What To Consider Before Investing in a DST

A Delaware statutory trust (DST) allows investors to earn passive monthly income without the headache of managing properties. It is also an excellent vehicle for deferring taxes on the sale of real estate. However, returns are not guaranteed. This is why they should get a second opinion before selecting a DST investment.

For those who are preparing for or nearing retirement, mitigating risk goes beyond maximizing potential returns. They must protect the wealth they have built. To achieve their desired lifestyle, cover health care expenses and preserve their estate, they need to know how a DST works, what factors to consider and when to seek professional help.

How a Delaware Statutory Trust Works

A DST is a distinct legal entity that enables fractional ownership of real estate. Each investor holds an undivided fractional interest in the property. It is an excellent investment vehicle for those who want to earn passive income without managing a real estate portfolio.

Investors often purchase a DST through a 1031 exchange for tax benefits. They must work with a specialized broker, select properties and transfer funds through a qualified intermediary within a short amount of time.

This Internal Revenue Service (IRS)-recognized tax-deferral strategy allows beneficial owners to reinvest proceeds from sold property into a DST. By acting as a like-kind replacement property under IRS Revenue Ruling 2004-86, the trust allows them to defer capital gains taxes.

Certified public accounting firm SDO CPA highlights its integration with Section 1031 of the Internal Revenue Code as one of its biggest advantages. It describes the 1031 timeline as notoriously tight, stating, “An investor has only 45 days from the sale of their relinquished property to formally identify potential replacement properties and 180 days from the sale to close on purchasing the new property.”

Sponsors vet properties in advance so they can showcase acquisition-ready portfolios. Prospective investors can select them quickly, meeting their exchange requirements and fully deploy their exchange proceeds more easily.

Reasons to Consider Investing in a DST

A DST enables diversification in high-yield, private markets. Investing in one is exclusive to high-net-worth individuals who meet certain wealth criteria. According to the U.S. Securities and Exchange Commission (SEC), “The individual must have a net worth greater than $1 million, either individually or jointly with the individual’s spouse.” Those with an income of at least $200,000 for the past two years also qualify.

By pooling equity from multiple SEC-accredited investors, individuals can invest in high-value properties that would otherwise be unaffordable. This maximizes their investment capacity, increasing potential returns.

A property’s type, size and location determine the return on investment beneficial owners can receive. Realized, a 1031 exchange marketplace, states, “A DST’s annual projected RoR can span 4-9%, while its total rate of return can far exceed this figure depending on the property’s ability to appreciate.” The actual expected returns are higher for high-risk properties.

While these returns are modest compared to those of other investment vehicles, DSTs are relatively low-risk. Also, while a 4% return seems low, prospective investors shouldn’t forget that only high-net-worth individuals can participate, allowing them to invest in multi-million dollar assets.

If a person invested in a $1 million property yielding 4.5% over a five-year holding period, they would receive $225,000 in cash flow. If their investment grew to $1.5 million, they would gross an additional $500,000 before accounting for fees.

Key Factors to Consider Before Investing

Like many passive real estate investment vehicles, a DST is imperfect. For some, the hands-off approach is ideal. For others, the lack of control is frustrating. Sponsors make all decisions regarding maintenance, leasing and potential sales.

This lack of control stems from illiquidity. Someone who owns real estate can sell when market conditions are favorable, maximizing their return. In contrast, DSTs have fixed holding periods.

Property can’t sell until the predetermined holding period is up, regardless of market conditions. During this time, investors can earn cash flow distributions each month. According to Forbes, “The typical DST hold period ranges from five to seven years.” Once someone invests, their capital is tied up until the property is sold. The only way to exit early is to find someone willing to buy the DST interest on the secondary market, which is not guaranteed.

Fees are another common concern, as people must pay multiple fees and brokerage sales commissions. According to Origin Investments, a private real estate investment firm, “Syndicated DSTs through brokers can have upfront fee structures as high as 14%.” High fees eat into returns.

To avoid falling into a high-yield trap, individuals should invest based on front-end loads rather than on the advertised yield alone. They should also consider the property details and market projections to ensure their investment is strategically sound. For added protection, they should evaluate the sponsor’s history and potential exit strategies.

Frequently Asked Questions About DSTs

Like many real estate investment vehicles, DSTs are easy to learn and challenging to master. Here are the answers to some frequently asked questions for those who need additional insight.

Should I get a second opinion before selecting a DST investment?

SEC-accredited investors didn’t build their wealth by accident. They have seen success because they understand the value of due diligence. Anyone considering investing in a DST should speak with a finance or tax professional specializing in highly appreciated real estate and tax-efficient exit strategies.

While wealth management consulting firm Sera Capital points out data indicates DST investments are growing, it acknowledges these investments “Are by no means guaranteed, there is always a risk of loss with any investment, and past performance is not indicative of how it will perform in the future.” Moreover, although a secondary market exists, it states. “We only see availability sporadically.” Getting a second opinion from professionals can help investors navigate these potential challenges.

How do I know if I am eligible to purchase a DST?

DSTs are generally structured exclusively for SEC-accredited investors. Non-accredited investors rarely have access to direct DST syndications. There is no formal certification process. Rather, investment firms verify eligibility.

How will a DST qualify for a 1031 exchange?

As EisnerAmper points out, a DST must adhere to Revenue Ruling 2004-86 to qualify as a like-kind replacement property for a 1031 exchange. It states, “These rules (the 'Seven Deadly Sins') prevent the DST from being classified as a 'business trust,' which would make it ineligible for a 1031 exchange.” If parties don’t comply, they risk making it ineligible for a 1031 exchange.

Integrating DSTs into a Wealth Strategy

A DST is a tool, not a complete strategy. Investors can only unlock its value through meticulous due diligence. They should get a second opinion before selecting a DST investment. Consulting tax experts and wealth consultants will ensure they make the right decision.