Delaware Statutory Trusts: Asset Class Rejection

Victor Coronado:

Hi, everyone. My name is Victor Coronado, Senior Associate here at Kay Properties and Investments. Thank you everyone for joining us on the Kay Properties 1031 Exchange DST Investment conference call. We will begin with risks and disclosures.

DST 1031 Properties are only available to accredited investors, generally described as having a net worth of over $1 million exclusive of primary residence, and accredited entities only. Those are generally described as an entity owned entirely by accredited individuals and or an entity with gross assets of greater than $5 million. If you are unsure if you're an accredited investor and or an accredited entity, please verify with your CPA and attorney.

The information herein has been prepared for educational purposes only and does not constitute an offer to purchase securities, DST Properties and or real estate. Such offers are only made through a private placement memorandum, PPM, which is solely available to accredited investors and accredited entities. Securities are offered through FINEX member FINRA and CPIC. FINEX and Kay Properties are separate entities.

This material is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice guidance regarding your particular situation. There are risks associated with investing in real estate and Delaware Statutory Trust properties, including but not limited to loss of entire investment principle, declining market values, tenant vacancies and illiquidity. Investors should read the PPM carefully before investing, paying special attention to the risk section.

Because investor situations and objectives vary, this information is not intended to indicate suitability for any particular investor. Please speak with your CPA and or attorney to determine if an investment in real estate DST properties is suitable for your particular situation or circumstance. Past performance is not indicative of future returns. Potential cash flows, returns, appreciation are not guaranteed and could be lower than anticipated.

Thank you everyone for listening in and now I'd like to turn the call over to Alex Madden, our Senior Vice President here with Kay Properties and Investments.

Alex Madden:

Hey, thank you so much. And I want to thank everyone today for joining us on the call. We're going to have a great time going on DST Essentials with Kay Properties. And this is where we take an in depth look at the many recurring themes and nuances of the DST investment process. In this series, we're going to be interviewing many members of the Kay Properties team who each bring their unique and valuable perspectives that they've formed over vast transactional experience in the DST investment landscape.

Before we introduce our guest today, I'm going to start with a little bit about Kay Properties. Kay Properties is a national Delaware Statutory Trust investment firm. The www.KPI1031.com platform provides access to the marketplace of DSTs from over 25 different DST sponsor companies. This includes custom DSTs only available to Kay clients and an active DST secondary market listing from time to time. Kay Properties team members collectively have over 150 years of real estate experience and are licensed in all 50 states. And we've participated in over $30 billion in DST 1031 investments.

I'm very excited to have our very own Orrin Barrow on the call today. Orrin Barrow is a Senior Vice President that works out of the Kay Properties headquarters in Los Angeles. Orrin is a leader and a specialist in the 1031 DST space and has helped investors purchase hundreds of millions of dollars in DST real estate. Orrin, thanks for being on the line today.

Orrin Barrow:

Yeah, thank you for having me. Can you hear me properly?

Dwight Kay, Founder and CEO of Kay Properties discusses specific Delaware Statutory Trust Properties for 1031 Exchanges:

Delaware Statutory Trust: Example DST Investments for 1031 Exchange

Alex Madden:

I've got you loud and clear. Yeah, really great to have you here. And today we're going to be talking about asset class rejection. Specifically, we're going to be discussing which asset types Kay Properties avoid and some of the reasons behind that. So Orrin, thanks so much and would love to hear a little bit about...

Before we get into asset class rejection, could you just explain what is an asset class? What kinds of asset classes do we typically find on the Kay Properties platform?

4:26 – What is an asset class?

Orrin Barrow:

Yeah, absolutely. So asset classes refers to the type of property. That's usually... The asset class is really real estate jargon, but essentially what it's defining is the type of property. The sort of subject line that you would use for a property. For example, an asset class in real estate can be distribution. Distribution facilities for Pepsi, for FedEx, for UPS, for DHL. That would be considered an asset class.

Multi-family would be considered an asset class. And there's different sub-set classes identified in multi-family versus... Class A multi-family, which is typically multi-family built from the 2020s on upward. Class B multi-family, which is a little bit older and probably had some renovations done before you see it on the platform. Value add multi-family. Value add multi-family, you typically... Whereby there are some significant renovations or significant lease up to the actual property where there is some sort of risk involved. But the reward is great if we can properly do the value add strategy that we've intended to do. So there's different asset classes. Some asset classes have sub-asset classes. But ultimately when you hear the term asset classes, it's used to define the type of property that you're looking at.

