Investors are drawn towards Delaware Statutory Trusts (DSTs) because, aside from passive income and tax-deferral status, these investment vehicles enhance diversification to another level. In real estate investing, diversification is the spread of capital across different assets to reduce exposure to a single risk. The nature of DSTs, which usually own multiple assets, makes them excellent avenues for those who prioritize diversification.
However, some investors aren’t aware that investing in multiple DSTs is allowed. This strategy is another method for enhancing diversification and spreading risk with DSTs. In this article, Realized 1031 shares strategies you can take if you plan to implement this plan of action. Keep reading to learn more.
Is It Necessary to Diversify a DST Portfolio?
DSTs already have built-in diversification, so why are multiple investments still necessary? This practice is often employed in 1031 exchange portfolio diversification because—aside from the ease brought about by the low entry requirements—it can provide additional benefits. These can include:
- Avoiding concentration risk, especially if the DST is focused on one asset class or sector
- Helping blend risk profiles
- Making your income stream more stable since you’re not depending on one DST for monthly distributions
DST Diversification Strategies To Implement
Investing in multiple DSTs must be done with the intent to maximize the advantages. Here are some specific best practices you can follow.
1. Diversifying by Property Type
The most common strategy when investing in multiple DSTs is to vary the property types. For example, you can allot 30% of your capital to multifamily DSTs, 40% to healthcare or medical DSTs, and 30% to industrial DSTs.
Each sector has its own unique characteristics and behavior in various economic cycles. For example, in recessions, most healthcare DSTs remain stable because of the nature of the service. As such, even when other DST investments are underperforming, you have a cushion that helps balance the losses. You are more protected from sector-specific volatility compared to investors who focus on one property type.
2. Geographic Diversification
In addition to different property types, you can invest in DSTs that own assets across multiple geographic locations. The performance of an asset is still highly dependent on local demand. As such, any economic downturn could greatly affect property performance. Multiple DSTs provide a cushion against these local risk factors, ensuring that your overall investment won’t be affected.
3. Credit and Tenant Mix Diversification
Another source of risk in DSTs is tenant risk. For DSTs depending on a single tenant, the latter’s operations make a direct impact on the cash flow of the trust. If the tenant defaults, then income could be disrupted.
To mitigate tenant risk, tenant diversification is necessary. You’ll want to choose multiple DSTs with varying tenant creditworthiness. Those with the highest ratings (AA to AAA) usually provide stability and are often seen in national companies or franchises. Investing in DSTs with lower-graded tenants is still possible, especially for regional businesses with promising potential. The risk is higher, but there’s also a heightened possibility of maximum returns.
4. Income vs Appreciation Potential
Another aspect to consider when diversifying through multiple DSTs is the investment objectives of the sponsor. Some want to focus on increasing income, and others lean more towards enhancing the appreciation potential of the underlying assets.
- DSTs with NNN leases, for example, focus on stable income flow to ensure long-term stability.
- DSTs with multiple assets may focus on value-added components or tenants with high credit ratings to increase the potential for higher property values after the holding period.
Savvy investors put capital in either category to ensure that their portfolio is balanced. Otherwise, one DST that is too partial to enhancing appreciation potential could result in less-than-ideal monthly returns, and vice versa.
5. Liquidity Planning
One more aspect where diversification is critical is liquidity. DSTs have long holding periods, and after the full cycle event, the market could look entirely different. Interest rates may have risen, resulting in lower valuations and decreased final distributions.
To mitigate this liquidity risk, one strategy is to invest in DSTs with differing timelines. This helps shield some of your capital from economic issues in one specific year. For those who no longer want to continue another 1031 exchange cycle, staggering the holding periods also helps manage tax liability.
Wrapping Up: Diversification Through Multiple Delaware Statutory Trust Investments
For the investor who wants to minimize risk as much as possible, one DST isn’t enough. Investing in multiple DSTs helps ensure that factors like tenant risk, local economic downturns, and sector-specific challenges won’t make a significant impact on their cash flow and overall investment strategy. This strategy is one of the ways you can reduce risk and position yourself for stronger long-term results.
Sources:
https://smartasset.com/investing/delaware-statutory-trusts-dsts
