The Delaware Statutory Trust (DST) is an increasingly popular investment option among property owners using a 1031 exchange for an investment property sale. Not only does the DST satisfy ‘like-kind property” requirements of a 1031 exchange and provide the tax deferral benefits identified in Internal Revenue Code Section 1031, but it also offers several additional unique benefits.
One DST benefit that is often overlooked, but quite powerful, is the ability to achieve greater diversity in your investment portfolio. Diversification is an investment strategy that stipulates a portfolio comprised of different asset classes like stocks, bonds, and cash has the potential to reduce risk, improve returns and provide lower volatility than a portfolio that holds a single asset class.
Adding real estate to your investment portfolio is one way for you to be more diversified, and many investors do this by investing in public REITs, real estate mutual funds, or DSTs. Since investment properties structured as DSTs can have up to 2,000 investors, minimum investments are relatively low e.g., $25K to $100K, thereby providing investors who sell more valuable properties with an opportunity to diversify their proceeds into multiple properties.
A DST provides several additional ways for you to diversify your real estate portfolio, including:
A DST can hold real estate assets in any state in the U.S., enabling investors to own properties in markets they believe will deliver a desirable combination of ongoing income and gains from appreciation upon liquidation. Many of our clients favor investing in tax-friendly, high-growth states like Texas and Florida, among others.
If you would like to diversify your portfolio by property type, you can readily do that with a DST. DSTs are offered across a wide range of asset types including apartments, office buildings, senior housing, storage facilities, warehouses and distribution centers, medical offices, etc. Essentially any asset that can qualify as a “like kind” 1031 exchange property can potentially be structured as a DST.
Most DSTs consist of a single property. DSTs may own a single property.
Some DSTs however consist of a portfolio of similar assets e.g., multiple apartment complexes, self-storage facilities, office buildings, or retail properties.
You can achieve portfolio diversification by investing in single-asset DSTs that own different property types; however, DSTs that consist of a portfolio of assets have a “built-in” diversification component that many investors find attractive.
Like most real estate investments, DSTs are illiquid investments and investors should be prepared to hold properties for 5-7 years on average before a liquidation event. The projected holding period of some DSTs, however, may be ten years or longer, so laddering your portfolio with DSTs of differing projected liquidation dates may provide a measure of liquidity over an extended period that may appeal to some investors.
A DST can own property with no debt, some debt (e.g., 50% of the property value), or a lot of debt (such as a zero-coupon DST). Combinations of DSTs can be assembled to meet a wide range of leverage options to accommodate investors who do not want any debt, to investors that may need to replace a large amount of debt or are desirous of adding debt to take advantage of today’s historically low interest rates in order to potentially increase cash flow.
Diversification across multiple DST sponsors is another popular risk mitigation tool used by our clients. Since the IRS issued a Revenue Ruling in 2004 allowing DSTs to be treated as “like kind” 1031 replacement properties, many DST sponsors have established notable track records of developing, managing, and selling DST properties. In addition to well established DST sponsors, there are a growing number of new firms that are entering the DST industry who have DST offerings that may be appealing as part of an overall asset allocation strategy.
Diversifying your investment portfolio by including DSTs can be a practical approach to potentially improving your returns, reducing risk, and minimizing volatility. And while diversification is not a guaranteed strategy to deliver on these benefits, a properly designed diversified portfolio can help reduce concentration risk and provide investors with greater confidence that their investments will perform over various market cycles and economic conditions.
Please contact us if you would like to discuss diversifying your portfolio using the DST structure.