DSTs are unique real estate investment vehicles that allow a group of individual investors to purchase fractional interests in large commercial real estate assets that typically would be well beyond their financial reach as solo investors. DST investors don’t actually own physical real estate, however – they own shares of a trust that was formed 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 pool of DST investors.
Below we’ll take a closer look at how Delaware Statutory Trusts work and why they are investment options for 1031 exchange and other types of real estate investors. We’ll also examine the importance of timing as it relates to DST investments, as well as how to conduct due diligence on prospective DST sponsors.
What Is a Delaware Statutory Trust?
Delaware Statutory Trusts are legal entities created under the statutes of Delaware trust law. DST investors, also called beneficiaries, own fractional (beneficial) interests in the trust, which is the legal owner of the trust’s underlying properties. However, since the Internal Revenue Service treats each investor’s beneficial interests as direct property ownership, DSTs are eligible for 1031 exchanges both upfront and upon exit.
DSTs are typically formed by real estate companies called sponsors, who identify and acquire the assets that are placed under trust using their own capital. DST sponsors engage a registered broker-dealer to open an offering period, and individual investors purchase fractional shares of the DST. Although they provide equity capital, DST beneficiaries are passive investors. DSTs can theoretically have an unlimited number of beneficiaries, though the number usually is capped at 499 by the DST sponsor.
History of DSTs
Delaware Statutory Trusts were created in 1988 with the passing 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 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 possess any assets held under trust.
Potential Benefits of Investing in a Delaware Statutory Trust
The fractional ownership structure of Delaware Statutory Trusts gives solo investors access to commercial-grade real estate assets that are similar to those owned by institutional investors, insurance companies, pension funds and real estate investment trusts (REITs). These properties may include large Class-A multifamily apartment complexes, office buildings, retail centers, industrial distribution and warehousing facilities, self-storage facilities and similar commercial assets.
Some additional benefits of investing in a DST can include:
Limited liability. DST laws protect investors from incurring personal liability from the assets held under trust. Investors can enjoy the benefits that come with investing in commercial-grade real property without the added risk of direct property ownership.
Diversification and sizing. 1031 exchange investors can exchange into multiple DST investments at the exact amounts needed to satisfy the like-kind replacement requirement. They also can exchange into multiple DSTs with varying property types, such as senior housing or medical offices, or in different geographical regions in an attempt to better manage their investment risk.
Timing. Timing is crucial for investors trying to complete 1031 exchanges and defer capital gains taxes. Exchangors have just 45 days from the close of sale of their relinquished assets to formally identify suitable like-kind 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, rent rolls and financing are already in place, so exchange investors can quickly meet the 45-day identification deadline 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-dealer or registered investment adviser to invest in a Delaware Statutory Trust.
DST interests are available only to accredited investors. Accredited investors are individuals with income above $200,000 for two consecutive years ($300,000 for married couples), and with a net worth above $1 million. The value of your primary residence does not count toward the $1 million threshold.
How to Evaluate DST Sponsors
DST sponsors control the day-to-day operations of assets held under trust. Sponsors also are responsible for distributing monthly cash flow distributions, quarterly reporting, tax returns and performance reviews of the assets under their management. Sponsors can vary greatly by management experience, core competencies in specific property types, geographical footprint, underwriting experience and exit strategies.
Generally speaking, sponsors with a long track record allow prospective investors to better gauge sponsor performance, especially during economic downturns. Sponsors with shorter tenure, meanwhile, could also prove viable – just make sure you do as much research as you can on their history, especially if they were involved with other types of real estate investments. Management teams with a long history of experience also may be better positioned 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 scale to devote more resources to analyze current and prospective properties, as well as potentially secure better loan pricing and terms. Communication is another area where large sponsors may excel through regular reporting and asset performance updates. Like any investment, it’s important to do comprehensive due diligence on sponsors and their offerings prior to making any investment decisions. DST investors can learn more about sponsors by checking reviews from third-party firms such as FactRight.
If this type of research or property-specific research isn’t in your wheelhouse, you can engage an experienced commercial real estate investment firm to complete due diligence for you.
Additional Considerations for Investing in a DST
DST investments aren’t for everyone. Here are some important considerations to make before investing in a Delaware Statutory Trust:
Illiquidity. DSTs have a hold time between five and 10 years, making them illiquid investments best suited for individuals with long-term investment horizons.
Passive investment. Beneficiaries are not involved with the day-to-day operations of commercial properties held under trust. Some investors may welcome this hands-off approach, while investors with extensive experience owning and managing real estate may not prefer being so hands off.
Expected returns. Factors such as property type, location, mortgage balance and interest rates determine return objectives for DSTs; however, annual return objectives between 3% and 6% are common. Total returns can potentially be higher or lower due to tax benefits and property appreciation.
Sponsor research and evaluation. DST sponsors are not created equally. It may be difficult for an investor to do the recommended due diligence on their own, which is why working with a broker/dealer or a firm experienced in DST investments can be beneficial for investors interested in purchasing DST interests.
Working with an experienced financial adviser, conducting independent research and engaging an investment firm with deep knowledge of commercial real estate can help investors better determine if 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 with a licensed professional for advice concerning your specific situation.