In terms of the asset classes that you typically find on the Kay Properties platform, you have all your major food groups. So you have retail, you have multi-tenant shopping, you have distribution, you have medical, you have office, you have multi-family and all the flavors of multi-family. Class A multi-family, Class B multi-family, value added multi-family. Manufactured housing communities. Built for rent housing. And I didn't mention office. Office is typically the type of asset classes that we have. The type of assets, usually it's a little bit... Usually we have different types of assets. Right now we've actually added education as a type of asset class. Typically, this is just a building for a school. That's a new asset class that's been added to the marketplace. But ultimately over the years as different asset classes become more and more popular, and more and more amenable to the actual DST marketplace and its investors, we will add them to the platform.

But I think it's actually easier to name the asset classes that we don't do. And I think those are the asset classes that we'll be getting into today. But just to name them off. First you have hospitality. So that's hotels. Many hotels, motels, those type of asset classes we tend to avoid. Senior care and memory care. And that sometimes is a surprise to investors. We do have an aging population in the United States, so those asset classes are becoming more and more popular with higher occupancy rates. But as we'll get into a little bit later, those asset classes have their own issues. It can be very risky for investors, especially in the Delaware Statutory Trust structure. We also don't do student housing. So student housing is an asset class that we've not done. We invited [inaudible 00:07:31] actual marketplace a couple years ago, and then after the pandemic we saw that there's more risk attached to that asset class than ever before. So we decided to take it off our menu.

Am I missing any of these asset classes that we don't do? I know senior care, memory care, hospitality and student housing. Is there anything else, Alex, that I'm missing on that list that we've decided not to do?

Alex Madden:

Sure. No, I think that really hits it at a high level. The only one I would add on there is oil and gas.

Orrin Barrow:

Okay.

Alex Madden:

There are some different oil and gas type of DSTs out there. It's a specific asset class.

And Orrin, without going into each one specifically because we will do that in a moment. But why? Could you... What's the thought process? What's wrong with these asset classes at large that we would just wholesale write off a whole swath of investment real estate?

8:29 – Why Asset Class Rejection?

Orrin Barrow:

Of course. So the Delaware Statutory Trust is a very rigid structure. If anyone is having a problem. What they call having issues going to sleep. Or even if they just want to know more in depth about the DST. There's something called the seven deadly sins that essentially make the asset class very rigid. Which is why revenue ruling 2004-86 allows the Delaware Statutory Trust to be admissible for 1031 exchange proceeds. It's because of its rigidity that it qualifies for 1031 proceeds.

In that rigidity, however, certain asset classes just don't fit the bill. Certain asset classes already have inherent risk built into them. Like hospitality, like senior care, like memory care. In order to properly manage those asset classes, you need the flexibility to be able to infuse cash, to be able to change course if necessary, to be able to withstand any sort of economic burdens that fit those asset classes. It's no mistake that during times of economic downturn, hospitality assets are one of the first ones to be hit. Because people stop traveling and therefore hospitality tends to suffer. Those asset classes essentially have the inherent risk that we feel as though are too great for our investors to take on, especially in a rigid asset class like the DSTs where you're not able to move flexible. Not able to be flexible enough to be able to handle the bumps and bruises that come along with managing those asset classes that have that inherent risk.

So all the asset classes I've named, and again we'll go over them in detail, but they have inherent risk associated with them that make them very risky. And we made a declaration, a promise if you will, to our investors early on that we will not make them guinea pigs just to make a few extra bucks. So just because it's on a platform or those particular asset classes are paying a higher commission, it doesn't mean we're going to add it to our asset class and cross our fingers and hope the deal works out. We want to make sure we're putting the side of favorable investments on the side of our investors. And of course there is no guarantee, but we've seen those asset classes suffer over the course of our time as a company and we've decided to take them off our platform.

Alex Madden:

Yeah. No, I think that's great. And looking across all of these. What they have in common is that they're historically very volatile. And the way that you can hedge against volatility. Do not suit themselves well to the DST structure.

And Orrin, I'm sure you're the same. You've spoken with different investors. I've spoken with some investors. Their family is in oil and gas and has been for multiple generations. And they may be able to get comfortable with knowing the ins and outs of a specific oil and gas investment. And in a situation like that, maybe that investor has the ability to pick out the good one versus the bad one. But there's a specific business plan that's inherent to something like oil and gas that is beyond a typical real estate investment. There's other specific knowledge necessary. And there's other hedges that are typically going to be built into an investment like that which kind of preclude them from conforming to the seven deadly sins that you were just referencing there, Orrin.

