In this recording, Kay Properties & Investments Senior Vice Presidents Orrin Barrow and Matt McFarland explore how Delaware Statutory Trusts (DSTs) can assist 1031 exchange investors in meeting the critical debt replacement requirement. When an investor sells a leveraged property, the debt relief they receive must be replaced in the new investment to achieve full tax deferral. Failure to do so results in taxable "boot," which can significantly diminish the financial benefits of the exchange.
Barrow and McFarland explain that DSTs offer an elegant solution to this challenge. Many DSTs are structured with pre-arranged non-recourse financing at the trust level. When an investor acquires a beneficial interest in such a DST, they are allocated a proportionate share of that existing debt. This allocation effectively offsets the debt relief from the sold property, satisfying the IRS requirements without the investor having to personally qualify for or secure a new loan.
The discussion further highlights the advantages of this approach, particularly for investors who may struggle to obtain traditional financing within the strict 180-day exchange window. By utilizing DSTs, investors can preserve their tax-deferred status while gaining access to institutional-quality real estate, all without the burden of personal loan guarantees or the hassle of securing new mortgages.
Eugene Ma (00:01)
<Silence> Hello everyone. Thank you for joining us once again on the DST Essentials with K Properties and Investments and an in-depth look at all things Delaware statutory trust and 10 31 exchanges. For nearly two decades, the K Properties team has had the privilege of helping thousands of 10 31 exchange investors nationwide investing into Delaware statutory trust. What sets K Properties apart is our truly unique platform at ww KPI 10 thirty.com. This website provides investors the access to offerings from over 25 different DST sponsored companies, giving investors the range of options they deserve when evaluating DST and 7 21 upbeat opportunities. In addition, every offering featured on the K Properties platform undergoes a rigorous due diligence process conducted by our in-house team of analysts and real estate professionals. Also, our investors get the benefit of our team members experience in completing over 9,000 10 31 Exchange DST and 7 21 re transactions.
Eugene Ma (01:15)
This material is not tax or legal advice. Please speak with your CPA and attorney for tax and or legal advice. All offerings discussed, if any, are regulation D Rule 5 0 6 C offerings, which are only available to accredited investors, generally described as having a net worth over a million dollars exclusive of your primary residence. This information is educational only and is not an offer to purchase securities or DST properties. Such offers are made only through private placement Memorandum or PPM, which investors are encouraged to read. Past performance does not guarantee future returns. Diversification does not guarantee profits or protection against losses. Returns are never guaranteed and could be lower than anticipated. All real estate and DSC properties may go ban in value. Securities are offered through FIN Member finra, SIPC, finra, and K properties are two separate entities. Today we'll be hearing from Senior Vice Presidents or Barrow and Matt McFarland in discussing how Delaware statutory trust can help 10 31 exchange investors replace debt. Without further delay, let's turn it over to Orrin and Matt.
Eugene Ma (02:46)
Well, hello everyone. Welcome and thank you for joining us on another Friday conference call. For those of you who are joining us for the very first time, this is a call that we host every Friday at 11:00 AM Pacific time, two o'clock Eastern time. And here we shed light on some of the recurring themes and nuances of the 10 31 exchange and more specifically the DST investment landscape. So today we're gonna be focusing on debt replacement and specifically how debt replacement works in the context of a 10 31 exchange, but more specifically applied to the Delaware statutory trust structure. Orin and I, who I'm gonna introduce in just a minute, we've been doing this a long time and for whatever reason, this is a topic that a lot of investors struggle with, right? Just to comprehend. So we're hoping that today all the listeners come away with a little bit better understanding of how this works conceptually and also apply to their own specific 10 31 exchange situation. So without further ado Orin welcome. Thank you for joining us. I look forward to diving in with you.
Orrin Barrow (04:03)
Yeah, thank you very much for having me. My name is Orin Barrow. I'm one of the senior vice presidents along with Matt McFarland here, the host of this particular conference call. And we've both helped numerous amounts of investors. One of the main sticking points, one of the main conversation pieces, especially when we're talking from an introductory standpoint in terms of their 10 31 exchange into Delaware statutory trust, is how am I going to replace my debt? Do I need to replace my debt? Right? A lot of times the conversation will start off, well, I've got net proceeds of say a million dollars, and many investors don't understand they have to buy as much as they sold for. We'll go into that. So investors have a complete understanding of how taking on debt for your 10 31 exchange works. Right. So first and foremost, we're gonna be going into the basic 10 31 requirements for a full tax fraud,
Matt McFarland (04:59)
Correct? Yeah, absolutely. And so maybe, or just to tee you up, can you maybe just quickly run through the basics and so we can level the playing field here and if you can specifically press into the value aspect of the 10 31 exchange and specifically what investors need to be aware of Yeah. As it relates to the debt, that would be extremely helpful to start.
