Before entering a Delaware Statutory Trust (DST) investment, you’ll receive the DST offering memorandum, also called the private placement memorandum (PPM). This document outlines almost everything you need to know about the DST, from the financial projections to the characteristics of the underlying properties.
The offering memorandum serves as a key piece of documentation that investors must scrutinize before committing their capital to a DST. Realized 1031 shares what you need to know about the PPM to help with more comprehensive DST due diligence. Keep reading to learn more.
Looking Beyond the Executive Summary
Some investors may only look at the PPM’s executive summary, which is a high-level synopsis of the entire offering. This section does provide details of key elements, such as the condition of the underlying properties, the sponsor profile, and financing terms. However, the executive summary must only be treated as a starting point.
A savvy investor must look at the finer details to gain a full picture of the investment and make more confident decisions. Sections like financial projections, sponsor background, and risk factors must be examined to determine whether this investment aligns with your investment goals.
1. Property Description
This section details information about the underlying assets. You’ll find specifications about the property, location details, and tenant information. Pay close attention to the tenant concentration, especially if an asset is supposed to have multiple occupants. If a huge percentage of the income comes from one tenant, then the DST may have a higher risk should that tenant default or vacate.
We also recommend looking for any recent renovations or if there’s a major repair being anticipated. These could affect cash flow in the future.
2. Financial Projections
Scrutinizing the financial projections of the PPM is also a critical step for passive real estate investing due diligence. This section outlines expected income, expenses, and investor returns over the life of the trust. Check the following details.
- Projected annual cash flow distributions
- Rent growth and expenses
- Debt service obligations or loan terms
- Estimated internal rate of return (IRR)
Work with your accountant or financial advisor to understand how these numbers affect your overall investment goal. Be cautious of optimistic projections. Comparing the projected numbers to market data and other DST offerings can help you assess whether the numbers are realistic.
3. Debt Structure
The majority of DSTs leverage financing to acquire the assets. However, renegotiating loans or refinancing is prohibited once the offer closes to maintain compliance with Revenue Ruling 2004-86. As such, it’s important to look at the debt structure section to determine how the sponsor will handle debt. Check the amortization period and maturity dates, as well as the loan-to-value (LTV) ratio, which indicates how much debt the asset carries relative to its value.
4. Sponsor Background and Track Record
Investors must not have any direct involvement with the DST’s operations to preserve its passive nature. As such, you are entirely dependent on the sponsor to ensure the success of the investment. This fact means sponsor expertise and track record are critical points of evaluation. Check the PPM to understand if the sponsor has handled similar assets in the past, and what came of their oversight. Consistent past performance and transparency in reporting are strong indicators of reliability.
5. Risk Factors
Offering memorandums must include a comprehensive list of all the potential risks associated with the DST and its underlying properties. This section is usually the lengthiest and most exhaustive, so patience is necessary to ensure that you’re aware of all the challenges that DST may face and their impacts. Common risk factors you may find include the following.
- Illiquidity: It’s difficult, if not entirely impossible, to liquidate your capital while the DST is operational.
- Property-Specific Risks: Risks associated with the property, including its location, age, and vulnerability to natural disasters.
- Sponsor Risks: The investor’s dependence on the sponsor’s management and decision-making creates this risk.
- Market Risks: Check how rising interest rates, inflation, and other broader market conditions could affect the investment and its revenue.
6. Fees and Compensation
The property’s gross income will not be the same as the net income you’ll receive on a regular basis. Make sure to check how and where the sponsor spends some of the revenue to determine whether these costs are reasonable.
Wrapping Up: Examining the Offering Memorandum of Delaware Statutory Trust Investments
In a 1031 Exchange DST transaction, the offering memorandum is perhaps the single most important document you’ll encounter as an investor. Thorough examination of the critical sections, like the risk factors, property description, and sponsor background, is how you gain a solid understanding of the investment and determine whether it’s the best fit for your investment goals.
Sources:
https://www.investopedia.com/terms/l/loantovalue.asp
