By Dwight Kay, Founder and CEO, Kay Properties and Investments
As one of the nation’s leading expert real estate investment firms specializing in Delaware Statutory Trust investments, Kay Properties is regularly asked about the nuances and strategies surrounding Delaware Statutory Trust investments for 1031 exchanges or direct cash investments. Recently, I sat down to discuss some of Frequently Asked Questions investors ask regarding Delaware Statutory Trusts and 1031 exchanges. I recorded and transcribed this informative article, so investors can have easy access and use it as a reference for their own Delaware Statutory Trust and 1031 exchange questions.
I believe this is a “must-read” interview for any potential investor because I provided a straight-forward and direct answers to the most frequently asked questions regarding Delaware Statutory Trusts.
- What is a Delaware Statutory Trust (DST)?
- How does the Delaware Statutory Trust Differ from a Tenant in Common (TIC) Investment?
- Are Delaware Statutory Trusts Eligible for 1031 Exchanges?
- How are the Proceeds from Delaware Statutory Trusts 1031 Properties calculated?
- What is the Typical Hold Period for Delaware Statutory Trust properties?
- Can you 1031 Exchange out of a Delaware Statutory Trust?
- What are Some of the Advantages of Delaware Statutory Trusts?
- What are Some Examples of Delaware Statutory Trust 1031 Properties?
Introduction by Dwight Kay:
Thanks so much everybody for taking the time today to either listen or read this interview on “Delaware Statutory Trust Basics and Frequently Asked Questions.” This is going to be short but informative presentation covering how Delaware Statutory Trusts work and some of the most frequently asked questions we receive from investors. I also think it’s important to note that this information comes from the experience of Kay Properties. We’ve participated in over $30 billion of DST properties and investments, and so we think this type of interview can be a big help to investors. This is an opportunity to kind of shine some light on the subject of DSTs, something we've been living and breathing for a very long time now and have helped many, many clients throughout the country. So, let’s just jump right into it.
So, a DST 1031 property is a type of replacement property that's used for 1031 exchange as well as for direct cash investments.
The answer is yes. The DST structure has been approved by the IRS as 1031 exchange compatible under IRC revenue ruling 2004 - 86. This was the ruling whereby the IRS said, yes, a properly structured DST will indeed qualify for like-kind purposes for a 1031 exchange. And while there were a handful of DSTs used back then, they really didn't come to fruition and were utilized by sponsor companies until 2009, 2010, 2011, and even 2012.
And that was because, back then, the kind of go-to structure for group ownership and passively managed real estate was the Tenant in Common (TIC) structure. But with the credit crunch and the Great Financial Crisis of 2008 and 2009, lenders really didn't want to make 34, 35 different individual loans to a group of owners that were part of a TIC.
So that's how the TIC structure was put together with DSTs because lenders were much more comfortable with making one loan on a property with one sponsor and one trustee that was responsible for that loan. It was secured by the property, and they didn't have to deal with 35 different co-owners as was typical of the TIC structure. So, when that credit crunch happened in 2008, lenders immediately started shying away from the TIC structure and wanted to see more of the DST structure, which had a more professional sponsorship of the asset, and with just one loan on behalf of that DST. Then IRC revenue ruling 2004 – 86 came along and the IRS blessed the DST structure for 1031 exchanges.
The Delaware Statutory Trust is an entity that's used to hold title to real estate. In some ways, DSTs are like an LLC. It's just an entity that is used a hold title to that real estate. Many of you might own your properties in a family living trust and an LLC. You might have a partnership with some partners, and that's how you hold title to your property. The DST is the same thing. It's an entity used to hold title. But unlike an LLC, however, a DST is qualified as like-kind property for a 1031 exchange. And again, that was through that IRC ruling 2004 - 86, stating that a properly structured Delaware statutory Trust would qualify as like kind.
So, number one, DST investors receive their pro rata portion of the potential distributions from the property. So if you were to purchase 1% of the Delaware Statutory Trust, you would get 1% of the potential pro rata distributions from the property. If you purchased 10% of the DST, you would receive 10% of the potential distributions. So it's a pro-rata basis depending on your ownership level and amount. It is important to note that distributions from rental income from a DST is the same as the properties that you own on your own, whether you own multifamily or have an industrial property or a retail property, or frankly, any type of investment real estate that you own and operate on your own. That is there's no guarantee that your tenant will pay rent each month. And the same applies to DSTs.
