By Chay Lapin, Senior Vice President
Recently a client in a 1031 Exchange with $4,000,000 of equity was working with another registered representative and talking to a sponsor directly. In talking with Kay Properties and Investments, they learned that we specialize in DST 1031 Exchanges and that we have access to a variety of DST properties from many DST sponsor companies throughout the industry.
After we hosted the family at our Los Angeles Headquarters and they had a chance to visit with our team, we learned more about their situation.
The building they were selling was debt free. In this scenario, the client could go into DSTs that are debt free with no mortgage. This means that these DST properties could never be foreclosed on by a lender and do not carry the risk of mortgage maturity and refinancing.
During the visit we learned that the client was being advised by another registered representative to place his entire $4,000,000 equity piece into a single DST property that had a large balloon mortgage due. The clients said that the sponsor and registered representative told them “it’s okay because the DST is already diversified with multiple properties in it.
Although we have utilized the DST recommended by the other registered representative and sponsor company for clients in need of debt replacement in their 1031 exchange, for this particular client it did not make sense. Prior to speaking with us, the client had not been properly educated about the implications of taking on debt in relation to the mortgage/refinancing/foreclosure risk and was unaware that he was going to have to continue to take on more debt or add a very large amount of outside cash in order to purchase equal or greater value on his next 1031 Exchange. Coincidentally, the client mentioned that the other registered representative and sponsor company did not discuss these risks with the client or that the DST that they were recommending had the highest paying commission as well (interesting that they left that out!)
After walking the clients through all the potential risks, the clients were incredibly grateful to Kay Properties and decided to diversify their exchange across 5 DSTs with multiple asset classes and DST sponsor companies and not put all their eggs in one basket.
This is an example of one of our investors’ experience may not be representative of the experience of all customers. It is not a guarantee of performance and the client has not been compensated.
Below are some examples on how debt can result in a loss of investment and halt cash flows. The examples below are hypothetical scenarios used to help investors understand the potential risks that come with taking on unnecessary debt.
Class A Multifamily Apartment
If financing were to come due in a recession, the DST would have been forced to sell the property in a down market. Had the property been owned debt free, the sponsor potentially would have been able to hold the property for a few extra years and sell it in a better market.
NNN Net Lease DST with debt occupied by a national tenant in the North East.
If the tenant filed bankruptcy and sponsor could not re-tenant the property in time per the requirements of the lender, the property would be sold at a major loss because it could no longer service debt.
NNN Net Lease Portfolio DST with debt occupied by an investment grade tenant.
If the tenant’s credit rating decreased, although this would have no effect on the performance of properties in the DST, per certain loan terms, the lender would have the right to sweep the cash flow until the tenant credit rating were to go back up.
If the above examples were all-cash/debt-free DST offerings, instead of selling the DSTs at a loss or at an inopportune time in the market cycle, there would potentially have been an opportunity to re-tenant and reposition the assets, potentially boosting overall investment performance and returns.
Although we often do use DSTs with financing for those clients that have mortgages on the properties that they are selling, we are extremely cautious to advise clients to diversify and not take on debt when at all possible.
This is an example of one of our investors’ experience may not be representative of the experience of all customers. It is not a guarantee of performance and the client has not been compensated. This material does not constitute an offer to sell nor a solicitation of an offer to buy any security. Such offers can be made only by the confidential Private Placement Memorandum (the “Memorandum”). Please be aware that this material cannot and does not replace the Memorandum and is qualified in its entirety by the Memorandum.