Investors Seeking Alternative Investments in Debt.

Investors for over 20 years have used Delaware Statu­to­ry Trust (DST) for direct cash invest­ment as well as a 1031 replace­ment prop­er­ty. Giv­en the cur­rent invest­ment cli­mate indi­vid­ual investors may be seek­ing an alter­na­tive invest­ment strat­e­gy of debt financ­ing.

August 14, 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

Delaware Statu­to­ry Trust spon­sors mov­ing to offer­ing debt.

DST spon­sors with access to cash from accred­it­ed investors are mov­ing to offer­ing debt and reflects a notable shift in real estate invest­ment strate­gies. DSTs as a real estate offer­ing by design have focused on equi­ty invest­ments. DSTs pro­vide investors with the abil­i­ty of own­ing invest­ment grade real estate as a frac­tion­al own­er.  Many investors are hap­py with their invest­ments into a DST espe­cial­ly via a 1031 tax deferred exchange. Here’s what this shift by investors seek­ing debt offer­ings might be pro­vid­ed by DST spon­sors:

DSTs: A Quick Overview

• Since 2004 as a legal enti­ty, DSTs allows for frac­tion­al own­er­ship by mul­ti­ple investors in a vari­ety of real estate prop­er­ty types.  Prop­er­ty types may also be referred to as asset class­es. These asset class­es fol­low all the tra­di­tion­al real estate types as com­mer­cial real estate. Mul­ti­fam­i­ly (apart­ments) have long been the most offered and acquired prop­er­ties by investors.  Recent­ly indus­tri­al offer­ings have increased in both offer­ings by spon­sors and acqui­si­tions by investors.
• Com­mon Use: DSTs pro­vide cash investors with the abil­i­ty to invest in insti­tu­tion­al real estate at a frac­tion of the amount attempt­ing to pur­chase the real estate indi­vid­u­al­ly.  Min­i­mum invest­ment may be $100,000 (or low­er) for accred­it­ed investors.  How­ev­er, by and large most DST investors are seek­ing defer­ral of cap­i­tal gains on their appre­ci­at­ed real estate via a §1031 tax deferred exchange.  Investors must fol­low all the require­ments  of the exchange.

Why Spon­sors Are Mov­ing to Debt Offer­ings

1. Diver­si­fi­ca­tion of Invest­ment Prod­ucts: Spon­sors have per­formed count­less hours of due dili­gence on a vari­ety of prod­uct offer­ings. The expan­sion into debt offer­ing (on an under­ly­ing asset spon­sors have exper­tise) make strate­gic sense. Investors who are seek­ing a pre­dictable income stream may be drawn to this style invest­ment. In addi­tion, investors who have com­plet­ed exchanges may have oth­er cash to put to work. The spon­sors may devel­op offer­ings for prop­er­ty acqui­si­tions, devel­op­ments, financ­ing or oth­er needs in a secure offer­ing.
2. Low­er Risk Pro­file: Dur­ing an uncer­tain or volatile mar­ket, investors may be seek­ing an alter­na­tive to own­ing real estate them­selves. Invest­ing in debt typ­i­cal­ly car­ries low­er risk to invest­ing in equi­ty. The hold­er of the debt much like a bank will have a high­er claim on the asset and any income that may come from that asset in the case of default. Spon­sors will per­form the due dili­gence to ensure the cred­it­wor­thi­ness of the bor­row­er.
3. Shift in Mar­ket Dynam­ics: There’s no secret that the increase in inter­est rates over the past 12 to 18 months has cre­at­ed a change in the veloc­i­ty of many real estate mar­kets through­out the coun­try. Com­mer­cial real estate as well as res­i­den­tial are inter­est rate sen­si­tive for new buy­ers com­ing into the mar­ket. The need for pro­vid­ing financ­ing espe­cial­ly short-term financ­ing has become appar­ent since many region­al banks have pulled back lend­ing for a vari­ety of rea­sons. Spon­sors who have a lega­cy of §1031 exchange investors will see debt as poten­tial­ly safer and more appeal­ing way to attract addi­tion­al investors.
4. Increased Demand for Pas­sive Income: As investors approach retire­ment age a sta­ble steady pas­sive income stream becomes a very impor­tant goal. Over­all investors demand reg­u­lar inter­est pay­ments that debt oblig­a­tions and instru­ments pro­vide.
5. Lever­age Exist­ing Real Estate Knowl­edge: DST spon­sors have demon­strat­ed some for 20 years a deep under­stand­ing and par­tic­i­pa­tion in the real estate indus­try. Large equi­ty firms have offered that debt that will be part of their invest­ment strat­e­gy short­er term debt pro­vides for above aver­age return espe­cial­ly with the pull­back of bank lend­ing. The abil­i­ty for spon­sors to eval­u­ate the via­bil­i­ty of a project and the amount of equi­ty and debt required for the project enables the spon­sor to lever­age their real estate knowl­edge in a debt offer­ing.

