By Dwight Kay
Many 1031 exchange investors researching Delaware Statutory Trust (DST) properties are looking to find out if the DST 1031 concept is “too good to be true”. What’s not to like about mailbox money from an institutional piece of real estate, that is prepackaged and easily closed on in 3-5 days? Well, understanding potential Delaware Statutory Trust problems and things that can go wrong is something that every investor must be aware of before making any investment decisions.
As the CEO and Founder of Kay Properties, I have been personally involved in over 7 Billion dollars of DST properties as a registered representative and have worked with many major and minor DST sponsor companies throughout the industry.
Here are some of the problems that we have seen Delaware Statutory Trust properties have over the many years that Kay Properties has been helping DST investors:
DST Delaware Statutory Trust Risk #1 Overuse of Leverage
It is no secret that the real estate investment world, whether it is individual investors, REITs, Private Equity Funds, Pension Funds and/or DST sponsors, is addicted to leverage. Who wouldn’t want the potential for increased cash flow and increased total returns that debt utilization in a real estate acquisition can potentially provide? However, the increase in risk assumed by investors in leveraged properties is substantial and needs to be addressed. Many 1031 investors that own their properties free and clear are being advised by certain registered representatives and sponsors that leveraged DSTs are the best for them. In my opinion and experience – to limit unnecessary risk that debt creates – these investors should invest in all-cash/debt-free DST properties that do not have a lender or loan encumbering the property. Staying debt free in a DST property completely eliminates the risk of a lender foreclosure.
The problem with many DST sponsors is that they are heavily reliant on leverage to create positive arbitrage between the acquisition capitalization rate and the interest rate on the loan, which can often create increased cash-on-cash distributions to investors. Obviously, investors like higher cash-on-cash distributions, however, it often is a grave mistake for a 1031 investor that does not have to replace any debt in their exchange to go from a 0% loan-to-value to a 50-65% loan-to-value situation. Why? Just ask the myriad of individual investors, REITs, TIC sponsors and investors, homeowners, pension funds, developers, etc. that all lost property to their lenders from 2008 to 2012.
If an investor doesn’t need to use leverage for their 1031 exchange then they shouldn’t, especially if they are at or near retirement and want to potentially reduce their risk level.
Delaware Statutory Trust Risk #2 Sponsors Overpaying for Assets.
The DST structure is widely considered like-kind for a 1031 exchange under IRC Revenue Ruling 2004-86. Although the DST structure is sound, not every property purchased by a DST sponsor is acquired at a price that makes sense considering the market.
One of our Kay Properties analyst and due diligence teams’ favorite thing to do is analyze how a property was purchased compared to other sales in the market place. You would be shocked to see how often properties are being overpaid for by sponsors due to the fact that they are obligated to bring out new products for investors even if the buying opportunities don’t make sense. It’s a Delaware Statutory Trust risk that is often overlooked.
One of the due diligence models constantly updated by Kay Properties’ analysts shows the percentage the sponsor paid for the property over or under the comparable properties that were sold in the market. We all know that in real estate a large component of a potentially successful investment happens when you buy the property. With our analysts report, we are able to show a comparative analysis of DST properties available to investors and help our clients understand which offerings were, relative to comparable market sales, grossly overpaid for (we have seen offerings marketed to clients as the best thing since color TV that the sponsor paid 15-30% over the market!) In addition our report also shows the offerings that the sponsor bought considerably below market comparables, which we believe creates considerable value for investors, which potentially helps to offset the fees and costs associated with DST properties. Additionally, those properties bought below market comparable sales can help insulate investors from a correction in the real estate market as a whole.
These are two problems that we see in the DST industry that need to be properly understood. We believe that apart from providing an understanding of these Delaware Statutory Trust risks, empowering investors with the proper information enables them to make the right choices for their particular situation. If you are interested in learning more about our DST offering comparative analysis and want to see the various offerings side by side, feel free to reach out to us by emailing firstname.lastname@example.org, visiting our website at www.kpi1031.com or calling us at (855)466-5927.
Benefits of Delaware Statutory Trust 1031 Exchange
In light of the above mentioned Delaware Statutory Trust risks, we thought it’d be good to offer a complete or rather more balanced perspective of the Delaware Statutory Trust properties and 1031 exchange by discussing their benefits too.
One of the biggest benefits of investing in a DST property is that since it’s not restricted to only 35 investors, it’s possible for people to make a much smaller investment. The ability to make a fractional investment is no doubt a favorable feature for prospective investors.
Furthermore, given that a fractional interest becomes eligible to be considered as a like kind of property for a 1031 exchange, it’s not surprising that the Delaware Statutory Trust holds the interests of potential investors. It’s a significant advantage that expands the avenue of opportunities for investments, both in terms of the type and nature of new investments.
By buying a fractional investment, potential investors have the golden opportunity to invest in a broad range of new investments of different classes and that belong to varied sectors. But that’s not all!
Another crucial advantage of a DST investment is that it does not carry the risk of multiple borrowers, as does a TIC ownership, since the former approves only one qualified borrower, who is in effect the DST sponsor.
Finally, for those of you who want to reap the benefits of Delaware statutory trusts and a 1031 exchange without the hassle of managing real estate properties, there’s always the option of becoming a passive investor.