Real estate investing in multi million-dollar properties isn’t just for blue blood elites, cryptocurrency and startup billionaires, or world-famous athletes with money to spare. Although wealthy Americans have amassed more money to invest in coveted institutional-grade properties, everyday investors also can participate in these types of investments by purchasing fractional interests in Delaware Statutory Trusts (DSTs).
In this article we’ll take a deep dive into the unique way DST ownership structures function and why they are used by both retail and well-heeled investors to purchase some of the most desirable real estate in the country.
What Makes a Delaware Statutory Trust Unique?
DSTs are passive investment vehicles that allow investors to purchase fractional shares of institutional-grade commercial properties that typically are well beyond the financial means of solo retail investors. These assets can include industrial buildings, self-storage facilities, freestanding multi-story medical office buildings, net-leased retail centers, multi-family apartment complexes, and similar types of commercial properties.
There are many aspects of the Delaware Statutory Trust ownership structure that makes it a unique investment vehicle, including:
- Investor-Sponsor relationship
- Fractional ownership
- 1031 exchange eligibility
- Real property ownership
Let’s take a closer look at each.
Investor-Sponsor Relationship. A Delaware Statutory Trust is established by a Sponsor, who identifies and acquires the commercial property that’s held within the trust. Sponsors typically review many properties and complete all financial modeling, environmental reporting, appraisals, and other due diligence before selecting assets that will be held within trusts. Sponsors secure financing prior to the offering, and many also act as property managers once offerings are fully funded. Sponsors often elect to outsource management to third-parties for multi-family apartment complexes or retail centers that require day-to-day oversight. In short, Sponsors source, acquire, finance, and package DST offerings, as well as provide all monthly or quarterly financial and annual tax reporting documents to investors.
Fractional Ownership. Individual investors -- also called beneficiaries -- purchase fractional interests in the DST until the Sponsor’s original investment is displaced. Investors own a percentage of the property according to their investment amount, but no single owner can claim sole ownership rights of the asset(s) regardless of their investment amount. Beneficiaries receive regular monthly or quarterly distributions, when applicable, but they don’t have any authority or voice regarding the asset’s operation or performance. DST investors basically assume completely passive roles within the trust.
1031 Exchange Eligibility and Real Property Ownership. Despite the co-ownership structure, the IRS views DST interests as real property ownership. Investors receive tax treatment as individual owners within the trust. It’s an important distinction since it provides 1031 exchange eligibility for DST interests. Investors who divest real assets can reinvest the exact amount of proceeds needed to satisfy 1031 exchange replacement property requirements and defer capital gains taxes on their relinquished assets. Lastly, despite being treated as real property owners, investors are shielded from asset liabilities through the DST ownership structure.
DSTs also are subject to additional rules and limitations established by the IRS. These include a Sponsor’s inability to:
- Receive new funds once the original offering closes
- Renegotiate leases or enter into new lease agreements
- Reinvest proceeds from the assets or retain any cash generated from its performance
- Make major repairs on assets
The prepackaged nature of DST investments often makes them an attractive option for investors seeking to quickly complete 1031 exchanges. They also can be used to diversify real estate holdings since investors can purchase multiple equity interests in DST offerings of different asset classes and geographical locations. The ownership structure, meanwhile, can be beneficial to investors since Sponsors assume all the heavy lifting. The ownership structure also provides investor protection against bankruptcy and liens from creditors since beneficiaries don’t assume any personal liabilities within the trust.
These are the primary reasons why the unique ownership structure of a DST benefits both retail and accredited investors.