A Delaware Statutory Trust (DST) is a versatile tool for real estate investment property owners to facilitate 1031 exchanges, spread their risk, and potentially receive passive income from real estate investments. However, like any other form of investment, DSTs have pitfalls that must be understood and managed to achieve the desired results.
Most investors are drawn to DSTs for the advantages they offer, but entering this market without sufficient research and due diligence can lead to strategies that negatively impact financial outcomes.
In this blog, we will outline what we are calling the Seven Deadly Sins of investing in a DST—mistakes that can harm your investment strategy. Understanding these risks will help you avoid pitfalls and maximize your DST investment returns.
1. Insufficient Investigation
One of the biggest mistakes property owners make is insufficiently investigating DST investments.
Properties in a DST can vary significantly in quality, so you cannot expect all DSTs to perform similarly. An important factor in the potential yield of your investment depends on the quality of the properties within the trust.
Key considerations before investing:
- Location of the properties
- Tenants and their creditworthiness
- Lease agreements
- Quality of property management
- Financial status and track record of the DST sponsor
Thorough research is essential to ensure the DST aligns with your investment goals.
2. Ignoring Liquidity Constraints
DST investments, unlike stocks or mutual funds, are not liquid. Once you invest in a DST, it is challenging to sell your interest or withdraw funds before the trust’s properties are sold or refinanced.
Actionable insight:
Evaluate your liquidity requirements. If you might need access to your funds in the short term, a DST may not be the right investment vehicle for you.
3. Overlooking Risks of Passive Ownership
DSTs enable investors to take a passive interest in real estate investments, which can be appealing to those seeking hands-off management.
However, this comes with risks:
- The DST sponsor and trust manager control all decisions, including property management, leasing, and sales.
- Poor decisions by the sponsor (sponsor risk) can lead to underperformance or reduced returns.
Recommendation:
If you prefer direct control over your investments, DSTs may not suit your style. Always evaluate the experience and track record of the DST sponsor before committing.
4. Underestimating Fees and Costs
Investing in DSTs involves fees that can erode your long-term profits. Common fees include:
- Management fees
- Acquisition fees
- Loan origination fees
- Disposition fees
Advice for investors:
Understand the fee structure and its impact on your cash flow and returns. Avoid being caught off guard by costs you didn’t pay attention to after investing.
5. Misunderstanding Tax Implications
One advantage of a DST is the ability to defer capital gains taxes through a 1031 exchange. However, tax implications can become complex.
Critical considerations:
- If you cash out your DST investment, you will owe capital gains taxes.
- Ensure that your DST strategy aligns with your overall tax planning.
Pro tip:
Consult a tax expert to understand the tax implications of each investment stage.
6. Chasing High Yields Without Assessing Risks
DSTs can offer high returns, but prioritizing yield without considering associated risks is a common mistake. High-yield properties often come with challenges such as:
- Low-quality tenants
- Substandard lease agreements
- Undesirable property locations
- Higher vacancy risks
Best practice:
Understand your risk tolerance. Adopt a balanced approach. Assess risk-return trade-offs by evaluating tenant composition, property location, and the quality of property management.
- Neglecting Exit Strategies
Many investors focus on the initial investment without planning how and when to exit. DSTs are considered illiquid investments because they lack a secondary market. A lack of an exit plan can lead to complications, such as:
- Being forced to hold an underperforming property longer than desired
- Relying on the trust manager’s decisions, which may conflict with your goals
Advice:
Understand your options for liquidating your interest, whether through property sales, share conversions, or other means.
Summary
Delaware Statutory Trusts (DSTs) can be an excellent way to expand your investment portfolio, defer capital gains taxes, and earn passive income through real estate. However, as with any investment, certain pitfalls can undermine your financial success.
By avoiding the Seven Deadly Sins of DST investing—such as insufficient due diligence, ignoring fees, prioritizing high yields without assessing risks, and neglecting exit plans—you can make more informed decisions that align with your financial goals.
Final tip:
Learn as much as possible about DSTs, assess potential risks, and seek advice from financial and tax advisors. This will ensure you use your DST investment effectively and achieve the results you’re aiming for.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.