February 2023-The amount of Delaware Statutory Trust (DST) equity offerings that was in the pipeline in the later part of 2022 was intended to provide advantages for investors. Once the acquisition wheels were put in motion mid 2022 all the sponsors needed to do was to acquire the property or asset, perform the due diligence, create the Private Placement Memorandum and offer the properties to DST investors.
February 2023- MONTHLY LANDSCAPE COMMENTARY
By Al DiNicola, AIF®, CEPA™
March 22, 2023
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC
The flurry of additional properties brought to the market were intended to solve the availability issues that plague many 1031 tax deferred exchanges as well as the cash investors seeking passive income and no management responsibilities. One of the main features of DST ownership is the passive income coupled with the void of management responsibilities which aligned with many investors over the past few years. It appears that trend will continue with the expectation of investors who have actively managed their properties for many years who are seeking to remove themselves from the burden and other potential problems.
Sponsors did in fact solve the inventory issues that stifled investor options during most of 2022. Actually, the inventory gap started in the 4th quarter of 2021 and continued into 2022. Now investors have found some breathing room or escape from the urgency created by a lack of inventory or the need to identify something (unfortunately anything) to preserve the 1031 tax deferred exchange execution. The benefit was not only increased inventory but also additional loan to value percentages or what is known as leverage component.
Let’s focus on inventory.
There is a reported $3.5 Billion of equity or inventory that is being offered by sponsors through representatives and advisors. Representatives and advisors review the programs and offerings and determine suitability for individual investors. (We on average review two to three offerings each week). Individual investors have different risk assessments as well as asset class interest and not all DST offerings are for each and every investor. Multifamily offerings continue to dominate the available equity but to a smaller percentage than in past years. In past years Multifamily offerings would comprise 55-58% of the available equity. During an equity snapshot at the end of February multifamily made up only 43% of the offerings. What caused the double digit drop from past years? Potentially the increase in industrial offerings. Industrial now represents 20% of the offerings. The other factor may be the increase in office offerings. We have seen some specialized office offerings that may not be the traditional office but rather a specialized environment of office. Highly trained technical and medical related call centers are becoming more prevalent as we enter a different style of office. There has also been a slight uptick in the retail offerings that typically are considered necessary retail. Self-storage continues to attract investors, but the offerings have been limited going in to 2023. Student housing looks promising based on early fall 2023 lease ups. Hospitality has reentered the arena and with mostly all cash offerings.
The lack of inventory at the end of 2021 created pent up demand moving into 2022. Based on our experience the first quarter of many years have been quiet with regards to DST investment via 1031 exchange. The logical reason may point to investors finishing their previous year taxes and then having a discussion with their CPA. This discussion often focuses on potential tax efficiency. Aside from tax efficiency some CPA will review the depreciation schedules of the real estate owned by the investor. Together the investor and the CPA may determine there needs to be an asset realignment so to speak. This realignment may be selling one property that is fully depreciated and strategically acquiring other real estate. Investors who have owned properties for many years which may have been fully depreciated could benefit in selling those properties and repositioning with a DST asset. The investor may reset their potential tax efficient position all over again.
Over the past twelve months there has been a shift in the offering structure with regards to leverage. The underwriting criteria has shifted with respect to the loan to value (LTV) ratio. There are two forces working against each other at times. Sponsors are dealing with the increase in financing cost as interest rates rise. This prompts sponsors to reduce the LTV below 50% and in many cases in the 20% to 40% range. Naturally there will be more equity needed to balance the purchase. The move to a more conservative underwriting (with regards to LTV) may create pressure and anxiety for investors who need to replace debt to satisfy the 1031 exchange. There is a requirement to replace debt being paid off on the sale of the down-leg with new debt or additional cash. The “Down Leg” is referred to as the property that is being sold and qualifying for the 1031 exchange. The “Up Leg” is the property that is being acquired or the replacement property. An investor coming out of an exchange with a higher LTV creates a challenge for the investor and the financial advisor. There is also a large increase in the number of all cash DST (no debt) that have come to market.
Good news and challenging news
Increased inventory is good news for investors. Investors as long as they identify prior to the expiration of the 45-day notification period may enjoy additional time to review documents and take a deeper dive into the alternatives. Investors may have two to three times the number of specific alternatives than a year ago. So, what is the challenge? The challenge would be to balance the debt replacement for those investors who need debt replacement. The few DSTs that have an LTV above 50% LTV have become very popular for certain investors. The goal for meeting debt replacement and suitability for investors is always a concern. Recently we assisted an investor faced with this challenge. As a recommendation we positioned the investor with a suitable zero DST (no direct distribution) that had a high LTV. This recommendation enabled the investor to invest in an all-cash DST as well as a low LTV DST. The blending of the zero DST, all cash DST and a DST with a leveraged DST enables us to balance the exchange. As a reference a zero DST does not pay direct distributions to investors and uses those distributions to pay down the loan on the property. The other challenging issues (which may be viewed as an opportunity) is the diversification of assets with more selections. DSTs by design have a low barrier to entry typically $100,000. An investor engaged with a $500,000 exchange may acquire 4-5 DSTs (under the correct guidance) creating a diversified portfolio of different asset classes as well as geographical location.
Certain sponsors are reporting activity better than pre pandemic levels so far in 2023. Albeit less than the 2021 and 2022 frantic activity. At the end of February equity invested almost reached $1B. As noted previously the beginning of the year tends to be slower than third and fourth quarters typically. A new asset class (subset of multifamily) has entered the offering stack. The Built for Rent (BFR) asset class has started to gain popularity. Think of this as a horizontal apartment with detached single story dwelling units with smaller square footage than detached homes. There are limited offerings at this time but be aware of more offerings in the future. The other underlying factor is the housing unit deficit. We are still facing a housing deficit of 4 million living units. Multi family development will continue. The challenge is to locate the right property for you, the investor. Call to review your specific needs.
Crystal Ball for balance of 2023
What is the equity that may be invested in the balance of 2023? We see the underlying motivation of certain investors still the same as in the past five years. Seasoned investors are moving out of active management and into passive income vehicles. Investors are seeking non-correlated investments with respect to the stock and bond market. Seasoned investors are seeking less volatility in their investments.
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 firstname.lastname@example.org.
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.
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