[Webinar Recap] Understanding Due Diligence: Overview and Methodology

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Posted by Grace Copeland on Aug 18, 2022

If you’re interested in learning more about pursuing a passive income without the full-time hassle of managing a property, a Delaware Statutory Trust, or DST, might represent an investment opportunity for you. A DST offers fractional ownership in commercial real estate, so you can enjoy the retained investment without the responsibility of managing the property yourself as you would with direct ownership. DSTs are also an investment option to consider if you need to conduct a 1031 exchange to defer any capital gains taxes due when you sell an investment property.

We are seeing an increasing number of investors coming to see DSTs as a viable replacement property option for 1031 exchanges, you should not consider a DST a “plug-and-play” investment. With so many new Sponsors entering the market, we believe it’s become more critical than ever to do your due diligence before investing in a DST.

At Realized, every offering we present goes through a rigorous due diligence process, and we wanted to share some of our insights on how to evaluate a potential DST investment.

Defining Our Pillars of Due Diligence

Before selecting DSTs for investment, it’s important to thoroughly evaluate potential opportunities. At Realized, we rely on eight pillars of due diligence:

  • Real estate analysis
  • Leveraging third-party data
  • Reviewing the DST’s financial structure
  • Conducting case studies
  • Sponsor analysis
  • Securities review
  • Suitability for the investor
  • Wealth management approach

Understanding Our Due Diligence Model

We use a hybrid due diligence model to evaluate potential offerings, reviewing a DST from the top down and then the bottom up.

We begin with macro-level, “top-down” questions to assess the property and current markets:

  • What is the property type and metro market?
  • Is the property experiencing tailwinds or headwinds?
  • What are the overall market and real estate market conditions?
  • What metro economic and demographic drivers will the property encounter?

Next we give the DST a look with a microlens (or from the bottom up), addressing these key questions:

  • What are the DST’s property-specific or deal-specific attributes?
  • What are the individual offering’s structural components?
  • What is the sponsor’s track record and management history?

Why We Feel a Hybrid Due Diligence Approach Is Critical

Using our hybrid “top-down, bottom-up” due diligence metrics, we strive to help you avoid potential pitfalls. For instance, an ideally located property in an economically stable area (positive macro attributes) may not have a strong sponsor or a favorable deal structure for investors (micro attributes). 

Conversely, there could be a great bottom-up story like a solid investment structure and sponsor, but the top-down factors have headwinds that can’t be overcome.

A few years ago, for example, Realized had a deal with an A+ sponsor, who presented a compelling financial structure. However, the asset in the deal was an apartment building located in a city with an economy driven primarily by the oil industry. That meant the city’s population and the performance of the property would be subject to the status of the oil market regardless of the operator and structure strength.

We believe due diligence is a key factor in managing investment risk, so it’s important to look beyond the property itself to the sponsor’s track record and the individual offer’s structural components. At Realized, we evaluate every opportunity we put on our marketplace through the hybrid due diligence lens.

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. 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. 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.

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