During 2023 equity infusion into Delaware Statutory Trust (DST) has continued. Many investors utilizing §1031 tax deferred exchanges seized the opportunity to repurpose their equity. There were many more investors who were prevented from executing a sale on their investment or commercial real estate for a variety of reasons.
By Al DiNicola, AIF®, CEPA ™
adinicola@namcoa.com
December 16, 2023
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC
Investors who were able to enter into a sale and closing took advantage of a variety of DST offerings including a variety of asset classes and geographical location. There were many significant changes in the economy during 2023 that tempered the equity infusion seen in the past two years (2021 & 2022).
Three immediate changes:
- Reduction in LTV
- Longer Shelf Life of Offerings
- Fewer New Sponsors
The performance of DSTs over the years may parallel the commercial real estate market in some respects. When capital for buyers is available (in the form of financing), at a reasonable interest rate, the real estate market heats up. Occasionally the market heats up too much, affecting the amount of inventory (meaning limited) or more buyers than sellers of certain properties. During the past few years (before 2023) multiple offers on real estate were received with some offers above asking price were common. In addition, many non-contingent contracts were submitted. COVID created an under supply of DST assets.
Coming into 2023 the rising interest rates created many of the issues for an overall slowing of the commercial real estate market.
Going forward into 2024 the fundamentals are still strong on who is the potential (typical) DST investor. The investor may be seeking to remove themselves from active management of the real estate or even dealing with a property manager. The investor may have seen an appreciation of their property in a relatively short period of time. Other investors may have held the property for a long period of time and have fully depreciated the property and potentially sitting on a large amount of cash equity. We have seen other investors (aka baby boomers) who seek alternative activities other than taking care of their real estate. Generational ownership of investment property may have also lost its glow. Recent surveys have indicated that only 1/3 of heirs (second generation) of business may actually really want to manage the business, asset, or property.
Were the changes positive or negative?
The lower loan to value (LTV) resulted in more sponsors offering all cash DST as well as leveraged DST well under the 50% LTV. This may be looked at as a more conservative underwriting. It may also be created as a necessity since interest rates were rising. Bottom line more equity needs to be raised and less debt needed. For some investors this was not welcome news. Investors with a higher required debt replacement may be scrambling to find just the perfect DST with the right LTV.
Longer shelf life has created more time for investors to review the alternatives. When DST inventory was tight (short supply) investors may not have had the luxury to select several alternatives. Now with DSTs being available for a longer period of time more analysis can be performed. Suitability and risk assessment may be the key for individual investors.
Historically, when the DST Equity market was expanding rapidly, this hot market enabled new untried real estate companies to jump into the DST offering market, to be a DST “Sponsor”. However, in today’s DST marketplace, “Less” can mean “More”, through the intrinsic value of additional benefits for accredited investors. To those with deep investor experience, we recognize that fewer new DST sponsors launching their first DST offering can benefit investors in the long term. It’s not an area for an amateur to serve in such a critical role. Sponsors with a long track record of successful offerings are usually an investor preference. Seasoned sponsors who are well funded with a solid understanding of the acquisition, packaging, compliance, and disposition resources of the DST clearly is an advantage. In addition, seasoned sponsors know and understand the importance of management of the asset and the trust on a day-to-day basis. All of these intrinsic elements can benefit the DST investor when it comes to the time for the asset to be sold.
DST Advantages:
§1031 offer significant tax benefits for investors who want to defer capital gains It appears that §1031continues to be an accepted part of the IRC and along with it the utilization of DST as replacement property.
There are several asset classes or sectors of the real estate market that are resilient year over year. Multifamily, industrial, self-storage and net lease properties appear to be performing well. The DST offerings in these asset classes may also provide investors with geographic diversification. General real estate brokers may be limited in the numbers of alternatives when compared to the DST alternative offered by financial advisors.
The subject of cash flow comes up often when comparing regular real estate to DSTs. When it is all said and done investors may realize a higher cash flow distributions than traditional real estate investments. Especially if the investor is actively managing the property. DSTs also have the potential appreciation and depreciation benefits.
DST Disadvantages:
DSTs may possibly (but unlikely) face regulatory uncertainty, as the IRS may change the rules or interpretations regarding the eligibility and viability of DSTs for 1031 exchanges. Over the years §1031 have been the topic of discussion regarding changes. However, it may be unlikely this will happen based on a number of factors.
Investors do not control the DSTs. This results in limited liquidity and exit options. The sponsors determine when the asset i.e. the DST is sold. This could take several years. The private placement memorandum (PPM) lists this as one of the risks.
Investors need to understand the fees and commission that are associated with the DSTs The PPM provides full transparency regarding fees and commission. However, the sponsor has full authority over the trust and management operations.
We encourage a deep dive into the advantages and disadvantages of DSTs both for cash investors as well as 1031 exchange investors. We conduct due diligence review of many of the major sponsor’s DST offerings.
Final Thoughts and comments:
We anticipate the amount of equity to be invested in DST by the end of 2023 to reach near $5.6-$6B this is less than 2022. In 2024 even though interest rates may not come down much the invested equity could be as high as $7B. The underlying factors are encouraging as real estate investor move to a more passive role. The political landscape in 2024 will be interesting to monitor and its effect on the overall markets.
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.
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