Join Kay Properties along with Matthew McFarland, Senior Vice President and Tommy Olsen, Vice President for a podcast on Delaware Statutory Trust liquidity and Exit Strategies.
What We Will Be Covering:
- Various DST Exit Strategies
- DST Hold Period Expectations
- DST Secondary Market Transactions
- Estate Planning
Hi everyone, my name is Tom Wall, senior associate here at Kay Properties, and thank you so much for joining us this Friday for our investor conference call. It's titled DST Essentials with Kay Properties where we take an in-depth look at different aspects of the DST 1031 exchange investment process. To begin the call, we'll start with a few risks and disclosures. DST 1031 properties are only available to accredited investors, which are generally described as having a net worth of greater than $1 million, not including primary residence. And accredited entities, which are generally described as either an entity which is owned entirely by accredited individuals or an entity with gross assets of greater than $5 million. If you're unsure whether you are an accredited investor or if you have an accredited entity, please verify with your CPA or attorney. The information herein has been prepared for educational purposes only and does not constitute an offer to purchase securities, DST properties or real estate. Such offers are only made through a private placement memorandum or PPM, which are solely available to accredited investors and those with accredited entities.
Securities are offered through FNEX, Member FINRA and SPIC. FNEX and Kay Properties are separate entities. This material is not to be interpreted as tax or legal advice, so please speak with your own tax and legal advisors for guidance regarding your particular situation. There are risks associated with investing in real estate and Delaware Statutory Trust or DST properties, which include but are not limited to the loss of entire investment principle, declining market values, and in vacancies and illiquidity. Investors should read each 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, so please speak with your CPA and attorney to determine whether an investment in real estate or DST properties is suitable for your particular situation.
Past performance is not indicative of future returns, so potential cash flows, returns and appreciation are not guaranteed and could be lower than anticipated. Thank you everyone for listening in. Now I'd like to turn the call over to Tommy Olsen, Vice President with Kay Properties and Investments.
Thank you, Tom. And hi everyone. Thank you so much for joining us today on the DST Essentials conference call with Kay Properties. We're going to have a great time as always here on our Friday calls where we take an in-depth look at the many recurring themes and nuances to the DST investment process. In the series we will be and we have been interviewing many members of the Kay Properties team who each bring their own unique and valuable perspectives that they've formed over their 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, DST, investment firm. The www.kpi1031.com platform provides access to the marketplace of DSTs from over 25 DST sponsored companies. This includes custom DSTs only available to Kay clients and an active DST secondary market listing.
Kay Properties and its team members collectively have over 130 years of real estate experience, are licensed in all 50 states, and have participated in over 30 billion dollars worth of DST 1031 investments. I am excited to have our very own Matt McFarland on the call today. Matt is a senior vice president who works out of our Kay Properties headquarters office in Los Angeles, helping clients with their 1031 exchanges and direct investments. Since joining Kay Properties, Matt has participated in over 1300 transactions and over $15 billion worth of real estate. Matt works hand in hand with all Kay Properties executive vice presidents, educating clients on what particular investments make sense for their situation. And today with Matt, we're going to be digging into liquidity and exit strategies as it relates to Delaware Statutory Trust properties. So Matt, welcome to the call and thank you for being with us.
Thank you very much, Tommy. I'm looking forward to getting into this.
That's great. Yeah, there's a lot to unpack. This is a common question, liquidity, as well as the exit strategies for DST. So we start out by quickly outlining the various exit strategies that DST properties or these offerings may employ. Just give us a brief overview.
Absolutely, and before I even jump into that, I think I'm going to take just one step back to just orient our listeners to how the DSTs are set up and what they are set up to accomplish. So the DST is short for Delaware Statutory Trust, it's an entity that holds title to investment real estate. This is a very passive structure specifically geared for passive accredited investors to achieve a certain degree of diversification .
And really the priority of DSTs is to, one, protect investor principle, two, create a hopefully consistent durable income stream over the holding period, and three, creates some potential appreciation that investors will benefit for. So these investments tend to be more stabilized what we would consider A class or newer properties that are set up to accomplish really those first two goals and then also the third, which is appreciation over the holding period.
So this is really kind of a buy and hold cash flow sell strategy. So investors are stepping into immediate income in a majority of these, the properties are already leased up, they're already producing revenue. And the typical strategy is for these sponsor companies to hold the properties for between five to 10 years, realize their business plan, the business plan is going to be mapped out in advance, and eventually position the asset sometime in the five to 10 year future to be worth more than it is today, sell and create a liquidity event through the sale.
So what that looks like typically is the property being marketed and sold to an unrelated third party. The property would go through the normal kind of escrow period. Investors would be made aware of the timing of the sale and they would be able to make the election for themselves if they want to either cash out, have the money sent to a bank account, which would trigger a taxable event, or complete another 1031 exchange. And the process would effectively repeat itself at that point.
