Many modern investors have recognized the appeal of Delaware Statutory Trusts (DSTs), with promises of enhanced diversification, tax-deferral benefits, and passive and predictable income. The latter is affected by two major factors: lease terms and the type of tenant occupying the property. These two variables are often overlooked when evaluating offering memorandums, but tenant type and lease terms can fundamentally affect the cash flow and risk profile of the DST.
Realized 1031 dives deeper into these factors to help you understand the complex interplay. Keep reading to learn more about DST 1031 exchange rental income stability.
Why DST Cash Flow Stability Matters for Investors
The main reason why investors, retirees, and income-focused portfolios turn to DSTs is because of the stable cash flow these trusts offer. The revenue comes from the income-generating activities of the properties, like leasing, which yields rental income. Once deductions like operating expenses are calculated, the remaining net operating income (NOI) is distributed to beneficial interest holders. This consistent distribution provides the following benefits:
- Predictability that allows investors to plan long-term income needs
- Preservation of liquidity while deferring capital gains taxes
- Reduced stress and excessive planning compared to more speculative investments
These benefits will only apply if the DST is actually able to ensure a stable cash flow. Sponsors take into account both lease terms and tenant types to predict and maintain a reliable income stream.
3 Ways Lease Terms Affect Income Predictability
The lease agreement is the contract between the DST and the tenant that outlines how much the tenant pays and how frequently. However, Delaware Statutory Trust lease terms can have structural differences that dramatically affect income stability.
1. Length of Lease
In general, long-term leases provide the most income stability. These are common in net-lease DSTs, which assign some net operating expense to the tenant. Contracts that last 10 to 30 years ensure stable occupancy and can provide long-range income certainty. Meanwhile, DSTs with shorter lease terms may face more renewal cycles, increasing the risk of cash flow volatility.
2. Rent Escalation Clauses
Having rent escalation clauses is standard practice in most lease terms. These are provisions that allow landlords or DST sponsors to increase the rent to keep up with inflation. Various structures are available, such as annual increases or CPI-indexed escalations.
3. Net vs Gross Lease Structures
As mentioned, net lease structures assign net operating income to tenants. For example, triple net leases remove the burden of paying property taxes, insurance premiums, and maintenance costs from the DST. This lowers the monthly income, but also offers greater predictability.
Gross leases can offer higher distributions. However, since the DST is exposed to net operating costs—which can fluctuate based on economic conditions—the actual monthly distributions can be less predictable.
How Tenant Type Affects Stable Income From DST Investments
DST tenant types also influence the performance of the trust and, by extension, your monthly income. Even if a lease structure is robust and sound, the DST can still perform poorly if the tenant lacks financial strength.
Credit-Rated Corporation
These are among the most stable tenants because these companies have a high credit rating and strong financial reserves. Such corporations typically sign long-term net leases, leading to consistent DST contributions and lower vacancy risk. Examples are big-box retailers, pharmacies, and logistics operators.
Government or Healthcare Tenants
Due to the nature of their services, government and healthcare tenants can provide a steady income flow, even when inflation or recessions occur. They are also more likely to renew, especially healthcare tenants who’ve already invested a lot of capital in making the building fit their operational needs.
Franchises and Regional Operations
Generally, regional operations and franchises can provide a predictable cash flow. However, risk can arise based on variables like market dominance, demand, and franchise system strength.
Multifamily Tenants
For multifamily tenants, a few vacancies are less likely to affect cash flow since these types of properties enjoy steady demand. However, risks like tenant default or unexpected operational expenses can still impact net operating income (NOI) and lower distributions.
Considerations for Investors
The details of both lease terms and tenant type are found in the offering memorandum. Since you can’t directly negotiate lease terms due to the passive nature of the DST, the only time you get to assess these two factors is during the initial assessment of the DST offering. Work with your financial advisor to better understand the complex interplay between tenant types and lease terms. That way, you can conduct thorough due diligence on each identified DST.
Wrapping Up: Delaware Statutory Trust Lease Terms, Tenant Types, and Income Stability
The stability of DSTs heavily relies on the tenant type and lease terms. The ideal scenario is a long-term lease with a creditworthy tenant that can withstand economic downturns and maintain financial strength throughout the DST’s lifecycle. However, even DSTs with short-term leases can still work. What’s important is for you to understand the relationship between these two variables, allowing you to make more informed assessments when choosing where to invest.
Sources:
https://www.investopedia.com/terms/t/triple-net-lease-nnn.asp
https://www.legalnature.com/guides/what-is-a-lease-agreement
https://smartasset.com/investing/delaware-statutory-trusts-dsts
