DSTs are unique real estate investment vehicles that allow a group of individual investors to purchase fractional ownership interests in large commercial real estate assets that would typically be well beyond their financial reach as individual investors. However, DST investors don’t actually own physical real estate – they own shares of a trust that was created specifically to be the legal owner of the underlying properties held within the trust. This distinction is important because of the legal separation it creates between the trust and the DST investor pool.
Below, we’ll take a closer look at how Delaware statutory trusts work and why they are investment options for the 1031 exchange and other types of real estate investors. We’ll also look at the importance of timing when it comes to DST investments, as well as how to conduct due diligence on potential DST sponsors.
What is a Delaware Statutory Trust?
Delaware statutory trusts are legal entities created under Delaware trust laws. DST investors, also known as beneficiaries, own fractional (beneficial) interests in the trust, which is the legal owner of the properties underlying the trust. However, because the Internal Revenue Service treats each investor’s beneficial interests as direct property, DSTs are eligible for 1031 exchanges both on departure and on exit.
DSTs are usually set up by real estate companies called sponsors, who identify and acquire the assets placed in trust using their own capital. DST sponsors engage a registered broker to open an offering period, and individual investors buy fractional shares of DST. Although providing equity, the beneficiaries of the DST are passive investors. DSTs can theoretically have an unlimited number of beneficiaries, although the number is usually capped at 499 by the DST sponsor.
History of DSTs
Delaware Statutory Trusts were created in 1988 with the passage of the Delaware Business Trust Act, which was renamed the Delaware Statutory Trust Act in 2002.
These special business trusts create a legally secure and clearly defined trust entity that establishes a legal separation between the trust and its beneficiaries. Since the trust is recognized as a separate legal entity from its beneficiaries, creditors cannot seize or hold any assets held in trust.
Potential Benefits of Investing in a Delaware Statutory Trust
The fractional ownership structure of Delaware Statutory Trusts provides individual investors with access to commercial-grade real estate assets similar to those held by institutional investors, insurance companies, pension funds and real estate investment trusts (REITs). ). These properties may include large multi-family Class A apartment complexes, office buildings, shopping centers, industrial distribution and warehousing facilities, self-storage facilities and similar commercial assets.
Some additional benefits of investing in a DST may include:
- Limited Liability. DST laws protect investors from personal liability for assets held in trust. Investors can enjoy the benefits of investing in commercial-grade real estate without the added risk of direct ownership.
- Diversification and sizing. 1031 exchange investors can exchange for multiple DST investments in the exact amounts needed to meet the similar replacement requirement. They can also trade in multiple DSTs with different types of property, such as seniors’ residences or medical practices, or in different geographic regions to better manage their investment risk.
- Hourly. The timing is critical for investors trying to complete 1031 exchanges and defer capital gains taxes. Exchangers have only 45 days from the closing of the sale of their derelict assets to formally identify suitable similar properties – and in competitive real estate markets, finding suitable replacement properties is onerous at best and impossible at worst. DST offerings can reduce transactional risk because they are pre-packaged by sponsors – due diligence, inspections, environmental reports, financial statements, rental listings and financing are already in place, so stock investors can quickly meet the 45-day identification period and conduct due diligence before the 180 days required under the 1031 exchange laws.
How to Invest in Delaware Statutory Trusts
DST interests are sold as securities, so investors must work with a registered broker or registered investment adviser to invest in a Delaware statutory trust.
DST interest is only available to accredited investors. Accredited investors are people with income over $200,000 for two consecutive years ($300,000 for married couples) and net worth over $1 million. The value of your principal residence does not count towards the $1 million threshold.
How to Evaluate DST Sponsors
DST sponsors control the day-to-day operations of the assets held in trust. Sponsors are also responsible for distributing monthly cash flow distributions, quarterly reports, income statements and performance reviews of assets under their management. Sponsors can vary widely based on management experience, core competencies in specific property types, geographic footprint, underwriting experience, and exit strategies.
Generally speaking, sponsors with a long track record allow potential investors to better assess the performance of sponsors, especially in times of economic downturn. Sponsors with a shorter tenure, meanwhile, could also prove viable – just be sure to do as much research as possible on their history, especially if they have been involved in other types of real estate investments. . Management teams with long experience may also be in a better position to leverage existing relationships, resources, and knowledge to acquire assets, as well as organize and market the Delaware Statutory Trust.
Another important consideration is the size of the sponsor’s management team – larger sponsors have the ability to devote more resources to analyzing current and potential properties, as well as potentially obtaining better pricing and terms. ready. Communication is another area where major sponsors can excel through regular reporting and asset performance updates. As with any investment, it is important to do thorough due diligence on sponsors and their offerings before making any investment decisions. DST investors can learn more about the sponsors by checking reviews from third-party companies such as FactRight.
If this type of research or property-specific research is not in your wheelhouse, you can hire an experienced commercial real estate investment firm to perform the due diligence for you.
Additional Considerations for Investing in a DST
DST investments are not for everyone. Here are some important considerations to make before investing in a Delaware statutory trust:
- Illiquidity. DSTs have a holding period of between five and 10 years, making them illiquid investments best suited to people with long-term investment horizons.
- Passive investment. The beneficiaries are not involved in the day-to-day operations of the commercial properties held in trust. Some investors may welcome this hands-off approach, while investors with extensive experience in owning and managing real estate may not prefer to be so hands-off.
- Returns expected. Factors such as property type, location, mortgage balance, and interest rates determine DST return targets; however, annual return targets between 3% and 6% are common. Total returns can potentially be higher or lower due to tax advantages and property appreciation.
- Commission research and evaluation. DST sponsors are not created equal. It can be difficult for an investor to perform the recommended due diligence on their own, so working with a broker or firm experienced in DST investments can be beneficial for investors interested in purchasing DST interests.
Working with an experienced financial advisor, conducting independent research, and engaging an investment firm with extensive knowledge of commercial real estate can help investors better determine whether Delaware Statutory Trusts are an appropriate investment vehicle for their needs.
Full disclosure. The information provided here is not investment, tax or financial advice. You should consult a licensed professional for advice regarding your specific situation.
Founder and CEO, Directed
David Wieland, is CEO and co-founder of Realized, a company that helps people manage their real estate assets. He has engineered over $3 billion in institutional real estate and capital markets transactions. David leads Realized’s vision to help investors maximize their after-tax returns and create personalized investment portfolios tailored to each investor’s risk tolerance, long-term goals and income needs.