Risk Management in DSTs: Analyzing the Risks involved and Strategies for Mitigating them in DST Investments.

All invest­ments, includ­ing alter­na­tive invest­ments such as real estate and Delaware statu­to­ry Trust (DST) come with risk.  Risk man­age­ment is crit­i­cal no mat­ter which invest­ment strat­e­gy you sub­scribe to for your invest­ments. 

March 15, 2024

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

DSTs are rel­a­tive­ly new invest­ments (since 2004) and there are com­mon risks asso­ci­at­ed with this Alter­na­tive.

Mar­ket Risk:
RISK: Investors under­stand there may be cycles in the econ­o­my that may affect poten­tial returns of any invest­ment. The per­for­mance of real estate and asso­ci­at­ed assets are affect­ed by mar­ket con­di­tions. Prop­er­ty val­ues may fluc­tu­ate based on eco­nom­ic down­turns.  Inter­est rates ris­ing (affect­ing poten­tial buy­ers) may also be a risk that investors may not real­ize.

MITIGATION: Due dili­gence pri­or to any invest­ment is required. Not only of the invest­ment itself but the local mar­ket as well as the over­all mar­ket con­di­tions. DST investors have access to geo­graph­ic loca­tion as well as asset class. Under­stand­ing the trends (local and nation­al) becomes a vital key to mit­i­ga­tion strate­gies.

Spon­sor Risk:
Risk: The finan­cial com­mit­ment to bring a DST to the mar­ket may be over­whelm­ing. Spon­sors need to man­age the prop­er­ties effec­tive­ly and han­dle the finan­cial respon­si­bil­i­ty entrust­ed to them. The spon­sor or trustee will be direct­ly respon­si­ble for the suc­cess of the DST. Fail­ure to man­age the DST will affect the returns in a neg­a­tive way.

Mit­i­ga­tion: While past per­for­mance may not pre­dict future suc­cess, it helps.  Mean­ing if a spon­sor is expe­ri­enced and has a track record of effec­tive­ly man­ag­ing prop­er­ties that can mit­i­gate the risk. Spon­sors may be large real estate com­pa­nies with decades of expe­ri­ence and now enter­ing the DST offer­ing. We con­duct due dili­gence review­ing the his­tor­i­cal track records of the spon­sors and their offer­ings.

Liq­uid­i­ty Risk:
Risk: Invest­ing in frac­tion­al real estate with lim­it­ed con­trol and sell­ing your inter­est may not be read­i­ly avail­able mean­ing liq­uid­i­ty may not be avail­able. Investors in a DST face the same lim­it­ed liq­uid­i­ty.  DST have a def­i­nite lifes­pan as defined in the PPM.

Mit­i­ga­tion: The exit strat­e­gy (AKA Steven Cov­ey) should be defined in the PPM and the investors dur­ing the due dili­gence should under­stand the exit.  If there are any restric­tion on the exit mean­ing any manda­to­ry 721 UPREIT, investors may want to invest in a dif­fer­ent DST.

Inter­est Rate Risk:
Risk: There are many items that effect the val­u­a­tion of DST and a rise in inter­est rate is one that becomes over­looked. A rise dur­ing the hold­ing peri­od may affect the cash flow. At the end of the hold­ing peri­od high inter­est rates may affect the over­all exit price.

Mit­i­ga­tion: DST that can uti­lize a fixed rate financ­ing arrange­ment dur­ing the hold­ing peri­od may mit­i­gate the rise in inter­est rate dur­ing the hold­ing peri­od. All cash DST (by design) avoid the inter­est rate risk. Investors should stay abreast of eco­nom­ic con­di­tions includ­ing inter­est rate rise.

Prop­er­ty-Spe­cif­ic Risks:
Risk: LOCATIONS, LOCATION. There are prop­er­ty con­di­tions relat­ed to the phys­i­cal struc­ture as well as ten­ant qual­i­ty, lease terms and oth­er risks, The loca­tion and what poten­tial­ly appeals to ten­ant (and even­tu­al­ly the next buy­er) become the biggest risk.

Mit­i­ga­tion: Every­thing goes back to due dili­gence pri­or to any invest­ment. All real estate is local in nature. The appeal of the prop­er­ty to the expand­ing the poten­tial list of ten­ants can mit­i­gate risk.

Reg­u­la­to­ry and Legal Risks:
Risk: Gov­ern­men­tal changes may be an unknown risk.  This may be espe­cial­ly true in the ESG focused envi­ron­ment. Elect­ed offi­cials may force changes to zon­ing, envi­ron­men­tal changes as well as many oth­er risks asso­ci­at­ed with a polit­i­cal change in lead­er­ship.  All of these may impact DST per­for­mance.

Mit­i­ga­tion: Spon­sors need to include extend­ed due dili­gence in set­ting up the DST. Reg­u­la­to­ry aspects of the offer­ings need to be an exhaus­tive exer­cise. Investors and advi­sors should stay abreast of local reg­u­la­tions and poten­tial changes. 

Ten­ant Vacan­cy and Lease Renew­al Risk:
Risk: Vacan­cies and Ten­ant turnover dras­ti­cal­ly effect cash flow. There may also be lease renew­al issues cre­at­ed by local changes, acces­si­bil­i­ty to the prop­er­ty among oth­er issues.

Mit­i­ga­tion: Long term ten­ants (with sta­bil­i­ty) and long-term leas­es can mit­i­gate risk (triple net leas­es). Respon­sive man­age­ment to ten­ant needs with nor­mal leas­es help in ten­ant reten­tion. Mul­ti­fam­i­ly prop­er­ty man­age­ment response to ten­ant needs also helps to mit­i­gate risk.

Sum­ma­ry:
As finan­cial advi­sors we review mate­ri­als and per­form due dili­gence. The offer­ing doc­u­ments, Pri­vate Place­ment Mem­o­ran­dums (PPMs) will out­line the typ­i­cal risk in the offer­ings.  We also review third par­ty reports on the offer­ings. Over­all mar­ket trends and eco­nom­ic indi­ca­tors are vital to mit­i­gate risks in DST offer­ings.

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 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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