These distributions are not guaranteed - they are potential. They can stop for any number of reasons, which we will dig into as we get further down the line. So in addition to receiving your pro-rata portions of the potential distributions of the property, you're also going to receive a hundred percent of your pro-rata portion of any appreciation potential of the property. And that's net of sales costs. So, when the property sells, if you were to have owned 10% of that Delaware Statutory Trust, you will receive 10% of that potential appreciation of the property.
So when a Delaware Statutory Trust property sells, we call that a “full-cycle” event. So investors exchange into a DST that is operated by the DST sponsor company for any number of years, there will eventually be the opportunity for the Sponsor company to sell the DST investment. Typically, we are seeing 3 to 5-year hold periods, but they can be as long as up to 10 years. I was personally invested in a DST that went for more than 12 years. So obviously, DSTs can go much longer than a typical three to five or three-to-seven-year hold period. But we have also seen DSTs sell in as quickly as a year and a half. And again when a DST property sells we call that a full cycle event. So, the DST sells the property that you exchanged to a third-party buyer. This is another unique about DST investments is that you as the investor receive a hundred percent of your pro rata portion of the appreciation on the property, whereby a lot of the REITs out there, or crowdfunding sites or LLCs, or real estate funds typically have a waterfall split where the investor doesn’t receive a hundred percent of the pro-rata portion of the appreciation potential. You receive a preferred return. After that, it's a waterfall split with the real estate sponsor company where it's 70%-30% or 50%- 50% or 60%- 40% after your preferred return. In those other types of investments I mentioned, investors give up a portion of their upside to the real estate sponsor company. And again, this is kind of the beauty of the DST in that you as the investor receives a hundred percent of your pro rat portion of any potential appreciation of the property net of sales costs. But again, just like buying a property in your town or city. You buy a piece of property for a price, and there's no guarantee that it's going to be sold at a higher price in a number of years. That’s just not how real estate works. So same thing with DSTs. No guarantees.
So when a DST property is sold, are investors able to do another 1031 exchange? The answer is, “yes”. So when that property, like I stated earlier, goes full-cycle as it's called, the DST 1031 property is sold, and you as an investor are free to do another 1031 exchange into any type of like kind replacement property. So you can exchange into another DST if you want, or diversify into a portfolio of DSTs, or you could exchange out of your DST into an apartment building that you would manage on your own. You could also exchange into a warehouse or a piece of land, or any other type of like kind real estate held for investment or business purposes. So once you 1031 into a DST, you're not stuck there forever. When that DST goes full cycle and sells, you will be able to 1031 exchange out into any other type of like kind property.
As I said earlier, unlike most other forms of private equity real estate such as LLCs, partnerships, private REITs where investors are typically unable to execute a 1031 exchange upon the sale of that entity's assets or properties (and instead, have to pay capital gains taxes and depreciation, recapture taxes upon that sale). On the other hand, with DSTs you can 1031 exchange into another like-kind property. Or if you make a direct cash investment, which a lot of investors like to do to diversify out of the stock market and get away from volatility in the stock market while also looking for potential tax advantages, potential monthly distributions. So, when that DST property is sold, you're able to do another 1031 exchange in any type of like kind replacement property.
Okay, with Delaware Statutory Trusts, one of the main reasons investors like to consider these is that there's no more day-to-day management headaches. So, no more tenants, toilets and trash and no more dealing with trying to get your tenants to pay rent. I know that with COVID 19 and the pandemic, when the CDC had the eviction moratorium as well as a lot of state and local governments had eviction moratoriums, it was very, very difficult for a lot of clients that own multifamily properties. In many cases, these investors weren't able to collect rent. They still had to pay all their expenses, property taxes, mortgages, et cetera.
With DSTs, investors don’t have to chase down the tenants, that's now done by the sponsors. So no more tenants, toilets and trash. You don't have to do the daily upkeep of the property and things like coordinating with the landscaper or the roofing company or the contractor or whatever you're doing at your properties.
Another advantage DSTs provide investors is the actual bookkeeping, accounting, et cetera. That's all done for you by the asset manager, which is the Delaware statutory Trust sponsor company. So number two, they have professional asset and property management in place, again, by a professional real estate owner and operator that has a staff typically of full-time property managers, asset managers, acquisitions and disposition, accounting team, and in-house legal counsel. You've got a fully integrated real estate team that is dealing with a day-to-day of asset and property management.