So let's dive in here. Maybe we'll just run through these differentasset classesreal quick and you can tell us why these are rejected. We know what the specific things to look at. And then I would just encourage any listeners here. If you have greater questions about these, please reach out to your Kay Properties representative. We can speak about it in depth. Because some of them are a little bit counterintuitive.

And I'll start off with the one that is probably the most counterintuitive because all the time I hear senior care. Assisted living. Baby Boomers. They're all starting to retire. They're all going to these 65 plus communities and getting assisted living and this sort of a thing. And that's absolutely right. Nobody can argue with the demographics going on with the Baby Boomers. But Orrin, what are some of the inherent risks of senior care that people are not often told about?

12:41 – Inherent Risks of Senior Care DSTs

Orrin Barrow:

Yeah. Of course. So just like you have a larger uptick in terms of the aging of our population and that becoming more of a focal point. Obviously, maybe you have occupancy rates are rising all over the country in these particular facilities. It also opens it up toregulatory risk. So now that this is becoming more and more of a trend, more regulators are starting to actually be aware of the issue. And they start making sweeping and mandated changes into the operations of these businesses.

For example, a couple years ago they changed the amount of nurses that can be per bed or per patient. And that could materially affect the operations of your business. Nursing is a... We'll consider one of the higher paying professions. If you now have... As an operator of this particular facility have to have... There used to be one nurse per six patients. Now there's one nurse per two patients. If that were to change, and it has changed in the past, that could materially affect your operations for the foreseeable future. Being that you have to have much higher employment costs, much more higher administrative costs that will eat into your [inaudible 00:13:48], drop your actual income, and therefore make your particular investment that you thought would be profitable maybe breaking even or even going down into the negative.

And in the Delaware Statutory Trust, they are self-contained entities. So ultimately they're not going to be pulling from any other resources or any other assets to be able to help stabilize this asset. And so after reserves are taxed. Reserves are money put aside to handle any bumps and bruises in the real estate. If the administrative changes are so severe that you have to tap your reserves in order to meet your actual expenses, you can end up having to sell the property for a loss.

And so this is happening more often than not. We expect more sweeping regulation changes to come in the future, especially as our population continues to age and the occupancy rates of these particular properties tend to go up. So from that perspective, because there can be sweeping changes that formidably affect the overall income or the overall expenses of a property like senior care, memory care, assisted living, we tend to avoid those asset classes.

Now do some of those classes perform well? If you can be very, very prudent in your ability to foresee those risks, and be very prudent in the way that you are performing, or expecting the type of income that you're expecting, it can be possible. But we don't want to put our investors in the possibility that the particular sponsor company did not properly set aside funds or properly look at their actual projections to be able to take account for any sweeping regulations that come in the future and then your actual investment get materially affected.

Alex Madden:

Yeah, that's spot on. That's spot on, Orrin. The regulatory risk when you gave the example of the nurses there, and that's one that has certainly been present. But it could be literally anything. It could be a situation from the local government, the state government, the federal government changes handicap accessibility. Or changes food handling requirements. Or medical administration. Elevator safety. There's virtually an endless list that any three levels of government here could regulate. And in that situation, from our perspective, it just seems like investors are not getting a risk adjusted return. Typically, you're seeing maybe a 1% increase. Maybe even less than that on some of these different investment potentials. To get into what is substantially a... What we consider to be a substantially higher investment risk factor there. So, yeah. It's something to be considered just as the risk adjusted return. Is the juice worth the squeeze on something like that?

So speaking of some of these other risks. Orrin, how about hotels? What are some of the risks historically associated with hotels?

16:41 – Hospitality Delaware Statutory Trust Risks

Orrin Barrow:

Yeah. So obviously hotels can be a very lucrative investment, specifically in great times. In great times everyone's traveling, so you have a high occupancy rate. The higher the occupancy rate... Specifically if you have a hotel in a very travel friendly destination place. Those particular occupancy rates go sky high. The higher the occupancy rate, the more you can move the rate per unit. The hotel rate. I'm sure everybody's seen this. If you're going to a particular destination during a hot time at that particular destination. You're having a large scale event. You will see the prices of the hotel skyrocket and that only benefits the owner of those hotels.

