With a number of recent innovations, Delaware Statutory Trusts (DSTs) are offering a lot more opportunities for investors. There are now more property types to choose from, along with a couple of new ways to structure your DST. Flexible financing is always a great option to have in your investment toolbox, so be prepared to make some room for DSTs. Towards the end of this article, you’ll learn about special financing that only comes with DSTs. Let’s dive in and evaluate three areas where DSTs can directly benefit investors.
Exposure To New Property Types
DSTs began gaining traction in the early 2000s and especially the mid-2000s, which made them more favorable for 1031 exchanges. The multifamily market has dominated DSTs. But that is starting to change with more property types going into DSTs. DSTs have never been restricted to multifamily. They can be used across a large number of property types, including:
- Single-Tenant Net Lease Retail
- Student Housing
- Net Lease Industrial and Warehouse/Fulfillment Center
- Net Lease Commercial Office Building
- Self-Storage Facility
- Medical Office
The latest trends show DSTs opening up in new products such as hotels and senior living properties. This larger number of property types allows investors to diversify properties within their portfolio or properties contained within a single DST.
Investors traditionally went into DST deals with equity. It is more common now that after the deal closes, the investor’s ownership share consists of equity and the assumption of a proportionate share of the debt.
New DST Structures
DSTs offer two beneficial structures — the first is a cash-out transaction. This is similar to a direct property cash out. In a direct property cash out structure, the investor takes on debt in order to access equity tied up in the property.
The way a cash-out works with a DST is that after the deal closes, investors assume financing on the DST property. Then the trust returns investors a large portion of their capital contributions. Each investor’s beneficial interest does not change.
DST cash outs also comply with IRS Revenue Ruling 2004-84. This ruling allows for tax deferral of the originally invested amount under section 1031 for DST investments.
In the rare case where the investment does not generate the ideal cash flow to satisfy debt service, any earnings that come off the investment are paid to the creditors first. However, many DST investments are non-recourse, meaning that the creditors only have access to the invested cash and cannot come after the individual investors.
The second DST structure is a zero cash flow. A zero cash flow structure has no cash flow and is based on a net-lease tenant with a strong credit rating. All cash flow from the property goes toward servicing the debt. These deals are also highly leveraged (high LTV), with many deals needing only 20% down. Loan rates are fixed, and the loan is amortized.
During the loan term, the investment may generate little income or a net loss. The loss allows the investor to offset other income. At the end of the loan term, the investor has built up substantial equity in the property.
Additionally, a zero cash flow deal can be an effective way to increase the depreciable basis in a 1031 exchange. This is great for investors who have exhausted all of their depreciable basis in their relinquished property, and want the benefit of depreciation deductions on taxable income. In some cases, going into a zero cash flow may actually help improve after-tax returns.
While the DST structure may be rigid, the financing terms are increasingly flexible. The market is increasingly seeing DST loans have the capability of being prepaid without any prepayment penalty, defeasance, or lockout period, which increases optionality upon sale.
DSTs offer a large range of property types to choose from. Arrangements such as cash-out transactions and zero cash flow provide new ways of using debt to finance deals. It’s always great when you can pay off a loan early without being slapped a prepayment penalty. That’s what you’ll find with DSTs.
We believe that having options is critical for successful investing in real estate. We’ve discussed a few great options that DSTs now offer, making them a worthy consideration for any real estate investor. To learn more about DSTs and how they fit into your goals, download our ebook, Are Delaware Statutory Trusts Right For You?