Understanding Delaware Statutory Trusts: The Advantages and Disadvantages of DSTs
Carl E. Sera, CMT
November 3, 2020
Investing in a DST property or properties is like any real estate investment. It comes with its own risks and benefits. In this article, you will learn about the advantages and disadvantages of investing in a Delaware Statutory Trust. If you'd like to discuss your specific DST situation, schedule a free 30 minute call with us.
Pros of a Delaware Statutory Trust (DST)
Because the minimum investment in a DST is between $25,000 and $100,000, even someone with as little as $200,000 can own multiple DSTs and thus create their own little custom real estate portfolio. Investing in a DST allows you to diversify your real estate investment portfolio easily. And since DST there is no set limit on the number of DSTs one can invest in, you can easily spread your investment amongst different sponsors, asset classes and geographical locations.
2. Passive Investment
Owning a typical rental property requires that you deal with the day-to-day running of the affairs of the rental. But investing in a DST relieves you of the regular landlord responsibilities—toilet, termite, tenant, trash and telephone. A DST is really for someone that wants to leave a legacy and wants to get out of the responsibilities of being a landlord. As we like to say at Sera Capital, when you want out, call us in.
A DST is a passive investment because the sponsor is responsible for identifying the properties, due diligence, raising funding, and sometimes managing the DSTs on behalf of the beneficiaries. All that you need do is to purchase equity in the DST to participate in the distribution of its income and sale proceeds.
3. 1031 Exchange Tax Deference
1031 Exchange Tax Deference is the single most significant reason to invest in a DST. Why? Because people hate paying taxes and the taxes due on the sale of highly appreciated real estate can run as high as 40% of the sales proceeds depending on someone’s state of residence.
As a side note, we don’t’ recommend that people invest their regular money or non 1031 money into DSTs because by design, reputable DSTs error on the side of being conservative. They are for people that have already succeeded in the real estate marketplace and are at a point in life where security is more important than the potential for a higher rate of return because they no longer want to take the risks associated with the potential for higher returns. For those still looking for higher returns, we offer a number of possibilities.
For those that want to know what gives a DST this tax advantage we refer you to IRS revenue ruling 2004-86, which clearly states that beneficiary ownership in a DST meets the requirements of like-kind property in a 1031 exchange.
What this means is that your ownership interests in a DST investment are eligible for 1031 exchange upon the sale of the DST. You can use your share of the sale proceeds to do a 1031 exchange into another DST or like-kind property thereby deferring the payment of capital gain taxes indefinitely.
4. Institutional Grade Assets
Investing or doing a 1031 exchange into a DST allows you to be a beneficiary owner of institutional-grade real estate that would ordinarily be out of most investor’s financial reach. DSTs are institutional-grade properties worth tens and up to hundreds of millions of dollars. With as little as $25,000-$100,000 you can 1031 exchange into a professionally managed $100 million property as an example. Please be advised, that DSTs are for accredited investors only.
Cons of a Delaware Statutory Trust (DST)
1. Lack of Control
Lack of control is a big one especially for those that have spent their entire careers controlling property. It’s a hard one to let go. When you invest in a DST, you have no control over the happenings within the DST. The IRS ruling about DST structures stipulates that investors could not have any control over their specific DSTs both in the aspect of operations and decision making. While sponsors may request monthly or quarterly feedbacks from investors, this shouldn’t be misplaced with control.
All the decision-making power lies in the hands of the sponsor as does the financial risk associated with any loans or mortgages on the property. The sponsor bears 100% of the responsibility for paying back any and all loans or mortgages.
2. DST Properties Are Illiquid
This at first seems like a major hurdle to overcome but in our experience, most investors have sufficient other assets that this is not an issue. If it is an issue, then we advise our clients to keep some portion of the sale proceeds for themselves, and pay taxes on that portion, and then invest another portion in the DSTs.
When considering whether to invest in a DST, you should be aware that your equity will remain invested until the DST is sold. Equity invested in a DST is difficult to convert to cash which can give pause for investors looking for a great investment with easy liquidity. If you need liquidity, once again--pay taxes on a portion of the proceeds and then invest the rest.
DSTs typically take 5-10 years to go from start to finish or what we refer to as going full cycle. Please note, there are a number of DST sellers that would have a DST investor believe their investment is liquid because they tout there is a secondary market for your DST investment. Don’t believe them. While it is theoretically possible to sell your DST if in fact there is an unforeseen event and you need liquidity, the reality is that it’s not like selling shares of a stock, ETF or mutual fund. The bid ask spreads on these are typically pennies per hundred thousand of investment while in the DST space, the bid ask spread can be in the thousands and tens of thousands. As registered investment advisors with 30 plus years trading securities, we would never classify the DST market as having a secondary market.
3. DSTs Cannot Raise New Capital
Again, as per the IRS ruling of 2004-86, once the initial offering for investments in a DST is closed, the sponsors are unable to make new capital calls or receive contributions from investors. Also, a change in occupancy or rental vacancy can lead to a reduction in the expected monthly rental income of investors and the property cash flow. This is one of the reasons why the IRS expects DSTs to be in great condition upon their purchase. As always, working with a 1031 exchange professional will help you navigate any potential murky waters.
As 1031 Exchange and Delaware Statutory Trust Consultants, it is our goal at Sera Capital to shine a light on the DST industry, especially when it comes to DST Commissions and Fees. If you’d like to set up a complimentary call, schedule a call on our calendar today.