.  The all cash struc­tured elim­i­nat­ed the pos­si­bil­i­ty of fore­clo­sure since the was no loan on the prop­er­ty. Fast for­ward to today and the rise in bor­row­ing inter­est rates may have prompt­ed the struc­ture of addi­tion­al all cash DST offer­ings.  In look­ing at the DST Land­scape Overview there may be 10–12 all cash DST offer­ings. Many hos­pi­tal­i­ty offer­ings are still all cash. There is now a selec­tion (albeit lim­it­ed) of oth­er asset class­es that are all cash includ­ing Indus­tri­al, Senior Hous­ings, Health­care, Mul­ti­fam­i­ly and Retail. The assets may be sin­gle site prop­er­ties or port­fo­lio loca­tion includ­ed in one offer­ing. There is also a notable dif­fer­ence in the size of the all-cash offer­ings.  A few years ago, all cash offers (for exam­ple self-stor­age) were under $15M.  Now there are sev­er­al all-cash offer­ings that are well over $50M.

Appeal of All Cash DST

Investors who are not engaged in a 1031 exchange may wel­come an all-cash DST struc­ture. In addi­tion, there are 1031 exchanges that are con­sid­ered all-cash when there is no mort­gage to be paid off on the sale of the relin­quished prop­er­ty. The elim­i­na­tion of any debt elim­i­nates one the risk fac­tors asso­ci­at­ed with any real estate acqui­si­tion mean­ing fore­clo­sure of the loan.  All cash investors seek­ing the pas­sive income also have the lux­u­ry to acquire the DST as soon as the offer­ing is avail­able. All cash 1031 investors still need to time the clos­ing of the relin­quished prop­er­ty being sold in con­junc­tion with the DST being avail­able. This tim­ing may be chal­leng­ing. Anoth­er advan­tage an all-cash offer­ing would have for the investors who are able to invest cash is when the DST offer­ing goes full cycle (sold).  If the investor enters into anoth­er 1031 exchange, there would be no need to seek debt replace­ment. There are all-cash investors who are will­ing take on debt to increase their poten­tial tax advan­taged returns with an increase of depre­ci­a­tion.

Draw­back of All Cash DST

The imme­di­ate draw­back on an all-cash DST is the lim­it­ed appeal of the offer­ing to 1031 investors who need debt replace­ment. The oth­er con­cern may be the effect of the car­ry for­ward basis and the tax effect. In a 1031 exchange, investors should under­stand the effects of depre­ci­a­tion and how that may affect their car­ry over tax basis. 1031 investors who actu­al­ly are in an all-cash posi­tion (with no debt replace­ment require­ment) may want addi­tion­al basis cre­at­ed with a lever­aged DST. The lever­aged DST will have an assign­ment of non-recourse debt pro­por­tioned to the equi­ty invest­ed and based on the LTV of the DST. This may assist the investor seek­ing addi­tion­al tax shel­ter and ben­e­fits from depre­ci­a­tion. Please con­sult your CPA on your spe­cif­ic sit­u­a­tion and any antic­i­pat­ed tax ben­e­fits.

Future DST Offer­ings

Spon­sor will con­tin­ue to under­write new DST offer­ings with a debt com­po­nent enabling investors to sat­is­fy the 1031 exchange require­ment of debt replace­ment.   There will also be DST offer­ings that will rep­re­sent all-cash offer­ings.  The all-cash offer­ings will appeal to direct cash investors as well as the 1031 exchange investors with no debt replace­ment require­ment. Advi­sors who mon­i­tor the DST avail­abil­i­ty and per­form due dili­gence on offer­ings are in the best posi­tion to assist all DST investors,

Keep up with oth­er top­ics on https://dstnews.org/

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