Orrin Barrow (05:21)
Absolutely. So for any new investors who are on the call today under just trying to understand how to go through a and do a successful 10 31 exchange, first and foremost, and you'll be surprised at how many times we get this question, you have to utilize the services of a qualified intermediary, right? We used to call them qi, many times they're known as accommodator. However, they all serve the same purpose. The funds from the sale of your property, meaning once you sell your property and the money hits escrow, it cannot hit your make account. If it does, you'll have a failed 10 31 exchange. So the funds from escrow need to be transferred to a qualified intermediary upon the sale of your down leg property, the property that you're selling. A lot of times people are under the impression that you can get a qualified intermediary after the fact.
Speaker 3 (06:10)
That is not the case. You will have a failed 10 31 exchange. The best rule of thumb is to be in agreement or have a, you know, designation for your qualified intermediary before the closing date of your down leg property, the property that you're selling, right? That is the first step. Without a qualified intermediary, you effectively have nullified your 10 31 exchange. One of the second items here is gonna be reinvesting a hundred percent of the net sales proceeds into replacement properties. Okay? So if you sell for a million dollars, you have to buy a million dollars worth of property, right? And that's where step three comes in. How does the debt factor into step two? How does a debt factor into buying a hundred percent of what you sold for in order to have that full tax deferral? Right? Let's go through an example for a second.
Speaker 3 (07:02)
You sold for a million dollars, you have half a million dollars, $500,000 of debt on the property, which means your equity, your net equity left is gonna be roughly around $500,000. Now, the 10 31 rule state, you have to take $500,000 and buy a million dollars worth of property purchase an equal or greater value and replacement properties as they had of the relinquish property. Step three, there's two ways to go about this. First is the most common way, and that's to buy into a Delaware statutory trust that has the same amount of nominal dollar value for debt so that you can buy $8 million worth of total property. So what do I mean by that? If you have $500,000, you need to take your $500,000 and be investing inside of a Delaware statutory trust that will allow for you to assume $500,000 worth of debt so that you can buy a million dollars worth of total property and that, and if you're able to do that and you have a representative like myself or Matt to walk you through that process, you can buy equal or greater value in the replacement property that you had of the relinquished property.
Orrin Barrow (08:15)
And we'll cover that in a little more detail as we continue out this call. Just to kind of finish the basic steps, you then have to identify the replacement properties within 45 days of closing escrow. So once the money is transferred from escrow to the qualified intermediary, you've got 45 days from that date to identify your replacement property. And then step five, you've got 180 days from the date of sale to purchase your replacement properties. So for anybody that's going through the process of doing a 10 31 exchange for the first time, those five steps that I mentioned are crucial for you to understand so that you can have a successful 10 31 exchange.
Matt McFarland (08:58)
Absolutely. And I appreciate the rundown there. Orrin, one of the things we really want to press on is the value part of the equation. And I think some investors get confused by this, but just to repeat back what Orrin said said a little bit differently, the IRS cares about two different aspects when it comes to an exchange. They want to see an investor spend 100% of the cash value that's generated from the sale. The net equity proceeds, the net cash proceeds, there's many different terms. So that's number one. Number two, they want to see an investor purchase equal or greater value of than what they sold. So we went through orange's example, you sell for a million dollars, $500,000 of cash. The IRS wants to see the investor invest the full 500,000 and purchase a property or properties that are worth a million dollars or more.
Speaker 2 (09:53)
What's interesting, and this is going a little bit outside the lines here, the IRS actually doesn't specifically care that an investor replaces a specific debt amount. So technically speaking, going back to orange's example, an investor can reinvest the full 500,000 of cash from their exchange. They can reach into their back pocket, pull out $500,000 of outside cash and buy something free and clear for a million dollars. The reality with that is one people, a lot of people don't have $500,000 in their back pocket, right? Number one, right? Number two, a lot of people, even if they did, they don't want to do that, right? Right. So the natural kind of process of how investors approach a 10 31 exchange where there is debt involved in the relinquish property is they replace that debt in a traditional sense that's going to a lender that's qualifying for a loan that's getting the bank to lend you that same amount or more of mortgage value to apply to your next purchase.
