How to Review a Private Placement Memorandum (PPM) for a Delaware Statutory Trust (DST) Offering ‑Part 3

This is Part 3 of the series on the review of the PPM.  There are many experts who feel the Use of Pro­ceeds is the most impor­tant part of the PPM.  In Part 1 How to Review a Pri­vate Place­ment Mem­o­ran­dum (PPM) Part 1 we cov­ered Com­pli­ance, Investor Pro­tec­tion and Reg­is­tra­tion as well as DST qual­i­fy­ing for §1031 exchange.  In part 2 How to Review a Pri­vate Place­ment Mem­o­ran­dum (PPM) Part 2  we cov­ered the Spon­sor and Man­age­ment as well as the review of the under­ly­ing Asset or Prop­er­ty.  

Use of Pro­ceeds

Over the past num­bers of years, we have attend­ed inde­pen­dent third-par­ty con­fer­ences where PPMs (as well as Spon­sor back­ground and expe­ri­ence) are reviewed, and the attend­ing attor­neys opine on the struc­ture and func­tion of the PPM.  Most of these par­tic­i­pants agree that the “Use of Pro­ceeds” sec­tion is one of the most impor­tant parts of a Delaware Statu­to­ry Trust (DST) Pri­vate Place­ment Mem­o­ran­dum (PPM). This is because it out­lines exact­ly how investor cap­i­tal will be used. This direct­ly impacts the risk, return, trans­paren­cy, and cred­i­bil­i­ty of the invest­ment. If you’re eval­u­at­ing a DST PPM and the “Use of Pro­ceeds” sec­tion is vague, over­ly com­plex, or seems heav­i­ly skewed toward spon­sor prof­its — that’s a red flag.

Here’s why it mat­ters so much:

1. Investor Trans­paren­cy & Trust                                  

Investors want to know where their mon­ey is going. The “Use of Pro­ceeds” sec­tion pro­vides a detailed break­down of how the spon­sor plans to allo­cate funds: pur­chase price, fees, reserves, improve­ments, com­mis­sions, etc. Full dis­clo­sure builds trust and reduces the risk of mis­rep­re­sen­ta­tion or fraud.

2. Risk Assess­ment

How pro­ceeds are used gives investors insight into the risk pro­file of the DST. There are two ele­ments that may be very observ­able. A high per­cent­age going to fees or com­mis­sions could be a red flag. A large reserve allo­ca­tion could indi­cate cau­tion or antic­i­pat­ed cap­i­tal needs. Cer­tain investors may require lever­age (for debt replace­ment in a §1031 exchange) oth­er investors may desire lever­age to increase poten­tial tax effi­cien­cies. Investors can eval­u­ate whether the lever­age (if any) is rea­son­able and whether cap­i­tal expen­di­ture is being used to improve the asset or just to main­tain it.

3. Fee Struc­ture Clar­i­ty

Attempt­ing to have a clear view of the fee struc­ture may be chal­leng­ing at times.  Most PPMs will have a list of the asso­ci­at­ed fees that are need­ed to bring the DST to the mar­ket. DST invest­ments often have lay­ered fees (e.g., acqui­si­tion fees, loan fees, prop­er­ty man­age­ment fees). This sec­tion shows how much of the investor’s mon­ey goes to the actu­al real estate asset ver­sus to the spon­sor or inter­me­di­aries. It helps com­pare offer­ings across spon­sors and avoid over­priced deals. Third par­ty reports will eval­u­ate how fees of the PPM (offer­ing) are being eval­u­at­ed com­pared to oth­er offer­ings and pro­grams. Here is an exam­ple of a third-par­ty eval­u­a­tion firm review­ing that aspect. [Report­ing firm] assessed the fees and expens­es for this offer­ing rel­a­tive to the fees and expens­es of oth­er recent DST offer­ings. The indus­try medi­ans and mid­dle-eighty per­centile ranges (labeled as DST Range through­out this sec­tion) were derived using infor­ma­tion from pri­vate DST offer­ings ana­lyzed by [Report­ing Firm] between [Date] and [Date].

Larg­er offer­ings may have more poten­tial effi­cien­cies than small offer­ings when eval­u­at­ing fee struc­ture. There are basic costs for the legal aspects (com­pli­ance) to facil­i­tate the prop­er struc­ture of the DST.  Here is an exam­ple of a third-par­ty eval­u­a­tion firm review­ing that aspect. Offer­ing expens­es are above the typ­i­cal DST indus­try range, due to the pres­ence of a whole­saler fee, and above aver­age orga­ni­za­tion and offer­ing (O&O) costs, which is a func­tion of the fixed costs of a rel­a­tive­ly small equi­ty raise.

