Delaware Statutory Trusts (DSTs) are an attractive investment option, providing benefits like tax deferral, enhanced diversification, and passive income. However, like any other investment, DSTs are unfortunately vulnerable to economic downturns. Inflation, recession, and other negative economic activity all affect the income of DSTs, possibly resulting in less-than-ideal returns. Can investors do anything to address these challenges?
Realized 1031 is here to share strategies on managing risk in DST investments during economic downturns to help you gain insights.
DSTs are legal entities that own underlying real estate assets, and many investors join by acquiring beneficial interests using 1031 exchange proceeds, resulting in tax-deferral benefits.
Rules such as those outlined in Revenue Ruling 2004-86 restrict certain roles to only the sponsor, meaning DSTs also offer hands-off involvement and truly passive income. But are investors allowed to do anything to help the DST weather the effects of economic downturns?
The answer is no.
Managing the underlying properties and implementing risk mitigation strategies falls entirely on the sponsor.
Since investors can’t take an active role in the DST, managing personal risk starts well before entering one.
One strategy you can leverage is choosing DSTs that own property in stable asset classes — sectors that remain relatively stable even during market downturns. Examples are healthcare facilities, self-storage, and multifamily rental housing. These asset classes have steady demand, regardless of the state of the economy. As such, the DST income is more likely to remain consistent.
Since DST investors rely on the sponsor for management decisions, the sponsor’s financial strength and operational experience are crucial. During downturns, a capable sponsor would have systems and strategies in place to protect investments, such as the following practices.
When evaluating a DST, it’s important to look beyond the property itself. Examine the sponsor’s track record, capitalization, and crisis management history. Sponsors with deep experience are better equipped to navigate economic headwinds.
Placing all funds into one DST leaves more exposed when economic downturns occur, so it’s a better practice to diversify and spread your capital across various DSTs that have specific concentrations. This practice is allowed in 1031 exchanges, as the 200% rule lets you identify as many DST offerings as you want, provided that their total value doesn’t exceed 200% of the relinquished asset’s value. This strategy is made easier by the fact that DSTs have low minimum investments, allowing you to enter with as little as $100,000 in some cases.
The most involvement you can have, if you’re already in a DST and foresee the possible effects of a market downturn, is to prepare beforehand. This means forecasting possible reductions in regular distributions and adjusting your expectations. Setting realistic expectations and thinking long-term helps reduce stress and prepare you for the period of difficulty.
DSTs are not immune to economic downturns, and because investors cannot have direct control of the management of properties, managing market volatility starts way before you enter the investment. Choosing DSTs that own stable asset classes, vetting sponsors thoroughly, and diversifying are a few of the strategies you can employ to cushion yourself against inevitable economic challenges.
Sources:
https://www.americanbar.org/groups/real_property_trust_estate/resources/real-estate/1031-exchange/