When you receive reports from asset managers or sponsors in Delaware Statutory Trusts (DSTs), you may notice adjustments or line items that don’t immediately translate to cash in hand. Three items that warrant closer inspection are the lender reserves, rent credits, and lease abatements. What are these three adjustments, and how are they reflected in institutional real estate reports? Realized 1031 goes into the details to help you stay informed.
Cash reserves are an amount set by the DST sponsor or asset manager to help protect against unplanned property-level expenses. In this case, the “lender” in the lender reserve refers to the amount a financier requires as a reserve for the DST.
Typically, lender reserves appear as balance sheet assets. However, they do not count toward distributable income. Lender reserves may show up as restricted cash, given their purpose. You indirectly own these funds, but they will not be available for distribution. Having these funds is a marker of prudent financial management, so don’t think the withheld amount automatically means the DST is under financial stress.
Rent credits are non-cash income adjustments that add another level of complexity to the relationship between net income and the cash distribution. These credits are essentially free or reduced rent. The DST may temporarily create these arrangements to incentivize a tenant for early occupancy or tenant improvements.
From an accounting standpoint, rent credits are recognized as rental income but are matched by an equal expense or reduction in receivables. The credits can make the income statement look unchanged even though less cash is received. For investors, taxable income remains the same, but the cash flow might be lower.
Similar to rent credits, lease or rent abatements are a practice where an asset manager or DST sponsor suspends rent payments for a longer period of time, ranging from three to six months. The abatement can also serve as an incentive, typically to secure multi-year contracts with the tenant. In other cases, the suspension of rent stems from the fact that the tenant cannot use the property.
In Generally Accepted Accounting Principles (GAAP) accounting, lease income is “straight-lined” across the entire lease term. The abatement is also spread evenly, so there’s no noticeable dip in income during the rent-free period. For investors, this means that the net income won’t change, but cash distributions may fall. As such, it’s important to read offerings thoroughly to set expectations. It may take a few months before cash flow becomes more stable.
Overall, the main reason investors should learn how to analyze these line items is to understand why cash flow may not always reflect net operating income. Plus, having an idea of these numbers helps you see the bigger picture and interpret the investment’s performance more accurately.
Lender reserves, rent credits, and lease abatements are glossed-over line items in institutional investment reporting, but they can provide key insights that help you understand the performance of the investment and set expectations regarding cash flow. Work with your tax advisor to learn how these adjustments support the property’s financial health. That way, you can have peace of mind and prepare for any other possibility.
Sources:
https://www.rent.com/blog/rent-abatement/
https://hollanderpllc.com/2024/08/rent-credits-in-commercial-real-estate-leases/