Orrin Barrow (11:02)
In the case of A DST, it's finding a DST or DSTs that you're effectively assuming the in-place financing that is already set up in those specific investments to an equal or greater value of the total debt that was paid off at closing. So Orin, can you maybe walk our listeners through one, I guess mechanistically maybe how an investor should think about how this works through their 10 31 exchange into A DST and how debt is assigned. And then maybe if you can also touch on some of the advantages that this prearranged financing potentially offers investors in this context, that would be really helpful.
Matt McFarland (11:47)
Yeah, absolutely. So there are really three types of DSTs out there in terms of, of like main categories, main food groups that you can categorize DSTs into. First you have your debt-free DSTs and obviously K properties and investments. We are very conservative as a firm. We are looking to remain conservative here as a firm. We want to protect investors' capital. And so we've been known to have the largest inventory of debt-free assets. But the second group, which is DSTs with debt to investors many times do come to us having not necessarily paid off their entire loan before the sale. They have debt on their property going through the scenario that Matt went through, are not really keen on pulling out additional cash or don't have the additional cash to put inside the transaction. They need to utilize Delaware statutory trust with debt in order to have that full tax deferral.
Matt McFarland (12:39)
And the third category, which we'll probably get to on another conference call, is zero coupon, where your loan to value the amount of loan that you have in accordance with the value of the property that you sold is higher than your traditional DSTs with debt to where you are now having to use what's considered a zero coupon offering where you're not getting any cash flow. But that deal is highly levered and you're getting additional leverage so you can have that full tax deferral. But for the sake of this call, we'll talk about category two and those are the DSTs with debt in the marketplace today. You can see DSTs with a loan to value that ranges anywhere from 30 to 60%. So let's go over that topic. What does loan to value mean? It's how we look at how much debt an investor has to assume when they're buying into the property.
Matt McFarland (13:31)
Let's take something very simple like a 50% loan to value. And when you go on our KPI 10 31 platform, the deals that have debt will have a number assigned to them besides the loan to value moniker. So it's very important that you understand what that means. If a deal has a 50% loan to value, it means that 50% of the offering is debt and they're raising 50% of that equity. So as an investor, if you're putting in a hundred thousand dollars into a 50% loan to value offering, you are actually going to be assigned and you're buying into and assigning yourself a hundred thousand dollars worth of debt, non-recourse debt to buy $200,000 of total property. And that $200,000 of total property is what goes to the value of property that you have to buy in order to have that full tax deferment. And so what investors can do is you can mix and match some of these loan to values where you have some of your equity going into a debt-free property, some equity going into a higher loan to value property so that you are buying the exact dollar amount that you need to in order for you to have that full tax deferral.
Matt McFarland (14:45)
So DSTs have prearranged debt where the debt is already on the DST, you as the investor get to buy into that actual DST and assume the debt that you need in order to have a full tax deferral. Another benefit of having that prearranged debt is that 99.9% of all the deals you're gonna see, especially on our platform, which on our platform is gonna be a hundred percent, is non-recourse financing. Which means that you're not having to sign on any loan covenants or on any loan documents that would ascribe you directly to the loan. So you get the benefits of being able to assume that loan for your 10 31 tax deferral, well, without having to actually be a part of your own balance sheet and you having to be personally responsible for that loan. Many time lenders are not gonna do non-recourse debt for a property that you're gonna buy on your own.
Orrin Barrow (15:40)
But because of the institutional quality and style of these properties, lenders are willing to do non-recourse debt on these assets. And you get the benefit of that a lot. Obviously when you're taking on debt, you have the benefits, the tax benefits, the write-offs, the interest deductions, all of the same benefits that you enjoyed taking on debt on your fee, simple assets or assets that you own and manage. You'll still be able to have those benefits inside of the Delaware statutory trust. And so there are benefits to taking on debt. We always are, again, we're a very conservative firm, so we wanna understand your situation before moving on, on taking debt. But if you need debt in order to have a 10 31 full tax deferral, we have options available to all those investors.
Matt McFarland (16:23)
Yeah, I think that was really helpful. And just to press in a little bit more on a few of the aspects that Orrin, that you talked about, I want to circle back on what you were talking about with respect to this concept of loan to value. Some investors pick up on it, you know, very easily. For others it can be a little bit more confusing. I mean, how loan to value translates specifically to the amount of debt that they would assume Yep. Based on a specific equity investment amount. I want to go back to the example you gave. Yep. But just say it a couple different ways. Yeah. So in case any of the listeners missed it, maybe we could fill in the, the picture a little bit more. Makes sense. So Orin Orin talked about loan to value the loan amount divided by the total value of the offering.