Many investors like this because it's allows them to concentrate further on what really matters to them in this time of life. Whether that be your kids, your grandkids, travel or it could be other businesses. Another interesting fact is that we have more and more clients that are younger. They're not at that retirement age or, or might be at the stage of life right before retirement. They're younger. They just don't want to have to deal with owning and operating the real estate anymore. They would much rather focus on other areas of life. So, again, your freedom. DSTs free up your time to enjoy life without the burden of actively managing your apartment and commercial properties.
Another question receive is do I receive a K-1 at the end of the year for tax purposes? A lot of people are thinking of partnerships or real estate funds where they are issued K-1’s, The short answer is no. With a Delaware Statutory Trust, at the end of the year, you're going to receive an operating statement for the DST that will show your portion of rental income and expenses at the property. This is sometimes referred to as a substitute 1099, and essentially shows that property has X amount of gross revenue, X amount of expenses, and then the net operating income is X as well.
So, for example a substitute 1099 will it'll show you owned 2.75% of the property. So it's 2.75% of each one of those items, revenue expenses, net operating income. You will take this to your C P A, and he or she will input it on the schedule e on your tax return, which is the same as all of your other commercial and rental properties. For your CPA and tax preparer, it's going be the exact same way that you're reporting your rental properties and investment properties on your tax return through Schedule E. No K-1 with a Delaware Statutory Trust.
Many times, investors want to know how quickly can I close on one of these things if I'm coming up on my 45 days or wanting to plan ahead and just get ahead of the whole 1031 timeframes and not have the risk of a potential failed exchange.
In many cases, investors want to close on the investment quickly. The typical DST property can be closed on within three to five business days after submitting correctly executed subscription documents. Three to five business days. So it's a very quick process. We've had clients closed in as little as 24 hours. The reason why these properties, these Delaware Statutory Trusts can be closed on this quickly, is that typically all the appraisals, environmental reports, property condition reports, financing already in place for a turnkey 1031 exchange. Many of the properties that we work with at Kay Properties have financing. However, a lot of the properties that we work as well don't have any financing. So there's no debt on the properties, they're debt free. So the SNDA’s, the estoppels from the tenants, all of that has already been completed.
The key takeaway here is that DST investments are pre-packaged for 1031 exchange investors. The real estate sponsor company, or the DST sponsor already went through the entire process on the actual asset. The real estate, whether it's a 300 unit apartment building or a 200,000 square foot industrial distribution warehouse facility, the property's been purchased, all the due diligence has been done by the sponsor getting that appraisal, the property condition report, the environmental report, digging through the lease, all that stuff is already done. This makes it pre-packaged for a DST investor. You get the full private placement memorandum. It goes into the business plan of the asset, it goes into the risk factors that you should be aware of with real estate. Also investors have access to all this due diligence material. Same as if you were to go buy a 300 unit apartment building, you would order an appraisal, you would get a property condition report, you'd want an environmental report, et cetera.
All that information is pre-packaged there for investors to digest, which is why it's able to happen so quickly. So three to five business days to close is not uncommon. On the other hand, if you were to go out and decide to close on your own asset, whether you wanted to buy, you know, another 25 unit apartment building, or, a self-storage facility or whatever it was, from getting your offer accepted to closing on that asset, it's going to be at least 30 days, and more likely, 60 or 90 days before you're able to close on that asset. Where with the DST, as I said, it's a much quicker process.
So here's some of the examples of the types of Delaware Statutory Trust investments that are available through Kay Properties and Investments on www.kpi1031.com platform.
First and foremost, multi-family apartments. We've worked with a lot of sponsors over the years doing multi-family apartment DSTs.
Number two, long-term net lease properties, aka triple net properties whether the tenant might be Walgreens, FedEx, CVS, or Amazon, these are oftentimes large Fortune 500 companies where they've signed 5, 10, 15- or 20-year lease. And instead of you buying that $15 million FedEx distribution facility, with that 10-year lease and having all that exposure to one asset, that FedEx distribution facility is in a DST.
Typically, the minimums are $100,000 investments, so you can allocate a portion of your 1031 exchange to that long-term net lease, FedEx and a portion to a 300-unit apartment building and build a diversified portfolio. A quick note here, diversification does not guarantee that an investor won't sustain losses, and it doesn't guarantee appreciation. But we still believe that diversification is a very prudent thing to do, especially in today's economic environment.
