A common question that we receive is to explain the difference between a Delaware Statutory Trust (DST) and Real Estate Investment Trust (REIT). While both are forms of real estate investment that utilize a trust structure, there are several important differences that investors must know to evaluate whether one form should be preferred over the other to achieve desired investment objectives. First, let’s understand what they are and what both forms of investment have in common.
What are they?
Investors who invest in DSTs own a pro rata portion of the trust based on amount of their investment as compared to the total equity being raised. As an example, an investor who invests $100,000 in a DST with a total equity of $10,000,000 would own 1% of the DST. While the title of the property is technically owned by the trust, the IRS issued Revenue Ruling 2004-86 in 2004 which allowed DST interests held by investors to be treated as being equivalent to owning title in the underlying properties. As a result, DST investments were deemed to be “like-kind” investments that should meet 1031 replacement property exchange requirements.
REITs are companies that own or finance portfolios of income-producing real estate properties typically in specific asset classes. REIT investors acquire shares in the company and do not have actual ownership of the underlying properties. REIT companies may be privately owned with limited liquidity options or they may be publicly traded where shares can be bought and sold like other public shares.
Similarities between DSTs and REITs
Both DSTs and REITs allow investors to purchase fractional interests in larger properties or portfolios of properties that are fully managed by a third party. The investor does not have an active role in the management of the property and relies on the management team to deliver results.
DSTs and REITs can provide investors with the potential of both income and appreciation. However, like most other real estate investments, the performance for both DSTs and REITs is not guaranteed and subject to real estate risks that could result in loss of income or equity or both.
Investments in DSTs and private REITs are illiquid, and investors should anticipate that committed funds will be tied up for several years before they are liquidated. Some private REITs offer periodic redemption periods and, of course, shares in public REITs can be freely traded.
How they differ
- Minimum investment. Minimum investments in a private REIT are typically in the range of $1,000 to $5,000. For public REITs, investors may be able to purchase a single share at the prevailing market price. DST interests can be acquired for as little as $25,000 for cash investors and $50,000 to $100,000 for 1031 exchange investors.
- Tax deferral options. Investors who are selling rental properties can defer capital gains taxes through reinvesting in DSTs via a 1031 exchange. When those DST properties are sold, investors may do another 1031 exchange and continue to defer capital gains taxes. While some REITs will permit sellers of rental properties to reinvest proceeds in their REIT in a tax deferred transaction (called an UPREIT), the investor will not be able to complete a subsequent 1031 exchange when the REIT shares are sold, and tax consequences may arise.
- Tax shelter of income. Since DSTs are considered to a be a direct investment in real estate, investors can take advantage of numerous income deductions e.g., depreciation, interest expense, miscellaneous business expenses, to significantly reduce their taxable income. Dividends from REITs are generally taxed as ordinary income like dividends from stocks.
- Investments from retirement accounts. While direct cash investments can be made in both REITs and DSTs, DST sponsors will generally not accept funds from retirement accounts. Many of our clients include REIT investments in their retirement account portfolios.
- Accredited investors. DSTs and private REITs are only available to accredited investors i.e., individuals who have a net worth greater than $1 million excluding equity in their personal residence or// minimum annual income of $200,000 if single or $300,000 if married. Non-accredited investors can invest in public REITs.
- Fees and expenses. Private REITs and DSTs both have upfront fees that are generally higher than public REITs. Private REITs’ fees and expenses generally range 9% to 10% while DSTs generally range 8% to 14%.
Suitability
DSTs are best suited for investors who are planning to complete a 1031 exchange and who wish to retain the option to complete a 1031 exchange in the future when the DST interests are sold. DSTs should be considered longer term investments as they are illiquid, and sale is generally at the option of the sponsor and not the investor
A REIT is best suited for investors seeking stable income from a large portfolio of real estate related assets. Public REITs may be especially attractive to real estate investors who wish to be able to quickly convert their investments to cash through the sale of shares in the REIT in the public markets.
Conclusion
While both DSTs and REITs provide investors with options to invest in real estate, there are very important differences that must be considered to determine which structure best meets your investment strategy and goals.
Please contact First Guardian Group for more information on DST and REIT investment options.
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