4. Align­ment of Inter­ests

Align­ment of inter­est is how the spon­sor struc­tures the use of pro­ceeds reflects their align­ment with investors. Are they invest­ing along­side the investors? Are they front-load­ing fees? A fair, trans­par­ent allo­ca­tion usu­al­ly indi­cates a spon­sor is more like­ly to act in the best inter­ests of investors. Here is an exam­ple of a third-par­ty eval­u­a­tion on inter­est and fees. [Report­ing Firm] con­sid­ers the front-end and back-end spon­sor com­pen­sa­tion to be with­in the typ­i­cal range for mul­ti­fam­i­ly DST offer­ings that [Report­ing Firm] has recent­ly ana­lyzed. How­ev­er, the ongo­ing oper­at­ing com­pen­sa­tion met­rics are slight­ly high­er than the indus­try range due to the rel­a­tive­ly small size of the pro­gram.

5. Reg­u­la­to­ry & Legal Pro­tec­tion

Inac­cu­rate or vague use-of-pro­ceeds dis­clo­sures can lead to legal con­se­quences under SEC rules (espe­cial­ly for Reg D offer­ings). This sec­tion pro­tects both the investors and the spon­sor by clear­ly doc­u­ment­ing expec­ta­tions.

Sum­ma­ry

Here’s a sam­ple “Use of Pro­ceeds” break­down for a typ­i­cal DST offer­ing, show­ing how investor cap­i­tal might be allo­cat­ed. This is a sim­pli­fied ver­sion, but it reflects com­mon struc­tures seen in real estate DST pri­vate place­ments.

Total Offer­ing Size: $80,000,000
DST Prop­er­ty Type: Mul­ti­fam­i­ly Apart­ment Com­plex
Lever­age: 50% LTV (Loan of $40M; Total Project Val­ue = $80M)

Key Insights from This Exam­ple

There are a few items to ampli­fy from the exam­ple above. 80% of funds go direct­ly toward the real estate equi­ty. This is a good sign, indi­cat­ing that most of the cap­i­tal raised is being invest­ed. The total Fees reflect­ing the3% acqui­si­tion plus 5% com­mis­sions and 4% orga­ni­za­tion­al costs equal a total 12% of the raise. This may indi­cate the DST is worth com­par­ing to oth­er DSTs. $1.6M in reserves shows some cush­ion for prop­er­ty expens­es or capex (if indi­cat­ed in the PPM). This helps reduce oper­a­tional risk. Note: reserves not used are returned to investors.

What to Watch for in Real Deals

Well, it may be obvi­ous that if there are too many fees (15–20%) this reduces how much cap­i­tal is work­ing for the invest­ment. Not all DST will have reserves (Poten­tial­ly in the case of triple net lease struc­tures with large play­ers like Ama­zon). How­ev­er, no reserves may sig­nal future cap­i­tal calls (which DSTs typ­i­cal­ly can’t make). There may be Hid­den fees in oth­er sec­tions. Many advi­sors well versed in DST will cross-ref­er­ence with the “Fees and Com­pen­sa­tion” sec­tion.

Near­ly Final Ques­tions to Ask regard­ing the Use of Funds: (there are many, but here are a few in sum­ma­ry)

1. What per­cent­age of funds for prop­er­ty acqui­si­tion ver­sus fees and reserves?
2. Are sell­ing com­mis­sions and orga­ni­za­tion­al costs clear­ly dis­closed?
3. Does the spon­sor retain a per­for­mance pro­mo­tion or oth­er incen­tive com­pen­sa­tion?

Over­all Best Prac­tices for Review­ing a PPM

1. Read beyond the exec­u­tive sum­ma­ry.
2. Engage tax, legal, and real estate advi­sors.
3. Com­pare fee struc­tures across offer­ings regard­ing the Use of Funds.
4. Under­stand lever­age and refi­nanc­ing terms.
5. Assess spon­sor align­ment and co-invest­ment.

Con­clu­sion

A DST can be an effec­tive vehi­cle for tax-deferred real estate invest­ing, but it is not with­out risk. The PPM is the sin­gle most impor­tant dis­clo­sure doc­u­ment. Investors who care­ful­ly ana­lyze the PPM, engage pro­fes­sion­al advi­sors, and com­pare offer­ings are bet­ter equipped to pro­tect cap­i­tal and make sound deci­sions.

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.

Alter­na­tive invest­ments and DSTs are not for all investors.  The acqui­si­tion of a cer­tain alter­na­tive invest­ments includ­ing DSTs 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. 5 Cen­ter­pointe Dri­ve, Ste. 400 Lake Oswego, OR, 97035MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.

Thank you.

Ref­er­ences

• FINRA. (2023). Under­stand­ing pri­vate place­ments. Retrieved from https://www.finra.org
• Inter­nal Rev­enue Ser­vice. (2004). Rev­enue Rul­ing 2004–86. Wash­ing­ton, D.C.
• Secu­ri­ties and Exchange Com­mis­sion. (2022). Pri­vate place­ment guid­ance. Retrieved from https://www.sec.gov
• Nation­al Real Estate Investor. (2023). Trends in Delaware Statu­to­ry Trust offer­ings. Retrieved from https://www.nreionline.com