Delaware Statutory Trusts (DSTs) provide a passive, institutional-quality investment opportunity without the burden of active management. However, moving into these structured products requires comprehensive due diligence. Two crucial aspects are appraisals and valuations, but they are often conflated, which may lead to some confusion regarding the true value of your beneficial interests.
In this article, Realized 1031 clarifies the differences between these two numbers and how they each affect your perception of the asset’s initial price and subsequent performance. With this understanding, you can accurately assess risk and determine the fairness of the initial offering. Keep reading to learn more.
DST Appraisals and Valuations: Definitions and Differences
Understanding DST offerings involves knowing how much you’re paying to enter the trust, given how these are structured investments. Appraisals are key to understanding this aspect.
DST Appraisals
An appraisal is a formal, independent report by a licensed third-party appraiser. The most reliable ones are those who follow standards set by the Uniform Standards of Professional Appraisal Practice (USPAP). DST appraisals are point-in-time assessments (at the time when the offering is launched) where the appraiser establishes the fair market value (FMV) for the lender. The appraised value is then used as an initial baseline for the purchase price of the interests, and it’s based on the comparable sales, cost, and income approach.
DST Valuations
In contrast, DST valuations are estimates of the DST shares’ worth after the offering is closed. This assessment is less formal, and it’s usually conducted by the sponsor themselves or a third-party appraiser annually. A valuation is a critical internal process for financial reporting and taxation purposes. Unlike the initial snapshot of the appraisal, a valuation is model-dependent. It relies on financial projections, discounted cash flow (DCF) analysis, and the unique structural factors of the DST to arrive at an accurate value.
Role of Appraisals for Investors
The initial appraisal serves as the initial gatekeeper of the DST, assigning the base purchase price of the physical asset that the DST will own. Lenders mandate this step, as knowing the value of the real estate properties is critical for financing.
For investors, the appraisal serves as a key element in evaluating DST investment value. This value confirms the commercial viability of the asset itself through the FMV and the loan-to-value ratio. Keep in mind, though, that the appraised value will seldom be the same as the total offering price. Other costs, like acquisition fees and structuring costs, will add to the offering price. As such, it’s crucial to look beyond the appraised value. You must also take into account the full “load” to determine the cost basis and possible equity dilution.
The Importance of Ongoing Delaware Statutory Trust Property Valuation
Ongoing valuation, on the other hand, serves as a financial scorecard. Since DST shares are illiquid securities that don’t have a public trading market, you have to rely on the periodic valuation to determine how well your fractional interests are performing relative to the initial purchase price. Three main factors determine the calculation.
- Net Operating Income (NOI): The NOI is the remaining income after operational and management expenses have been reduced. Rising NOI directly increases the property’s value.
- Capitalization Rate Changes: This value is the ratio of the NOI over the property’s value. If the cap rate of other similar properties in the location lowers, then the DST asset’s value typically increases.
- Debt Reduction: As the DST pays its debt service regularly, the underlying equity increases. This then results in a higher valuation of your shares.
Key Questions To Ask as an Investor
A 1031 Exchange real estate appraisal and ongoing valuation of DST shares can become complicated. Knowing the right questions to ask can help you gain a clearer understanding of the processes and how appraisers arrive at the numbers.
For Appraisals
- When was the date of the latest appraisal?
- Who is the third-party appraiser, and do they have the right qualifications?
- How does the total offering price compare to the appraised FMV?
For Valuations
- How frequently are valuations performed? The sponsor should conduct a valuation at least once a year.
- What is the specific methodology being used for valuation?
- What are the key financial assumptions driving the valuation model?
Wrapping Up: Understanding DST Offerings Through Appraisals and Valuations
DST appraisals and valuations are important aspects of this investment, informing investors about the property’s initial and ongoing value. Through the rigorous evaluation of these numbers and how appraisers arrived at the values, investors can go beyond the sales brochure and execute a more in-depth analysis of the investment.
Sources:
https://appraisalfoundation.org/products/uspap
