DSTs (Delaware Statutory Trusts) are unique real estate investments that provide some potential benefits to investors, particularly those who are executing a 1031 exchange or simply want to transition from active investment to passive. Here is how a DST investment works:
DSTs facilitate the pooling of capital from multiple investors (as many as 499) and investing the funds in commercial real estate. Each trust beneficiary (the shareholders) owns a fractional interest in the properties the trust holds. A sponsor creates the DST, selects and acquires the property, and then seeks investors. Sponsors typically work with a master tenant who manages the subleasing.
Essential facts about DSTs include that they are considered securities and thus regulated by FINRA (the Financial Industry Regulatory Authority). They are passive real estate investments, which means the investor does not have input into management.
DSTs have advantages.
First, investing in a DST will give an investor access to property they could not afford to buy on their own. Sponsors usually target high-quality assets and often focus on a particular CRE sector. Investors can easily balance their portfolios by choosing multiple DSTs.
Second, because DSTs are considered pass-through entities, the trust doesn’t pay income taxes. Instead, the income is distributed to the shareholders, who pay income tax at their individual rate.
Third, investors can use a 1031 exchange to enter and exit a DST. Since 1031 exchanges involve adherence to strict timelines, access to ready-made investments in customizable amounts may be an excellent option for the investor trying to complete the exchange within the allotted time.
Since the investor can also exit a DST using a 1031 exchange, they can preserve the deferral of capital gains tax, which they achieved with the exchange.
Also, DSTs are non-recourse, which means that creditors can’t pursue individual shareholders for debts of the trust.
How do investors benefit?
Beneficiaries receive a prorated share of trust income during the investment period. DST rules require that income be distributed monthly or quarterly, and sponsors may not seek additional capital or renegotiate loans or leases.
However, the potential for earning profits and the return of the original investment comes at the conclusion of the holding period.
Liquidity is a concern for some.
The standard holding period for a DST ranges from five to ten years. The PPM (Private Placement Memorandum) will declare the trust’s holding period along with other terms of the offering. Because DSTs are not liquid, investors must be accredited, and the minimum investment is often $100,000. DSTs are not ideal investments for those who may need access to their capital before the declared trust termination date.
A DST termination often coincides with the maturity of its loans. Since the sponsor cannot revise loans, that date doesn’t usually change. If the investor needs to exit prematurely, they would lose the advantage of the 1031 if they entered the DST in that manner and owe taxes on the investment.
Early exits can be challenging.
There is no public market for DST shares, and some sponsors restrict resales. Setting a secondary market price on DST shares is challenging because it depends on several factors, including the DST performance, the current value of the properties held, and the overall market conditions.
However, Realized has launched an alternative trading system for DSTs and, to date, has completed over $5 million in transactions. There is no guarantee that investors will be able to sell for their asking price if they need to dispose of their shares before the DST end date. Talk to your financial advisor or contact Realized to learn more.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
All investments have an inherent level of risk. The value of your investment will fluctuate with the value of the underlying investments. You could receive back less than you initially invested and there is no guarantee that you will receive any income.
No public market currently exists, and one may never exist. DST programs are speculative and suitable only for Accredited Investors who do not anticipate a need for liquidity or can afford to lose their entire investment.