Many investors are unsure of whether or not they need a Delaware Statutory Trust Sponsor. In this article, you’re going to learn about how a sponsor works, how to identify a good one from a bad one, and why it might be your ideal exit strategy.
How Does a Delaware Statutory Trust Sponsor Work?
The best way to explain this is to provide an example. Let’s say that the Delaware Statutory Trust owns multi-family units with a total of 500 apartments. A master tenant will lease that complex from the DST Sponsor. They’ll manage the property, collect rents, and make those payments to the DST. Everyone investing in the trust gets a cut of the income based on their percentage of ownership. This doesn’t have to only apply to multi-family units and can exist in single-family residential and commercial as well.
How Do You Know If You Need a Delaware Statutory Trust Sponsor
The biggest question is, why would you invest this way and not simply go out and purchase these properties on your own? Why get involved in something that seems and feels more complicated than it has to be? What you’ll discover is that it’s actually much simpler this way and it puts a lot less pressure on you in the long run.
In the case of a DST, you’re simply investing in the trust. Your money is being used to purchase new properties and enhance existing ones. This takes all the liability off of you. You don’t have to manage tenants, chase people for rents, or worry about maintaining buildings and grounds. All you need to do is invest in the trust.
This method does share some things with single-entity or TIC but it offers a lot more simplicity for the investor. Any other form of co-ownership is mandated within JV structures but in the case of a DST, you only need to execute a trust agreement which provides each investor with a Class B beneficial interest in the trust. The sponsor then has the choice to act as a manager, lessee, or trustee.
Here are some of the scenarios in which a DST makes the most sense.
This is similar to a JV relationship where the raise in equity is done with the acquisition. The sponsor is responsible for funding the acquisition through an outside investment. Transfer of title occurs only once all equity requirements are met.
Time is the main difference between these two. In a back-end raise, the investment entity already has funding and is closed prior to the offer. The asset gets packaged with the new debt in-place along with the property management company and operator. Since the sponsor is taking most of the risk here, there is generally a higher acquisition fee. It helps sponsors stay in the deal while being able to bring in third-party operators and expand the ownership profile.
Why Hire a Delaware Statutory Trust Sponsor Company?
The main reason investors turn to DSTs is for the tax benefits. They’re recognized as direct ownership of real estate by the IRS which makes them 1031 exchange eligible. This is in accordance with the U.S. Internal Revenue Code that allows you to avoid paying capital gains taxes when selling an investment property if you reinvest the sale money within a certain time into another property of equal value.
A likely scenario where this works well for investors is upon the sale of an investment property, you take that money and instead of having to go through the process of reinvesting it into the market, seeing properties, undergoing inspections, you simply invest in the DST and allow them to do the rest of the work for you. The process is much faster, easier, and yields much of the same results if you do your homework.
Another reason why investors choose a DST is because they don’t have to own the whole asset. Since you’re only owning a small percentage of a property it allows you to invest in more assets than you would be able to obtain on your own. It also doesn’t require as much knowledge on your end because the sponsor is in charge of performing their due diligence in checking the properties and determining the profitability of an investment. This makes it much easier for you to get some skin in the game.
Risks of Participating in DSTs
Even with something as sound as a Delaware Statutory Trust, there are risks. These investments rely entirely on the performance and execution of the master tenant and sponsor. You need someone you can trust because if these individuals are unsure of what they’re doing, it can dramatically affect your ability to profit from the deal.
Changes in tax law can also impact the performance of an investment portfolio. These are unpredictable and many of the investment benefits may change over time without you having any control over it.
It’s important to keep in mind that a DST is illiquid because of the holding period and the fact that it cannot add more capital once the deal is closed. High rates of vacancy and large property expenses can hurt the cash flow of the property ultimately impacting how much you make. This is again why it’s so important to choose the right DST broker.
Does the Sponsor You Hire Matter?
As mentioned, yes DST sponsors are incredibly important. They vary dramatically so you’ll want to take a look at their track record before settling on an investment. Large-scale sponsors will have the advantage of understanding the local market which can reduce costs and help investors get better loan prices but bigger doesn’t always mean better.
Most importantly, you want to evaluate and communicate with the sponsor and other investors about the conditions of the deal. Make sure all materials are available in a timely manner so you can fully understand the terms of the deal as well as critical information about the investment properties.
If you are interested in learning more about Delaware Statutory Trust sponsors, you can register today for free listings or give us a call at 1(855) 466-5927.