What does DST Diversification Cost? Part 1

We do enter into dis­cus­sions regard­ing the cost of diver­si­fi­ca­tion when uti­liz­ing Delaware Statu­to­ry Trust (DSTs) with investors reg­u­lar­ly. The bot­tom line is rough­ly 10 to 30 basis points.

April 27, 2025

By Al DiNi­co­la, AIF®
1031 Tax Deferred Exchange Spe­cial­ist & DST Advisor/Specialist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC

That’s typ­i­cal­ly all it takes to pro­vide con­sid­er­able down­side pro­tec­tion through strate­gic diver­si­fi­ca­tion. We need to under­stand the whole sto­ry why?

The diver­si­fi­ca­tion may occur by spread­ing avail­able funds (as with a 1031 exchange) into dif­fer­ent indi­vid­ual DST offer­ings.  Alter­na­tive­ly, there are spon­sors that offer strate­gi­cal­ly diver­si­fied Net-Leased Port­fo­lios typ­i­cal­ly gen­er­ate a 5.00%–5.30% first-year return, this means that investors would net cash flows in the 4.70% to 5.20% range even after fac­tor­ing in the cost for their CPA to han­dle all their state tax fil­ings. Indi­vid­ual results will of course depend on the spe­cif­ic cir­cum­stances of each investor.

The aver­age year-one cash flow across all DSTs in the mar­ket is 4.86% accord­ing to Moun­tain Dell as of 2/15/25, before fac­tor­ing in any tax fil­ings. This means that investors are able to access the strate­gic diver­si­fi­ca­tion pro­vid­ed by cer­tain NNN offer­ings while still enjoy­ing net cash flows that are at or greater than the aver­age year-one cash flows for sin­gle-asset and less diver­si­fied DSTs

Even if net cash flows (after state tax fil­ing costs) were slight­ly low­er than the mar­ket aver­age, the cost would still be worth the reduc­tion in risk achieved through diver­si­fi­ca­tion. How­ev­er, some Net Lease Port­fo­lio offer­ings are pro­vid­ing among the high­est cash flows in the indus­try, help­ing investors achieve the best of both worlds.

THE COST OF BINARY RISK

 The cost of mak­ing an invest­ment into an offer­ing that is over­con­cen­trat­ed in any one prop­er­ty, loca­tion, mar­ket, ten­ant, indus­try, or lease term, how­ev­er, is hard­er to appre­ci­ate up front, more dif­fi­cult to mea­sure, and can be dras­tic. (Bina­ry may be ref­er­enced as the all-or-noth­ing nature of invest­ing). John Tem­ple­ton, one of the great­est investors of all time, observed that “diver­si­fi­ca­tion is a safe­ty fac­tor that is essen­tial because we should be hum­ble enough to admit we can be wrong.” Diver­si­fi­ca­tion is espe­cial­ly impor­tant for investors in or near retire­ment, where strate­gic diver­si­fi­ca­tion can great­ly reduce the impact of under­per­for­mance of any one prop­er­ty, mar­ket, ten­ant, or indus­try on their nest egg and the income on which they depend.  This les­son was made painful­ly clear in the Great Reces­sion, where the dif­fer­ence between investors who got wiped out and those who made it through intact gen­er­al­ly boiled down to their lev­el of diver­si­fi­ca­tion. The more strate­gi­cal­ly diver­si­fied an investor was by prop­er­ty, geog­ra­phy, indus­try, and ten­ant, the more like­ly it was that they would sur­vive and even­tu­al­ly thrive on the oth­er side of the eco­nom­ic cycle. With rare excep­tion, those who had their exchanges over­con­cen­trat­ed in only one to three prop­er­ties were far more like­ly to suf­fer loss­es of most or all of their income and cap­i­tal.

Invest­ments lack­ing strate­gic diver­si­fi­ca­tion expose investors to bina­ry risk, the risk of being over­ly depen­dent on any one fac­tor that could under­per­form and cause the entire invest­ment to mate­ri­al­ly under­per­form or fail. Mul­ti­ple lay­ers of bina­ry risk occur when an invest­ment is over­con­cen­trat­ed in a par­tic­u­lar prop­er­ty, mar­ket, ten­ant, or indus­try, so that its suc­cess depends on favor­able out­comes at each and every one of those lev­els, in addi­tion to favor­able con­di­tions in the macro­eco­nom­ic mar­ket, real estate mar­ket, and debt mar­kets through­out the hold peri­od.

Put anoth­er way, over­con­cen­tra­tion of an investor’s cap­i­tal into any one invest­ment requires the stars to align sim­ply to pro­tect the investor’s cap­i­tal and deliv­er pro­ject­ed cash flow returns. A per­for­mance fail­ure or sig­nif­i­cant head­wind at any one lay­er of bina­ry risk could dis­rupt an investor’s income and result in a mate­r­i­al loss of their invest­ment cap­i­tal.

When we work with cash investors and espe­cial­ly larg­er 1031 tax deferred exchange investors, we pro­mote review­ing sev­er­al alter­na­tives to diver­si­fy the replace­ment port­fo­lio as in the case of the 1031 exchange. There is addi­tion­al work on our part with due dili­gence (and addi­tion­al sub­scrip­tion paper­work). How­ev­er, the time and effort are worth con­sid­er­a­tion.  There are only small addi­tion­al trans­fer costs assessed by the Qual­i­fied Inter­me­di­ary (QI) in most cas­es for addi­tion­al acqui­si­tion.

STRATEGIC DIVERSIFICATION

To pro­tect investors from these bina­ry risks, Spon­sors may diver­si­fy each of their Net-Leased Port­fo­lio DSTs across 15–25 prop­er­ties (and typ­i­cal­ly just about as many mar­kets), eight to 10 dif­fer­ent ten­ants, mul­ti­ple reces­sion resilient indus­tries, and across approx­i­mate­ly eight to 12 dif­fer­ent states. What may be impor­tant for an investor is to look at the cur­rent and past track record of the spon­sor. If you have an inter­est in review­ing your 1031 exchange replace­ment needs or are a cash investor, please give us a call. 

Part 2- Check­ing the Math on Diver­si­fi­ca­tion Cost- A Real-Life exam­ple.

NAMCOA® is a SEC reg­is­tered invest­ment advi­so­ry firm that pro­vides com­pre­hen­sive port­fo­lio man­age­ment, finan­cial plan­ning, and fidu­cia­ry deci­sion-mak­ing ser­vices on behalf of retire­ment plan spon­sors. Our Dif­fer­ence is sum­ma­rized by our fidu­cia­ry approach which enables us to bet­ter meet port­fo­lio and retire­ment plan objec­tives, result­ing in stronger risk adjust­ed returns for investors and peace of mind for Clients. We also focus on alter­na­tive real estate invest­ment. Many real estate investors are seek­ing tax deferred solu­tions uti­liz­ing §1031 exchanges or Oppor­tu­ni­ty Zones.

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 §1031 Tax 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. 5 Cen­ter­pointe Dri­ve, Ste. 400 Lake Oswego, OR, 97035. MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.

Thank you.