Which Is A Better Investment?
If you are like most real estate investors looking to defer the payment of capital gains taxes, then finding the best 1031 exchange strategy will be your utmost concern. For most investors thinking of doing a 1031 exchange, they are always faced with the option of exchanging into real property, DSTs or TICs.
What makes DSTs and TICs attractive is the freedom these two passive investment vehicles afford investors looking for a way to hand-off the day-to-day management of their properties. The other attractive feature is that while going from a real property to real property exchange has settlement risk, meaning many real to real 1031 exchanges fall apart, the same can’t be said for DSTs and TICs. In fact, many astute 1031 exchangers name them as backup properties even when the intention is to pursue a real property for real property exchange.
However, the questions on the mind of most investors are which should I go for? Which offers more benefits and solves my 1031 exchange purpose? In this post, you’ll learn more about the TIC and DST 1031 exchange strategy, and which is better especially for first-timers.
What is DST?
The DST which stands for Delaware Statutory Trust is an IRS-backed legal entity that allows up to 499 investors to pool their resources together to purchase a beneficiary ownership interest in the assets of a trust. While there are several legal differences, a DST is similar in function to a limited partnership. The most notable characteristics of DSTs are that they are eligible for use in a 1031 exchange.
What is a TIC?
While Tenant in Common is similar to Joint tenancy, a TIC is a co-ownership agreement that allows up to 35 investors to pool their resources together to own a single joint property. Each investor owns an undivided (must not be equal) share in the property and benefit from the resultant proportionate share of the tax shelters, income, and growth.
Unlike a DST structure, investors in a TIC receive a separate property deed for their percentage of interest in the property and may have equal voting rights as the single owner. One of the key differences between a DST and TIC is that while investors in a DST are unable to transfer their beneficial ownership interest, co-owners in a TIC can do so without seeking the approval of other owners in the trust.
Similarities between DST and TIC Structure
- They are both managed by a professional management company hired by the sponsor
- Both DSTs and TICs can be used as a like-kind property in a 1031 exchange
- They are excellent diversification strategy since they allow for minimum investments
DST vs. TIC: Which One is Better?
Below are some of the reasons why we prefer the Delaware Statutory Trust investment strategy over Tenants in Common.
- Easy Decision-Making Process
In a TIC structure, decisions regarding the sale of the property, or refinancing of the property must be unanimously agreed upon by all the parties involved in the TIC. Unfortunately, there have been instances where 98 percent of the investors are voting for the sale of the property and yet 2% are against it putting the entire sale process in jeopardy.
However, in a DST structure, the entire decision is in the hand of the Trustee. Only the Trustee is charged with the responsibility of making decisions regarding the sale, maintenance, and all other vital aspects of the DST.
- Lower Minimum Investment when compared to a TIC
The DST structure allows for up to 499 investors which typically reduces its minimum investment amount when compared to TICs, which only allows for 35 investors. The typical DST minimum investment amount of $100,000 makes it possible for investors to diversify their investment across multiple DSTs at a single time.
For instance, if the potential property is a $50,000,000 retail complex with a loan to value ratio of 40%, the equity to be raised will be $30,000, and with only 35 investors allowed in a TIC, the minimum investment amount would be $857,142 vs $60,120 in a DST. For an investor with $2,000,000 looking to diversify their investment, they would only be able to invest in just two TICs.
The freedom associated with DSTs in terms of its lower minimum investment amount makes it a great investment vehicle for small scale yet accredited real estate investors.
- Quick Closing
One of the downsides to investing in a TIC is its slow closing process which usually takes anytime between 45-60 days. This delay is due to the need for investors of a TIC to be approved and underwritten by a Lender.
When compared to a DST with a closing process of 2-5 days, a TIC may not be a great option for investors faced with a 45 days identification timeline in a 1031 exchange. More importantly, investors in a DST do not need to be underwritten by a Lender since the sponsor is solely responsible for the financing and mortgage acquisition activities.
What’s the main advantage of DSTs? The answer is the market has decided. While TICs were very popular in the 1990s as 1031 exchange vehicles, they lost their luster once the DST came along with its more accommodating structure. To add insult to injury, when the credit crisis hit in 2007-2009 period, TIC holders could not unanimously agree on what actions to take to save their investments and the lack of a unanimous consent led to many losses for TIC investors.
Sera Capital as fiduciaries and 1031 consultants are open to both solutions but we clearly favor the DST as well. To understand the benefits of working with fee-based consultant we urge you to read our post on Delaware Statutory Trusts and 1031 Exchanges.