The DST really helps investors - whether they're smaller investors, which we work with a lot of investors that $2 to $5 million net worth range, and their exchanges are anywhere from $300,000 - to $1 million dollars. Or we also often work with larger investors, where we've got clients that are worth $50 million to $100 hundred million plus, and they're doing $50- and $100 million-dollar exchanges. We’re helping every level of investor build a very large diversified portfolio of DST investments. Of course, they know they could go and buy that $15 million or $20 million distribution facility or a partner building on their own, but they're looking for one, a passive investment where they don't have to manage it all. It's being done professionally by the Delaware Statutory Trust sponsor company.
Also, many investors don't want all that exposure to one property with one tenant, or in the case of net leases, one commercial property. Also, they don't want all that exposure to one apartment market or one sell storage market because things can happen. Companies move into towns, they leave towns, maybe there’s lots of development in the town, town and absorption slows down and rental rates soften. So building that diversified portfolio is something that those that are considering Delaware Statutory Trust investments are are keenly aware of and interested in.
The third type of Delaware Statutory Trust property that is common is healthcare and medical related buildings. We've done a lot of work with tenants like DaVita dialysis and Fresenius dialysis and other medical related tenants.
Finally, as I mentioned before, we also have self-storage properties available.
Kay Properties and Investments also has what many say to be the largest amount of debt free DST properties on the market available on our kpi1031.com platform. Our marketplace and debt free is something that we're really keenly focused on because a lot of our clients are looking to mitigate risk. Although leverage can be nice, you can enhance potential returns, have higher potential cash flow, higher potential appreciation when things don't go well. But when the economy does have backfires. when there's job losses, when the economy slows down, leverage can be problematic. You know, there's approximately $1.2 trillion of commercial real estate debt coming due by 2025 in America. So there's going to be a lot of leverage coming due, and people are concerned about that.
Now, when you go into an all-cash debt free DST, you don't have to worry about leverage because the property is owned free and clear, and there's never a risk of lender foreclosure. The tenant could move out or the property value could go down or, cashflow could stop. But you could never be foreclosed on that asset. And that's the main thing, is having staying power and not losing a large portion of your 1031 exchange dollars. Kay Properties has a number of debt free properties. We've got leverage properties for those that want or need debt replacement for their 1031 exchange, typically 50 to 60% loan value. And then we've also got zero coupon properties for those looking for the higher highly leveraged properties.
The kpi1031.com has typically 20 to 40 different offerings, DSTs, Delaware, Statutory Trust properties for our investors to consider. Also these offerings on the Kay Properties marketplace come from around 25 different DST sponsor companies. So Delaware Statutory Trust sponsor companies are the asset managers that go out, they find the properties, they buy them, they package them as a DST, and then make them available for investors. We’ll walk you through those offerings, the 20 to 40 different DST offerings, walk you through the potential pros and the potential cons of each one of them, help you understand why investors would consider one in their situation, why they might not want to consider another one in their situation. We'll walk you through the various ins and outs and intricacies of the Delaware Statutory Trust. Again, we've been doing this for a long time. Our team has, you know, participated in over $30 billion of DSTs from pretty much every major DST sponsor company since this industry started.
Kay Properties has essentially been the top provider of equity for many of these sponsor companies. So we've seen their past and we've seen what they've done well and what they might not have done well, and we will share with you, that knowledge and insight. Personally, I have, I think it's over 75 different Delaware Statutory Trust investments that I've made personally through 1031 exchanges or direct cash investments with many different sponsor companies. Like I said, the one of the DSTs that I was in went for 12 years. So we can walk you through, you what these scenarios look like. That’s something a lot of our clients appreciate because a lot of others that may have access to DSTs or might be a financial planner that maybe is only done only one or two of them over the years.
And so having participated in over $30 billion of DSTs, we can give you insight. We'd love to share that insight with you. And if it makes sense to help you with your exchange, we'd love to help you. But if not, we'll let you know, and we will walk you through the potential pros and cons there.
So if you go to kpi1031.com, you're going to be able to log in, and get free access to these offerings. Also if you'd like a, a free copy of my book on Delaware Statutory Trust Properties, which is said to be by many the first book ever published on Delaware Statutory Trust properties, we'll send you a copy of that as well, as well as a free subscription to the 1031 DST Digest Magazine.
So if you give us a call, or visit our website, we will definitely get you access and, free copies of these materials. Lastly, like I said earlier, our team's here to help. We've done a lot of these DST transactions, we've helped thousands of investors nationwide complete their 1031 exchanges into DSTs. We're here for you. Reach out to us at any time and, we just really appreciate everybody taking the time to join us today. Thanks so much.