Things they don’t tell you part II
As promised, here is the follow up regarding the three real estate sleeves I work with. This week we will discuss a basic overview of a 1031 structured product called a Delaware Statutory Trust (DST).
The Back Story
About 20 years ago the major sponsors of private real estate investments became concerned about the limiting structure of Tenants In Common (TICs). TIC structure only allows for 35 investors, the debt is usually recourse and personal guarantees are typically demanded by the lender.
As prices rose, and real estate as an investment became more popular, the TIC structure was simply to confining and complex. The major sponsors met with Treasury and the IRS to review what could be done to realign these structures that would allow for more investors to participate and remain within government-approved guidelines. They came to an agreement on the current structure and finalize the regulations in 2004.
But TICs were still the rage of the day, so not many took notice of this new investment vehicle. The great financial depression of 2008 changed all of that! Banks had to deal with up to 35 different investors who all had to agree on any loan covenant terms and any other changes to the original agreement between the parties. As we all know, this problem did not end well.
On the surface, DSTs are simple, but they do have complicated rules and structures “beneath the hood”. An investor must be an “accredited Investor” to start with. This means that they have a net worth (excluding their primary residence) of $1 million, or consistently earn over $200,00 a year if single or $300,000 a year if married. Please don’t get me started on this pretzel logic.
Essentially the DST real estate asset is a prepackaged 1031 trust that is ready to invest in right now. The Sponsor has selected the property, done due diligence, purchased it (typically) and placed non-recourse debt on it. All this means that the investor has institutional quality information and can review all the aspects of the investment before they invest. The vast number of tasks needed for the exchange are already done.
An investor can usually place as little as $100,000 into a DST. This means that if there is any left-over boot from the exchange, it can be completed by placing part of the proceeds into a DST. They also have various levels of debt. This allows the investor to match up the correct amount of debt they need to exchange with a possible portfolio of DSTs. Cash flows are paid monthly. The investment time horizon is usually 5-9 years. Loan to value ratios run from 0-83%.
Most won’t hold longer than 10 years as they use CMBS debt with 10-year maturities and refinancing is not allowed. This is a risk as the economy may not be conducive to selling as the 10-year mark approaches. Sponsors try to mitigate this risk by understanding they want to sell the property within about 8 years and not get into what I call the “red zone” of timing. The debt being non-recourse is a big deal for older investors who want to reduce liabilities to their estate.
Risk
Risk is an eye of the beholder concept but usually isn’t perceived that way by regulators. One of the biggest “risks” is the lack of control. The investor has no input as to when the property will be sold. That is solely up to the sponsor. This is perceived to be a large risk by regulators. And of course, one has all the normal risks of owning real estate also. There are also some great estate planning opportunities that can be arranged using the DSTs. Upon the sale of the property, the investor is totally back at choice.
Of course, there is much more to share with you about DSTs, so I have added a link to and educational pdf from one of our Sponsors, Inland Capital.
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