Fractional investments in real estate using tools like Delaware Statutory Trusts (DSTs) are often attractive options for real estate investors who prefer not to be obligated to manage the day-to-day operations of their investment property actively.
In fact, DSTs offer numerous potential advantages. Like any investment, potential participants should carefully evaluate the DST offering before investing. Let’s review how DSTs work:
The basic concept of DSTs is that they allow multiple investors to each own a fractional interest in a single property. DSTs are created by a sponsor, who identifies and acquires the property or properties to be held in the trust. A Delaware Statutory Trust (DST) can have up to 499 individual investors. This provision allows investors to pool their money to purchase significant, institutional-grade real estate assets.
Because a DST structure enables many investors to pool their funds together, the group can invest in real estate that the participants could not access independently. Each investor owns a share of the overall property and thus gets a proportional share of income and appreciation.
In addition, DST participation offers some potential tax benefits, including employing a 1031 exchange to enter and exit the trust, thus deferring applicable capital gains taxes. DST investment amounts are frequently able to be customized, which offers a great deal of flexibility to investors who need to quickly invest a specific amount that matches the proceeds from a sale.
Trust participants (beneficiaries) are protected against creditor claims because they are not personally liable for trust finances. The beneficiaries have no management oversight since the sponsor creates the trust and chooses the properties.
DSTs have low average minimum investment requirements, making them attractive to some accredited investors. However, many DSTs have higher fees, particularly acquisition and disposition costs and asset management fees. These costs may adversely affect the income distributed to shareholders.
DST investments are illiquid, and investors may be unable to facilitate an early exit, so these vehicles aren't ideal if you need access to the funds. Potential investors should inquire about the holding period (often as much as ten years) and disposition strategy.
Once the sponsor acquires and finances the properties held in the trust and sells the shares to investors, they can't obtain additional capital. Sponsors also may not renegotiate either loans or leases. Typically, the sponsor will lease the property in the trust to a master tenant, who will then oversee individual leases with tenants. Since the sponsor must distribute monthly or quarterly income to beneficiaries, they can't reinvest or retain cash.
Despite these specific limits to what a sponsor can do, the sponsor’s qualifications and past performance are crucial considerations for potential DST participants since the sponsor chooses the properties for inclusion, arranges the financing, and also selects and contracts with the master tenant. It’s essential for a potential shareholder to research the sponsor’s qualifications and experience, including how long they have been a real estate professional, their record of asset management in multiple economic environments, and the sponsor’s financial strength.