Potential Pitfalls To Consider When Choosing A DST Advisor Or Broker

With the right guidance investing in a Delaware Statutory Trust (DST) can be a straightforward process. However, you don’t buy shares of DSTs on a public exchange like other investments, you need to work with an advisor who has a specialty in DSTs. 

Because DSTs are private securities potentially lacking transparency and liquidity, picking an advisor can be as important as picking the DST.   

What does it mean to have a DST specialty?

For additional clarity, let’s start at the top with the mechanics of a Delaware Statutory Trust. 

A DST sponsor is the individual or entity that sets up the trust that holds real estate assets. The sponsor buys and sells the property and develops the offering to investors. The sponsor might also manage the real estate hands-on or outsource the job to property or asset management companies. 

In most cases, the DST sponsor might use its funds to buy the real estate and then offer fractional shares from the trust to potential investors. DSTs can have numerous beneficiaries, though most have less than 500.

Meanwhile, an advisor, with a DST specialty, is an individual or entity that analyzes the DST sponsor and the trust’s holdings. The advisor also meets with you, the investor, to determine your risk appetite and investment goals, while providing information about the DST investment process lifecycle. 

If you’re considering investing in a DST and evaluating potential advisors to work with, you should examine more than licensure. Here are some criteria to evaluate when performing your due diligence on a potential advisor with a DST specialty.

Conflicts of Interest

The advisor you work with might be independent (for example, Realized is an independent advisor in that we also don’t act as a Sponsor). Or the advisor could be sponsor-affiliated, which means it’s connected somehow with the DST sponsor. Those firms are required to disclose sponsor affiliations. But that “disclosure” can range from full transparency to tiny fine print. 

Not all sponsor-affiliated advisors are bad. But the issue to consider is that the advisor might not be acting in your best interest when it comes time to offer the DST shares. Rather than helping you reach your investment goal, that individual or entity may be trying to pitch you a particular deal or offering from a single sponsor. That offering might not be suited to what you need.

The best way to learn about any sponsor/advisor connection is to ask. Find out if the advisor offers deals from just one sponsor or multiple. If the relationship between the DST advisor and sponsor is buried beneath a lot of paperwork (or the above-mentioned tiny fine print), ask about the lack of transparency. And if the broker seems motivated to sell against other offerings, find out why. It’s also a good idea to research this information on FINRA’s BrokerCheck, which will provide information on where DST sponsors and advisors are registered.

Buying into Myths

You might also want to be wary of a DST advisor that passes along the following.

Claims that All Debt is Bad

In truth, debt isn’t really “good” or “bad.” Use of debt depends on many things. 

Additionally, there are different amounts of leverage (a fancy term for “debt”). Modest leverage might be okay. It could put little strain on a property’s cash flow and its ability to cover mortgage payments. Still, this shouldn’t dissuade you (or an advisor) from considering whether to invest in that offering.

In certain cases, debt can provide meaningful income tax shelters. Furthermore, some debt-free offerings might raise suspicions among a number of lenders due to the asset’s quality, location or even tenants. Similarly, brokers could position risky properties as “safe” because they don’t have any debt.

While debt can add risk to a real estate investment, it’s essential to understand which is riskier: a poorly performing property with no debt or a well-performing property with a modest debt. 

Avoids Income Tax States

No one likes paying taxes. But be wary of the DST advisor that only offers investments in no-tax or low-tax states in an attempt to avoid taxes.

First, you only pay on taxable income. This is the case whether a state is no-tax, low-tax or high-tax. Many DST investments are likely to be fully sheltered, making this point moot whether the properties are in a no-tax or high-tax state. Additionally, that tax might be a small price to pay, especially if it gives you access to better-quality investments or helps reduce risk through portfolio diversification.

A quality DST advisor shouldn’t offer products based only on state income tax. Geography should be one of many criteria an advisor evaluates when presenting possible investment opportunities. Furthermore, income taxes shouldn’t be the primary focus or driver of any investment decision. 

Ignores Property Types

Industrial properties weren’t at the top on investors’ lists shortly after the Great Financial Crisis. The Great Recession meant companies pulled back on manufacturing and distribution, leading to sublets and higher vacancies. Fast forward about a decade, and industrial is the darling of investors – while offices are having issues.

But it’s best to avoid the DST advisor that claims “all offices are bad” or one sector in particular is underperforming. Indeed, there are plenty of doom-and-gloom headlines about the office sector. But not all offices are struggling – highly amenitized, Class AA trophy assets continue to perform exceptionally well. Older office buildings in prime locations also report decent vacancies. This is a bifurcated sector.

This isn’t to suggest that you should rush out and invest in a DST that holds office properties. But a DST advisor claiming that an entire sector should be avoided isn’t conducting thorough due diligence.

Commission Manipulation

DST sponsors earn their money through upfront or back-end fees and commissions. DST advisors earn their money through commissions when an investor purchases interests in DSTs. Reputable advisors are upfront about the percentages they take from a buying or selling activity. But watch out for an advisor that does the following:

Marks the commission down. Some advisors might offer an above-market fee solely to "mark it down” when an investor balks. This could appear as if you’re getting a deal. However, you could end up paying  more than planned under this arrangement, especially if the “original” commission is above 10%.

Charges a “planning fee.” Be wary if the DST advisor claims they don’t charge a commission but a “planning fee” instead. There’s nothing wrong with a planning fee. But an actual planning fee isn’t contingent on a successful transaction. Likely, the cost is a commission in disguise.

Calls it a “real estate commission.” Real estate commissions are fine for brokers buying and selling real estate. DST broker-dealers  are responsible for buying and selling securities, and they have nothing to do with the underlying real estate assets. DST advisors also buy and sell securities and offer a host of advisory and value-added services. Again, advisors have nothing to do with the actual real estate assets.

Inflates the purchase price. This is another common ploy when the advisor increases an asset’s selling price. In this scenario, the seller pays the commission. This allows the broker-dealer to tell you that you, the investor, aren’t paying anything for services. Someone else is footing the bill.

Researching the Advisor

On the positive side, FINRA Rule 2020 prohibits the use of manipulation, deception and other types of fraud to influence the purchase and sale of securities. That rule binds reputable DST advisors. But you might run into a bad actor with a conflict of interest. Or you could find someone who manipulates commissions or avoids specific offerings because of incorrect assumptions.

The DST advisor researches an offering and its sponsor, determines your investment goals and risk appetite then shares that information with you, the investor. As such, it’s fine to be wary and ask questions if that advisor tries to sell you something unsuitable for your particular objectives or you’re uncomfortable with how they collect the fees.