DST Risks & Fees

DST Risks & Fees
Posted by on Apr 2, 2019

Risk and Fees

It should come to no surprise that Delaware Statutory Trusts (DSTs) carry many of the same risks as a direct property investment. After all, the underlying asset driving the investment’s performance is some type of real estate asset. From illiquidity to macroeconomic risks, such as rising interest rates, DSTs are exposed to a variety of similar factors that may spell trouble for any real estate investment.

Unfortunately, due to their structure, DSTs are subject to further risks that may not exist in direct property or REIT investments. Because they are tax-heavy, financial products, DSTs are exposed to a variety of additional forces that include regulatory and execution risk, as well as financial risk due to the fees that are baked into most DST offerings.

This article will explore the various risks and fees that DSTs are subject to, and the impact that it may have on an investment. Although DSTs are costly, there are several misconceptions about the price of investing in a direct property versus a DST that this article will explore as well.

Risks

In a prior article we wrote titled “Disadvantages of Delaware Statutory Trust (DST) 1031 Exchange Replacement Properties”, we discuss several risks associated with owning a beneficial interest in a DST: illiquidity, lack of control, and capital restrictions. Although important and perhaps the most evident to new investors, one must not forget other key risks involved:

  • Macroeconomic Risk: As with any investment in real property, rising interest rates and the health of the U.S. economy play a role in determining how the property performs. While increasingly expensive debt can have a downward pressure on returns, recessionary periods may affect occupancy rates at the Property, as well as the ability to find a willing buyer when it comes time to sell.

  • Regulatory Risk: Because DSTs are tax-driven investments, they are subject to various regulatory constraints from the IRS. Executing a smooth exchange, while not violating any of the “7 Deadly Sins” of a 1031 exchange, is a risky endeavour and takes sufficient planning to ensure that you don’t lose the benefits of conducting an exchange. In addition, tax laws and regulations are constantly being debated and amended by Congress, with 1031 exchanges recently at the top of this list.

  • Execution Risk: As mentioned before, there are several moving parts and interested parties involved in a DST investment. One failed step by a qualified intermediary or sponsor may affect your ability to exchange.

Fees

A major concern about DSTs we hear from investors is fees. Understandable considering your hard earned money is going directly into the pockets of another, instead of getting put to work for you. The unfortunate truth, however, is that the companies involved in a DST transaction won’t work for free, and can sometimes be expensive. Fees are typically taken at three levels in the DST structure: upfront, operating, and disposition.

Although acquisition costs are typical in most real estate investments, such as legal costs, loan and lender expenses (when debt is being acquired), and other miscellaneous closing costs, some upfront costs in a DST are not as typical. These fees include:


Selling Commissions

Due to most Sponsors not being licensed to broker DST investment sales through their own platform, most of the selling efforts are done on behalf of third-party selling groups. These groups include registered representatives and registered investment advisors (RIA). Because RIA’s are compensated by their clients, typically based on assets under management, selling commissions are typically re-allowed to registered representatives that execute the sale of a DST interest in a given offering.

Broker-Dealer Allowance

Managing broker-dealers are often times reimbursed for expenses related to marketing and due-diligence efforts. This allowance can be in addition to managing broker-dealer fees, and is used to cover costs of obtaining third-party reports, marketing materials, or other relevant items.

Wholesaling Fees

Sponsor’s often times utilize an in-house selling team, known as wholesalers, that spend time working with registered representatives and RIA’s to ensure they have all of the information and documents they need to effectively sell an offering. These individuals are typically responsible for a geographical area, and are compensated a commission for sales that occur in their region.

Managing Broker-Dealer Fee

Due to the fact that DSTs are recognized as securities, offerings are often times issued through entities known as ‘managing broker-dealers.’ If a broker-dealer is involved, they will assist in due diligence, document preparation, and securities compliance, and are compensated for their efforts.

