Opportunities and Risks: The Dual Nature of DST Investing
As you consider DST (Delaware Statutory Trust) for your next 1031 Exchange, it is important to have the right perspective on both the pros and cons. What one investor deems as a drawback, another might consider as an advantage. Some risks involved with DST investing might be seen as opportunities by others. This principle is a helpful guide as you consider if DST Properties are the right replacement property for you.
These pros and cons are two sides of the same coin and are essential for making an informed decision. Below, we take a closer look at the key advantages and disadvantages of DST investing.
The Opportunities:
1. Passive Income
DSTs are considered true passive investments as they are structured to relieve real estate investors from the burden of day-to-day property management. If you are looking to offload management responsibilities and free up time, a DST will allow you to earn monthly income without dealing with tenants, toilets, or trash.
2. Diversification
One of the strongest advantages of DST investing is the ability to diversify both by asset class and geographical location. For example, a real estate investor who sold a single-family rental and exchanged into a DST will have new exposure to institutional-grade assets across different geographical locations. In some cases, a DST can have multiple properties in different states and regions, thus reducing portfolio risk.
3. Institutional-Grade Real Estate
DSTs allow real estate investors to own fractional interest in institutional-grade commercial assets such as multifamily, industrial, self-storage, etc., which otherwise might be financially out of reach in some cases.
4. Estate Planning Efficiency
Another unique advantage that DSTs offer is the efficiency of estate planning. Unlike sole ownership of a property, DSTs are considered as securities which can be easily divided among heirs. At the time of death, DST interests receive a full step-up in cost basis, eliminating the deferred capital gains tax. Heirs inherit the DST interest at fair market value.
The Risks:
1. Lack of Control
Because the sponsor manages the asset, investors cannot make property decisions, renegotiate leases, or refinance debt. For investors that want a hands-on approach, this may seem restricting. But for others, especially busy professionals, this is a key benefit that takes away stresses of operational management in place of peace of mind and freedom.
2. Illiquidity
Much like your typical real estate asset, DSTs are long-term investments with a hold period of 2-7 years. This structure keeps your money working for you, earning passive income and a potential appreciation at exit.
3. Interest Rate Risk
Like all real estate, DSTs are susceptible to changes in market demand, economic conditions, and interest rates. A rising interest rate market may impact property values and the offering cash flow, especially if debt is involved.
4. Sponsor Risk
The success of the portfolio depends on the experience and integrity of the sponsor. Asset selection and management decisions directly impact the performance of the underlying real estate properties. But before a DST is considered, there are multiple layers of due diligence on the quality of the sponsor and the offering. On the sponsor level, legal counsel and the lenders perform a due diligence review. Additionally, the Broker-Dealer will also perform its own rigorous due diligence before approving a DST for distribution.
Perspective is Key
Investing in a Delaware Statutory Trust is about understanding your own financial needs and objectives. For some, the lack of control is a disadvantage, for others, it’s freedom. Illiquidity may be an issue for some, another investor sees the opportunity for long-term, tax-efficient wealth planning.
If you are a real estate investor considering a DST as your replacement property for your 1031 exchange, considering the advantages and risks is highly important. A DST can be a powerful tool when rightly considered based on one’s financial goal and risk tolerance.
A 1031 exchange isn’t just replacing your relinquished property; it’s about finding the right product that fits your goals and objectives.