DST Due Diligence: What to Consider?

Although DSTs have been well received by investors as a viable replacement property option for 1031 exchanges, this type of investment should be more than a “plug-and-play” scenario. With the high velocity of deals and an ever-increasing number of sponsors looking to enter the market, due diligence is more important than ever to ensure you aren’t exposing yourself to unnecessary risk. In order to help you as an investor determine the good deals from the bad, this article addresses the integral questions you should always consider before investing in your next DST.

The Important Questions

Although DST offerings pass through a number of hands before making their way to investors, each conducting their due diligence along the way, it is important to have a grasp on exactly what you’re entering into. Different deals have different Sponsors, business plans, and exit strategies, and knowing these details may keep you out of an unnecessarily risky offering. Here are some of the important questions to ask:

• Who is the Sponsor, and what is their track record? Every DST Sponsor differs in experience, strategy, and overall capability. Has the Sponsor had experience with this particular type of investment? How has the Sponsor managed investments at different points of the real estate cycle? Although the internet is a good tool when looking into the background of a Sponsor, every offering memorandum includes the Sponsor’s prior performance as well, providing yet another tool for investors to use in their assessment. Always beware, however, that past performance does not guarantee future results.

• Are the projected financials reasonable? As with most investments, returns are projected and based on assumptions about a particular property's performance. These projections try to predict rent growth and occupancy levels and run the risk of being overstated. Referring to market reports and appraisals is a good first step in determining whether or not a deal’s financial projections are reasonable.
  
  

• What do the fees look like? Sponsors look to enter the DST space to turn a profit. Almost every Sponsor will take certain fees, such as acquisition, disposition, and asset management fees. However, not all fees are created equally, and you must assess the competitiveness of these fees to make sure they are not significantly detracting from your return.
  
  

• What is the intended exit strategy? As DSTs gain more traction in the 1031 space, Sponsors are developing new, creative ways to exit an investment. Sponsors utilize both third-party sales and UPREIT exit strategies, and assessing one’s long-term goals is important in determining whether or not this is a viable option.

In addition, never forget the importance of property due diligence. Assessing the strength of the tenant and market is just as important as the ideas mentioned above, and making oneself comfortable with these factors is half the battle.

Also, due diligence in a Delaware Statutory Trust (DST) involves a comprehensive assessment of the property and trust structure post-acquisition. DST sponsors and licensed independent brokers package and market the offerings to investors, ensuring transparency, compliance, and security within the investment.

Why Should You Be Concerned?

There are many reasons why you, as an investor, should be concerned with the structure and plan of a DST. Along with the factors mentioned above, sponsor alignment, questionable financial engineering, and conflicts of interest are additional factors that may or may not be evident in a particular deal. These factors provide evidence of the necessity of due diligence beyond just the property itself. DSTs are more than just ownership of a property. They are financial instruments with several moving parts. In an environment of increasing interest rates and real estate prices, the economics around DSTs may be strained, making proper due diligence more important than ever.