Investors Moving from Triple Net Leases to  Delaware Statutory Trust

Triple Net Leas­es (known as NNN) con­tin­ue to be a sought-after com­mer­cial asset class for many investors.

By Al DiNi­co­la, AIF®, CEPA ™
Feb­ru­ary 4 , 2023
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC

The agree­ment used in a NNN lease specif­i­cal­ly spells out what the own­er of the prop­er­ty pro­vides and the respon­si­bil­i­ties of the ten­ant. Typ­i­cal­ly, in a NNN the ten­ant is respon­si­ble for all expens­es asso­ci­at­ed with the prop­er­ty includ­ing oper­at­ing expens­es, insur­ance, as well as tax­es on the prop­er­ty. The own­er of the prop­er­ty has lit­tle man­age­ment respon­si­bil­i­ty for the prop­er­ty. Items such as the roof and oth­er major items may be nego­ti­at­ed. By com­par­i­son a stan­dard com­mer­cial lease typ­i­cal­ly insur­ance and tax­es are paid by the investor/landlord. There are sin­gle net leas­es where the ten­ant pays prop­er­ty tax­es and in a dou­ble net lease the ten­ant pays for prop­er­ty tax­es and prop­er­ty insur­ance.

Triple Net leas­es may be use for a vari­ety of ten­ants in many com­mer­cial asset class­es. Typ­i­cal­ly retail, man­u­fac­tur­ing and oth­er ser­vice busi­ness­es enter into triple net leas­es. Cred­it ten­ant would include Take 5 Oil Change, Advanced Auto Parts, Wal­mart neigh­bor­hood stores, CVS, and oth­er nation­al ten­ants. There are ben­e­fits enter­ing into lease with a nation­al ten­ant. All real estate has risks involved and NNN are no dif­fer­ent.

In small­er strip cen­ters if the main ten­ant gets in finan­cial trou­ble, defaults on their busi­ness loans and can­not make their rent pay­ments, the land­lord may be faced with a big deci­sion. There have been nation­al ten­ants clos­ing their doors or even fil­ing chap­ter 11 or 7 (bank­rupt­cy). If the anchor ten­ant goes down there may be dif­fi­cul­ty fill­ing a spe­cif­ic space.

On the pos­i­tive side a triple net offers a steady and con­sis­tent rev­enue stream. The investor expects to have lim­it­ed man­age­ment involve­ment since the ten­ant is nor­mal­ly respon­si­ble for util­i­ty expens­es, repair costs, tax­es, and any prop­er­ty man­age­ment costs and issues. The investor or land­lord is free to focus on oth­er busi­ness oppor­tu­ni­ties.

Triple net leas­es tend to have low­er rents because the ten­ant assumes ongo­ing expens­es that would oth­er­wise be the respon­si­bil­i­ty of the prop­er­ty own­er.

Triple net leased prop­er­ties have become pop­u­lar invest­ment vehi­cles for investors because they pro­vide low-risk, steady income.

The man­age­ment free aspect of the NNN for investors have been the main rea­son for invest­ing into this spe­cif­ic asset class. Many baby boomer investors who have invest­ment real estate are seek­ing a solu­tion where a pas­sive invest­ment may be in their future. There are also oth­er investors seek­ing an eas­i­er way to get into a pas­sive real estate invest­ment for a num­ber of rea­son. For the most part the NNN prop­er­ties seem to be a solu­tion. But there are still a vari­ety of risks. There has been a tremen­dous amount of investors mov­ing out of tra­di­tion­al NNN as well as oth­er asset class­es and invest­ing in Delaware Statu­to­ry Trust (DST).

The Delaware Statu­to­ry Trust (DST) struc­ture embraces all the syn­er­gies of the NNN with mul­ti­ple addi­tion­al ben­e­fits. The DST struc­ture oper­ates as a pas­sive invest­ment where the investors have no man­age­ment respon­si­bil­i­ties. The DST struc­ture also includes a mas­ter ten­ant who han­dles all the man­age­ment of the prop­er­ty. The prop­er­ties includ­ed in this struc­ture include mul­ti­ple asset class­es. Hav­ing a vari­ety of asset class­es pro­vides the investors with asset class diver­si­fi­ca­tion. There is also geo­graph­ic diver­si­fi­ca­tion where an investor may invest in sev­er­al prop­er­ties in a vari­ety of loca­tions and even states.

Under­stand­ing a Delaware Statu­to­ry Trust

Investors typ­i­cal­ly invest in tra­di­tion­al deed­ed real estate. Pri­or to DSTs being approved as a qual­i­fy­ing replace­ment asset for a 1031 exchange by the IRS, investors were faced with lim­it­ed strate­gic solu­tion. A DST rep­re­sents a ben­e­fi­cial inter­est in a trust. The Trust (Delaware Statu­to­ry) owns the real prop­er­ty. One of the advan­tages of a DST struc­ture is the method of how the prop­er­ty is held. The DST prop­er­ty may be a sin­gle asset or prop­er­ty such as a 275 unit apart­ment com­plex in Texas. Alter­na­tive­ly, the DST may own a port­fo­lio of 18 nec­es­sary retail prop­er­ties (Wal­green, Trac­tor Sup­ply, and gro­cery stores for exam­ple) that are locat­ed in nine states. The typ­i­cal min­i­mum invest­ment for a 1031 exchange into a DST is $100,000. The oth­er advan­tage is the abil­i­ty to pur­chase the exact amount of your replace­ment prop­er­ty to avoid any “boot”. For exam­ple, if you sold a prop­er­ty (once again the relin­quished prop­er­ty) for $524,750.90 you can spec­i­fy that amount in a DST (based on avail­abil­i­ty).

