DST Market Trends and Opportunities: What Investors Need to Know
Carl E. Sera, CMT
July 21, 2023
Explore the latest trends in the DST (Delaware Statutory Trust) market, including changes in investor preferences, market growth, and technological advancements.
Delaware statutory trusts have climbed in popularity in the past few years, as 1031 investors have taken advantage of rising asset prices to complete 1031 exchanges into products that allow them to grow their wealth with an entirely passive investment vehicle.
In this article, we’ll provide a brief insight into what DST is all about and some growing trends in the DST and 1031 Exchange industry. Keep reading to learn more.
What is a DST?
DSTs are unique real estate investment vehicles that allow a group of individual investors to purchase fractional interests in large institutional quality real estate assets that typically would be well beyond their financial reach as solo investors.
However, DST investors don’t actually own physical real estate – they own shares of a trust that was formed specifically to be the legal owner of the underlying properties held within the trust. This distinction is important because of the legal separation between the trust and the pool of DST investors.
What are the Benefits of a DST?
Depending on whether you're looking for a traditional DST or a 721 DST can mean a very big difference for your hold period and future 1031 exchanges. They both offer equity appreciation, cash flow, tax deferral, and a stepped-up basis. While some may see value in doing future 1031 exchanges through Traditional DSTs, many of our clients gravitate towards the DST that gets bought by a major REIT, the 721 DST. They typically choose this because there's a higher degree of confidence and predictability associated with the 721 Exchange DST investments. Though the adage of location, location, location is critical when examining traditional DSTs, that becomes less relevant when you own hundreds of properties across geographies and asset classes.
Top Trends in the DST Industry
With the real estate market cycle notably marked by higher interest rates, inflation, and slower growth, the real estate industry has a more pessimistic outlook which will also impact the number of 1031 Exchanges and DST investments that may occur. 2023 according to industry experts, is expected to be a year of challenges and opportunities.
Delaware Statutory Trust real estate may be considered an “alternative” asset class, but there’s no denying it has moved into the mainstream as of late. Large and small investors are clamoring to add a core stabilized property to their portfolios. One of the challenges, of course, is that institutional-quality real estate is typically expensive and has high barriers to entry. Few people can access high-caliber deals on their own. This is because they'd be competing with REITs.
The need for investors to get into institutional-grade properties is one of the primary reasons why Delaware Statutory Trusts, or DSTs, are touted to become a more popular choice among investors in 2023 and beyond. Rising interest rates that have stalled investment sales activity are contributing to an imbalance in DST supply and demand for DSTs, and impeding what had been a booming trajectory for the marketplace. On paper, the DSTs market had a great year in 2022 with $9+ billion in fundraising, up nearly 27 percent compared to the $7.2 billion in fundraising from 2021, according to recent data.
The housing market will continue to be negatively impacted by rising interest rates, and housing market activity is likely to stay low. Higher mortgage rates and near-record price levels make ownership less attainable, especially for first-time homebuyers. However, this will support continuing growth in the rental house market spurring opportunities for single-family homes and income producing multifamily investments.
Within the DST industry, multifamily and industrial are predicted to remain popular asset classes. Retail with repurposed class usage and hospitality, particularly with the growth of Airbnb and VRBO rental investment, will continue. These asset classes generally structure their transactions as 1031 Exchanges.
DST sponsors in recent times have also been reacting to shifting market conditions accordingly by buying fewer assets and bringing fewer DST offerings to the market. However, a massive amount of DST inventory is still built up from past offerings. As of Jan. 15, there were $3.5 billion in DST offerings across 82 products from 39 different Delaware Statutory Trust Sponsors. Based on the fundraising rate seen in the first half of January, that amounts to about 7.5 months of inventory. This was a far cry from the hay-day in recent memory when deals were selling out in minutes and hours. Investors have more time to decide which investment is right for them.
Registered Investment Advisors vs. Brokers
When we started in the DST industry years ago, it was completely dominated by brokers who were happy to receive their big commissions and walk away. Then every few years, once the DST went full cycle, they'd charge their big commission again. Rise and repeat. Since we got into the space as a fee-only fiduciary Registered Investment Advisor, we've played an important part in changing the DST landscape. The difference is the fiduciary standard vs. the suitability standard. We must do what's in our client's best interest vs. recommending something simply suitable. Suitability often leans towards brokers making high recurring commissions throughout the investor's lifetime. We don't like this model or practice.
The Biggest Trend Yet
We briefly touched on 721 UPREIT DSTs earlier. 721 DSTs are DSTs that get bought by major multi-billion dollar REITs through the 721 UPREIT mechanism. Essentially, an investor purchases a DST through a 1031 exchange, but after a safe harbor period of 2-3 years, for example, the REIT buys the DST. In doing so, investors get to own operating partnership units of that REIT that act like shares of that REIT. Regarding trends, the companies specializing in 721 DSTs raised between 30-40% of all the equity last year. We're big advocates for this solution; this trend is here to stay.
Although recent data and trends point toward the rise in DST investments, these investments are by no means guaranteed, there is always a risk of loss with any investment, and past performance is not indicative of how it will perform in the future. In addition to this, many suggest that there's a secondary market for traditional DSTs. We only see availability sporadically.
Anyone considering investing in a DST will want to carefully vet the DST sponsor and the offering, just as they would conduct thorough due diligence on any other proposed investment, and it’s always a good idea to also speak with your finance or tax professional. That said, investing in a DST can be an excellent option for real estate investors looking to access high-caliber real estate on a truly passive basis.
Sera Capital is a wealth management consulting firm specializing in all aspects and all available tax-efficient exit options for business owners, real estate investors, and developers. Our team works with you and your advisors to examine all available solutions, including 1031 Exchanges, Delaware Statutory Trusts, 721 UPREITS, Opportunity Zone Funds, and Section 453 Installment Sales, including Deferred Sales Trusts and Structured Installment Sales. We have two mottos. The first is “We help landlords and business owners exit tax efficiently,” and our second is “When you want out, call us in.”
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