Blog

Subscribe to Our Blog

Subscribe to Email Updates

Featured Post

Recent Posts

Evaluating Distribution Rates for DSTs

It is very common for investors who are first learning about DSTs to be initially attracted to properties that offer the highest current distribution rate or cash flow. While distribution rates are an important consideration in selecting investments, more experienced risk-averse investors tend to consider other factors ahead of the reported current cash flow.

Among them are the following:

Sponsor Track Record

When DSTs were first made available to investors in 2004, as active managers of real estate nationwide, we were skeptical over giving up full management control to DST sponsors that had not yet established a track record of successfully managing and ultimately selling DSTs. It was not until we saw how certain sponsors were able to successfully navigate the deep 2008 – 2009 recession that we began to develop confidence that this form of investment might be appropriate for certain of our clients. 

Today we have over 30 firms in the US that sponsor and manage DSTs – and most of them have limited track records. Fortunately, we have access to the full track records of most DST sponsors and can evaluate and compare their prior performance with other sponsors.

We encourage our clients to be wary of new industry entrants since managing a DST can be more complex than managing traditional real estate due to limitations on raising capital if unexpected conditions develop. As an example, a DST sponsor is not allowed to obtain additional funds from DST investors, nor can they obtain additional financing from a lender if a cash crunch develops. DSTs must be managed in a way that all expenses can be funded either from operations or reserves that were set aside when the DST was created. Also, if there is a loan on the property, the DST sponsor is the sole guarantor of the loan and the lender may have recourse against them in the event the DST fails to meet loan obligations. 

Fortunately, there are now a number of DST sponsors who have excellent track records spanning multiple years of operating DSTs and these more experienced sponsors are most often selected by our clients even if the distribution rates for their offerings may be less than that of a newer DST sponsor who may be offering a higher yielding DST in order to establish a track record. 

Asset Class

Most DST investors have a preference to invest in asset types that perform well in tough times. Residential properties such as apartments and single-family rentals fare better in recessionary periods since tenants are generally highly motivated to pay rent to keep a roof over their head. Select storage, necessity retail e.g., supermarkets, and industrial warehouses e.g., Amazon warehouses also have performed well in tough times. By contrast income from hotels, conventional retail, commercial office, and discretionary service providers e.g., elective surgery centers are more negatively impacted when the economy is not doing well. 

Due to the relatively higher demand for recession resistant properties, distribution rates will generally be lower for less volatile properties than for properties whose income streams may be reduced during recessions. 

Location, Location, Location

I owned my first rental properties where I grew up in the Midwest. While I was able to obtain good cash flow, I discovered that properties in the area where I lived did not increase in value at anywhere near the rate of properties located in warmer coastal locations such as California. By contrast, when moving to California, our first rentals had negative cash flow that required that we invest additional capital until we could sufficiently raise rents to cover expenses. Even today, those of us that invest in California rental properties typically are investing for appreciation and not income. 

DST investors are generally looking for a balance of acceptable income with at least a return of their original capital at time of sale or, better yet, with appreciation of their property over the holding period. 

Fortunately, there are many areas in the US where select rental properties can provide investors with both attractive cash flow and appreciation. At the top of the list are growing cities offering multiple employment options in low-tax landlord friendly states such as Texas, Colorado, Tennessee, and the Southeast portion of the US from Florida up through Georgia, the Carolinas, and Virginia. The vast majority of DSTs are found in these areas. 

Impact of Depreciation Write-offs 

As the old saying goes, it is not how much you make, but how much you keep. One of the largest potential tax write-offs currently available to real estate investors is the depreciation deduction on their property. There are important differences in comparing DST distributions which become more apparent in looking at after-tax income. 

Per IRS rules, residential real estate e.g., apartments can be depreciated over 27.5 years. The allowed depreciation schedule for commercial properties such as office and retail buildings is generally 39 years. Due to differences in allowed depreciation, a commercial building that has a reported distribution of 6% may deliver after tax income which may be comparable to an apartment property distributing 5%. 

