Is a Delaware Statutory Trust (DST) a Security?

Is a Delaware Statutory Trust (DST) a Security?

Posted by on Jul 1, 2021

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Delaware Statutory Trusts (DSTs) are complex financial investments that can provide individuals with access to ownership of commercial real estate properties that they would not be able to own on their own. Some DSTs own properties similar to those held by large institutional investors like pension funds, REITs, and insurance companies. DSTs are considered securities and are subject to regulation as such.

What Makes DSTs Different From Other Real Estate Investments?

In the formation process, a DST sponsor (often a large real estate company) creates a plan to produce a portfolio of real estate assets. The DST may focus on one sector, such as multi-family housing or industrial buildings, or it could be spread across commercial types and classes. Typically, the target assets are acquisitions that may be unreachable for individual investors.

When the portfolio is assembled, the sponsor offers shares to investors. The individual shareholders anticipate receiving distributions of income based on their respective ownership percentage, and this income may be tax-advantaged. One potential advantage to the DST investors is that the shares they purchase are eligible to be treated as like-kind exchange replacements in a 1031 exchange. If you need to identify a replacement property, you can designate the DST in that position and customize the amount of your investment to match your required spend.

DSTs are passive investments, allowing no control by the shareholders. The sponsor usually hires a master tenant to manage the properties and work directly with the remaining tenants. The number of investors can range up to 499, but additional capital contributions aren't allowed once the initial offering closes. If portfolio properties need significant infusions of capital, profits can be affected, and investors must be qualified as accredited. 

Are DSTs Strictly Regulated?

Because of the tax advantages and status as a security, the DST structure carries restrictions. As mentioned, one disallows additional capital contributions after the initial offering closes, and there is a prohibition against refinancing and borrowings. The trustee or sponsor is also precluded from reinvesting the profits from selling properties in the portfolio and is restricted to improvements that are allowed to the held properties. Further, cash can only be invested in short-term instruments and must be distributed promptly, except for appropriate reserves.

If a DST Is a Security, Can I Sell It?

One of the potential risks of owning a DST is the holding period, usually between five and ten years. Although ownership in the trust is a security, you may not be able to dispose of it quickly or at all. Usually, the trust is dissolved at the planned time, and properties are sold. Investors split the proceeds according to their pro-rata ownership.

Under certain circumstances, the sponsor can convert the DST into an LLC to raise additional capital, alter financing, or achieve other goals precluded by the DST structure. Still, these options are not under the control of the individual investor.

Two potential exits for the investor are a 721/UPREIT exchange or a private sale on a DST Secondary Market. Investors should consult their financial advisor regarding either of these approaches, which may have unforeseen repercussions but may facilitate departure from the DST in some circumstances. In most cases, the investor should consider the DST a long-term, illiquid, passive investment.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. No public market currently exists and one may never exist. DST programs are speculative and suitable only for Accredited Investors who do not anticipate a need for liquidity or can afford to lose their entire investment. The actual amount and timing of distributions paid by programs is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of their capital. Costs associated with a 1031 transaction may impact investor's returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. All real estate investments have the potential to lose value during the life of the investment.

 


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