At Pacific Coast Commercial, we pride ourselves on delivering sound advice and specialized Commercial Real Estate Services to our clients, and in order to do so we must be knowledgeable of every investment opportunity available to achieve their commercial real estate goals.
Steven Prescott, Regional Sales Vice President of Kingsbarn Real Estate Capital, a private real estate investments firm specializing in Delaware Statutory Trust's (DSTs), met with our team of associates to extend his knowledge and resources about the subject.
Most people understand the benefits of passive investments, but many are not familiar with the benefits of DSTs. Below you will find a brief summary about this replacement option for 1031 exchanges.
Passive Investment Benefits
Many baby boomers who hold highly appreciated real estate assets may be at a stage of their lives when they are seeking more passive investment opportunities. Passive, professionally managed ownership may allow them to concentrate on other opportunities in life that they may have always been passionate about but never had the time to thoroughly enjoy.
Rather than deal with the "Terrible T’s" consisting of toilets, trash, and tenants, many older investors are in search of the "Terrific T’s" which give them time, travel and teeing off. To accomplish these goals, some seasoned investors have turned to real estate investment strategies such as a Tenants in common 1031 exchange.
Tenants in common 1031 exchanges have long permitted investors to own high-caliber, professionally managed properties occupied by established tenants, with virtually no property management responsibilities. Most of these investors have been able to accomplish these forms of ownership in a tax-deferred manner through a 1031 Exchange.
Delaware Statutory Trusts
Though Delaware Statutory Trusts (DST) are not new, current tax laws have made them a preferred investment vehicle for passive 1031 exchange investors and direct (non-1031) investors alike. DSTs are derived from Delaware Statutory law as a separate legal entity, created as a trust, which qualifies under Section 1031 as a tax-deferred exchange.
In 2004, the IRS blessed DSTs with an official Revenue Ruling about how to structure a DST that will qualify as replacement property for 1031 Exchanges. The Revenue Ruling (Rev. Ruling 2004-86) permits the DST to own 100 percent of the fee-simple interest in the underlying real estate and may allow up to 100 investors -- sometimes more -- to participate as beneficial owners of the property.
How DSTs Work
The real estate sponsor firm, which also serves as the master tenant, simply acquires the property under the DST umbrella and opens up the trust for potential investors to purchase a beneficial interest. The investors may either deposit their 1031 exchange proceeds into the DST or the investor may purchase an interest in the DST directly.
DST investors may benefit from a professionally managed, potentially institutional quality property. The underlying property could be a 500-unit apartment building, a 100,000 square-foot medical office property or a shopping center leased to investment-grade tenants. The possibilities are endless.
Most DST investments are assets that your run-of-the-mill, small- to mid-sized accredited investors could not otherwise afford. However, by pooling money with other investors, they can acquire this type of asset.
Investors who are familiar with the tenants in common (TIC) investment strategy may see some similarities in the DST concept; however, it is important to understand the differences between the two concepts. While a TIC may have up to 35 investors, each owning an undivided, pro-rata share of title to the property, a DST may have up to 100 investors (sometimes more), with each investor owning a beneficial interest in the trust which, in turn, owns the underlying asset.
DST vs TIC Ownership
There are two benefits that the DST structure offers over the TIC concept. One is that because a DST is not limited to 35 investors, the minimum investment may be much lower, sometimes in the $100,000 range. The second major advantage is that in a DST, the lender makes only one loan to one borrower -- the DST's sponsor.
In a TIC investment, the lender can fund up to 35 separate loans, one to each investor. In times of tight money, however, the DST gives the lenders greater security because the lender has fully qualified the sponsor, who is the underlying responsible party.
Be aware that the greater number of investors, plus the larger number of shares may or may not protect your investment. Careful scrutiny of the controlling partner/sponsor is advised. There are a lot of crooks in this business.
DSTs Pose Risks
DSTs are not without risks. As with any type of real estate investment, investors may be subject to high vacancy rates and loan defaults. DSTs are also not sole-ownership investments. A DST is a more passive investment made up of multiple owners and ultimately controlled by the master tenant -- the sponsor.
It is important for investors who may be considering the DST strategy to consult with an experienced investment professional and to obtain competent legal and tax advice. Upon thorough evaluation, the DST structure may be a viable investment alternative for qualified real estate investors. But only your tax adviser and a lawyer can tell you if it's right for you.
*Accredited Investors are individuals whose net worth is in excess of $1 million and/or earn an annual income of $200,000. Accreditation for entities means the entity's assets are in excess of $5 million and/or each entity member must be an accredited investor as an individual.
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Article By: The Balance
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