Man­ag­ing Risk through Diver­si­fi­ca­tion

Con­grat­u­la­tions you have suc­cess­ful­ly sold your NNN invest­ment prop­er­ty. Now what do you do? Do you sim­ply move all the pro­ceeds into anoth­er prop­er­ty? You may cau­tious­ly place all your pro­ceeds into one prop­er­ty. You may also won­der if you acquire more than one prop­er­ty eas­i­ly and with­out jeop­ar­diz­ing your exchange. The pre­vi­ous men­tioned stress of the 45-day iden­ti­fi­ca­tion peri­od locat­ing one prop­er­ty not to men­tion more than one prop­er­ty com­pounds the stress. How­ev­er, a poten­tial (and proven) strat­e­gy may be the uti­liza­tion of mul­ti­ple DST prop­er­ties. There may be NNN DST prop­er­ties as well as oth­er DST asset that per­form as NNN prop­er­ties. Many finan­cial advi­sors would sug­gest not plac­ing all your eggs in one bas­ket.

Diver­si­fi­ca­tion seeks to spread risk out to more than one asset class or in the case of DST dif­fer­ent geo­graph­ic allo­ca­tions. There is risk in all invest­ment strate­gies. We always sug­gest investors review their real estate port­fo­lios and con­sult with their CPAs on the depre­ci­a­tion sched­ules of their prop­er­ties. CPAs may be aware of the advan­tages of the 1031 exchange process but there are a lim­it­ed num­ber of CPAs who have the expe­ri­ence in deal­ing with DST for a num­ber of rea­sons. Real Estate attor­neys may also be famil­iar with the 1031 exchange process, how­ev­er, like the CPAs may have lim­it­ed expe­ri­ence with the DSTs. We always wel­come calls from your CPA or attor­ney to pro­vide detailed infor­ma­tion on the DST solu­tion.

Deal­ing with Infla­tion

The ben­e­fit for the per­son leas­ing the NNN space is the min­i­mal rent increas­es that occur over the term of the lease. In eval­u­at­ing a com­mer­cial prop­er­ty typ­i­cal­ly there is a cap rate assigned to the Net Oper­at­ing Income (NOI) that deter­mines the val­ue of the prop­er­ty. Many of the nation­al ten­ants enter into long term leas­es that may extend 20 years plus. There may be very small rent bumps in the agree­ment that may be erod­ed with infla­tion over time.

So how does a DST deal with infla­tion?

Many DSTs will have a short­er lease term than the typ­i­cal NNN. The pack­ag­ing of the DST with pas­sive income and no investor respon­si­bil­i­ty may be con­sid­ered oper­at­ing sim­i­lar to a NNN. In effect oth­er asset class­es such as mul­ti­fam­i­ly apart­ments, stu­dent hous­ing, self-stor­age and oth­ers cre­ate oppor­tu­ni­ty for rents to be reset on an annu­al basis or in some cas­es short­er peri­od of time. This enables the DST to respond to the mar­ket.

Quick Deliv­ery and Response for Investors

The cash investors are typ­i­cal­ly at an advan­tage when pur­chas­ing a DST. The cash investors are ready. The 1031 Investors still have the abil­i­ty to “strike quick­ly” when they have com­plet­ed the sale of their relin­quished prop­er­ty and their pro­ceeds are sit­ting at the Qual­i­fied Inter­me­di­ary (QI). DST have been ref­er­enced as being pack­ages. Pack­aged from the stand­point of offer­ing doc­u­ments called Pri­vate Place­ment Memorandums(PPM) already com­plet­ed as well as being struc­tured with or with­out a debt com­po­nent. Many 1031 exchang­ers may be seek­ing debt replace­ment and DST debt is non-recourse to the investors. The quick deliv­ery means that if the 1031 exchange investor is pressed to the end of their 45-day iden­ti­fi­ca­tion peri­od they may still be able to iden­ti­fy a few solu­tions and save their exchange.

What can go wrong may go wrong.

Once a 1031 exchange investor has iden­ti­fied a tra­di­tion­al replace­ment prop­er­ty there may be a host of issues to keep a keen eye on so that your exchange will not fall apart. Inspec­tions, approvals for financ­ing, clos­ing con­tin­gen­cies all need to be tied up with­in the 45-days to pro­vide addi­tion­al com­fort for the investors.

NAMCOA can pro­vide a start­ing point.

Typ­i­cal­ly, we would engage an investor with just a few sim­ple ques­tions. Have you spo­ken with your CPA to deter­mine your poten­tial cap­i­tal gains. In some cas­es, the 1031 exchange options may not be the best solu­tion. How­ev­er, we can shed light on the entire 1031 exchange process since we deal with exchanges all the time. As men­tioned pre­vi­ous­ly CPAs and attor­neys may not han­dle 1031 exchanges as a com­mon prac­tice. Please let us know how we can assist you through edu­ca­tion, under­stand­ing and cre­at­ing a exit strat­e­gy.

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. 8215 SW Tualatin- Sher­wood Rd, Suite 200, Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.
Thank you.

NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC