When choosing to invest in real estate, there are a number of approaches an investor can consider. Two of the most popular investment methods include Real Estate Investment Trusts (REITs) and Delaware Statutory Trusts (DSTs). These two investment options have several benefits, which will be discussed below.
Before we dive in, let’s first highlight the difference between ‘direct properties’ and ‘indirect properties.’ Investing in a direct property refers to purchasing a commercial, industrial, residential, or retail property. The investor can either have direct ownership of the title, meaning they fully own the building and have complete autonomy over the asset, or they can own it with a group of other investors through a fund or trust, making it an ‘indirect property.’ REITs and DSTs both involve indirect properties.
What is a Delaware Statutory Trust (DST)?
A Delaware Statutory Trust (DST) can be used anywhere in the U.S. (not just in the state of Delaware). A DST is a legally-recognized trust in which property is held, managed, and invested. DSTs allow investors to pool together their 1031 exchange proceeds into the trust, making it an extremely attractive investment option.
Here’s how it works: the real estate sponsor will open the DST. Investors will then deposit their 1031 exchange proceeds into the DST. Properties will then be purchased under the DST umbrella. The investor then receives cash distributions from the properties that were acquired through the DST (through rental income or the eventual sale of the asset).
It is important to note that individuals who invest in DSTs must be accredited, meaning have a net worth that is higher than $1 million or income that exceeds $200,000 ($300,000 if married and filing jointly).
What is a Real Estate Investment Trust (REIT)?
A Real Estate Investment Trust (REIT) is an organization that acquires, manages, and sells real estate investment properties. Investors who purchase a share of a REIT benefit from the income that is generated from the investment properties. For example, a REIT may be comprised of several apartment buildings or retail spaces across the U.S. Instead of only owning one property, a REIT offers investors the opportunity to own a diverse portfolio with a variety of properties in several different markets.
Individuals who invest in REITs are often times not required to have a minimum net worth and can be new to real estate investing. Additionally, two types of REITs are available to investors: public and private. Public REITs are traded on the stock exchange and can be purchased and sold as frequently as the investor chooses. Private REITs, on the other hand, are not publicly traded and may have restrictions on investment liquidation, such as lockout periods, making it far more challenging for an investor to remove their funds from the trust.
Are REITs and DSTs similar?
Although REITS and DSTs are different investment structures, they do have some similarities. REITs and DSTs are both considered passive investments because investors do not have to deal with the hassle of managing properties, tenants, and other challenges that stem from owning a property directly.
Private REITs and DSTs are illiquid investments, meaning they cannot be sold on the open market. If you need to sell an asset to raise money quickly, you may not be able to do so with shares of a private REIT or DST because your funds are typically tied up for a period of time (which is known as the “holding period”). However, public REITs offer some liquidity and can easily be purchased and sold because they are part of the stock market. With that being said, there is also a stronger chance that investors will lose money with publicly-traded REITs due to stock market volatility.
What are the differences between REITs and DSTs?
Individuals interested in investing in a DST will need substantial capital to invest, with the minimum typically ranging from $25,000 for cash investments and $100,000 for 1031 exchange investments. Conversely, private REITs typically start with a much lower investment between $1,000 and $5,000. Public REITs are slightly less expensive, and can be comparable to the cost of acquiring a stock.
REITs and DSTs also have some fees attached. DSTs require that fees be paid to the trust’s sponsor, selling groups, and broker-dealers (when involved). DST fees include selling commissions, a broker-dealer allowance, wholesaling fees, a managing broker-dealer fee, offering and organization expenses, and acquisition fees. It is important to consider the various fees involved in a DST, because high fees mean the DST must sell for a higher price point to ensure a sizable return on the originally-invested equity.
REITs also have associated fees, but those fees will vary if you purchase a publicly-traded REIT or non-traded REIT. Publicly-traded REITs are purchased through a broker, so brokerage fees will apply. Private REITs are also typically sold by a broker or financial adviser and can have substantial up-front fees and commissions totaling around 9 to 10 percent of the total investment. These costs lessen the value of the investment by a significant amount.
What is a person’s objective when investing in a REIT or DST?
An investor’s primary objective when investing in a DST is typically that they are looking for an income-producing property with a long-term holding period.
A DST is a direct interest in real estate, meaning that it is eligible to be exchanged in a 1031 transaction. DSTs are also structured as pass-through entities, so trustees can avoid income tax at the entity level because all income goes directly to each trustee's Form 1040 and state's tax returns. In other words, income received is factored into the investor’s ordinary income.
In a DST, depreciation of the property and mortgage interest expenses can help reduce the investor’s taxable income. This applies to investors that have carried over depreciable basis from their relinquished property, have acquired more property value in their exchange thus picking up more depreciable basis, or have assumed debt in the replacement DST.
When you invest in a REIT, you own part of the company that owns the real estate, so the properties are not eligible for 1031 reinvestment – which is different than DSTs.
What is at risk when investing in a REIT or DST?
DSTs and REITs pose similar risks, including the possibility of an investor losing their funds entirely due to market volatility or an economic downturn. Additionally, DSTs and REITs are both subject to rising interest rates.
In terms of cash flow, DSTs have projected payouts based on a master lease but are subject to investors losing money due to property vacancies and increased operating expenses.
Those investing in DSTs and private REITs are prone to similar risks, including decreased return due to properties being sold for less than they were purchased for, depending on the market and economy. Public REITs are subject to fluctuations in the stock market, making them riskier and more volatile.
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