There is another potential exchange called the 721 exchange , that is a part of some of the DSTs, and the 721 exchange is essentially when a REIT or a fund, usually controlled by the same sponsor company that's managing the DST, will acquire the asset that DST owns and allow investors the ability to trade ownership interest in the DST for operating partnership units of the REIT or fund. So the 721 exchange is another potential exit option, if you will. A lot of the times the DST company that is purchasing the DST with another entity that they control, a lot of times they will offer investors the ability to take cash value for their interest and either cash out or do another 1031 exchange. So I know that's a lot, but just a quick overview of some of the different exit strategies .
That's helpful, thank you. I think with this, it sounds like most people should expect that five to 10 year hold that you mentioned, but what if that's not really what someone has in mind for themselves? What if they're looking for a shorter term investment opportunity, or maybe they're in it already and they just want to get out, what options may be available to an investor thinking this way?
4:54 – Various DST Exit Strategies
Yeah, really good question. And before I address that, I also think it's important to address the question that would come up, why five to 10 years? Why are these DSTs positioned to be held for that period of time? And there's a lot of different reasons, but just quickly to go through a couple, it usually takes at least five years in a normal real estate cycle to create enough value to justify a sale in the first place. As we all know, real estate is inherently a longer term investment strategy relative to other investment strategies that are out there. So five years in most cycles, like I said, is needed to create the value.
10 years is usually more or less the backstop for a couple different reasons. One, a lot of the leverage DSTs do carry 10 year loans, and those loans mature at the end of 10 years, so there is some pressure, if you will, for those DST companies to sell before that maturity event. Number two, when you're dealing with a DST, you are dealing with a group of 30, 40, 50 plus unrelated high net worth accredited investors who all have slightly different goals and objectives, and many of them want to have some level of certainty that there will be a liquidity event for them within a decade to reevaluate things from their financial position. So it could be an estate level, estate planning kind of plan there. It could be reevaluating the 1031 exchange as part of long-term strategy. Maybe people want to take some cash out and do a partial exchange or just tax out completely.
So it kind of appeals to the masses, if you will, in knowing that this isn't a forever investment. So I think that's really important to understand the why question behind some of these different aspects. I find that really helpful in unpacking that with potential investors.
Yeah. Matt, may I interrupt you for just a moment?
Because you mentioned two really important things that I think some of our investors who are just checking this out in the early stages, and maybe they haven't dug into the whole revenue ruling, IRS revenue ruling of 2004-86 and read about the seven deadly sins as we in a tongue in cheek way call them, but you mentioned the 10 year loan and said, "Why don't you just refinance the loan and then keep holding longer at the end of that year?" But as we know, DSTs in a traditional sense cannot be refinanced. The loans cannot be. And then you also mentioned something that it's not going to be a forever hold, and I've heard of people getting into something 50 years ago and they're still in it somehow today, and they'll get a capital call every so often just to keep that thing going because eventually the roof's going to need some attention or whatever it is that's going to come up, and that's also not allowed. So there's a couple different limitations that also keep that within that time horizon wouldn't you say?
9:53 – DST Hold Period Expectations
Absolutely. Yeah, and those are really important to understand, which kind of gets at that why question. But yeah, I think it's important to understand that DST is restrictive as it relates to a refinancing event, and also a capital call, like you mentioned Tommy. So you can't refinance the loan, and you have a maturing loan 10 years from when that loan was initially acquired for this specific investment. There is more or less a backstop that these DST companies have to operate within.
If you look back over the history of the DST space from when it originated in the early 2000s, I would say a very large majority of the DST investments have been leveraged DST investments. It's only really until the last I would say five to 10 years, but really the last five years that we've seen an emergence of the all cash or debt free approach , specifically for investors that do not need to replace debt. But if you consider that, that a majority has been leveraged, it makes sense why the average hold period has landed somewhere around six years.
I think if we did a more recent average with just the craziness of the last few years and a lot of these properties being in a position to sell much earlier due to extreme levels of appreciation that wasn't expected, maybe that average hold period is down closer to five years now. But I think it's important to know that before investing in a DST, the business plan will be very clearly mapped out. And typically what the DST sponsors will do is they'll identify a specific range where they say, "Okay, we're going to do X, Y, and Z, and hopefully this will position us to sell within this window," whether it's five to seven years, seven to 10 years, whatever it is. But on top of that, it's really, really important to know that there is the utmost flexibility, where these properties are under no obligation to sell on a specific date or before a specific date.
If you think about it, that's really what you want. You wouldn't want an investment, a fixed real estate investment that is required to sell at a specific point, because we don't know what the future's going to bring. We don't know where the real estate cycle is going to be in seven years from today. So I think it's really important to think about the flexibility of different approaches. We've seen DSTs sell in two years. We've seen DSTs hold for more than 10 years. So it is possible to exit before or after that five to 10 year window. Usually those have to do with some larger events that's taking place. So anyways, I'll push it back to you, Tommy, if there's anything else. If not, I can talk about the secondary market and what that looks like.
