What are the Differences Between a DST and Traditional Real Estate Investments?

Investors have a multitude of options when it comes to investing in commercial real estate (CRE).  

The CRE sector is vast, offering investors a tremendous range of asset classes (multifamily, retail, office), building types, locations, costs, lease structures, and many other important considerations. Investors also can pool their investment capital with others and purchase fractional shares of jointly owned real estate investment vehicles such as Delaware Statutory Trusts (DSTs) and Tenants in Common (TIC) properties. 

Let’s take a look at the main differences between traditional commercial real estate investments and DSTs. 

Considerations for Investing in Traditional Commercial Real Estate Properties 

A common approach for investors who want to dip their toes into CRE is to buy a commercial property that aligns with their investment strategies, financial goals, and appetite for risk. 

Before investing, you’ll need to compile an immense amount of information about the asset to gauge whether or not it meets your investment objectives and warrants your investment capital. Some of the many considerations for investing in commercial real estate include: 

• Investment horizon 
• Potential cash flows and opportunity for asset appreciation 
• Asset location, type, age, and classification 
• Asset cost and expected financial leverage 
• General health of the real estate market where the asset is located 

Each of these factors can have its own impact upon your CRE investment. Certain types of commercial real estate, for instance, are heavily dependent on residential population density, proximity to transportation infrastructure, or neighborhood appeal. These factors and many others all affect property valuations and the potential for the asset to generate a positive return. 

The investment horizon is equally important. Well-informed and strategic CRE investors often have clear hold timelines and exit strategies in place in an attempt to ensure they always have sufficient liquidity to maintain the property, pay the mortgage and insurance, and deal with the tax liabilities that come with long-term asset appreciation. 

Cash flow and leverage can be make-or-break factors on your CRE investment. Positive cash flow can alleviate financial distress, generate increased returns, and allow you to hold the asset longer and realize increased valuation through appreciation. Over-extending your financial wherewithal by over-leveraging the asset – especially in adverse market conditions – can leave you lacking sufficient liquidity to meet your ongoing financial obligations for the property. 

Many real estate investors have the experience required to properly navigate these pressures and others that will invariably arise during the investment’s holding period. Others do not. For the former, direct property investments in commercial real estate is often a full-time job. For the latter, you may do better with indirect property investments, such as investing in Delaware Statutory Trusts.  

Below we’ll outline how a DST works so you can see the many differences between DST investments and direct property ownership. 

Considerations for Investing in a Delaware Statutory Trust 

DSTs occupy a unique niche in real estate investments. For starters, DST investments are considered securities and are regulated by the Financial Industry Regulatory Authority (FINRA). Secondly, they are considered passive real estate investments – once you buy in, you’ll have no control over the direction and management of your investment. 

Here’s an overview of how a DST works: 

Delaware Statutory Trusts are formed by sponsors – typically large real estate companies – with the purpose of acquiring and holding commercial real estate properties under trust. DST sponsors often focus on one particular sector of CRE, such as multifamily, senior housing, or hospitality. These assets are usually large properties costing tens of millions of dollars (think big industrial warehouses, or sprawling multifamily apartment complexes and self-storage facilities) that would be well beyond the financial reach of many accredited solo investors. 

Once the sponsor acquires its portfolio of targeted assets, the sponsor opens up an offering period where investors pool their money to purchase fractional shares of the trust until the sponsor’s capital is fully displaced. Investors receive monthly or quarterly distributions from the DST, when applicable, according to their pro rata share of the trust. 

DST investors don’t actually own any real property; they own shares of a trust that is the legal owner of the properties held within it. This separation of  ownership creates an important legal buffer between DST investors and the trust – investors also enjoy legal separation from the assets held under trust and aren’t affected by tenant bankruptcy or any liens filed by creditors on a property held under trust. 

The DST sponsor does all the important legwork that we mentioned above with traditional commercial real estate investments. Sponsors handle all financial modeling and forecasting on target properties, order appraisals, and environmental reports, and complete other crucial due diligence that normally would fall to individual investors to undertake and analyze. Sponsors also obtain all financing and hire third-parties to manage assets such as multifamily apartment complexes or retail centers. They’ll also complete all financial and tax documentation for the properties, as well as for the trust itself. 

DSTs have to adhere to some strict Internal Revenue Service guidelines. Once formed and funded with investor capital, the DST sponsor cannot: 

• Renegotiate existing leases or enter into any new lease agreements 
• Accept new capital 
• Reinvest or retain any proceeds generated from assets held under trust 
• Complete any major facility repairs using asset proceeds 

Many CRE investors turn to DSTs to complete 1031 exchanges because they can purchase fractional shares of the trust in the exact amounts needed to satisfy their exchange requirements. They also can quickly meet their strict exchange timelines. Lastly, it’s important to note that DST investments are highly illiquid and may have a required holding period of up to 10 years. Traditional CRE investments, on the other hand, can be disposed of at-will if you find a willing buyer for your property. 

Putting it all Together 

Delaware Statutory Trusts are as comparable to traditional real estate investments as the New York Yankees are to the Dallas Cowboys – the two organizations may be popular professional sports franchises, but that’s pretty much where the direct similarities end. 

Traditional real estate investments require investors to have extensive knowledge of a multitude of factors that will weigh heavily on asset performance and its potential to generate positive returns. Delaware Statutory Trusts, meanwhile, are 100-percent pre-packaged investments – the DST sponsor has completed all the due diligence, financial modeling and required trust formation, and tax filing documentation. 

There are other important differences as well that we haven’t mentioned, primarily the tax treatment associated with direct property ownership. Consult with a certified tax professional to discuss these potential benefits and how traditional real estate or DST investments may fit within your investment goals.