When assessing Delaware Statutory Trusts (DSTs) as a possible alternative investment option for 1031 Exchange investors, it’s important to understand how different market conditions affect these trusts. Fluctuating interest rates, specific sector conditions, and inflation all affect the potential returns of the DST. A savvy investor will know how these factors affect the investment, and they’ll apply this knowledge to set expectations and prepare for any scenario.
Realized 1031 helps you become an informed investor by providing a detailed overview of how DST market conditions can influence income and returns. Keep reading to learn more.
1. Interest Rate Fluctuations
DSTs aren’t allowed to refinance. Even so, these investments are still affected by interest rate fluctuations, especially by the end of the holding period, when property disposition begins. Rising or falling interest rates affect the value of the assets in a few key ways. By extension, these effects influence how much is distributed to the investors after the holding period.
- Rising Rates: Increasing interest rates make borrowing more expensive, which pushes down valuations since buyers are less likely to purchase higher-valued assets. Plus, as cap rates rise, the DST assets’ values may drop.
- Falling Rates: The reverse is true for lower rates. Property value tends to rise, and investors are more willing to purchase properties sold by the sponsor. As such, DST sponsors usually time sales when interest rates are falling to maximize returns.
2. Inflation
The inflation rate is the rise and fall of the prices of goods and services over time. DSTs are sensitive to these fluctuations because the properties need maintenance. As the cost of maintenance services and products rises, the net income of the investment may dip, resulting in lower distributions to investors. Meanwhile, falling inflation rates result in lower operating expenses, which may increase the income of DSTs.
There’s a caveat: some lease structures often make DSTs more resilient to inflation. In some cases, these agreements make the trusts even more profitable. Rent escalation, in particular, allows sponsors to increase rental rates to keep up with inflation. As such, inflationary environments can actually be beneficial to the investment.
3. Employment and Economic Growth Trends
On a broader scale, the U.S. economy influences almost every type of real estate investment, and DSTs are not an exception. Tenant stability, occupancy levels, and rent growth are all tied to employment levels and regional economic health.
Positive Economic Conditions
If the country’s economy is growing, then there’s a higher demand for housing, industrial and warehousing facilities, and retail spaces. If the DST has properties under multifamily housing, retail, or manufacturing, then it may see increased gross revenue.
Weak Economic Conditions
When employment rates fall and purchasing power dips, regions may face higher vacancy rates and slower rent growth. These issues affect Delaware Statutory Trust performance, resulting in income or cash flow instability.
4. Sector-Specific Market Cycles
Different sectors experience distinct market cycles. DSTs that own properties under multiple asset classes tend to be more resilient. Meanwhile, those who specialize in certain sectors can be more keenly affected by these cycles. Here are a few example scenarios.
- Multifamily Homes: Residential housing tends to be stable and grows along with population growth. However, if new supply floods the market, property values and demand may fall.
- Office Buildings: Recent events, like the pandemic, showcased how vulnerable office buildings are to shifts in work culture.
- Retail: DSTs focusing on retail are highly sensitive to consumer spending patterns and e-commerce competition.
- Healthcare: Medical and healthcare DSTs are among the most stable, since these services are necessary no matter the economic conditions.
5. Supply and Demand in Local Real Estate Markets
DST investment returns are more sensitive to regional dynamics than national trends. That’s because real estate is still inherently local. As such, it’s important to look at the local supply and demand to predict the performance of a DST. Take into account the following factors that affect local market supply and demand.
- Population growth or decline
- New construction volume, especially for the multifamily sector
- Job creation and employer migration
- Zoning regulations and regulatory restrictions
- Infrastructure investments
- Transportation and access
As local market supply increases, the DST may enjoy higher occupancy rates, stronger rent growth, and better long-term exit values. The inverse is true. As such, this additional metric requires your attention when assessing the profitability of DSTs.
Wrapping Up: Understanding Economic Factors Affecting DSTs
Market conditions are a variety of factors that can affect the profitability of DST investments. Interest rates, inflation, and sector cycles all play a significant role in how well the trust performs and how much you’re earning monthly and at the end of the holding period. Having an understanding of these forces provides you with the knowledge to evaluate offerings, set realistic expectations, and align DST investments with your long-term investment plans.
Sources:
https://www.investopedia.com/financial-edge/0811/9-businesses-that-thrive-in-recession.aspx
