Both established real estate investors and those interested in dipping their toes into the commercial real estate pool increasingly are considering acquiring interests in Delaware statutory trusts (DSTs). While these vehicles come with several potential benefits, they are not for everyone. Here is what you need to know.

How DSTs Work

When you invest in a DST, you obtain a fractional equity interest in real property which is held in trust by a sponsor. The sponsor, usually a national real estate company, pools capital from multiple investors and handles the due diligence, paperwork and property acquisition. DSTs generally hold properties similar to those held by large institutional investors, including healthcare facilities and medical professional buildings, industrial buildings, retail properties, multi-family housing, storage buildings, warehouses and distribution centers.

Investors receive regular cash distributions, which are treated as passive income for tax purposes, and a fractional share of the proceeds when the property is disposed. Any debt taken on by the DST is non-recourse for investors, and investors’ own creditors can never reach the property held by the DST.

DSTs typically require a minimum investment of at least $100,000. You must be an accredited investor, though, with more than $1 million in net worth (excluding the value of a primary residence) or annual income of more than $200,000 in each of the previous two years with a reasonable expectation of the same for the current year (or $300,000 with your spouse or partner).

The Perks

DSTs have several features that make them attractive to certain investors, including:

Tax Deferral
Unlike real estate investment trusts (REITs), another form of pooled real estate investments, DSTs can be in used tax-advantaged Sec. 1031 like-kind exchanges. Like-kind exchanges generally allow you to delay the recognition of the gain on the sale of investment property if you use the proceeds to purchase another investment property, including a DST interest. That means you can put all of the proceeds to work for you, rather than sending part of it to the IRS.

Expedited Closing Time
Section 1031 exchanges have several requirements, including deadlines for when the replacement property must be purchased. Because a DST already holds the property, you generally can close the purchase of your interest more quickly than if you had to hunt for replacement property yourself.

Reduced Risk
DSTs can make it easier to diversify your portfolio. By investing in different DSTs, you can have interests in multiple types of properties in different locations and with different sponsors.

No Management Responsibility
A DST investment is passive, so you can leave day-to-day management decisions in the hands of experienced, vetted professionals. The idea of avoiding the many headaches of property management can be especially appealing to investors who have been dealing directly with tenants for years.  

Potential Drawbacks

For all their upsides, DSTs are not without possible downsides, including:

Lack of Control
While some investors see the passive nature of a DST investment as a positive, others view it as a disadvantage. The DST’s sponsor generally makes all of the decisions on refinancing, tenant selection, upgrades and similar issues, but some investors prefer to be more hands-on in the management of their assets.

Long Hold Periods
DSTs usually have hold periods that run five to ten years, making the investment relatively illiquid. Moreover, you will have little to no opportunity for an early exit, before the full DST lifecycle has run, because no secondary markets exist for the interests.

Fees and Costs
You will incur fees throughout the lifecycle of a DST. From your original investment until disposition, you can expect to pay sales commissions, broker fees, management fees and other expenses.

Inherent Real Estate Risks
Like any real estate investment, the value of a DST property can decline. The properties also can run into issues like problems meeting debt service obligations, vacancies and foreclosure, which could disrupt cash distributions.

Consider Your Circumstances

If you seek high-risk returns, direct management control, and liquidity, then DSTs would not be your best option. However, DSTs are worth considering if you are looking for stabilized, institutional quality real estate investments with steady cash flow or are looking for an easier way to defer taxes on the sale of investment properties.

If you have questions, contact Tammy Partridge at [email protected] or 312.670.7444 or your ORBA advisor.