Delaware Statutory Trusts (DSTs) offer an intriguing option for investors who are looking for properties to complete their 1031 Exchanges. Why? DSTs do not have the typical responsibilities associated with managing investment properties.
A DST is an “arm chair investment”, or a passive investment opportunity that allows individuals to own fractional shares in institutional grade properties. Some examples of properties that were recently structured as DSTs are:
- A portfolio of 17 storage properties in three states;
- An office building in Manhattan;
- A multi-family portfolio in Colorado;
- A student housing complex in Michigan;
- A portfolio of medical office buildings in Midwest; and
- A portfolio of CVS and Walgreens stores located in Southern states.
How does a DST work? A trustee of the DST initially purchases the property and takes title. The sponsor of the DST, the party who typically arranges the bank financing and coordinates the management of the property, then structures the transaction and arranges for sale of beneficial interests to individual investors. Though the beneficial interests are considered to be securities under federal securities laws, for purposes of 1031 Exchanges, Revenue Ruling 2004-86 states that a beneficial interest in a DST is considered “like-kind” real estate.
According to DST proponents, these are some of the benefits of DST ownership:
- DSTs can offer higher quality, investment-grade assets, such as high rise office buildings, that are typically only available to large institutions;
- DSTs provide investors with current income;
- DST investors have no management or day-to-day operation responsibilities; and
- The debt is non-recourse, which means that in the event of a default, the DST investor is not personally liable.
Of course, DSTs are not suited for all. Investors who enjoy managing the day-to-day operations of their properties may not be good candidates. A DST is also not for an investor who wishes to invest in property for a short period since DST investments are typically designed for a holding period of two years or more. Additionally, DSTs are designed for “accredited investors” which are higher net worth individuals as defined by the SEC.
Given the intricacies of purchasing suitable real estate to complete their 1031 Exchanges, taxpayers and their advisors should perform due diligence when considering properties; taking into account factors such as the reputation and track record of the DST sponsor. Remember that the sponsor will not only act as the sales agent but will also be managing the properties. The sponsor will provide a Private Placement Memorandum (“PPM”) which provides information about the properties, area demographics, leases, projections and other important disclosures. Due diligence emphasis should be placed on real estate, property management and asset management expertise, prior performance track record, experience with sophisticated financing structures, transparent investor communications, financial strength of the sponsor and excellent legal representation.