What Are Delaware Statutory Trusts And Why Should Investors Use Them?

What Are Delaware Statutory Trusts?

Rising interest rates, inflation, and worries of a recession have caused a reset in the multifamily market. Sellers are pulling back as buyers are not hitting price expectations, which in turn affects the deal flow and overall activity. In addition, weariness has made the buyer pool more shallow, as rising construction and borrowing costs hinder potential investors. However, the market is still active, with billions in capital needing to be placed — investors are looking to buy, just with a more selective eye. The sector offers solid rent growth and high demand while offering long-term security, outweighing the negative impact of rising costs. While institutional buyers may be taking a step back, private clients, large family offices, and syndicators are stepping up, vying for investments others are missing. In search of new opportunities, sellers are utilizing Delaware Statutory Trusts (DSTs), a unique real estate strategy that allows proportionate ownership in various asset types.

What Is a DST?

A DST is a legal trust formed by qualified sponsors for a business purpose and incorporated in the state of Delaware. DSTs have gained popularity as a notable real estate tactic, as investors look for different ways to diversify portfolios and secure assets. The trust allows individual owners to possess proportional shares of an investment. Using a DST sponsor, a company creates the trust to hold the assets and takes care of the distributions of the shares to investors. The sponsor then pays a percentage return on the equity or capital the investor puts into the deal.

DST sponsors vary considerably in size and sophistication; investors may want to consider the strength and track record of the DST sponsor when choosing the investment avenue. Larger sponsors may have an advantage in gaining economies of scale in operations which can reduce costs for their investors and possibly obtain more favorable pricing on loans.

Lastly, only accredited investors or high-net-worth individuals qualify for Delaware Statutory Trusts. The qualifications include the following:

An individual who has income in excess of $200,000 or joint income with his or her spouse in excess of $300,000, in each of the two most recent years and has a reasonable expectation of reaching the same income level this year.
OR an individual who has a net worth, or joint net worth with his or her spouse, excluding their primary residence, but including home furnishings and personal automobiles of more than $1,000,000.

When to Consider a DST

A DST investment isn’t for everyone but can be a valuable solution for investors looking to make a change to their investment portfolio or financial responsibilities.

If the investor is looking for:

1031 Exchange Tax Deferral – Since a DST qualifies as a 1031 Exchange, an investor can acquire the same tax benefits of a 1031 but with more flexibility and through a much simpler process. This is the single most significant reason to invest in a DST. The taxes due on the sale of highly appreciated real estate can run as high as 40 percent of the sale proceeds depending on the state of residence.

Passive Investment -Owning a property can require an owner to deal with the day-to-day management and bear all the operating costs. But investing in a DST relieves the owner of the regular landlord responsibilities—toilets, termites, tenants, and trash. A DST caters to an individual looking to leave a legacy, without all the work of a typical landlord. This type of investment is institutionally managed and relies on vetted, experienced managers to execute a business plan and operate the institutional quality properties.

Diversification – Using the trust, an investor can buy fractional ownerships in a variety of product types such as multifamily, retail, self-storage, industrial, and office. Having ownership in all types of commercial real estate will help diversify a portfolio and add depth to an investment roster. Plus, a DST sets no limit on the number of DSTs one can invest in, so buyers can easily spread investments amongst different sponsors, asset classes, and geographic locations.

Institutional Grade Assets – Investing in or doing a 1031 Exchange into a DST allows clients to be a beneficiary of institutional-grade real estate that would ordinarily be out of financial reach. DST properties are worth tens to hundreds of millions of dollars. For example, with as little as $25,000-$100,000 a buyer could 1031 Exchange into a professionally managed $100 million property.

Challenges to Consider

Although there are several benefits to exchanging into a DST investment, as with any investment, there are some challenges to consider before making a final decision. Because an investor owns a portion of the asset within a regulated trust, decision-making power is withheld. A DST beneficiary will have no say in property management decisions. Instead, power lies in the hands of the sponsor, as does the financial risk. The sponsor bears 100 percent of the responsibility for paying back all loans or mortgages. Another caveat is that once a DST deal has been completed, it is final; no additional capital can be added to the trust. Finally, there is no liquidity. An individual cannot take money out of a DST until the sponsor sells the asset, which typically takes five to 10 years. This can be difficult for investors that may need access to fast cash. However, investors that have access to liquidity and are willing to let go of the control can gain an institutional real estate partner that will outweigh some of DST’s challenges.

Why DSTs are Great for Multifamily Investments

A DST works for several types of commercial real estate but can be especially helpful for multifamily investments, specifically those in California. As mom-and-pop owners in California face tenant pushback and local government restrictions, it is getting more difficult for small owners to make a profit, simultaneously maintenance and construction costs are rising. Long-term owners are finding creative ways to exit multifamily management and exchange into passive investments that alleviate the day-to-day responsibilities all while increasing cash flow, resetting depreciation, and gaining appreciation.

The Benefits

A Strategic Exit and/or Retirement Strategy – Using a DST, an investor can take advantage of today’s highly appreciated real estate market and avoid capital gains taxes of 35 to 40 percent. Investors can unload the day-to-day management of apartments and move into passively held $50M+ institutional apartment complexes that have experience, scale, and efficiencies to drive annual net operating income. These institutional managers pass along increased net operating income to investors.

Preservation of Wealth – A DST offers all the same advantages of owning 100 percent of a single property, except with fractional ownership in an institutional asset, providing increased income, appreciation, and a tax shelter.

Estate Planning – As an investment vehicle, DSTs can be passed easily to beneficiaries upon death. In some cases, DST sponsors can assist in this transfer.

Diversification (Sponsor, Geography, and Asset Type) –There are 50 DST sponsors to choose from that all focus on different asset types in different parts of the country. DSTs offer a wide range of investment opportunities including industrial, multi-tenant net lease, hospitality, self-storage, single-family rentals, senior housing, student housing, and manufactured housing.

Long-Term Strategic Partnership – Although there is a loss of control for the stakeholder, investors gain strategic partnerships with some of the largest real estate companies nationwide that can provide knowledge, experience, scalability, and strategic execution to maximize returns for investors. For example, Ares, Cantor Fitzgerald, Inland, Passco, Nexpoint, and Exchange Right are a few top DST Sponsors. These sponsors manage well over $1B in assets, giving them a level of access that’s not available to an average retail investor. Institutional access leads to institutional returns.

Closing

A real estate strategy like a DST provides prized opportunities if utilized correctly. The multifamily market is changing but is still full of capital, growth, and potential. By using a DST, mom-and-pop owners can reallocate valuable capital into institutional-grade assets without the immense start-up costs and plan for retirement. Investors still looking to progress their portfolios can add various product types and form beneficial relationships with the industry’s top sponsors. Overall, there are plenty of different reasons DSTs are catching the eyes of today’s sellers and quickly becoming the go-to strategy for multifamily owners.