Orrin Barrow (17:13)
So I'm gonna use a very simple example. So say there's a $20 million DST offering, and this DST offering has a 50% loan to value. So 50% of this offering is equity, is investor cash, 50% is prearranged financing. The sponsor's gone to a bank, they've qualified for the loan, they've incorporated that loan into the original purchase of the property, they set up the DST. So you have this $20 million offering. 10 million is equity, 10 million is debt. So as an investor you come in and with a hundred thousand dollars to the same example that you gave, what I like to encourage investors to think about this conceptually is think about your equity as a down payment. So if this DST once again is a 50% loan to value, that means your down payment is 100% minus the loan to value, which in this case is 50%. Your a hundred thousand represents your 50% down payment.
Orrin Barrow (18:22)
I'm doing air quotes right now. You can't see me. Your down payment towards the DST investment and the other 50% is the debt that's pre-structured in the deal that is assigned to you. You're investing a hundred thousand, but you're purchasing $200,000 worth of the DST. I'm gonna say it another way. Yeah. In case that still, in case that doesn't register. So for all the mathematically inclined investors, we're gonna take the same example, $20 million DST, 50% loan to value, 10 million of equity, 10 million of debt. You contribute as an investor, a hundred thousand dollars of equity. This $20 million offering has a $10 million total equity value. So we divide $100,000 divided into $10 million, which represents the total equity. That's 1%. You own 1% of this DST, your 1% ownership does not just include the equity. You also are purchasing 1% of the debt. Here, the debt is also $10 million. So you are purchasing, once again, I'm doing air quotes, you're assuming a hundred thousand dollars of debt and you own 1% of ownership in the trust, which is valued at $20 million, 1% of $20 million, $200,000, 100,000 of equity, $100,000 of debt. So hopefully we're hoping that everyone's tracking with us at this point. If you're not, please reach out to your K Properties representative. This is a really, really important concept to understand specifically as it relates to your 10 31 exchange. Just
Orrin Barrow (20:13)
As an aside, Matt, before you go through, and obviously if you don't work in finance like the both of us, and this is a relatively hard concept to understand even after my explanation and match two examples, please note that each of the representatives here at your firm are very well versed in being able to do what's considered a sample portfolio. And a Seattle portfolio can be done for you, whether you're in your 45 days, meaning you're in the midst of your transaction or you're 60 to 90 days out from closing, or you're just in the research phase and you have aspirations, do a 10 31 exchange five, 10 years down the line, the representative that you're speaking to at our firm can do a sample portfolio where it breaks it down column by column, exactly the equity that you have invested in the deal, the amount of debt that you're taking on your total purchase price or your total amount of property you're buying with each investment, as well as the cash on cash return, the cash flow that you're receiving from each investment into the respective DSTs.
Orrin Barrow (21:15)
So, and you could also get a sense of how we look at the overall market, what offerings we feel like are best for your particular situation. And the most important part from there is you're using that as a canvas. I like to call it a starting point to be able to give us real time feedback as to what you think about the deals, what your viewpoint on the marketplace is. But more importantly, you can see exactly how each of the different investments that you're making with our firm, how you're taking on that debt and what kind of cashflow you're receiving or potential cashflow I should say, from each of the offerings that we're suggesting to you.
Matt McFarland (21:50)
Yeah, absolutely. Really well said. And I want to, I'm gonna circle back on on that in just a minute. A couple other aspects I wanted to press into a little bit more. Orrin, you talked about some of the advantages of deck, the fact that it's non-recourse for pretty much all the offerings, at least the ones that that we offer, which protects the investors' downside. For those of you that don't know what non-recourse means, it means that your exposure is limited to the, the equity amounts, the principle amount you have in that offering. And it stops there. The, the bank cannot collect on any other, on any other assets. You're not making any personal guarantees. And so it really limits a lot of the, the liability from that perspective. I think beyond that, just the ease at which an investor is able to assume debt. I mean, if anyone's been through the process of working with a bank to qualify for a mortgage, it's a very complicated and exhausting process.
