DST.EDU Series A Part 4- The Economic Focus

By design most Delaware Statu­to­ry Trusts (DST) are struc­tured with debt financ­ing. This sat­is­fies §1031 require­ments to replace debt. Over the past two years the cost of debt has increased. Cau­tion: under­stand the ris­ing inter­est rates.

Jan­u­ary 24, 2024, UPDATED
Orig­i­nal Post Feb 7, 2022

By Al DiNi­co­la, AIF®, CEPA™
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC

Many investors who are exe­cut­ing an exchange are sur­prised to find out that the debt being paid off needs to be replaced by anoth­er mort­gage or fresh cash equal to the mort­gage paid off on the relin­quished prop­er­ty. A key ele­ment in the DST struc­ture to note is the debt financ­ing is non-recourse debt for the indi­vid­ual investors.

Effects of Rate Increas­es

The over­all health of the econ­o­my as well as the rates on bor­rowed funds may deter­mine how the invest­ment per­forms.  From late 2022 inter­est rates start­ed to rise effect­ing many aspects of the econ­o­my. As the cost of debt increas­es there is a com­pres­sion of poten­tial returns.  Dur­ing down­turns in the econ­o­my vacan­cies can rise that will affect the bot­tom line or Net Oper­at­ing Income (NOI) of the prop­er­ty. This in turn may change the sell­ing price dur­ing the exit phase of the any real estate invest­ment. The rise in inter­est rates also affects the DST asset. We will cov­er the rela­tion­ship of NOI and the Cap­i­tal­iza­tion Rate (CAP Rate) and the price a prop­er­ty may sell for in the mar­ket­place in oth­er edu­ca­tion­al arti­cles. Tech­ni­cal­ly NOI is cal­cu­lat­ed before debt ser­vice. If the NOI is $200,000 for a real estate invest­ment and the debt ser­vice is $100,000 then the pre-tax income would be $100,000. If in 2024 the debt ser­vice on a loan is 50% high­er than 2021 then the pre-tax income may be $50,000 using the same exam­ple. Rental rates in some sec­tors have increased from 2021 that may off­set the inter­est rate increase to some extent.

Regu­la­tion. There is no ques­tion that there needs to be strate­gic plan­ning to car­ry out a suc­cess­ful 1031 exchange. There are strict tim­ing con­straints from the IRS. Over the years Con­gress has debat­ed the §1031 exchange and is sub­ject to being amend­ed by con­gress. EY (EY Macro­eco­nom­ic Study 2022) has con­duct­ed stud­ies over the past few years that demon­strat­ed the eco­nom­ic impact of all 1031 exchange on the econ­o­my.  The research demon­strates the val­ue of like-kind exchanges to the greater US econ­o­my, includ­ing employ­ment and wage con­tri­bu­tion, adding to GDP, and gen­er­at­ing con­sumer spend­ing.  

Exe­cu­tion of the Exchange. Putting the parts togeth­er for suc­cess may be chal­leng­ing at times.  There are a vari­ety of vari­ables to be aligned and set up in order for a §1031 exchange to be suc­cess­ful under nor­mal real estate invest­ment. Uti­liz­ing a DST also has mov­ing parts as well.  Any mis­step between the investor, the Qual­i­fied Inte­me­di­ary (QI) or the Sponsor’s abil­i­ty to deliv­er the replace­ment DST asset will cause the §1031 exchange to fail. First crit­i­cal exe­cu­tion (in the form of an agree­ment) is between the investor and QI. An investor work­ing with a sea­soned finan­cial advi­sor who has exper­tise in §1031 uti­liz­ing DST replace­ment is a tremen­dous advan­tage.  Uti­liz­ing a tra­di­tion­al real estate replace­ment prop­er­ty also comes with exe­cu­tion risks. The 45-day noti­fi­ca­tion peri­od pass­es quick­ly.

Asset-Classes. Offer­ings of DST include the same com­mer­cial assets as reg­u­lar real estate. Although the avail­abil­i­ty of the DST assets at any time may change.  Cur­rent­ly in 2024 the over­all mar­ket con­di­tions with regards to DST inven­to­ry and avail­abil­i­ty have increased pro­vid­ing investors addi­tion­al options and alter­na­tives.  Asset class­es are gen­er­al­ly mul­ti-fam­i­ly res­i­den­tial, sin­gle fam­i­ly res­i­den­tial, stu­dent hous­ing, senior hous­ing, man­u­fac­tured hous­ing, indus­tri­al, retail, office, Office Med­ical, Self-Stor­age, and a new asset class Life Sci­ence. The scope of each asset will be cov­ered in addi­tion­al edu­ca­tion­al mate­ri­als.

Look for Part 5: DST Fees… Com­ing Soon

DST’s (Delaware Statu­to­ry Trusts) are for accred­it­ed investors only.  Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your 1031 Exchange and com­pli­ment your finan­cial objec­tives. 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, in any form, involves risk, includ­ing but not lim­it­ed to the poten­tial of los­ing some or all 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.