But vice versa. When we hit a recessionary environment. An economic downturn. It can even be an overall economic downturn or a depression in that particular sub-market. Maybe something happens in that sub-market. A large employer moves out in that sub-market. There's negative population growth in that sub-market. Hospitality is one of the first asset classes to suffer. At the end of the day, they do not have a long term tenant. Usually their lease per customer is a day. A night, right? If not, two days. So they do not have long term customers, which means that they are one of the first set of asset classes to be affected by the overall economic environment.

So hotels are... Hospitality is what I would consider to be a front runner. When things are great, they are one of the better performing asset classes. When things are bad, they are one of the worst performing asset classes. Because of their short term leases, the fact that they do not have long term tenants involved, and that they have to actually move with the whims of the economy.

As an investor, we... As an advisor to investors, we want to hedge against economic downturn. Obviously there's only so much that you can do. If you have something like the great financial crisis, most real estate will be affected. But the idea there is to be able to protect investors' principle. Be able to protect investors' investments. And at the end of the day, hospitality is much too volatile to do that.

For investors who have large net burst who want to be exposed to hospitality, we totally understand that. However, the majority of our clients are ranging anywhere from $200,000 to $2 million in terms of their transaction size. Many of our investors are relying upon their incomes to maintain their livelihood. And so we feel like having hospitality in our menu for the majority of our customers is much too volatile. The risk parameters are way too high.

Alex Madden:

I couldn't agree more, Orrin. So thank you so much for laying that out. Let's move on to student housing.

Orrin Barrow:

Sure.

Alex Madden:

Why student housing? It seems like that's another one like senior care that might be a little counterintuitive.

19:16 – Risks Associated with Student Housing

Orrin Barrow:

Yeah. Student housing is... Student housing was great. For a while there we did not... For a while there we felt as though someone... Because student housing has much more variables than your typical multi-family property. Early in the... Early in Kay Properties formation, we felt like there was not a sponsor company out there that we felt had enough necessarily built up experience in managing the actual student housing in the Delaware Statutory Trust.

You have to remember that student housing is cyclical. At the end of the day, it's not always full like a normal multi-family property would be. Students typically go home during the summertime. And so the idea there is that there's a specific lease up period in student housing, I believe anywhere from May. Yeah, from May until June, they have to have the property 100% leased up.

Now, one of the benefits of student housing is many times you have... Instead of having the actual student on the hook, you have the parents on the hook. Correct? And so the parents typically have a much better balance sheet than the students. And so you have a much better tenant base than you would if you were renting directly to students. The problem is that if you don't get the property leased up properly during that lease up period, you'll face economic hardships for that entire school year. So the lease up period is very, very vital. Making sure that you're upgrading the actual student housing, making sure the student housing is actually very, very attractive to the incoming student base or the returning student base is vital to the operations of student housing.

Now student housing obviously is different than multi-family because many times you would have what... Normally in a multi-family property you would have one person to a 500 square foot unit. In student housing you could have three people to a 500 square unit. So that is different in student housing. There's actually much more. And you can squeeze per square foot out of a student housing property then you can out of a multi-family property. Which is typically why when we had student housing properties, the cash goals were much higher.

Obviously, enter the pandemic. No one was going to school. Everyone... If anyone was going... Not necessarily no one was going to school, but no one was staying in the student housing because of in how close proximity they were to other students. It wouldn't have been deemed safe by local or state or federal government. And so many students decided to work... To be able to do their actual schooling remote. Many student housing facilities have not recovered. And that's because the majority of the student housing that we have in the DST platform are not school sponsored. There's school sponsored student housing where they're very, very close to the campus, and typically the university will own them. And then on the outskirts of the actual university is where it... Private label student housing is owned. And so obviously, those student housing deals have yet to recover. Some have. Many have not.

And so we are seeing that as a potential shift in the culture of how we look at student housing. Are students going to be living on campus, or are they going to be getting apartments with their friends and their colleagues and staying off campus and not necessarily utilizing student housing properties? And so those particular deals we feel like are much too volatile being that they have that very, very tight window in the leasing up period. Meaning that many, many students are not staying in those particular type of asset classes anymore.

