We have written many articles on the types of Delaware Statutory Trust (DST), the due diligence process we engage as well as advising on the best alternative for each individual accredited investor. We track our compliance requirements prior to investors engaging with a DST Sponsor. There is one question that we have not addressed in a few years. That question is how we (and you as an investor) evaluate the DST Sponsor.
UPDATED: April 28, 2023
Original Release: August 2019
By Al DiNicola, AIF®, CEPA ™
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC
One of the first areas of consideration would be to identify the sponsors who would be offering the different DSTs as either a direct cash investment or replacement property for a 1031 tax deferred exchange. The landscape of available DST properties has changed over the past 2-3 years. The number of properties that were available prior to, during, and post COVID is an interesting analysis. As we came out of COVID there was a pent-up demand for 1031 replacement properties and a limited supply. This placed additional pressure on everyone involved in the DST “pipeline” or “supply Chain”. Fortunately, we are in a position where the investor has more opportunity to investigate the alternatives that are available. These alternatives are created by Sponsors.
What is the role of the Sponsor?
The Delaware Statutory Trust is formed under Delaware laws. This is set up for the purpose of conducting real estate business. This is considered a specialized type of investment entity. The entity or party setting up the DST is referred to as the sponsor.
The sponsor creates the trust, finds the property to be acquired, utilizing specialized attorneys to create the Private Placement Memorandum (PPM), and structures the management of the property once acquired. The sponsor also seeks to raise the necessary capital. The capital is raised mostly through financial advisors and representatives. Many times, the capital is raised through independent representatives and not a direct employee or associate with the sponsor. We will cover that aspect a little later.
The role of the sponsor is critical as they hold a key component in the successful launch, management, and eventual disposition of the property. Many times, you will hear the word asset class associated with the property. Asset class refers to the type of property. This may be multifamily, student housing, senior housing, build for rent, industrial, manufactured housing, self-storage, medical office, necessary retail, life science. These assets are institutional grade properties and typically out of the reach of many individual investors. The sponsor will be in charge of the offering and often be in control of and protect the DST so to speak. Their supervision is one of the key elements of success.
Preparing the offering
There are many critical steps sponsors need to take in order to prepare and present the offering to the individual investors. The sponsor will focus on the property that will be acquired and then packaged structurally as well as functionally. The DST needs to be prepared with documentation to be submitted to the SEC and FINRA. Attorneys need to prepare the Private Placement Memorandum (PPM) as well as a review of the offering by a third-party evaluation firm. Firms such as Fact Right, Mick Law, Bowman and others review the offerings. The review is a non-biased evaluation of the offering and comparison to other current and past offerings.
Independent advisors, registered investments advisors and broker/dealer representatives will review offerings that sponsors bring to market. Some advisors will meet and establish a line of communication with the sponsor to have access to all the background on the asset. Some firms require their representatives to complete due diligence and compliance reviews prior to interacting with individual investors. We review new DST offerings every week and hundreds over the past few years. Not every DST is suitable for every investor. Suitability and timing are key in the selection of the DST for the investor.
Does the Sponsor Matter?
Over the past 20 years, with DST being approved as a viable option for a 1031 exchange replacement property, there has been an increase in the number of Sponsors. Each sponsor is independent and may have a different approach to their offerings. Some sponsors will only focus on a specific asset class such as necessary retail or multifamily offerings. The size and level of sophistication will differ. The track record of the sponsor will also be different. Many of the new sponsors have long histories in the financial sector such as Real Estate Investment Trust (REIT) sponsors. The transition to DST offerings becomes another product offering for REIT sponsors. As a note, REITs do not qualify for 1031 tax deferred exchanges. However, the track record of the sponsor is important to consider.
Communication is important between the sponsor and the investor. It is difficult for the investor to gauge the level of expected communication and actual communication they will have with the sponsor. This is where the independent advisor may be of value. Independent advisors who have previous investors and relationships with sponsors can shed light on the ongoing communication that new investors will experience. Communication of important end of year tax document becomes top of mind as a must have for the investor. These documents need to be delivered on time to avoid any tax filing extensions for the investors.
How are sponsors established or organized?
It may be a little confusing at first trying to evaluate who is offering the DST. There are many private equity firms raising funds for a variety of real estate offerings and other alternative real estate investments. How a DST sponsor may be like and unlike a Private Equity Firm may be unclear.
Entities that invest money (equity) in other companies and potentially their own real estate are referenced as private equity firms. There may be an offering of a DST by the private equity firms. If that is the case the private equity firm will be the investment sponsor.
On the flip side the DST sponsor could be a private equity firm but does not need to be. This has more to do with structure than function. The DST sponsor’s organizational structure is different but still enables the DST sponsor to create offerings. Many of the individuals within the DST sponsors firm have years of experience in real estate, finance, and operations they bring to the firm.
DST Sponsor Credentials
When evaluating the DST investment options the review of the sponsor credentials or pedigree is one the most important factors
- Experience: The sponsors of DSTs who have a background in commercial real estate have a propensity for a better outcome than new comers to the commercial real estate arena. Large institutional REITs may be entering the DST marketplace and they bring decades of experience.
- Size: The overall size of the sponsor of the DST is very interesting. Some of the older sponsors are smaller firms who specialize in a very targeted asset class. Other sponsors are very large organizations handling multiple classes of offerings. Some investors may seek out larger firms simply based on the size of the company. There are very experienced companies who are laser focused on a smaller number of offerings each year. Larger sponsors may have 30-40 offerings in a year while smaller sponsors may have 5-10 offerings. Advisors who perform due diligence on the individual sponsors have insight into the overall competency of the sponsor. Finding the best DST that is suitable for the individual investor is most important.
- Asset Class: The same asset classes that exist in commercial real estate exist in DST offerings. Some sponsors of DST may be focused on a single asset class such as self-storage or multi family. Other sponsors may have a variety of asset classes in their offering menu.
- Cost: There are costs associated with establishing the DST and Sponsors charge fees. The amount of fees may vary by sponsor but typically the range is minimal from an overall cost structure. The costs in DST are packaged within the offerings meaning individual investors do not come out of pocket for additional fees on top of their investment. Costs and fees are fully disclosed in the PPM. Part of investor due diligence should include comparison of costs and fees between sponsors. You may hear the reference to the “load” on the offering. The load would be all of the cost of establishing the offerings that is added to the acquisition of the property. This may be compared to buying a regular real estate property where the closing cost on the property, points on the loan, title insurance, as well as commission paid (by the seller) are included in the overall cost of buying real estate.
We interface with all of the major sponsors and evaluate the newer sponsors entering the market place. Some of the more active sponsors are Inland, Capital Square, Passco, Exchange Right, Versity, Madison Capital, Cove Capital, Carter, NexPoint, Cantor-Fitzgerald and there are others we review and assist investors with their acquisitions.
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.
Social Media platforms are solely for informational purposes. Advisory services are only offered to clients or prospective clients where the advisory firm and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by NAMCOA unless a client service agreement is in place.