Investors who are considering Delaware Statutory Trust (DST) options need to prepare themselves to ask the right questions before investing. DSTs aren’t just about ownership in a replacement property, but also come with added complexities and potential risks that should be well understood before committing funds. DSTs vary by many factors including the business plan, sponsor, and exit strategy. Investors should perform adequate due diligence on not only the real estate but also on the representatives, sponsors, and legal agreements associated with each DST.
Here are several important questions about DSTs that may help you when considering or evaluating DST options.
What Experience Does the DST Representative Have?
Most DST sponsors expose their offerings through duly licensed representatives who are supervised under securities broker dealers that are not affiliated with the sponsor. While all DST representatives must pass securities examinations that demonstrate basic knowledge of securities laws, DST representatives vary widely in their experience and knowledge of real estate. They may claim to have several years of experience working with DSTs and be able to recite talking points from marketing literature but in fact may lack substantial experience with real estate investing.
Action: Confirm that the DST representative that you choose to work with has adequate real estate experience.
- What real estate credentials and licenses do you currently hold?
- What is the extent of your personal real estate investments and management experience?
- How long have you worked in the real estate industry and what is the volume of business that you have successfully transacted?
- Have you ever received complaints on your performance or been fined or formally censured?
What is the Track Record of the DST Sponsor?
The growing popularity of DSTs has encouraged many new sponsors to enter the industry in recent years and launch new offerings. Most firms that sponsor DSTs are real estate management firms that in many cases have prior history as a property or asset manager. While having good management history is very important, we know from our first-hand experience as a management firm that the creation and management of a DST is more complex and demanding than managing traditional real estate. We therefore weigh each sponsor’s prior experience and track record in working with DSTs as being one of the most important criteria in evaluating DST investments.
Action: When starting to assess DSTs, begin by researching the prior track record of the sponsor.
This information is generally found in DST’s Private Placement Memorandum (PPM) in a section entitled “Prior Performance” or similar. This section will generally provide detailed summaries of prior offerings including those offerings that have gone “full cycle” - meaning that they were acquired, managed for a period of time, and then sold. Note of course that past performance is not a guarantee of future performance. However, those sponsors with longer tenure in the industry that have managed through multiple real estate cycles and a greater number of successful “full cycle” DSTs are generally preferred by knowledgeable investors.
- What is the DST sponsor’s prior real estate management experience and the size of their current management portfolio?
- How many completed investments have they made?
- How do their past actual returns compare with their original projections?
- How many DSTs are they currently managing? How many have gone full cycle?
- Have they ever under performed relative to their original projections? If so, why?
- Have they successfully navigated through a downturn such as the Great Financial Crisis?
Are the Financial Projections Reasonable?
The DST Private Placement Memorandum will include a section detailing financial projections for the offering. Remember that projections are not guarantees but only estimates of planned future performance based on certain stated assumptions. For many investors, evaluating DST projections can be a daunting task and this is where the experience of a knowledgeable DST representative can prove to be invaluable. Be sure to take the time to review both the assumptions and projections with your representative. Also review other relevant data such as the property’s appraisal, and local market reports which your representative should be able to provide.
Action: Don’t assume that the projections are guaranteed and understand the underlying assumptions. Task your DST representative to provide additional third-party data to assist in corroborating assumptions and projections.
- Are the assumptions and projections reasonable and consistent with third party data not produced by the sponsor?
- What are potential “what if” scenarios that can affect occupancy and rent?
- What is the impact of debt service on projected distributions over the planned holding period?
- Are there any conflicts of interest that could impact potential future returns?
Are the Fees Reasonable?
Investors should review the fees charged by the DST sponsor. A summary of fees is generally in a section entitled “Estimated Use of Proceeds” in the DST Private Placement Memorandum. Sponsor fees can vary from one transaction to the next and from sponsor to sponsor. A knowledgeable DST representative should be able to provide a comparison of fees and let you know if any fees are outside industry norms. And the investor does not want to later discover that there are additional, hidden, or over-inflated fees.
Action: Confirm that fees are within industry norms for each category of fees including acquisition, marketing, asset management, and disposition.
- How do the fees in each DST offering under consideration compare with industry norms?
- How do fees affect the return?
What is the Exit Strategy?
Sponsors vary in how and when they exit from an investment. At the end of the investment cycle, most DST sponsors will sell to a non-related third party using traditional marketing methods to maximize the final selling price. Some sponsors however retain an option to sell the DST to a related party such as an affiliated fund or REIT. Related party sales can create conflicts of interest and investors should be aware of the planned exit strategy and possible impacts on exit value.
Action: Confirm the type of exit strategy. Assess if this is a viable option.
- What type of exit strategy applies to this DST?
- Does the sponsor retain an option to sell the DST to a related entity and, if so, how are potential conflicts of interest addressed?
- When does the sponsor expect to exit?
The above questions are by no means exhaustive – but will get you started in the right direction as you begin your evaluation of DST options.
For more information on 1031 Exchange tax deferral strategies, please contact First Guardian Group at 866-398-1031 or info@FirstGuardianGroup.com. You can also schedule a one-on-one consultation with Paul here.
Disclosure: DSTs, like all real estate, have risks, including illiquidity, potential for loss of property value, costs and expenses that could offset the benefits associated with tax deferral, and reduction or elimination of monthly cash flow.
Disclaimer: There is no guarantee that any strategy will be successful or achieve investment objectives. All real estate investments have the potential to lose value during the life of the investments. This material does not constitute an offer to sell nor a solicitation of an offer to buy any security. Such offers can be made only by the confidential Private Placement Memorandum (the “Memorandum”). Please be aware that this material cannot and does not replace the Memorandum and is qualified in its entirety by the Memorandum.
This material is not intended as tax or legal advice so please do speak with your attorney and CPA prior to considering an investment. This material contains information that has been obtained from sources believed to be reliable. However, FGG1031, First Guardian Group, LightPath Capital, Inc., and their representatives do not guarantee the accuracy and validity of the information herein. Investors should perform their own investigations before considering any investment. There are material risks associated with investing in real estate, Delaware Statutory Trust (DST) and 1031 Exchange properties. These include, but are not limited to, tenant vacancies, declining market values, potential loss of entire investment principal.
Past performance is not a guarantee of future results: potential cash flow, potential returns, and potential appreciation are not guaranteed in any way and adverse tax consequences can take effect. The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. All financed real estate investments have a potential for foreclosure. Delaware Statutory Trust (DST) investments are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments. Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions. Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits.
IRC Section 1031, IRC Section 1033, and IRC Section 721 are complex tax codes; therefore, you should consult your tax and legal professional for details regarding your situation.