Offering & Organization Expenses

Any overhead costs associated with establishing and running the DST. This can include printing costs, expenses related to the registration of securities, or and other miscellaneous costs that don’t fit another bucket. This line item could be described as a “catch all”, for which the Trust reimburses the Sponsor for.

Acquisition Fees

Sometimes referred to as a Sponsor’s “finder’s fee”, an acquisition fee is a payment to the Sponsor for identifying, negotiating, and acquiring the asset in the Trust. In addition, a Sponsor may take an additional loan fee for obtaining financing for the acquisition.


The amount of capital going towards fees and reserve accounts above the purchase price of the underlying property is known as the “load”, and is important to consider when thinking about returning 100% of your capital when it comes time to sell. While no returns are assured, the higher the load, the more the underlying property in the DST must sell for to return an investor’s original invested equity.

Fees don’t end there, however. Over the DST’s life, sponsors will often take asset management fees as additional compensation. In some cases, sponsors will structure cash flows to where investor returns are capped, leaving the Sponsor to receive the upside cash flow. Lastly, sponsors will often take a disposition fee upon the sale of the property, which may or may not be subordinate to investors returning all of their original investment.

 

The Misconception About Fees

One of the things we always hear is that DSTs are too expensive. The reality is, you are not wrong. In 2017, the median load-to-equity on a DST was 18.32%1, meaning that this percentage of each investment was being allocated towards expenses related to Sponsor compensation, selling commissions, and the establishment of the trust. Not ideal.

Although true, the fees baked into a DST offering should not be looked at in isolation. One should consider the benefits of investing into a passive investment with fees against the benefits of direct property without fees. Let’s take a look at the some of the differences:

  • Timeline: One of the most demanding parts of investing in direct property is finding a suitable property, from a suitable seller, for a suitable price. Believe it or not, this is a time-consuming process that could take months to complete. In the event that it is not an all cash transaction, one must find a suitable loan in the process, only complicating the process. Considering the timing and debt requirements of conducting a 1031 exchange, investing in direct property may prove to be more difficult than investing in a DST, where all of these items are established within the offering.

  • Management: Although you are often paying for property, asset, and potentially construction management fees in a DST, there is a lot of benefit behind having a professional property manager oversee the day-to-day operations of the property. Instead of having to drive out to your replacement property to repair the broken A/C unit, a third-party manager will take care of the hassle for you. With most DSTs using established property managers, such as Greystar, these entities may be able to operate the property more efficiently than you can, leaving the ability to increase property level income through decreased expenses and successful value-add initiatives, such as improved amenities that drive rent increases. Although you are paying a fee, you potentially have the ability to capture more upside.

  • Back-End Costs: At the end of a DST’s hold period, the Sponsor will often take a disposition fee as a percentage of the property’s sales price. For example in 2017, the median disposition fee taken from a Sponsor was 2%.1 Because these are often paid from the proceeds received from the sale of the asset, the distribution to the Trust will be reduced by this amount. Direct property doesn’t go without it own costs, however, including sales commissions, advertising costs, and legal and conveyance fees when it comes time to sell.

Although there are a lot of similar fees in both direct property and DSTs, there are extraneous costs and factors that must considered before entering into either. While DSTs may incorporate more tangible expenses related to the syndication of the investment, such as fees to the Sponsor and various selling and due diligence groups involved in the offering, direct investment expenses may relate to the opportunity cost of time loss spent performing one’s own due diligence, or the inability to obtain as favorable of financing terms as an established real estate operator could obtain. What is really comes down to is how much you value the benefits of a hands-free DST investment versus buying, operating, and selling a property in your own right.


At Realized, we understand the costs of investing in real estate, whether it be through direct property, a REIT, or Delaware Statutory Trust. If you have concerns regarding the risks of any of these investment vehicles, or would just like to compare typical fees, call us at 877-797-1031 or schedule a consultation at www.realized1031.com/contact-us.

 

  1. FactRight. Typical Fees and Metrics in DST Offerings. February 7, 2018.

 


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