If you are comparing different asset classes, be sure to ask your advisor to assist you in comparing potential after-tax income. 

Inflation Hedge

As I wrote in a previous blog, many investors are growing increasingly nervous over concerns about the possible impact of inflation on their investments. During extended periods of higher inflation, investors will tend to reallocate funds into assets that allow rents to be quickly raised to market rates. Properties that are perpetually leased such as apartments, single-family rentals, storage, and senior living are generally preferred over properties with long term fixed leases that limit rent increases such as commercial office, retail, industrial, and healthcare. 

Personal Considerations

Real estate investors should also take personal considerations into account when deciding which properties to acquire. Investing in a property near where a relative or friend lives or in an area that you wish to occasionally visit is a valid factor to consider – and might help increase your after-tax income since the business-related portion of cost incurred to visit your investment properties can be a legitimate tax write-off. 

Summary

While it is natural that most first-time DST investors will be initially attracted to those properties offering the highest current yields, several factors including those discussed in this blog should be considered before making any final investment decisions. As many of us learned when making our first investments, the adage that “the higher the reward, the higher the risk” is more often correct than not. 

In working with thousands of real estate investors over our many years in business, we have found that no two investors are exactly alike, and that each investor will weigh factors related to investment decisions differently. We strive to expose our clients to all pertinent facts that have in hand and help them understand trade-offs in making final investment decisions. 

For more information on how to select suitable real estate investments, please contact us at 408 392-8822 or info@FirstGuardianGroup.com. 


Help Save 1031 Exchanges
Write to your Member of Congress and Senators urging them to oppose restricting Section 1031 like-kind exchanges. As part of the American Families Plan, the Biden Administration has proposed eliminating the application of Section 1031 for gains greater than $500,000. Like-kind exchanges have been part of the U.S. tax code since 1921 and are one of the tax code’s most powerful economic tools. It is critical that we all vigorously and visibly oppose this proposal. Make your voice heard with a pre-filled letter, which you can customize to add personal anecdotes or powerful client stories to highlight the positive impact of Section 1031 like-kind exchanges. Take action today by clicking HERE.

New call-to-action

Paul Getty

Paul Getty is a licensed real estate broker in the state of California and Texas and has been directly involved in commercial transactions totaling over $3 billion on assets throughout the United States. His experience spans all major asset classes including retail, office, multifamily, and student, and senior housing. Paul’s transaction experience includes buy and sell side representation, sourcing and structuring of debt and equity, workouts, and asset and property management. He has worked closely with nationally prominent real estate brokerage and investment organizations including Marcus Millichap, CB Richard Ellis, JP Morgan, and Morgan Stanley among others on the firm’s numerous transactions. Paul also maintains a broad network of active buyers and sellers of commercial real estate including lenders, institutions, family office managers, and high net worth individuals. Prior to founding First Guardian Group/FGG1031, Paul was a founder and CEO of Venture Navigation, a boutique investment banking firm specializing in structuring equity investments made by institutions and high net worth individuals. He possesses over 35 years of comprehensive worldwide business management experience in environments ranging from early phase start-ups to multi-billion-dollar corporations. His track record includes participation in IPOs and successful M&A activity that has resulted in investor returns of over $700M. Paul holds an MBA in Finance from the University of Michigan, graduating with honors, and a Bachelor’s Degree in Chemistry from Wayne State University. Paul Getty holds Series 22, 62, and 63 securities licenses and is a registered financial representative with LightPath Capital Inc, member FINRA /SIPC. Paul is a noted speaker, author, and actively lectures on investments, sales, and management related topics. He is author of The 12 Magic Slides, Regulation A+: How the JOBS Act Creates Opportunities for Entrepreneurs and Investors, and Tax Deferral Strategies Utilizing the Delaware Statutory Trust (DST), available on Amazon and other retail outlets.

Your Comments :