The passive nature of Delaware Statutory Trusts (DSTs) makes them appealing to many investors who want a more hands-off investment. While you’re not expected to take part in administration or operations, it’s crucial to understand how the underlying properties of the trust are managed. With this knowledge, you can better assess DST offerings and sponsors, ensuring that you’re committing capital to ones that can properly oversee the income-generating activities of the assets.
Realized 1031 shares an article discussing DST 1031 exchange asset management to help you gain the right insights. Keep reading to learn more.
The Passive Nature of Delaware Statutory Trust Operations
To qualify for 1031 tax deferral benefits, DSTs must follow a structure outlined by rules like Revenue Ruling 2004-86. Primarily, the DST needs to maintain a passive nature. Investors and, to some degree, sponsors are not allowed to be involved in daily operations. Failing to follow this condition may lead to ineligibility for tax-deferral benefits.
Since investors cannot participate in active decision-making, and sponsors are restricted from being involved in certain tasks, the latter must assign a designated party to oversee operations. This carefully structured professional oversight ensures two things: the DST remains compliant and the underlying properties remain profitable.
DST Sponsor Responsibilities
Most of the sponsor’s role begins during the early stages of the DST. They acquire the assets, secure financing, and structure the DST before marketing it to investors. After the initial offering is over, their role evolves into high-level oversight. The sponsor is not allowed to take over daily property management, as this constitutes active management. Instead, they perform the following:
- Approving major operational decisions
- Overseeing financial reporting
- Ensuring compliance with IRS regulations and trust agreements
- Managing investor communications
In other words, the sponsor focuses on guiding the properties towards performance goals and overseeing long-term planning. Another entity will need to handle the day-to-day operations: the property management firm.
What the DST Property Management Company Does
The property manager is a professional company that enters a contract with the DST sponsor. This party serves as a buffer that prevents the sponsor from performing an active role. Some key responsibilities of the property manager include:
- Tenant Management: The property manager handles leasing activity, move-ins and move-outs, as well as tenant complaints. If necessary, they must reinforce or renegotiate lease terms (as master tenant) to ensure compliance with DST rules regarding lease negotiations.
- Operation and Maintenance: Instead of the sponsor, the property managers handle the maintenance, repairs, and security of the assets. This role prevents the sponsor from materially participating in the management of the structures.
- Financial Management: The property manager also handles the collection of rent, payment of net operating expenses, and management of cash reserves. Plus, this party prepares the financial reports for review by the sponsor.
The Benefit of Master Leases and Net Lease Structures DST Management
DST property management can come in various structures, and two of the most well-known arrangements are the NNN lease and the master lease structure.
NNN Lease
A triple net or NNN lease assigns three net operating expenses to the tenant: property taxes, insurance, and maintenance. This arrangement helps diminish the role of the property manager, allowing them to focus on lease compliance and financial monitoring. As such, this structure is popular within DSTs.
Master Lease
The master lease structure involves engagement with a master tenant. This party serves as the main “tenant” that subleases the property to other tenants. Under this structure, the DST can centralize every management decision in one operating entity that isn’t the sponsor. In many cases, the property manager serves as the master tenant.
Lifecycle Management: From Acquisition to Disposition
For the entirety of the holding period, the sponsor and property manager work together to achieve the following goals.
- Stabilize the Asset: Both parties work to manage occupants and ensure that the property has a tenant. As they stabilize the asset, the revenue becomes more aligned with projections.
- Optimize Performance: Together, the sponsor and property managers implement cost-saving strategies, renew leases, and improve building systems.
- Prepare for Disposition: Both parties monitor market conditions and determine the best time to sell the underlying assets when the full-cycle event draws near.
Final Thoughts on Managing Properties in a DST
Because of the passive nature of DSTs, investors aren’t allowed to participate in property management. Instead, the sponsor enters into a contract with a property manager to ensure 1031 exchange compliance. This property manager, who can act as a master tenant, handles all the daily administration and management of the asset, acting as a buffer that prevents both sponsor and investors from active participation. Because of the importance of the manager in the DST’s performance, investors must carefully vet these parties to gain more confidence in their investment decisions.
Sources:
https://www.investopedia.com/terms/t/triple-net-lease-nnn.asp