What These Debt Offer­ings Might Look Like

• First-Lien Loans: One of the most envi­able posi­tions to be in is to be in first posi­tion in any lien. These are typ­i­cal­ly ref­er­enced as senior secured debt oblig­a­tions. Being senior secure they are con­sid­ered the least risky form of debt.
• Mez­za­nine Loans: There may be the need to have addi­tion­al cap­i­tal for a cer­tain project. This may be known as a mez­za­nine loan and while maybe riski­er it does offer high­er returns than a senior secure posi­tion.
• Pre­ferred Equi­ty: When it comes to a liq­ui­da­tion sce­nario pre­ferred equi­ty while it is sim­i­lar debt in some respects will have pri­or­i­ty over com­mon equi­ty.
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Ben­e­fits for Investors

• Sta­ble Income: Pre­dictable cash flow is one of the main­stays that most investors look towards when decid­ing on where to place their invest­ment dol­lars. Fixed inter­est pay­ments with addi­tion­al incen­tives to investors may pro­vide a very sta­ble income stream.
• Low­er Risk: There is always risk in the vari­ety of real estate invest­ment pro­grams. Equi­ty maybe con­sid­ered a lit­tle riski­er than debt. Debt investors will be paid before equi­ty investors in the event of the liq­ui­da­tion or default.
• Port­fo­lio Diver­si­fi­ca­tion: investors may be mov­ing away from the tra­di­tion­al 60/40 split of equi­ty and bonds. Many advis­ers will prompt investors to look at diver­si­fy­ing their port­fo­lio to poten­tial­ly reduce or mit­i­gate risk. Hav­ing a por­tion of your invest­ment in debt may make sense for cer­tain investors.

Risks and Con­sid­er­a­tions

• Inter­est Rate Sen­si­tiv­i­ty: Over the past 18 months we have seen the impact on ris­ing inter­est rates and the afford­abil­i­ty of buy­ers espe­cial­ly in the res­i­den­tial mar­ket. Inter­est rate change will affect debt instru­ments. As inter­est rates rise this could affect the appeal for new offer­ings of debt. Bor­row­ers will need to cal­cu­late if they can afford the debt that’s being offered by the spon­sor.
• Cred­it Risk: Spon­sors will need to per­form due dili­gence to deter­mine the cred­it wor­thi­ness of the bor­row­er. In some cas­es, there may also be devel­op­ment risk if the project is just get­ting start­ed.
• Liq­uid­i­ty: Liq­uid­i­ty is always the top­ic of dis­cus­sion in a DST offer­ing. Any debt offer­ing, while there may be terms and pro­ject­ed time peri­ods, are sub­ject to exten­sions. Investors need to view dead offer­ings as a longer-term invest­ment as well as being illiq­uid.

Con­clu­sion

The mar­kets present oppor­tu­ni­ties for new prod­ucts and offer­ings depend­ing on the con­di­tions. The spon­sors of DST’s are actu­al­ly respond­ing to shift not only in the mar­ket con­di­tions but also a shift based on investor inter­est and pref­er­ences. Investors that are seek­ing sta­ble income and to be risk averse maybe look­ing at debt offer­ings. Spon­sors who deal in real estate offer­ings day in and day out will have an advan­tage over new spon­sors to the mar­ket­place. As with all invest­ment oppor­tu­ni­ties and offer­ings investors should seek pro­fes­sion­al advice pri­or to invest­ing in any that offer­ing.

Investor Restric­tion:

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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