DSTs offer an intriguing option for investors who are looking for properties to complete their 1031 Exchanges.
A DST (Delaware Statutory Trust) is an “arm chair investment”, or a passive investment opportunity that allows individuals to own fractional shares in institutional grade properties. A DST is a legal entity created as a trust under Delaware law that can hold real estate. In the context of real estate, DSTs are formed pursuant to private governing agreements under which a property or several properties are held, managed, administered, and/or operated for profit by a trustee for the benefit of the holders of the DST’s beneficial interests. 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 large retail shopping center in California
- 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 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
- 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 high net worth individuals as defined in Regulation D of the Securities Act of 1933.
Given the intricacies of purchasing suitable real estate assets and structuring these offerings, from both a securities and tax perspective, exchangers and their advisors should perform due diligence when selecting a DST sponsor. 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.