Matt McFarland (22:53)
And when you're dealing with that on top of all the other complexities that are involved with buying a piece of real estate within the context of a 10 31 exchange, which the timeframes are very tight, especially the 45 day window, this poses a really attractive option where investors can seamlessly, you know, replace that debt without having to individually qualify for it and do it in a very efficient manner where they can get the money placed and working for them in A DST and as short as three to five business days. Whereas typically going through a loan approval process, we're talking, you know, three weeks, six weeks Yeah. In certain cases, which could put the 10 31 exchange at, at jeopardy in certain cases. And the other thing is from just the caliber of properties and the type of debt that we're talking about here, these, the sponsor companies, the groups that are putting these deals together, these are some of the largest real estate institutions in the country.
Matt McFarland (23:57)
Most of these groups manage a billion dollars or more, you know, worth of property. A lot of 'em are preferred borrowers with the agencies, you know, Fannie Mae, Freddie Mac, so they have access to debt that you and I would never have access to. Right, right. Right. And the, and one of the attractive measures of that is the investor is able to take advantage of that through assuming the debt package that the sponsor was able to access. Right. You know, and structure into the DST. So a lot of investors, you know, really like that as well. And then lastly, just to kind of circle back on your topic about the sample portfolio and allocating equity to specific deals that produce a certain value of debt, I think that to me is one of the more attractive features of A DST in approaching this as a diversification strategy where we could control which investments are actually incorporating debt into the 10 31 exchange equation in which assets aren't.
Matt McFarland (25:06)
Right. And there's, there's certain asset classes, and we won't get into that, you know, in this call, but there's certain types of properties that interact with debt in a much less risky way Yeah. Than others. Yeah. And I think that's, that's one thing that we're really looking out for too on the K property side, is there's certain asset classes, specifically multifamily, that tend to behave better in the context of a leverage DST offering than maybe like a single tenant, you know, leveraged offering. And we can construct a portfolio for each investor's situation that matches exactly the amount of debt that they need to replace. Right. And I think that's, that's really the beauty of the DST. And from our vantage point on the advisory side, we're always gonna advise investors to minimize the amount of debt that they're taking on in the equation. We're our first response is, Hey, you have $500,000 of debt to replace, let's replace the 500, but let's not replace, let's not take on anymore. Of course there's situations where an investor may want to for various reasons, and you know, that's case by case. But the DST is a really attractive structure to control the, you know, the debt from that perspective. Yeah,
Orrin Barrow (26:29)
That makes sense. I mean, yes, this one of the only structures where you can be able to do that and you're not necessarily going over your debt allotment for the sake of buying a property. Right. You can take on just the amount of debt you need, be conservative, and like Matt mentioned, we even take it a step further in terms of how you're taking on that debt. Mm-Hmm <affirmative>. We're not just taking on that debt in any old property in any old DST, we're very mindful of how we're taking on that debt to try and potentially further reduce the overall downside risk that investors are experiencing. But obviously that type of diving into would probably take an entire other conference call. So for now, this is sort of just sticking exactly with the basics, helping investors understand what exactly they need to do in order to have a successful tax deferral.
Orrin Barrow (27:17)
And if you aren't an investor out there that has debt to replace, we're hoping that this particular phone call or conference call gives you what you need. Now, don't take just this phone call and use it. Please give one of the representatives here at the firm a call. We're happy to introductory calls and consultations in regards to your situation because there is even further nuance than this because your situation is different from the next person's situation. So feel free to reach out to our firm, www.kpitenthirtyone.com is the platform. Thank you very much for having me on the call. I appreciate that.
Matt McFarland (27:54)
Absolutely, Orrin. Yeah. Thank you for your time. And yeah, thank you for, to all our listeners, we hope that you found this conversation useful. As Orin mentioned, please visit our website. We have just so much wealth of, of information on the educational side. Utilize your K Properties team members as well. And just a reminder as, as we sign off here, we do host this call every Friday at 11 o'clock Pacific or two o'clock eastern. So please do join us next week on the K Properties Friday conference call. With that, I wish everyone a wonderful rest of your Friday and weekend, and we look forward to speaking with you again soon. Please
Eugene Ma (28:33)
Visit ww dot KPI 10 30 one.com for instant free access to exclusive investor resources. Get your free book on Delaware statutory trust, 10 31 Exchange Properties, plus a subscription to 10 31 DST Digest Pack with case studies, tenant insights and expert articles. The K Properties team has helped thousands of investors nationwide, and we're here to help guide you as well. Thanks for joining today's call. Please reach us anytime at 8 5 5 8 9 9 4 5 9 7 or visit at at online at WW KPI 10 30.