When evaluating Delaware Statutory Trust (DST) investments as part of a 1031 exchange, there are many moving pieces to consider. Sponsor experience, tenant creditworthiness, and property type often take center stage. Yet one factor, Loan-to-Value (LTV), can have just as much impact on outcomes. While LTV may sound like a technical calculation, its implications are far-reaching, influencing risk exposure, income stability, and long-term investment performance.
This article revisits the basics of LTV while expanding on why understanding it is essential for investors seeking to align 1031 DST replacement property decisions with their financial goals.
At its core, Loan-to-Value is a simple ratio: the size of the loan divided by the property’s appraised value. For example, if a DST acquires a property worth $50 million and secures a loan of $25 million, the resulting LTV is 50%.
In DST offerings, sponsors typically employ leverage to enhance potential returns, and LTV becomes the key measure of that leverage. Many DSTs fall within the 40%–65% range, though specific ratios may vary depending on property type, tenant strength, and market conditions. A higher LTV signals greater use of debt financing, while a lower LTV reflects a more conservative approach.
The LTV chosen by a sponsor can materially affect investor risk. Higher LTV ratios create less equity cushion. If property values decline during market downturns, investors in highly leveraged DSTs may face greater exposure to loan defaults or foreclosure risks. Refinancing also becomes more difficult, particularly if interest rates rise or lenders tighten credit requirements.
Investors who invest in DSTs with higher LTVs e.g., over 50%, may also have challenges in finding suitable replacement DSTs when interest rates increase over the holding period. As an example, many DSTs that were created during the past period of historically low interest rates had LTVs of 50% or higher.
By contrast, lower LTV DSTs typically present more conservative risk profiles. While the potential upside may be muted, these offerings can provide additional protection against volatility. For investors prioritizing capital preservation over aggressive return projections, lower leverage may be the more suitable fit.
It’s worth noting that in real estate, leverage is not inherently bad. It may amplify returns in strong markets, but it may also magnify losses in weaker environments. Understanding where a DST’s LTV falls on the spectrum is crucial for calibrating your own risk tolerance.
LTV also directly affects income distributions. Higher LTV offerings may target stronger yields since more capital is deployed through debt financing. However, these distributions may be reduced, paused, or even cancelled if debt service obligations strain cash flow. Even modest changes in occupancy, rent growth, or interest expenses may impact stability.
Conversely, DSTs with lower leverage have the potential to generate steadier cash flows. With less debt to service, distributions are less vulnerable to external shocks. For investors who value consistency, such as retirees relying on income to supplement their financial plans, this conservative structure may be preferable.
Ultimately, the choice between higher and lower LTV offerings comes down to your investment objectives. Are you seeking to maximize returns, accepting greater volatility along the way? Or do you prefer predictability, even if it means more modest yields? LTV helps frame that decision.
Many investors who have sold an investment property with little or no debt consider investing in higher leveraged DSTs for the following reasons:
More real estate can be purchased which may potentially improve after tax cash flow by increasing depreciation and interest deductions. For example, an investor who sells a debt free property worth $1 million may choose to reinvest their proceeds into a DST that has an existing debt ratio or LTV of 50%. In doing so, they would be purchasing property worth $2 million, thereby acquiring $1 million of additional real estate that may potentially provide additional depreciation and interest deductions that may increase after tax income.
DST investors who acquire leveraged DSTs are not required to qualify for the underlying debt. The debt has already been put in place by the DST sponsor – often at a lower interest rate that what the investor could obtain on their own when financing a wholly owned non-DST replacement property. Furthermore, the debt is not reflected in the investor’s credit profile.
DST loans are generally non-recourse to the investor meaning that, in a worse case, investors have only their original investment at risk and would not be required to repay the loan if the DST investment failed.
Keep in mind that DST distributions are calculated based on invested equity (cash or net proceeds) and not on the total value of property purchased.
Before committing to any DST, investors should ask thoughtful questions about LTV:
What is the sponsor’s LTV strategy and rationale? Is it driven by market conditions, tenant credit, or property type?
How does the LTV compare to industry norms? Is the offering more aggressive or conservative than peers?
What happens if conditions change? Are there safeguards in place if interest rates rise or occupancy weakens?
How does LTV interact with other factors? Strong tenants, long-term leases, and favorable market fundamentals may offset some leverage risk, but no single factor should be evaluated in isolation.
Evaluating LTV alongside other key variables provides a fuller picture of risk and reward potential in DST investing.
Loan-to-Value is more than just a number in a prospectus. It reflects a sponsor’s approach to balancing risk, potential return, and directly shapes your experience as an investor. Whether your priority is striving to maximize income, preserve capital, or build a legacy through estate planning, understanding LTV is essential when selecting DST replacement properties.
At FGG1031, we believe investors have the chance to benefit most when they look beyond headline yields and dig into the structural details that matter. If you’d like to learn more about how LTV considerations affect your investment strategy, contact us to discuss how different DST opportunities may fit your goals.
You can email us at info@firstguardiangroup.com or schedule a no-obligation consultation today!