Many passive real estate investment options exist nowadays, providing investors with a wide range of choices based on their needs and investment goals. Two popular avenues are Delaware Statutory Trusts (DSTs) and non-traded real estate investment trusts (REITs). Both offer benefits like passive income and enhanced diversification, but they have fundamental structural differences that affect 1031 Exchange eligibility, liquidity, cash flow, and lots of other critical considerations.
Realized 1031 explores Delaware Statutory Trust vs REIT structural differences to help you understand these characteristics and determine how each option may fit into your long-term investment strategy. Let’s take a closer look.
DSTs vs Non-Traded REITs
REITs and DSTs are highly similar investments, particularly in the way they own underlying properties that generate income. DSTs are also private placements, which makes them function like non-traded REITs. The latter are trusts that aren’t available to the public, which means that they cannot be traded on a stock exchange, which is allowed for public REITs.
Beyond these similarities, REITs and DSTs have fundamental legal and structural characteristics that make them distinct investments from one another.
Ownership and Legal Structure
The first major distinction between the two is their legal structure. DSTs are created under Delaware state law, and investors own beneficial interests in the trust. It’s the DST that owns title to the real estate assets, not the investors. Most importantly, DSTs can be structured to qualify for 1031 Exchanges, allowed by Revenue Ruling 2004-86.
Meanwhile, non-traded REITs are corporations or business trusts registered with the Securities and Exchange Commission (SEC). Instead of beneficial interests, you own shares of stock. REIT shareholders own equity in the company and not the underlying properties.
Investment Strategy and Asset Control
DSTs are passive by nature. After the initial offering period closes, the investors cannot add more capital, and sponsors can only handle high-level oversight of the properties. This creates a stable buy-and-hold structure that ensures long-term stability.
Meanwhile, non-traded REITs have more flexibility. Properties can still be sold, refinanced, or developed over time. While this allows the REIT to adapt to new markets, stockholders are still dependent on the management instead of fixed rules.
Liquidity Differences
Both types of investments are generally illiquid. For DSTs, the long holding period means capital remains tied up until the end of the full cycle event. Secondary markets exist for beneficial interests, but they’re not reliable. Due to the lack of exposure to public trading, REIT shares are also illiquid. Either the sponsor waits for a liquidity event, tries the secondary market, or utilizes the REIT’s redemption programs.
1031 Exchange Eligibility
Only DSTs are eligible for 1031 Exchange tax deferral, which allows investors to delay capital gains tax payments from the property they sold to enter the DST. While non-traded REITs do not qualify for these benefits, REIT distributions are partially sheltered through the IRS’s 20% pass-through deduction. In terms of 1031 Exchange investment comparison, DSTs are often the best option for investors because these trusts allow them to continue tax deferrals indefinitely.
Income Expectations and Cash Flow Stability
A DST’s “cash flow” is best understood as passive net rental income generated by the underlying real estate during the holding period. While a DST structure allows investors to be passive owners without day-to-day management responsibilities, passivity alone does not guarantee predictable or stable income. However, long-term triple-net (NNN) leases and creditworthy tenants may support more predictable, stable cash flows over time, subject to property performance, tenant behavior, and market conditions. Meanwhile, non-traded REITs are designed more for high income potential or capital appreciation. However, the more aggressive approach can lead to relatively less predictable dividend distributions.
Governance and Investor Rights
After the initial offering closes, DST investors have almost no control over the investment. It’s the sponsor and parties like master tenants that have any say regarding the administration and management of the DST.
Meanwhile, non-traded REITs are usually governed by board members, with some members coming from the pool of investors. The board is responsible for the overall strategy and management of the REIT. However, the REIT managers still maintain broad discretion over the activities of the REIT, limiting the power of the board members and investors.
Which Is Right for You? DST vs Non-Traded REITs
Based on the differences we outlined, DSTs and non-traded REITs have their own unique characteristics that make them each suitable for specific types of investors.
A DST may be ideal for those who prioritize the following.
- Continuation of 1031 Exchange tax deferral
- Relatively more assive and stable long-term income
- Minimal decision making
- Long-term illiquid investment
If you prefer the following, then non-traded REITs may be better for you.
- High potential for increased income over time
- Longer timelines and management discretion
- Potential capital appreciation beyond static ownership
- Tax benefits from distributed income
Final Thoughts on Delaware Statutory Trust vs REIT
Non-traded REIT and DST structural differences have a profound effect on matters like liquidity, investment stability, and income potential. When making a choice between these two options, it pays to be aware of these contrasts. That way, you can put your capital into an investment that fits your risk profile, involvement preferences, and long-term financial goals.