If you can get a student housing property that's very close to the university and is always having occupancies, then you've got yourself a great investment. However, we don't want to make the wrong bet that is not a particular case, and that you're suffering with a particular investment that's supposed to have a particular cash flow requirement or cash flow distribution and is yet to meet it year after year because they're missing their projected numbers on that lease up period. So that's why we're avoiding it. And I think we'll do so for the foreseeable future until the culture of academia and people staying in student housing changes.

Alex Madden:

That is exactly right, Orrin. I think you hit the nail on the head there. Where the reality is that you've got a very narrow lease up. In traditional multi-family, you can... If you lose a tenant in the middle of the winter or in the spring or summer or fall, it doesn't really matter. You can go and get another tenant in place. With student housing, it's in line with the cycle of education. The start of the school year. If you don't get fully leased up prior to that school year, chances are you're probably not going to get fully leased up throughout the rest of the year. So there's obviously some inherent risk there.

It's also a little bit more difficult to reposition a student housing asset. I don't know how many of our listeners have walked a student housing project recently, but they're usually going to be built to be basically indestructible. Cinder block create walls and that sort of a thing. They're more of the suite style of housing. Not something that your typical family of three or four is going to want to go ahead and move into. So should they try to reposition an asset like that, it's not really the style that a lot of families or other people are looking for. Not that it's impossible to do, but it can be an issue if you're trying to redirect.

And then lastly, supply. So supply is really the great killer of student housing here. Where if we've got the brand new biggest bestest rooftop pool. Everything's looking great. And that's great for a few years. But what happens if and when another beautiful new project is built across town or down the street? Well, all of a sudden where we were fetching top of the line prices, now we're looking at potentially giving concessions just to get to the minimum occupancy requirements. Because students are looking. They finally made it to college and they're willing to... No expense spared for four years and looking at the new property.

So there's a lot of volatility that we've seen there and we just don't think it's really something that we would want to be recommending particularly at this point in the market cycle.

So Orrin, I know we're going a little bit long here, but let's just wrap up what I think most people would consider a softball. Why oil and gas? Why would we not invest in oil and gas?

25:32 – Oil and Gas Concerns

Orrin Barrow:

Yeah. Oil and gas has been speculative for a long time. Inherently speculative. At the end of the day, they're necessary. They're going to different roles. Trying to hit oil. If it does, then it's very profitable. If it doesn't, then you're stuck with an empty well and your investment could essentially go down to zero.

Inherently it's very, very risky. It follows the same exact sort of principles that we use for hospitality. When things are great and oil is being found and being processed, that investment... And it can go for a long period of time. It is very, very profitable. But ultimately, if you are hitting an empty well or a dry well, or that particular land has already been tapped due to the fact that oil reserves have moved, or oil reserves have been tapped from a larger well acres away, you could find yourself in a dud investment.

So the idea here is that we're not trying to gamble with our investors' money. We're not trying to play necessarily games essentially. We're trying to figure out which one is going to hit. The idea here is we're trying to put together portfolios that make the most sense, that have durable income streams, and that hedge against the economic pressures that we're probably going to be facing here in the next couple years. That's what we're looking to do. That's why we always preach the debt free approach, which is why we're very conservative when we're adding debt to the investors' portfolio. We give them warnings about the pros and cons of each of the asset classes that they're getting into. A part of that is to... And part of that is avoiding asset classes like oil and gas, like hospitality, like senior care and memory care, and like student housing that have a very much volatile activity. Very volatile characteristic to them. And that's what we stand on in the book of business.

Alex Madden:

Absolutely, Orrin. Well, thank you so much for taking the time today. And really just phenomenal information there, Orrin. Thanks for being on with us.

Orrin Barrow:

Yeah, thank you guys for having me. Again, please. If you have any questions regarding the asset classes that you may be invested in or that are on the DST platform, please give your local representative from Kay Properties a call or visit our platform, which is www.KPI1031.com. Thank you for having me on.

Alex Madden:

Absolutely, Orrin. That's great. And on that platform you'll see that we have between 20 and 40 different DST offerings from over 25 DST sponsors. Please visit the website or call Kay Properties at (855) 899-4597 to speak with a licensed Kay registered representative who can walk you through your options.

Orrin, thanks again. And please join us next time for The DST Essentials with Kay Properties, an in depth look at the various aspects of DST 1031 Exchange Investment Properties.

To access a current list of Delaware Statutory Trust properties for 1031 exchanges and direct cash investments, please visit www.kpi1031.com .

To hear more Delaware Statutory Trust essential information, please visit our YouTube channel: https://www.youtube.com/@kpi1031