Entering a Delaware Statutory Trust (DST) through a 1031 Exchange provides key benefits like tax deferral, enhanced diversification, and passive income. However, not all DSTs can guarantee these advantages, and some may even underperform, resulting in less-than-ideal returns or even losses.
To increase the chances of a successful investment, DST due diligence is paramount. This extra step helps you see the full picture and determine whether or not the DST offering fits your investment goals. Realized 1031 — your trusted resource for all things 1031 Exchange — shares a comprehensive checklist on Delaware Statutory Trust due diligence. Take advantage of this guide to assess each offering thoroughly.
Evaluating DST Sponsors
Investors in DST are the only beneficial interest holders. Regulations imposed by Revenue Ruling 2004-86 prohibit you from taking any active role to preserve the passive nature of the investment. Because of this, the profitability of the investment becomes hugely dependent on the capabilities of the sponsor. Evaluating DST sponsors is thus a critical aspect of DST due diligence.
- Experience: How long has the sponsor been handling DST investments? Those who have been around long enough to experience multiple market cycles are usually the most experienced.
- Performance History: Check how well their previous DSTs have performed, looking at the consistency of returns, final proceeds amount, etc.
- Financial Strength: Does the sponsor have strong finances to handle market volatility and other economic challenges?
- Transparency: Assess the reporting methods of the sponsor, communication style, and documentation practices.
Property or Portfolio Analysis
The other factor that makes a huge impact on the success of the investment is the underlying property (or portfolio, if the DST owns multiple assets). Here’s what to evaluate.
- Location: Is the property located in a region or area that would allow consistent foot traffic or even rising property values? Or is it in a location experiencing downturns?
- Age and Condition: How old is the property? Are there any major repairs that need to be done that might affect future cash flow? How frequently is maintenance needed?
- Tenants: Review the creditworthiness of tenants, lease duration, and renewal options. Long-term leases with strong tenants reduce risk.
- Occupancy Rates: Higher rates indicate heightened demand, but the exact numbers change from industry to industry. For example, 90% occupancy is the healthy rate for mixed-use assets.
Offering Memorandum and Other Legal Documents
The offering memorandum or private placement memorandum (PPM) is a key document that details all you need to know about the DST, such as risks, financial projects, and investment structure. Make sure to assess the following aspects as part of 1031 Exchange due diligence.
- Risk Factors: These are the possible risks that might affect the profitability of the DST. There are various sources of risk, and each DST will have a unique set. Location risk, tenant defaults, and market changes are some of the most common ones.
- Financial Projections: You must also check the projected returns, cash flow estimates, and appreciation assumptions outlined in the PPM. Compare the numbers to other DSTs or fair market values to check whether they closely match similar investments or if the numbers are too optimistic.
- Management Fees and Expenses: The DST’s gross revenue will not be the same as the net income distributed because of operational and administrative expenses. Make sure to check if these costs are reasonable to ensure that you’re not receiving an amount that’s too low.
- Liquidity and Exit Options: If you’re considering starting a new cycle of 1031 Exchanges after the full-cycle event, you’ll want to check if the DST sponsor will implement an exit strategy that allows you to continue exchanging.
Market Conditions and Economic Trends
The PPM may show the economic changes as a risk factor, but it will still be up to you to make an independent assessment. This practice helps you understand if investing in that specific DST is the best investment decision today, up to the end of the holding period.
- Local Market Data: Is the location experiencing heightened demand? You can answer this by looking at rent growth, new construction in the area, or vacancy rates.
- Industry and Sector Performance: It’s also important to assess whether the asset’s sector is projected to perform well. Additionally, you can evaluate the tenant’s growth or stability based on the trends of its industry.
- Interest Rate Fluctuations: Higher rates can impact property values, especially by the end of the holding period.
Summing Up: DST Investment Checklist
DSTs can be a daunting investment for newbie investors. However, arming yourself with knowledge is how you can make informed decisions and gain deeper insight into each offering. With our DST investor guide checklist, you’ll have a handy reference and starting point for all the aspects and considerations you need to know about these investments.
Sources:
https://www.investopedia.com/terms/o/offeringmemorandum.asp
https://www.sobot.io/article/maximize-occupancy-rates-2025-strategies/
https://www.irs.gov/irb/2004-33_IRB