Yeah, I think that's where we're trying to get to. But I think what you said about these debt free properties is really important. Because when we're thinking about a profitable exit, being able to control that in your favor, whether it's early and being able to avoid prepayment penalties that could come with a loan, we talked about this in other calls as well, or if it's later than that 10 year mark and not having to worry about being forced into a sale by a lender in a down market. So I think that's really helpful. And if there's a 10 year loan, some of these we've seen recently with shorter term loans, and that's a real tight time horizon potentially to find that good exit, whatever that exit plan happens to be, whether it's the open market or the 721 exchange. But during the hold period, what if someone does want to get out early? Tell us more about the secondary market type of transaction and what investors should be aware of.
18:42 – Secondary Market Transactions
Absolutely. Yeah, so the DSTs are technically considered sellable securities. So interest can be bought and sold at any time without restriction, beyond that they must be bought and sold with accredited investors. This is only for accredited investors. So secondary market, what we refer to that is when a DST investor for whatever reason wants to exit their interest early, or earlier than the business plan. So the best way to succinctly describe this, it is possible to sell early, but it's usually not advisable. So the mechanism of how this works is typically when an investor wants out, they will come to us and we'll approach the sponsor company kind of collectively, and we'll notify them that this investor is looking to get out of their interests. Typically the sponsor company will start by offering it to the group of investors that are a part of that DST, and it makes sense as to why. These investors, they've been in the investment, they know how it's been performing, they're the obvious starting point.
Some sponsors will give a certain period of time, whether it's two weeks or 30 days, where more or less those investors in that DST have a right of first refusal, if you will. So they'll get to make offers first within a certain window, offers are made, and it's ultimately a negotiation between buyer and seller. And if there's a price that the seller, the person looking to exit early is comfortable with accepting, then that transaction would take place and the new investor would take over the ownership interest in that DST.
I think in my experience, this is a very, very thinly traded market. We do a couple thousand transactions a year, like primary transactions. We probably handle three to five secondary market transactions if that a year. So the best advice that I give to investors is do not ever enter a DST expecting to sell out earlier than the business plan. However, if life happens and an investor needs to get out, that path to liquidity is there. It might cost the investor something, they may need to agree to sell their interest at a discount, but ultimately it is possible to exit early.
I think we may have lost Tommy, so I'm going to just keep going here. Another topic that we wanted to touch on was related to estate planning. This is a common question. What if an investor passes away during the holding period of a DST? What happens next from that point on?
22:48 – Estate Planning
So what happens is that the DST interest would be treated the same way as any other real estate investment property. So the estate would be entitled to a stepped up basis. Usually the estate or whoever's in charge would reach out to us, we would put them in touch with the different DST sponsor companies, the estate would figure out a way to determine what the value is at that point, and then they would have a couple different options. The first option would be to stay in the DST until it's finalized, which is typically the approach. The other option is, like I said, they could sell early if they really wanted to, and that's where the estate has to figure out exactly what the best path forward is.
So in my experience, a lot of investors, they like the fact that if they diversify across several different DSTs, that each of these DSTs is going to operate independently from one another, and that's going to also relate to the eventual liquidation strategy. So if an investor let's just say is in four different DSTs, not all those DSTs are likely going to sell on the same calendar year. So from an estate planning perspective, they're almost able to create a staircase of liquidity for themselves or their estate depending on what situation they're in at that point. Happy to dig into more of this with you. Obviously there's a lot more that we could talk about there.
But the last thing that I wanted to mention as we close out the call is kind of asking the question, what should we be thinking about right now as it relates to holding periods, as it relates to liquidity? There's a lot going on in our world. There's a lot going on in the economy. And I think for us, and this is kind of the same messaging you hear day in day out from our team, is now is the time to really be defensive. And we can be defensive through diversification. We can be defensive through limiting the amount of debt that we take on. We can be defensive by being really selective with which types of properties we're targeting for different reasons. But also I think there's another part of all this where we also need to be realistic, in the sense that we have been through one of the most expansive real estate markets in the history of our country in the last call it 13 years. I don't think anyone really expects that to continue. Obviously it would be great if it did. But realistically, most investors don't believe that that's sustainable.
So with that assumption in mind, and I'll call it a realistic understanding, I think it's really important to be comfortable with maybe a few of these properties being held a little bit longer than they maybe would've been held in a previous context, say five years ago. Especially if the economy continues to turn and we have a period of recovery and reemergence. Going back to what we were talking about earlier, real estate is a long term buy and hold strategy. If the value's there and the opportunity's there, it's great that the DST has the flexibility to take advantage of that, obviously some more than others. But if it's not there, there is the option, and likely what would take place is these investments to be held a little bit longer, which ultimately is what you would want. I mean, the primary objective in all of this is preservation of principle, right? So these companies are going to prioritize that over anything else.
So what I'm encouraging or what I'm telling my investors is be prepared for some of these DSTs maybe to be held a little bit longer than they have been in the previous few years. So with that, I want to thank everyone for your time today. Hopefully you found this informative. I would encourage if there's any additional questions, please contact your Kay Properties registered representative. We're happy to dig into this in more detail. And as always, we do host this call live every Friday at 11 o'clock Pacific. So please do join us next week on DST Essentials with Kay Properties. With that, I wish everyone a wonderful rest of your Friday and a fantastic weekend ahead. We look forward to speaking with each and every one of you very soon. Thank you everyone, and take care.