Today, many passive investors undergoing 1031 exchanges use Delaware Statutory Trusts (DSTs) to complete the transaction. These investment vehicles provide key advantages like professional management, hands-off involvement, and access to institutional-grade assets.
However, like any investment, DSTs have timing risks, especially when it comes to reinvestment and changing interest rates. Strategies like laddering exist to help mitigate these risks.
By diversifying the timing of DST exits and reinvestments, you can smooth cash flow and lower your exposure to market volatility. Below, Realized 1031 discusses the specific laddering strategies you can use to maximize the beneficial impact.
The Basics of DST Maturity and Investing
DSTs have defined holding periods, typically between three and seven years, after which you must choose how to reinvest the proceeds of the sale of a DST property. For many, restarting the 1031 exchange is preferable since it continues the tax deferral benefits.
However, reinvestment issues occur if every DST in your portfolio matures at roughly the same time.
- Market Timing Risk: If the real estate market is weak or interest rates are high, reinvesting proceeds may not be as advantageous.
- Pressure on Liquidity: You must find and purchase replacement properties by the IRS’s strict deadlines.
- Tax Exposure: If you miss these deadlines, you may suddenly become liable to capital gains tax, resulting in disrupted cash flow or an unplanned expense.
Laddering and Its Benefits
Laddering is a practice that lets you invest in several DSTs with varying expected holding periods or exit dates. You acquire multiple DSTs with different maturities, such as five, seven, and nine years, rather than putting all capital in a single DST with one maturity date. Here are some key benefits of this practice:
- Staggered Liquidity: Proceeds from one DST sale can be reinvested while others continue generating income.
- Flexibility With Reinvestment Options: You have the option to take partial liquidity over time, switch to a different asset class, or reinvest proceeds into another DST. Plus, you won’t have to rush the acquisition of new investments all at once to preserve cash flow. Since you’re only reinvesting portions of your capital, you can take your time monitoring market trends and sponsor performance before the next maturity date, leading to more informed investment decisions.
- Market Diversification: To improve portfolio balance, DSTs with varying maturities often span various real estate sectors and geographical areas.
How Laddering Helps Mitigate Interest-Rate Risk
Another major benefit of laddering is managing the risk associated with interest rate fluctuations. When you ladder DST maturities, you can spread exposure across multiple market cycles. Otherwise, a singular maturity date leaves you vulnerable to whatever the interest rates are during the year you intend to reinvest.
For example, you have three DSTs set to mature in 2027, 2028, and 2030. In 2027, interest rates are low, resulting in higher property values and lower cap rates. In 2028, interest rates rise, which could reduce property values and make reinvestment less attractive. You won’t feel the impact as much since only a portion of your capital is maturing that year, leaving you less vulnerable to that single market shift.
Final Thoughts on the Advantages of Laddering DSTs
Laddering the maturity dates of DSTs provides an array of benefits, especially when it comes to managing reinvestments and mitigating interest-rate risk. Since only a portion of your capital is liquidated, you have lower exposure to unfavorable market conditions upon maturity. In addition, reinvesting gives you more flexibility, since you’re free to choose the best reinvestment option for that portion of your equity based on current market trends or personal financial needs. As such, laddering can be a powerful strategy for those focusing on DST investments.
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