What is a Delaware Statutory Trust (DST)?
A DST is an ownership model through a separate legal entity that allows for a number of accredited investors to pool their resources together to purchase beneficial interest into either a single asset or across a portfolio of properties.
Generally, Investors in a DST have the right to receive pro-rata distributions from the earnings of the DSTs from rental income and then from the sale of the property four to 7 years after their initial investment.
How does a Delaware Statutory Trust Work?
A typical DST process requires the sponsor (usually a national real estate company) to first acquire a property or properties that qualifies as a DST. These properties are typically institutional-grade real estate like office buildings, industrial complexes, and multi-family apartments, self-storage facilities and other multi-million dollar projects that are usually out of reach for an average investor.
After the acquisition of the property/properties by the sponsor, equity is offered to investors for purchase and usually sold through a secondary escrow closing until all the shares in the DST are claimed. Investors that purchased shares or equity in the DST are paid distributions monthly based on their beneficial ownership interest.
Let’s say you purchased an 18% equity interest in a DST, you’d receive 18% or a proportionate share of the realized net cash flow monthly as well as during the eventual sale of the DST. Depending on the DST agreement or type of financing associated with it, the lifespan of a DST varies but is typically sold after being held for 4-7 years though for flexibility, they are structured as ten year investments.
More importantly, upon the sale of the DST, investors have the option of either cashing out their realized share of the net sale proceeds or doing another 1031 exchange into another property. This is the power of the DST, it lets you continuously rollover your investments, continuously defer taxes and eventually avoid taxes in most circumstances.
Regulations of the Delaware Statutory Trust
While DSTs are less prone to risk, the IRS has outlined several restrictions to protect the purpose of the DST. These restrictions are known as the Seven (7) Deadly Sins.
- Once the offering is closed, there can be no future capital contributions to the DST by either current or new beneficiaries.
- The trustee cannot renegotiate the terms of existing loans and cannot borrow new funds from any party unless a loan default exists as a result of a tenant bankruptcy or insolvency.
- The trustee cannot enter into new leases or renegotiate current leases unless there is a need due to a tenant bankruptcy or insolvency.
- The trustee cannot reinvest the proceeds from the sale of its real estate.
- The trustee is limited to making the following types of capital expenditures concerning the property:
(a) expenditures for normal repair and maintenance of the property,
(b) expenditures for minor non-structural capital improvements of the property, and
(c) expenditures for repairs or improvements required by law.
- Any cash held between distribution dates can only be invested in short-term debt obligations.
- All cash, other than necessary reserves, must be distributed on a current basis
Benefits of Investing in a Delaware Statutory Trust
- Passive Investment
Doing a DST relieves you of all forms of landlord responsibilities. The sponsor is responsible for getting the financing, acquisition, and managing of the property. You do not have to deal with the typical landlord duties associated with a conventional rental property.
- Access to Institutional-Grade Assets
Investing or doing a 1031 exchange into a DST allows you to be a beneficiary owner of an institutional-grade real estate that would ordinarily be out of your financial reach. Most of the time, DSTs are institutional-grade properties worth tens of millions like triple-net lease and multi-family apartments, self-storage facilities and many more.
- Eligible for 1031 Exchange
Since each investor owns fractional ownership in the DST, which in turn owns the property, then according to the IRS, securities owned by investors in a trust are considered as direct ownership of a property which makes it eligible for 1031 exchange. So, you can use your beneficial ownership interest in a DST as a replacement property in a 1031 exchange.
- Limited Personal Liability
Unlike other forms of real estate investment structure, under the Delaware Statutory Trust, you are not responsible for any recourse debt either now or in the future. While it is uncommon to experience DST bankruptcy, even if it did occur, only your investment may be at risk but your assets outside the DST are safe.
Only the Sponsor who made the loan agreement with the Lender is responsible for the recourse debt. More importantly, you are not required by the IRS to include DST incurred debts on your financial statement.
Disadvantages of Investing in a Delaware Statutory Trust
- Available to Accredited Investors Only
According to the IRS, only accredited investors are qualified to invest in a DST. What this means is that you must have an annual income exceeding $200,000 ($300,000 for couples) for the last two years with the expectation of earning the same or a higher income in the current year.
- DST Properties Are Illiquid
This is one of the biggest downsides to investing in a DST. When considering whether to invest in a DST or not, you should be aware that your equity will remain invested until the properties are sold. Equities invested in a DST are difficult to convert to cash which makes it bad for investors looking for a great investment with easy liquidity.
- Long-term Investment
If you are an investor looking for a great investment with quick profits, then the DST is not for you because of its lengthy holding period and illiquid nature. Typically, DSTs are held for 4-7 years which makes it a bad choice for short-term investors.