Real Estate Investors- who are they?
Real estate investors who are also landlords gain a lot of education while they own the property. As the years go by the landlord look forward to their graduation meaning selling the property and graduating from active management into another stage of their life.
By Al DiNicola, AIF®
February 1, 2023
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC
At times it is confusing for investors answering the question what is next. When you are the owner of a single rental property or multiple properties it can be rewarding financially. Naturally there is a lot of responsibility attached with the ownership. COVID may have added to the stress of owning and managing rental properties. Real estate investors may be in a similar situation as a business owner who is trying to decide what to do when faced with selling their business. In other words what are the potential exit strategies. If a real estate investor purchased their investment property more than 20 years ago the option of investing in a Delaware Statutory Trust (DST) was not available. Real estate owner who may be classified as baby boomers are shifting their attention towards an easier way of owning a real estate investment than the stress of managing the property. The process may be similar to a landlord graduating to another phase of real estate investment.
The graduating (retiring) landlords are seeking a method to avoid or defer taxes on the sale of their property. However, the landlord may want to transition to a different style investor with a stream of income on a regular basis but not with the management responsibilities. DSTs are for accredited investors and provide an easy transition (through a 1031 exchange) enabling the investor to pool resources with other investors. The investors may acquire a single asset property or a portfolio of assets/properties. Prior to DST gaining in popularity, Tenants in Common (TICs) were the preferred investment vehicle. The IRS ruled the DST legal entity provides an investor in DST an acceptable alternative for a 1031 tax deferred exchange as a replacement property.
Many investors may not fully understand their exit strategies with respects to their investment properties. If an investor wishes to retire from active management their alternative may be to simply sell, pay their capital gains and invest the proceeds into another investment. Surveys of business owners have demonstrated that 76% of business owners do not know or understand their exit options on selling their business. Real estate investors may be in the same position thinking their only option is to attempt to do a 1031 exchange into another traditional real estate investment. Investors (as well as business owners) are concerned with deferral of taxes and retaining as much financial positioning as possible. DSTs could be the perfect solution for real estate owners looking to defer capital gains taxes and at the same time eliminate the responsibility of managing the real estate investment. What may sound like a silly statement, investor no longer want to deal with tenants, toilets or trash. Graduating from the landlord stage into what is next is the question.
Here are a few reasons to graduate from being a landlord into a passive investor utilizing a DST.
DSTs are eligible as replacement properties when using a 1031 Tax Deferred Exchange.
As mentioned previously 20 years ago DSTs were not utilized in a 1031 exchange. Once the IRS in the 2004-86 ruling cleared the way to use a DST for investing there has continued to be a surge of interest. All of the same advantages of a 1031 exchange using traditional real estate are available when using a DST. This includes the ability to defer 30%- 40% of your sales proceeds as capital gains taxes upon the sale of your investment real estate. The DST provides a beneficial interest (fractional interest) that satisfies the “like kind” requirement of the 1031 exchange. The surge in DST investment can be seen by reflecting on the past few years of acquisitions. In 2019 there was $3.3 billion invested in DSTs; in 2020 there was $3.5 billion invested. 2021 had a record $7.6 billion of equity invested. Based on preliminary reports 2022 may produce $10 billion in equity invested into DSTs. Since DST are available to cash investors as well as 1031 exchange investor not all the investments were made via 1031 vehicle. However, the majority of the equity came from 1031 exchanges.
Multiple asset classes and locations can lead to a diversified portfolio.
There is a distinct advantage of investing in a DST based on the variety of asset classes as well as geographic location. The same traditional commercial asset classes exist in DST offerings. Multifamily, Student housing, senior housing, manufactured housing, industrial, self-storage, retail, office all may be offered as DSTs. A landlord graduating from owning a $500,000 residential rental property may be in a position to acquire three to four DST in any of the asset classes mentioned. Depending on the specific time the investor is ready to invest, the locations of the offering or assets may change providing the investor with potential of geographic diversification.
The barrier to entry is also lower in a DST than traditional real estate.
We had an investor who sold a $525,000 property and invested into four DST located in Texas, Florida, and Georgia. Since this is technically an investment in a security, purchasers need to be accredited investors. The minimum investment for cash investors may be as low as $25,000. Typically, 1031 investors have a minimum of $100,000. There is also a private placement memorandum (PPM) that accompany the acquisition.
Oh, what a relief- no more property management.
For those of us who have been down the road of owning real estate as an investment when there is a tenant involved, there comes a day when we are ready to graduate to something less stressful. Regardless if you engage a property manager there is the ongoing concerns of property maintenance and management. The nature of the DST is a passive investment, and the sponsor (through the master tenant) handles all the running of the property. It is worth repeating investors no longer deal with tenants, toilets & trash. Sponsors also handle identifying the properties and in the case of a leveraged property arrange the financing for acquisition. Of special note is for the investor who relinquish a property and pay off debt (mortgage or loan) there is a 1031 exchange requirement to replace the debt on the replacement property. DST (that have leverage) come prepackage with non-recourse debt.
CPR for 1031 exchanges
Over the years we have taken numerous calls from investors who hypothetically are grasping for air or at least a backup solution. A DST Can Provide Relief. The IRS has no extension for the 45-day (from the closing on the relinquished property) identification period or the total 180 days (from same closing) to close on the replacement property. Investors are challenged lately to find the replacement property that will check all the boxes within the 45-day identification period. The investor may want to have inspections, conduct due diligence, arrange financing and a host of other actions which not only creates stress but exceeds the 45-day period. We have been fortunate to assist investors who were in the final days of their 45-day identification period and used several DSTs as a backup plan. In one example an investor was engaged in negotiations with three different properties and identified two DST as backups. In another real-life example, an investor had been searching with their real estate agent prior to the relinquished property going under contract and during the 45-day period to locate suitable replacement properties. With 5 days remaining in the identification period and working with the investor’s CPA and QI we were able to locate and identify a variety of DSTs for potential acquisition. Within a few weeks the investor closed on a portfolio of six DSTs that included three asset classes in four different states providing a back up plan as well as diversification.
Packaging may be the key.
The advantage the DST option has is the way the sponsor packages the offerings. DSTs as a backup work really well for a short period of time. The real benefit for the DST revolves around the 45-day period. If your contracts for replacement properties are in jeopardy around the45-day period than a DST maybe a great back up plan. Once a DST is identified the closing date for the DST happens in a matter of a week and surely not 180 days. The very nature of the DST offerings are the offerings are able to be acquired quickly and will not drag on for 180 days. This is good news for the investor. The QI will not be holding your investment proceeds and your investment dollars will be working for them sooner.
Ready to respond.
Financial advisors who specialize in 1031 exchanges and DST offerings may be in the best position to assist with your questions and education. We track all the major sponsors of DSTs on a weekly basis and interact with the sponsors. We are ready to assist you the landlord who may be seeking to graduate to another style of investing.
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 email@example.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. 8215 SW Tualatin- Sherwood Rd, Suite 200, Tualatin, OR 97062 MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
NAMCOA® – Naples Asset Management Company®, LLC